-----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, FZZHXHvev4UnQt0W0MRfgmvpUTY3OdNQF9O6KU2w3CGt+QPKZxE3Sx5DRE/PPxay 3yMJPHul4DnErCgYxJkQUQ== 0000893220-98-000838.txt : 19980504 0000893220-98-000838.hdr.sgml : 19980504 ACCESSION NUMBER: 0000893220-98-000838 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 28 FILED AS OF DATE: 19980501 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: KIRKLANDS INC CENTRAL INDEX KEY: 0001056285 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 621287151 FILING VALUES: FORM TYPE: S-1 SEC ACT: SEC FILE NUMBER: 333-51517 FILM NUMBER: 98607466 BUSINESS ADDRESS: STREET 1: 805 NORTH PKWY CITY: JACKSON STATE: TN ZIP: 38305 BUSINESS PHONE: 9016882444 MAIL ADDRESS: STREET 1: 805 NORTH PKWY CITY: JACKSON STATE: TN ZIP: 38305 S-1 1 FORM S-1 KIRKLAND'S INC. 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 30, 1998 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ------------------------ FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ KIRKLAND'S, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) TENNESSEE 5990 62-1287151 (STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
805 N. PARKWAY, JACKSON, TN 38305 (901) 668-2444 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) ROBERT E. ALDERSON PRESIDENT AND CHIEF OPERATING OFFICER 805 N. PARKWAY JACKSON, TN 38305 (901) 668-2444 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ WITH COPIES TO: BARRY M. ABELSON, ESQ. THOMAS R. BROME, ESQ. ROBERT A. FRIEDEL, ESQ. CRAVATH, SWAINE & MOORE PEPPER HAMILTON LLP 825 EIGHTH AVENUE 3000 TWO LOGAN SQUARE NEW YORK, NY PHILADELPHIA, PA 19103 (212) 474-1000 (215) 981-4000
------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this Registration Statement becomes effective. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] ------------------------ CALCULATION OF REGISTRATION FEE
========================================================================================================= PROPOSED MAXIMUM TITLE OF EACH CLASS OF AGGREGATE AMOUNT OF SECURITIES TO BE REGISTERED OFFERING PRICE(1) REGISTRATION FEE - --------------------------------------------------------------------------------------------------------- Common Stock, no par value.................................. $ 63,250,000 $ 18,659 =========================================================================================================
(1) Estimated solely for purposes of determining the registration fee in accordance with Rule 457(o) under the Securities Act of 1933. Includes shares of Common Stock subject to the over-allotment option granted to the Underwriters. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(a), MAY DETERMINE. ================================================================================ 2 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. Subject to Completion, Dated April 30, 1998 PROSPECTUS SHARES KIRKLAND'S, INC. COMMON STOCK --------------------------- All of the shares of common stock, no par value (the "Common Stock"), of Kirkland's, Inc. ("Kirkland's" or the "Company") offered hereby (the "Offering") are being sold by the Company, except for any shares sold pursuant to the Underwriters' over-allotment option which will be sold by certain shareholders of the Company (the "Option Shareholders"). Prior to the Offering, there has been no public market for the Common Stock. It is currently estimated that the initial public offering price will be between $ and $ per share. See "Underwriting" for a list of the factors to be considered in determining the initial public offering price. At the request of the Company, the Underwriters have reserved up to 5% of the shares of Common Stock offered hereby for sale at the initial public offering price to employees of the Company and other persons associated with the Company. The Company has applied to have the Common Stock approved for quotation on the Nasdaq National Market under the symbol "KIRK." --------------------------- THE SHARES OF COMMON STOCK OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. SEE "RISK FACTORS" BEGINNING ON PAGE 8. --------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
===================================================================================================================== UNDERWRITING PRICE TO DISCOUNTS AND PROCEEDS TO PUBLIC COMMISSIONS(1) COMPANY(2) - --------------------------------------------------------------------------------------------------------------------- Per Share................................. $ $ $ - --------------------------------------------------------------------------------------------------------------------- Total(3).................................. $ $ $ =====================================================================================================================
(1) The Company, each of its operating subsidiaries and the Option Shareholders have agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended (the "Securities Act"). See "Underwriting." (2) Before deducting expenses of the Offering payable by the Company, estimated at $750,000. The Option Shareholders will not be required to pay any of these expenses. (3) The Option Shareholders have granted the Underwriters a 30-day option to purchase up to additional shares of Common Stock solely to cover over-allotments, if any. To the extent that the option is exercised, the Underwriters will offer the additional shares to the public at the Price to Public shown above. If such option were exercised in full, the total Price to Public and Underwriting Discounts and Commissions would be $ and $ , respectively, and the Option Shareholders would receive $ . No proceeds from the sale of shares pursuant to an exercise of the over-allotment option will be received by the Company. See "Underwriting." --------------------------- The shares of Common Stock offered by this Prospectus are offered by the Underwriters, subject to prior sale, withdrawal, cancellation or modification of the offer without notice, to delivery to and acceptance by the Underwriters and to certain further conditions. It is expected that delivery of certificates representing the shares of Common Stock will be made at the offices of Lehman Brothers Inc., New York, New York, on or about , 1998. --------------------------- LEHMAN BROTHERS THE ROBINSON-HUMPHREY COMPANY BANCAMERICA ROBERTSON STEPHENS MORGAN KEEGAN & COMPANY, INC. , 1998. 3 The Company currently operates 141 stores in 25 states. The Company's existing stores are located in middle markets such as Little Rock, Arkansas; Birmingham, Alabama; and Tulsa, Oklahoma as well as in metropolitan markets such as Atlanta, Dallas and Houston and small markets such as Paducah, Kentucky; Florence, Alabama; and Lancaster, Pennsylvania. The following map and store list show the number of stores that Kirkland's operates in each state and the cities in which the Company's stores are located. [In the printed version, a gatefold is included which contains a map indicating the cities where Kirkland's stores are located and a group of photographs depicting various merchandise displays together with the Company's logo.] ALABAMA-8 GEORGIA-7 KENTUCKY-4 MISSOURI-4 OHIO-8 TEXAS-18 Birmingham(2) Atlanta(6) Louisville St. Louis(2) Dayton(2) Houston(7) Huntsville Columbus Lexington Springfield Cincinnati(3) Dallas(5) Montgomery Florence Joplin Canton Corpus Christi Mobile ILLINOIS-6 Paducah Cleveland Austin(2) Dothan Chicago(4) NEBRASKA-1 Dublin Lubbock Florence Moline LOUISIANA-9 Lincoln Amarillo Tuscaloosa St. Louis Monroe OKLAHOMA-2 El Paso Baton Rouge(2) NEW MEXICO-2 Tulsa ARKANSAS-3 IOWA-3 New Orleans(2) Albuquerque(2) Oklahoma City VIRGINIA-6 Little Rock(2) Davenport Lafayette Roanoke Fayetteville Cedar Rapids Shreveport NORTH PENNSYLVANIA-2 Richmond(3) Des Moines Slidell CAROLINA-9 Lancaster Lynchburg FLORIDA-16 Houma Charlotte(2) Erie Chesapeake Jacksonville(2) INDIANA-5 Greensboro Tallahassee Evansville MARYLAND-2 Fayetteville SOUTH WEST Orlando(3) Ft. Wayne Baltimore Wilmington CAROLINA-2 VIRGINIA-2 Tampa(2) Indianapolis Waldorf Durham Myrtle Beach Charleston Fort Walton South Bend Cary Spartanburg Barboursville Panama City Terre Haute MICHIGAN-1 Raleigh Naples Olcemos High Point TENNESSEE-12 Pensacola KANSAS-2 Jackson St. Petersburg Kansas City(2) MISSISSIPPI-7 Knoxville(2) Vero Beach Jackson(2) Memphis(3) Daytona Beach Tupelo Nashville(4) Coral Springs Harrisburg Chattanooga Biloxi Johnson City Columbus Meridian
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK. SUCH TRANSACTIONS MAY INCLUDE THE PURCHASE OF SHARES OF COMMON STOCK FOLLOWING THE PRICING OF THE OFFERING TO COVER A SYNDICATE SHORT POSITION IN THE COMMON STOCK OR FOR THE PURPOSE OF MAINTAINING THE PRICE OF THE COMMON STOCK, AND THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." The "Kirkland's" logo, Cedar Creek(R) private label brand and Now That's Real Style!(R) are registered trademarks and/or service marks of the Company. The Company also claims common law trademark rights in the Kirkland Collection(TM) for which the Company has filed an application for federal registration in the United States Patent and Trademark Office. All other trademarks or service marks appearing in this Prospectus are trademarks or service marks of the companies that utilize them. 2 4 PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information and the financial statements and notes thereto appearing elsewhere in this Prospectus. Historically, Kirkland's, Inc. has operated Kirkland's stores through separate corporations (collectively, the "Kirkland Companies"), and Kirkland's, Inc. has served as a management company for the Kirkland Companies. Unless the context otherwise requires, all references to the "Company" or "Kirkland's," with respect to any date or period prior to completion of the Offering, mean Kirkland's, Inc. together with all Kirkland Companies. The outstanding shares of the Kirkland Companies will be acquired by Kirkland's, Inc. in connection with the Offering. Unless the context otherwise requires, all information in this Prospectus (i) gives retroactive effect to (a) a -for-one stock split of the Common Stock which will occur immediately prior to the completion of the Offering, and (b) the contribution to Kirkland's, Inc. of all of the outstanding common stock of the Kirkland Companies and (ii) assumes that the Offering is consummated at an initial public offering price of $ per share on , 1998. See "Use of Proceeds" and "Certain Transactions - Pre-Offering Transactions." THE COMPANY Kirkland's is a leading specialty retailer of decorative home accessories and gifts. The Company's stores offer a broad selection of distinctive merchandise, including framed art, candles, lamps, picture frames, rugs, garden accessories and artificial plants, as well as an extensive assortment of holiday merchandise. The Company's stores are designed to provide style-conscious customers, the majority of whom are women age 25 and older, with a distinctive shopping experience characterized by a diverse, ever-changing merchandise selection at surprisingly attractive prices. Management believes that the Company's exclusive focus on decorative home accessories and gifts has led to its emergence as a leader in its retail category and a destination store for many mall shoppers. Kirkland's has generated operating income in each year since opening its first store in 1966, and currently maintains one of the highest operating margins among comparable specialty retailers. The Company's 141 stores in 25 states average approximately 4,400 square feet per store and are located primarily in enclosed malls. Although originally focused in the Southeast, the Company has expanded beyond that region. Currently, 58 of the Company's stores are located outside the Southeast, including 11 of the 20 new stores opened during 1997. In addition to operating in many middle markets, the Company also has stores in major metropolitan markets such as Atlanta, Houston, Chicago and Dallas, as well as in smaller markets. The Company has been able to operate stores successfully across a broad range of demographic and geographic markets. Kirkland's has developed and refined a merchandising strategy that differentiates it from other retailers of products for the home. The Company's merchandising strategy is to (i) offer distinctive, high quality home accessories and gifts at affordable prices, (ii) maintain a breadth of product categories, (iii) provide a carefully edited selection of the best-selling items within each category, rather than merchandising complete product collections and (iv) present merchandise in a visually appealing manner to create an inviting atmosphere which inspires decorating ideas. The Company believes that this strategy creates a shopping experience which appeals to the style-conscious as well as the price-conscious shopper. The Company's goal is to be the leading specialty retailer of decorative home accessories and gifts in each of its markets. The following elements of the Company's business strategy, which have evolved over 32 years of successful operations, differentiate Kirkland's from its competitors and position the Company for continued growth: Distinctive, Item-Focused Merchandising. While a Kirkland's store contains items covering a broad range of complementary product categories, the store emphasizes only the best-selling items within each category. The Company does not seek to dictate a design theme to its customers, nor does it necessarily seek to dominate any particular product category. The Company instead takes a disciplined approach to identifying fashionable merchandise reflecting the latest trends, selecting and test-marketing products 3 5 and monitoring and reacting to individual item sales. No single merchandise category accounted for more than 15% of net sales in 1997. Changing Merchandise Mix. The merchandise mix in a Kirkland's store changes frequently throughout the year, in response to both market and sales trends and changes in seasons. The Company's information systems permit close tracking of individual item sales, enabling management to react quickly to both fast-selling and slow-moving items. In addition, the Company strategically increases selling space devoted to gifts and holiday merchandise during peak selling seasons such as Christmas and Easter. The Company believes that its ever-changing mix of merchandise creates an exciting environment for customers, encouraging frequent return visits to its stores. Visually Appealing Store Environment. Kirkland's distinguishes itself through its stores' "interior design" look, achieved by its emphasis on visual merchandising. Using multiple types of fixtures, the Company groups complementary merchandise creatively throughout the store, rather than displaying products strictly by category or product type. This visual presentation helps customers to picture the merchandise in their own homes and thus inspires decorating ideas. As a result, this strategy provides the opportunity for add-on sales and also encourages customers to browse for longer periods of time. Competitive Pricing. Kirkland's merchandise ranges in price from approximately $5 to approximately $250, with most items selling for under $30. Kirkland's shoppers regularly experience the satisfaction of paying noticeably less for items similar or identical to those sold by other retailers or through catalogs. Consequently, the Company does not routinely engage in promotions or sales and typically holds only two regular sales events each year. Management believes that the Company's competitive pricing is an important element in making Kirkland's a destination store for many mall shoppers. Flexible Real Estate Strategy. The Company's stores are predominantly located in enclosed malls in middle, metropolitan and smaller markets. The Company believes that its stores' broad appeal makes Kirkland's a desirable tenant for community, regional and super-regional malls targeting both middle and upper-income customers as well as for selected non-mall venues. The flexibility of the Kirkland's concept enables the Company to select the most promising real estate opportunities that meet requisite economic and demographic criteria within the Company's target markets. Kirkland's opened its first store in 1966 and expanded steadily thereafter, focusing primarily on middle markets in the Southeast. The Company accelerated its expansion beginning in 1990, more than doubling its store base from 50 stores at the end of 1990 to 104 stores at the end of 1995. In June 1996, Advent International Corporation led a leveraged recapitalization of the Company. See "Certain Transactions - Recapitalization." Since then, the Company has made considerable investments in management and infrastructure to support an increased rate of expansion in the future. The net proceeds from the Offering will reduce the Company's total indebtedness and position the Company financially for continued growth. The Company anticipates that its future expansion will come primarily from opening new stores, expanding or remodeling existing stores and introducing new retail formats. The Company intends to open approximately 25 stores in 1998 and approximately 30 stores in 1999, and believes that there are currently over 500 additional malls in the United States that could provide attractive locations for the Kirkland's concept. The Company is also engaged in a selective expansion and remodeling program to update store appearance and expand store size. The Company intends to expand six stores in 1998 and seven stores in 1999, and to remodel a like number of stores in each of those years. In addition, the Company has developed several new retail formats, including temporary stores, outlet stores, strip center stores and more upscale stores called "the Kirkland Collection," which it believes have significant potential to create new channels through which to reach and expand Kirkland's target customer base. The Company is incorporated in Tennessee, its principal executive offices are located at 805 N. Parkway, Jackson, Tennessee 38305, and its telephone number is 901-668-2444. The Company's Internet website address is http://www.kirklands.com. 4 6 THE OFFERING Common Shares Offered by the Company.......................... Common Shares Outstanding after the Offering(1).................. Use of Proceeds.................. To repay indebtedness, including mandatorily redeemable preferred stock. Proposed Nasdaq Symbol........... KIRK - --------------- (1) Excludes an aggregate of 23,004 shares of Common Stock reserved for issuance under the Company's 1996 Executive Incentive and Non-Qualified Stock Option Plan, 1998 Incentive Plan and Employee Stock Purchase Plan. Options to purchase 10,154 shares of Common Stock have been granted under the Company's 1996 Executive Incentive and Non-Qualified Stock Option Plan, of which options to purchase shares will be exercisable upon completion of the Offering. PRE-OFFERING TRANSACTIONS The following transactions will occur immediately prior to the completion of this Offering: (i) a -for-one stock split of the Common Stock; (ii) the recapitalization or exchange of all of the outstanding shares of Class A Preferred Stock ("Class A Preferred Stock") and Class B Preferred Stock ("Class B Preferred Stock") of Kirkland's, Inc. and the Kirkland Companies into or for 42,679 shares of Common Stock; and (iii) the contribution of all of the outstanding shares of common stock of the Kirkland Companies to Kirkland's, Inc., resulting in the Kirkland Companies becoming wholly-owned subsidiaries of Kirkland's, Inc. Subsequent to these transactions, but prior to completion of the Offering, Kirkland's, Inc. and the Kirkland Companies will issue 11,905 shares of common stock upon the exercise of outstanding warrants, and such shares of the Kirkland Companies will be contributed to Kirkland's, Inc. All of these transactions are herein collectively referred to as the "Pre-Offering Transactions." See "Use of Proceeds" and "Certain Transactions - Pre-Offering Transactions". 5 7 SUMMARY COMBINED FINANCIAL DATA
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, -------------------------------------------------- ------------------ 1993 1994 1995 1996 1997 1997 1998 ------- ------- -------- -------- -------- ------- -------- (IN THOUSANDS, EXCEPT PER SHARE AND SELECTED STORE DATA) STATEMENT OF INCOME DATA: Net sales........................ $85,326 $99,901 $112,035 $127,946 $153,584 $26,178 $ 30,615 Gross profit..................... 33,080 38,088 43,200 47,508 56,586 7,559 9,505 Operating expenses............... 17,177 19,572 24,192 27,915 35,004 7,392 9,178 Severance charge(1).............. -- -- -- -- 756 -- -- Recapitalization expenses........ -- -- -- 854 -- -- -- Owners' compensation(2).......... 12,314 15,123 13,926 -- -- -- -- Depreciation and amortization.... 1,581 1,847 2,362 3,383 4,142 1,003 1,156 ------- ------- -------- -------- -------- ------- -------- Operating income(loss)........... 2,008 1,546 2,720 15,356 16,684 (836) (829) Interest expense, net(3)......... 719 814 1,253 6,247 10,099 2,508 2,313 Other income, net................ (184) (255) (221) (147) (154) (57) (64) Income tax provision (benefit)... -- -- -- 2,693 2,817 (923) (920) ------- ------- -------- -------- -------- ------- -------- Net income(loss)................. 1,473 987 1,688 6,563 3,922 (2,364) (2,158) Accretion of redeemable preferred stock and dividends accrued(4)..................... -- -- -- 2,313 3,755 939 998 ------- ------- -------- -------- -------- ------- -------- Net income (loss) allocable to common stock................... $ 1,473 $ 987 $ 1,688 $ 4,250 $ 167 $(3,303) $ (3,156) ======= ======= ======== ======== ======== ======= ======== PRO FORMA DATA(5): Pro forma net income (loss)...... $ 7,603 $ (1,283) ======== ======== Pro forma net income (loss) per common share: Basic.......................... $ $ ======== ======== Diluted........................ $ $ ======== ======== Pro forma weighted average number of common shares outstanding: Basic.......................... ======== ======== Diluted........................ ======== ======== OTHER DATA: EBITDA(6)........................ $16,087 $18,771 $ 19,229 $ 19,740 $ 21,736 $ 224 $ 391 Net cash provided by (used in) operating activities........... 3,422 2,040 1,269 11,065 8,669 (7,564) (7,874) Net cash provided by (used in) investing activities........... 2,818 2,652 (4,130) (4,205) (5,479) (735) (903) Net cash provided by (used in) financing activities........... 772 1,320 3,278 (982) (3,537) (617) 73 SELECTED STORE DATA: Comparable store net sales increase(7).................... 7.1% 4.4% 0.7% 1.4% 5.2% 4.8% 3.7% Number of stores at end of period......................... 80 91 104 120 138 120 140 Average net sales per store (in thousands)(8).................. $ 1,159 $ 1,159 $ 1,145 $ 1,147 $ 1,178 $ 216 $ 220 Average gross square footage per store(9)....................... 3,753 3,821 3,942 4,091 4,186 4,174 4,382
6 8
MARCH 31, 1998 ---------------------------- ACTUAL AS ADJUSTED(10) --------- --------------- (IN THOUSANDS) BALANCE SHEET DATA: Working capital............................................. $ 13,793 $14,754 Total assets................................................ 44,596 44,596 Total long-term and short-term debt, including mandatorily redeemable Class C Preferred Stock........................ 92,682 43,585 Common stock warrants....................................... 879 -- Redeemable convertible preferred stock (Class A and Class B Preferred Stock).......................................... 47,584 -- Shareholders' deficit....................................... (105,651) (7,130)
- --------------- (1) The 1997 severance charge represents the total salary continuation payments which the Company is required to make to a former management employee who resigned in 1997. (2) Owners' compensation represents distributions to the Company's shareholders during the periods when Kirkland's, Inc. and the Kirkland Companies were Subchapter S corporations, prior to the Recapitalization. Such distributions ceased upon the Recapitalization. See "Certain Transactions - Recapitalization." (3) Interest expense includes amounts associated with the Class C Preferred Stock of $990,000 and $1.8 million in 1996 and 1997, respectively, and $450,000 and $385,000 for the three months ended March 31, 1997 and 1998, respectively. Interest expense also includes the accretion to the fair value of detachable put warrants to purchase Common Stock, issued by the Company in connection with its issuance of subordinated debt, of $190,000 and $389,000 in 1996 and 1997, respectively, and $97,000 for the three months ended March 31, 1997. The holders of these warrants agreed to terminate the put as of January 1, 1998. (4) Reflects the accretion of the Class A Preferred Stock and Class B Preferred Stock to its redemption value and the accrual of dividends on such preferred stock at 8% annually. (5) Assumes the Pre-Offering Transactions were effected as of the beginning of the period. Also assumes repayment of $20.0 million of subordinated debt (together with accrued interest) and $12.2 million of senior debt and the purchase or redemption of all outstanding Class C Preferred Stock (together with amounts classified as interest associated with such preferred stock) from the proceeds of the sale of the shares of Common Stock offered hereby. See "Use of Proceeds," "Capitalization," "Unaudited Pro Forma Condensed Combined Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." (6) The term EBITDA as used herein represents income before income taxes, net interest expense, depreciation and amortization expense, owners' compensation and non-recurring charges. While EBITDA should not be considered in isolation or as a substitute for net income, cash flow from operations or any other measure of income or cash flow that is prepared in accordance with generally accepted accounting principles or as a measure of a company's profitability or liquidity, EBITDA has been presented because the Company believes it is commonly used in this or a similar format by investors to analyze and compare operating performance as well as to provide additional information with respect to the ability of the Company to meet its future debt service, capital expenditure and working capital requirements. EBITDA may differ in method of calculation from similarly titled measures used by other companies. This information should be read in conjunction with the Combined Statement of Cash Flows contained in the Combined Financial Statements and notes thereto included elsewhere in this Prospectus. (7) For periods ended on or before December 31, 1996, comparable stores were defined as those stores opened prior to January 1 of the preceding fiscal year. Effective January 1, 1997, in response to increased expansion and remodeling activity, the Company modified the way comparable store net sales are calculated to more accurately reflect the Company's ongoing expansion and remodeling program. Commencing January 1, 1997, the Company excluded from comparable store net sales calculations each store that was expanded, remodeled or relocated during the applicable period. Each such store is returned to the comparable store base on January 1 of the first year following the one-year anniversary of the expansion, remodeling or relocation. (8) Calculated using net sales of all stores open at both the beginning and the end of the period. (9) Calculated using gross square footage of all stores open at both the beginning and the end of the period. Gross square footage includes the storage, receiving and office space that generally occupies approximately 30% of total store space. (10) Adjusted to give effect to the Pre-Offering Transactions and the sale of the shares of Common Stock offered hereby and the application of the estimated net proceeds therefrom. See "Use of Proceeds," "Capitalization" and "Unaudited Pro Forma Condensed Combined Financial Statements." 7 9 RISK FACTORS In addition to the other information contained in this Prospectus, the following risk factors should be considered carefully in evaluating an investment in shares of the Common Stock offered by this Prospectus. AGGRESSIVE EXPANSION STRATEGY; MANAGEMENT OF GROWTH The Company intends to pursue an expansion strategy involving opening more stores than it has in recent years, and its future operating results will depend to a substantial extent upon its ability to open and operate new stores successfully. In addition to planned openings of new mall-based stores, the Company plans to expand by developing new retail formats both in malls and non-mall venues. The new formats may involve different risks than the Company's current mall-based activities. The Company also has an ongoing expansion and remodeling program, and intends to expand and remodel six stores in 1998 and seven stores in 1999, and to remodel (without expanding) a like number of stores in each of those years. The Company will also enter certain new markets in new regions of the United States which may present competitive and merchandising challenges that are different from those currently encountered by the Company in its existing markets. In addition, the Company's ability to open new stores on a timely basis will depend upon a number of factors, including the ability to properly identify and enter new markets, locate suitable store sites, negotiate acceptable lease terms, access adequate inventory, secure capital resources and financing, construct or refurbish sites, hire, train and retain skilled managers and personnel, and manage other factors, some of which may be beyond the Company's control. The Company's senior credit facility, which the Company is seeking to amend, also places a limit on the number of new stores which the Company is permitted to open during any given year. The failure by the Company to open new stores on a timely basis or otherwise to achieve its expansion plans could materially adversely affect the Company's business, results of operations and financial performance. There can be no assurance that the Company's new stores, when opened, will be profitable or achieve sales or profitability levels comparable to the Company's existing stores. Furthermore, the Company believes that its expansion within existing markets could adversely affect the financial performance of the Company's existing stores within those markets. To manage its expansion, the Company will need to continually evaluate the adequacy of its existing systems and procedures and to adapt accordingly. In addition, the success of the Company's expansion program will be dependent on its ability to promote and/or recruit enough qualified district managers, store managers and sales associates to support the expected growth in the number of its stores, and there can be no assurance that the training and supervision of a large number of new managers and associates will not adversely affect the performance of the Company's stores. In addition, the Company relies upon its existing management information systems for operating and monitoring all major aspects of its business, including sales, warehousing, distribution, purchasing, inventory control, merchandise planning and replenishment, as well as various financial functions. Any failure by the Company to upgrade such systems or unexpected difficulties encountered with such systems as its business expands, or in general any disruption in these systems, could adversely affect the Company's results of operations and financial performance. The Company believes that cash generated from operations and available borrowings under revolving credit facilities will be sufficient to satisfy its currently anticipated working capital and capital expenditure requirements through the end of 1999. However, in connection with its expansion strategy, the Company may be required to seek additional funds, and there can be no assurance that such funds will be available on satisfactory terms. Failure to obtain such financing could delay or prevent the Company's planned expansion, which could adversely affect the Company's results of operations and financial performance. MERCHANDISING RISKS; INVENTORY The Company's success depends, in large part, on its ability to anticipate and respond, in a timely manner, to changing merchandise trends and consumer demands. Accordingly, any failure by the Company to identify and respond to emerging trends could adversely affect consumer acceptance of the merchandise in the Company's stores and the Company's image with its customers, which in turn could materially adversely affect the Company's business, financial condition and results of operations. In addition, if the Company 8 10 miscalculates either the market for the merchandise in its stores or its customers' purchasing habits, it may be faced with a significant amount of unsold inventory, which could have a material adverse effect on the Company's business, financial condition and results of operations. A major shift in consumer demand away from gift items and home accessories could also have a material adverse effect on the Company's business, results of operations and financial condition. The Company purchases its products from approximately 140 vendors with which it has no long-term purchase commitments or exclusive contracts. None of the Company's vendors supplied more than 8% of the Company's merchandise purchases in 1997 or during the first quarter of 1998. The Company's results of operations could be adversely affected by a disruption in purchases from any of its key vendors, any of which could discontinue selling to the Company at any time. FOREIGN-SOURCED MERCHANDISE Many of the Company's vendors are importers of merchandise manufactured in the Far East, Mexico and India. While the Company believes that buying from vendors instead of directly from manufacturers reduces or eliminates the risks involved with relying on products manufactured abroad, its vendors are subject to those risks, and it remains subject to those risks to the extent that their effects are passed through by its vendors to the Company or cause disruptions in supply. These risks include fluctuations in the value of currencies, increases in customs duties and related fees resulting from position changes by the United States Customs Service, import controls and trade barriers (including the unilateral imposition of import quotas), loss of "most favored nation" ("MFN") trading status, restrictions on the transfer of funds, work stoppages, economic uncertainties, changes in foreign government regulations and, in certain parts of the world, political instability causing disruption of trade from the countries in which the suppliers of the Company's vendors are located. The Company's ability to obtain merchandise cost-effectively through importers from manufacturers in China, from which the Company currently purchases approximately 30% of its merchandise, is subject to retention by China of its MFN tariff status and its compliance with certain other requirements. Pursuant to MFN status, products imported for the Company from China currently receive the lower tariff rates made available to most of the United States' major trading partners. In the case of China, however, this MFN treatment is made possible under the Trade Act of 1974 by virtue of certain Presidential findings that waive restrictions that would otherwise render China ineligible for MFN treatment. China's MFN status is reviewed annually. Although the President has waived these restrictions each year since 1979, there can be no assurance that China will continue to enjoy MFN status in the future. If products manufactured in China enter the United States without the benefit of MFN treatment, such products will be subject to significantly higher duty rates, ranging between 20% and 66% of customs value. Any such increased duties or tariffs could significantly increase the cost or reduce the supply of products from China. In addition, the United States Trade Representative is monitoring China due to concerns regarding the protection of intellectual property rights and market barriers to United States exports to and investments in China. China's failure to comply with the terms of agreements entered into with the United States regarding these matters could result in sanctions against China, and the imposition of new duties on certain imports from China potentially including products to be supplied to the Company. Any significant increase in duties or tariffs on the products imported for the Company from China could have a material adverse effect on the Company's results of operations and financial condition. Historically, instability in the political and economic environments of the countries in which the Company's vendors obtain its products has not had a material adverse effect on the Company's operations. The Company cannot predict, however, the effect that future changes in economic or political conditions in such foreign countries could have on operations. Although the Company believes that it could access alternative sources in the event of disruptions or delays in supply due to the impact of future changes in economic or political conditions in foreign countries on its vendors, such disruptions or delays could adversely affect the Company's results of operations unless and until alternative supply arrangements could be made. In addition, merchandise purchased from alternative sources may be of lesser quality or more expensive than merchandise currently purchased abroad by the Company. 9 11 Although the majority of the foreign-sourced products sold by the Company are not currently subject to quotas, countries in which the Company's vendors obtain these products may, from time to time, impose new or adjust prevailing quotas or other restrictions on exported products, and the United States may impose new duties, tariffs and other restrictions on imported products, any of which could disrupt the supply of such products to the Company and adversely affect its operations. Other restrictions on the importation of products obtained for the Company by vendors are periodically considered by the United States Congress, and no assurances can be given that tariffs or duties on such products may not be raised, resulting in higher costs to the Company, or that import quotas with respect to such products may not be imposed or made more restrictive. COMPETITION The business in which the Company is engaged is highly competitive. The Company competes with a variety of specialty stores, department stores, discount stores and catalog retailers that carry merchandise in one or more categories also carried by the Company. One or more of its competitors are present in substantially all of the malls in which the Company has stores. Many of the Company's competitors are larger than the Company and have access to significantly greater financial, marketing and other resources than the Company. The Company believes that its stores compete primarily on the basis of merchandise quality and selection, price, visual appeal of the merchandise and the store and convenience of location. There can be no assurance that the Company will continue to be able to compete successfully against existing or future competition. Expansion by the Company into the markets served by its competitors, entry of new competitors or expansion of existing competitors into the Company's markets could have a material adverse effect on the Company's business, financial condition and results of operations. SEASONALITY; VARIATIONS IN QUARTERLY RESULTS The Company has experienced, and expects to continue to experience, substantial seasonal fluctuations in its sales and operating results, which are typical of many mall-based specialty retailers and common to most retailers generally. Due to the importance of the fall selling season, which includes Thanksgiving and Christmas, the fourth calendar quarter has historically contributed, and is expected to continue to contribute, a substantial majority of the Company's operating income and net income for the entire year. The Company expects this pattern to continue during the current fiscal year and anticipates that in subsequent years the fourth quarter will continue to contribute disproportionately to its operating results, particularly during November and December. Any factors negatively affecting the Company during the fourth quarter in any year, including unfavorable economic conditions, could have a material adverse effect on the Company's financial condition and results of operations. The Company's quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including, among other things, the timing of new store openings, pre-opening expenses associated with new stores, the relative proportion of new stores to mature stores, net sales contributed by new stores, increases or decreases in comparable store sales, adverse weather conditions, shifts in the timing of holidays and changes in the Company's product mix. The market price of the Common Stock may fluctuate significantly in response to changes in the Company's quarterly results of operations. ECONOMIC CONDITIONS AND FLUCTUATIONS IN CONSUMER SPENDING The Company's sales are also subject to a number of factors relating to consumer spending, including general economic conditions affecting disposable consumer income such as employment, business conditions, interest rates, the level of consumer debt and taxation. The Company's sales could also be adversely affected by a weak retail environment. No assurances can be given that purchases of home accessories and gift items will not decline during recessionary periods or that a prolonged recession will not have a material adverse effect on the Company's business, financial condition and results of operations. In addition, economic downturns during the fourth quarter could adversely affect the Company to a greater extent than if such downturns occurred at other times of the year. 10 12 COMPARABLE STORE SALES RESULTS Numerous factors affect comparable store sales results, including among others, weather conditions, retail trends, the retail sales environment, economic conditions and the Company's success in executing its business strategy. The Company's comparable store sales results have experienced fluctuations in the past. In addition, the Company anticipates that opening new stores in existing markets may result in decreases in comparable store sales for existing stores in such markets. There can be no assurance that comparable store sales for any particular period will not decrease in the future. Variations in the Company's comparable store sales results could cause the price of the Common Stock to fluctuate significantly and could have a material adverse effect on the Company. RISKS ASSOCIATED WITH INDEBTEDNESS Following the Offering, the Company will continue to have substantial indebtedness and, as a result, significant debt service obligations. On a pro forma basis, giving effect to the sale of the shares offered hereby and the application of the estimated net proceeds therefrom on January 1, 1998, the Company would have had total outstanding indebtedness as of March 31, 1998 of approximately $43.6 million, including approximately $43.1 million outstanding under its senior credit facility, and its total interest expense for the first quarter of 1998 would have been $1.1 million. On a pro forma basis, giving effect to the sale of the shares offered hereby and the application of the estimated net proceeds therefrom on January 1, 1997, the Company would have had total outstanding indebtedness as of December 31, 1997 of approximately $36.6 million, including approximately $36.1 million outstanding under its senior credit facility, and its total interest expense for the year ended December 31, 1997 would have been $4.3 million. The degree to which the Company is leveraged could have several material adverse effects, including, but not limited to, the following: (i) making it more difficult for the Company to satisfy its obligations; (ii) limiting the Company's ability to obtain additional financing to fund future working capital, capital expenditures, acquisitions and other general corporate requirements; (iii) increasing the Company's vulnerability to a downturn in general economic conditions; (iv) requiring the dedication of a substantial portion of the Company's cash flow from operations to the payment of principal of, and interest on, its indebtedness, thereby reducing the availability of such cash flow to fund working capital, capital expenditures, acquisitions and other general corporate requirements; (v) limiting the Company's flexibility in planning for, or reacting to, changes in its business and the industry; and (vi) placing the Company at a competitive disadvantage with respect to less highly leveraged competitors. The Company's senior credit facility contains financial and operating covenants including, but not limited to, restrictions on the Company's ability to incur additional indebtedness and issue preferred stock, pay dividends or make other distributions, create liens, sell assets and enter into certain mergers and consolidations. The Company's inability to service its obligations would have a material adverse effect on the market value and marketability of the Common Stock. In addition, failure by the Company to comply with the covenants contained in its bank credit facility may result in an event of default, which, if not cured or waived, could have a material adverse effect on the Company. MARKET CONCENTRATION Approximately 83 of the Company's 141 stores are located in the southeastern region of the United States. The Company's current expansion plans anticipate that many of its new stores will be located in the states where the Company currently has operations or in contiguous states. Consequently, the Company's results of operations are more subject to regional economic conditions, weather conditions, demographic and population changes and other factors specific to a particular region than are the operations of more geographically diversified competitors. In addition, changes in such regional factors which reduce the appeal of the Company's stores and merchandise to local consumers could have a material adverse effect on the Company's business, results of operations and financial condition. The Company expects to open new stores in certain markets in which it is already operating, which could adversely affect the financial performance at existing stores within those markets. 11 13 DEPENDENCE ON CUSTOMER TRAFFIC IN MALLS Substantially all of the Company's existing stores are located in enclosed malls. As a result, the Company must rely, in part, on the ability of mall anchor tenants and other tenants to generate customer traffic in the vicinity of the Company's stores. The Company's future operating results will also depend on many other factors that are beyond the Company's control, including the overall level of mall traffic and general economic conditions affecting consumer confidence and spending. DEPENDENCE ON KEY PERSONNEL The Company believes that it has benefitted substantially from the leadership and performance of its senior management, especially Carl Kirkland (Chief Executive Officer) and Robert E. Alderson (President and Chief Operating Officer). Although the Company maintains key man insurance in the amount of $3 million on each of Messrs. Kirkland and Alderson, the loss of the services of either of these individuals for any reason could have a material adverse effect on the Company's business, financial condition and results of operations. Many members of the Company's management have substantial experience and expertise in the Company's business and have made significant contributions to its growth and success. As the Company continues to grow, it will continue to hire, appoint or otherwise change senior managers and other key executives. The Company has employment agreements with Mr. Kirkland, Mr. Alderson and other members of senior management which expire, in the cases of Mr. Kirkland and Mr. Alderson, in June 2000. There can be no assurance that the Company will be able to retain its executive officers and key personnel or attract additional qualified members to its management team beyond the stated terms of these employment agreements or otherwise in the future. VIOLATION OF LEASE TERMS A substantial number of the Company's store leases contain provisions that permit the landlord to terminate the lease upon a change in control of the Company. The Offering and the Pre-Offering Transactions may give rise to a change in control under certain of the Company's leases. There can be no assurance that the Company's landlords under leases which contain the above provisions will not attempt to terminate those leases or to alter the terms thereunder, and that such actions would not have a material adverse effect on the Company's business, results of operations or financial condition. HOLDING COMPANY STRUCTURE Upon completion of the Offering, all of the Kirkland Companies will be subsidiaries of the Company and the Company will be a holding company that will derive substantially all of its operating income from its subsidiaries. The Company expects that distributions from its subsidiaries will be its principal source of the funds to meet its obligations. The Kirkland Companies are, and any additional subsidiaries formed following the Offering will be, separate and distinct legal entities and will have no obligation, contingent or otherwise, to pay any dividend or make any other distribution to the Company, other than for interest and principal payments on indebtedness owed to the Company, if any. The ability of the Company's subsidiaries to make payments will be subject to, among other things, the availability of sufficient cash and restrictive covenants in the documents governing the Company's senior credit facility which prohibit the Company's subsidiaries from paying dividends or making other distributions to the Company, including indebtedness owed to the Company. The Kirkland Companies are co-borrowers under the senior credit facility, their obligations thereunder are secured by security interests in the Kirkland Companies' assets and have been guaranteed by the Company, and the stock of the Kirkland Companies will be pledged by the Company to the bank as security for its guarantee. The Company's inability to service its obligations would have a material adverse effect on the market value and marketability of the Common Stock. IMPACT OF YEAR 2000 ISSUE An issue exists for all companies that rely on computers as the year 2000 approaches. The "Year 2000" issue is the result of past practice in the computer industry of using two digits rather than four to identify the 12 14 applicable year. This practice will result in incorrect results when computers perform arithmetic operations, comparisons or data field sorting involving years later than 1999. Independent of the Year 2000 issue, the Company intends to install a new point-of-sale ("POS") system throughout its store network in 1998 at a cost of approximately $1.5 million, which will be Year 2000 compliant. The Company anticipates that it will be able to test its entire system using its internal programming staff and outside computer consultants and intends to make the necessary modifications to prevent disruption to its operations. The Company does not expect costs in connection with any such modifications to be material. However, if such modifications are not completed in a timely manner or if costs are greater than anticipated, the Year 2000 issue may have a material adverse effect on the operations of the Company. The Company is in the process of exploring with each of its key vendors the impact the Year 2000 issue will have on their ability to source products for the Company and process purchase orders with delivery requirements and terms involving years later than 1999. There can be no assurance that the systems of vendors on which the Company's systems rely will be modified in a timely manner to account for the Year 2000 issue, or that a failure to so modify by a vendor, or a modification that is incompatible with the Company's systems, will not have a material adverse effect on the operations of the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Year 2000 Issue." NO PRIOR PUBLIC MARKET; VOLATILITY Prior to this Offering, there has been no public market for the Common Stock, and there can be no assurance that an active trading market will develop or be sustained. The initial public offering price for the shares of Common Stock to be sold in this Offering will be determined by agreement among the Company and the representatives of the Underwriters and may bear no relationship to the Company's book value, net worth or any other established criteria of value or the price at which the Common Stock will trade after completion of this Offering. The market price of the Common Stock could be subject to significant fluctuations in response to the Company's operating results, general trends in prospects for the retail industry, changes in equity analysts' recommendations regarding the Company and other factors. In addition, the stock market in recent years has experienced extreme price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of companies. These fluctuations, as well as general economic and market conditions, may adversely affect the market price of the Common Stock. SHARES ELIGIBLE FOR FUTURE SALE Sales of substantial amounts of Common Stock in the public market following this Offering could have an adverse effect on the market price of the Common Stock. The shares offered hereby by the Company (plus any of the shares purchased pursuant to the exercise of the Underwriters' over-allotment option) will be freely tradeable in the public market, except to the extent purchased by "affiliates" or "underwriters" (as those terms are defined under the Securities Act) of the Company. All of the remaining 146,683 shares ( shares if the Underwriters' over-allotment option is exercised in full) to be outstanding upon consummation of this Offering will become eligible for sale in the public market, subject to compliance with the holding period, volume and manner of sale requirements of Rule 144 under the Securities Act, upon the expiration of certain "lock-up" agreements not to sell such shares until 180 days after the date of this Prospectus, as described in "Underwriting." Holders of such shares of Common Stock have the right to require the Company to register the shares for sale under the Securities Act in certain circumstances and have the right to include those shares in a Company-initiated registration. If the Company is required to include shares of Common Stock held by these holders pursuant to these registration rights in a Company-initiated registration, sales made by such holders may have an adverse effect on the Company's ability to raise needed capital and on the price of the Common Stock. In addition, if these holders exercise their demand registration rights and cause a large number of shares to be registered and sold in the public market, such sales may have an adverse effect on the market price of the Common Stock. Following this Offering, the Company also intends to file registration statements with the Securities and Exchange Commission covering 23,004 shares of Common Stock issued or reserved for issuance under the Company's 1996 Executive Incentive and Non-Qualified Stock Option Plan, 1998 Incentive Plan and Employee Stock Purchase Plan. Upon effectiveness of such registration statements, any shares subsequently issued under such plans will be eligible for sale in the 13 15 public market, except to the extent restricted by the lock-up agreements referred to above and subject to compliance with Rule 144 in the case of affiliates of the Company. Sales of a large number of shares of Common Stock issued under these plans in the public market may have an adverse effect on the market price of the Common Stock. See "Shares Eligible for Future Sale." CHARTER AND BYLAW PROVISIONS; ANTI-TAKEOVER EFFECT OF TENNESSEE LAWS The Company's Amended and Restated Charter (the "Charter") authorizes the issuance of "blank check" preferred stock with such designations, rights and preferences as may be determined from time to time by the Company's Board of Directors. Accordingly, the Board is empowered, without shareholder approval, to issue preferred stock with dividend, liquidation, conversion, voting or other rights which could materially adversely affect the voting power or other rights of the holders of the Common Stock (including those of the purchasers in the Offering). Holders of the Common Stock will have no preemptive rights to subscribe for a pro rata portion of any capital stock which may be issued by the Company. In the event of issuance, such preferred stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of the Company. Although the Company has no present intention to issue any shares of preferred stock, there can be no assurance that the Company will not do so in the future. The Company's Charter and Restated Bylaws (the "Bylaws") contain certain corporate governance provisions that may deter and inhibit unsolicited changes in control of the Company. First, the Charter provides for a classified Board of Directors, with directors (after the expiration of the terms of the initial classified board of directors in 1999, 2000 and 2001) serving three year terms from the year of their respective elections and being subject to removal only for cause and upon the vote of 80% of the voting power of all outstanding capital stock of the Company entitled to vote (the "Voting Power"). Second, the Charter and the Bylaws do not generally permit shareholders to call, or to require that the Board of Directors call, a special meeting. The Charter and Bylaws also limit the business permitted to be conducted at any such special meeting. In addition, Tennessee law permits action to be taken by the shareholders by written consent only if the action is consented to by holders of the number of shares required to authorize shareholder action and if all shareholders entitled to vote are parties to the written consent. Third, the Bylaws establish an advance notice procedure for shareholders to nominate candidates for election as directors or to bring other business before meetings of shareholders of Kirkland's. Only those shareholder nominees who are nominated in accordance with this procedure will be eligible for election as directors of Kirkland's, and only such shareholder proposals may be considered at a meeting of shareholders as have been presented to Kirkland's in accordance with the procedure. Finally, the Charter provides that the affirmative vote of at least 80% of the Voting Power is required to amend or repeal the foregoing provisions of the Charter. In addition, the Bylaws provide that the amendment or repeal by shareholders of any Bylaws made by the Board of Directors of Kirkland's would require the affirmative vote of at least 80% of the Voting Power. Furthermore, the Company is subject to provisions of certain Tennessee law, including certain Tennessee corporate takeover acts which are, or may be, applicable to the Company. These acts are the Investor Protection Act, the Business Combination Act and the Tennessee Greenmail Act, and these acts seek to limit the parameters in which certain business combinations and share exchanges occur. The existence of the Charter, Bylaws and Tennessee law provisions could be expected to have an anti-takeover effect, including possibly discouraging takeover attempts that might result in a premium over the market price for the Common Stock. See "Description of Capital Stock - Anti-Takeover Effect of Charter and Bylaw Provisions and Tennessee Laws." CONTROL BY CERTAIN SHAREHOLDERS The Company's current directors, executive officers, existing shareholders and their affiliates will, in the aggregate, beneficially own approximately % of the Company's outstanding shares of Common Stock after this Offering, assuming no exercise of the Underwriters' over-allotment option. As a result, these shareholders, acting together, would be able to exercise a controlling influence over matters requiring approval by the shareholders of the Company, including the election of directors, and over the business and affairs of 14 16 the Company, including determinations with respect to mergers or other business combinations involving the Company and the acquisition or disposition of assets by the Company. DILUTION Investors purchasing Common Stock in the Offering will, on a pro forma basis, incur immediate and substantial dilution in the amount of $ per share. To the extent that currently outstanding options to purchase Common Stock are exercised, there will be further dilution. See "Dilution." DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS This Prospectus contains forward-looking statements relating to future events or the future financial performance of the Company. Such statements may relate, but are not limited to, expectations of future operating results or financial performance, capital expenditures, construction or expansion of facilities (including new stores), plans for growth and future operations, or financing, as well as assumptions relating to the foregoing. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Such risks include, but are not limited to, the matters discussed in the foregoing paragraphs under "Risk Factors." Future events and actual results could differ materially from those set forth in, contemplated by or underlying the forward-looking statements. 15 17 USE OF PROCEEDS The net proceeds to be received by the Company from the sale of the shares offered hereby will be approximately $50.4 million, after deducting underwriting discounts and commissions and estimated offering expenses. The Company expects to use the net proceeds from the Offering as follows: (i) $20.2 million to repay outstanding subordinated debt (including approximately $210,000 of accrued interest); (ii) $18.0 million to purchase or redeem all of the outstanding shares of mandatorily redeemable Class C Preferred Stock (including approximately $900,000 of amounts classified as interest associated with the Class C Preferred Stock); and (iii) $12.2 million to repay outstanding senior indebtedness. Substantially all of the shares of Class C Preferred Stock are held by affiliates of the Company. The Company will not receive any proceeds from the sale of shares pursuant to any exercise of the Underwriters' over-allotment option. See "Certain Transactions - Pre-Offering Transactions." As of March 31, 1998, the Company's senior indebtedness consisted of $55.3 million outstanding under a senior credit facility which matures in June 2002. As of March 31, 1998, the weighted average interest rate on the senior indebtedness expected to be repaid with net proceeds of the Offering was 9.1%. Immediately following the completion of the Offering, the Company expects to have remaining outstanding senior indebtedness of approximately $43.1 million. The Company's subordinated debt consists of $20.0 million of notes bearing interest at 12.25% until June 13, 1998 and at 12.5% thereafter and maturing on June 30, 2003. By their terms, the notes are required to be repaid in full with proceeds of the Offering. The Company's Class C Preferred Stock was issued in connection with the Recapitalization and had an aggregate stated value of $17.1 million at March 31, 1998. The Company pays an annual amount equal to 9% of the outstanding balance to the holders which has been reflected as interest expense in the Company's Combined Financial Statements. DIVIDEND POLICY The Company intends to retain future earnings to finance the continued growth and development of its business, and does not, therefore, anticipate paying any cash dividends on its Common Stock in the foreseeable future. In addition, the Company's senior credit facility prohibits the payment of cash dividends without the prior written consent of two-thirds of the lenders. No dividends have been paid on the Common Stock subsequent to 1995. Future cash dividends, if any, will be determined by the Board of Directors, and will be based upon the Company's earnings, capital requirements, financial condition, debt covenants and other factors deemed relevant by the Board of Directors. 16 18 DILUTION The pro forma net negative tangible book value of the Company as of March 31, 1998, after giving effect to the Pre-Offering Transactions, was $57.2 million, or $ per share of outstanding Common Stock on such date. Pro forma net negative tangible book value per share is determined by dividing the pro forma net negative tangible book value of the Company (total tangible assets less total liabilities) by the number of shares of Common Stock outstanding on a pro forma basis, giving effect to the Pre-Offering Transactions. Without taking into effect any changes in pro forma net negative tangible book value after March 31, 1998, other than to give effect to the sale by the Company of the shares of Common Stock offered hereby and the application of the estimated net proceeds therefrom (after deducting estimated offering expenses and the underwriting discounts and commissions), the as adjusted pro forma net negative tangible book value of the Company as of March 31, 1998 would have been $7.1 million, or $ per share. This represents an immediate increase in pro forma net tangible book value of $ per share to existing shareholders and an immediate dilution of $ per share to purchasers of Common Stock in the Offering. The following table illustrates this per share dilution: Assumed initial public offering price per share............. $ Net negative tangible book value per share at March 31, 1998................................................... $ () Adjustment(1)............................................. ------ Pro forma net negative tangible book value per share before the Offering.................................... () Increase attributable to new shareholders................. ------ Adjusted pro forma net negative tangible book value per share after the Offering............................... () ------ Dilution per share to new shareholders...................... $ ======
- --------------- (1) The adjustment gives effect to the Pre-Offering Transactions. The following table sets forth, on a pro forma basis as of March 31, 1998, giving effect to the Pre-Offering Transactions, the number of shares of Common Stock purchased from the Company, the total consideration paid to the Company, the average price per share paid by existing shareholders, and the average price per share to be paid by purchasers of Common Stock in the Offering:
SHARES PURCHASED TOTAL CONSIDERATION -------------------- --------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE --------- ------- ---------- ------- ------------- Existing shareholders................ % $ % $ New investors........................ $ --------- ----- ---------- ----- Total........................... 100.0% $ 100.0% ========= ===== ========== =====
The foregoing tables do not include (i) 10,154 shares of Common Stock issuable upon exercise of outstanding options at exercise prices ranging from $0.045 to $285.65 per share, of which shares are subject to options which will be exercisable upon completion of the Offering, or (ii) 12,850 shares of Common Stock reserved for future issuance under the Company's 1996 Executive Incentive and Non- Qualified Stock Option Plan, 1998 Incentive Plan and Employee Stock Purchase Plan. See "Management - Employee Benefit Plans." 17 19 CAPITALIZATION The following table sets forth, as of March 31, 1998, (i) the actual capitalization of the Company, (ii) the pro forma capitalization of the Company after giving effect to the Pre-Offering Transactions and (iii) the pro forma as adjusted capitalization of the Company after giving effect to the Pre-Offering Transactions and the sale of the shares of Common Stock offered hereby and the application of the estimated net proceeds therefrom (after deducting estimated offering expenses and underwriting discounts and commissions). The information set forth below should be read in conjunction with the Company's Combined Financial Statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this Prospectus.
MARCH 31, 1998 ---------------------------------------- PRO FORMA ACTUAL PRO FORMA(1) AS ADJUSTED --------- ------------ ----------- (IN THOUSANDS, EXCEPT SHARE DATA) Short-term debt........................................ $ 4,588 $ 4,588 $ 4,588 ========= ========= ========= Long-term debt: Senior credit facility............................... $ 50,887 $ 50,887 $ 38,687 Subordinated debt.................................... 19,775 19,775 -- Other indebtedness................................... 310 310 310 Mandatorily redeemable preferred stock(Class C)...... 17,122 17,122 -- --------- --------- --------- Total long-term debt.............................. 88,094 88,094 38,997 --------- --------- --------- Common stock warrants.................................. 879 -- -- --------- --------- --------- Redeemable convertible preferred stock (Class A and Class B Preferred Stock)................ 47,584 -- -- --------- --------- --------- Shareholders' deficit: Common Stock, at stated value, 92,100 shares issued and outstanding, actual; 50,000,000 shares authorized, shares issued and outstanding pro forma; and 50,000,000 shares authorized, shares issued and outstanding, pro forma as adjusted(2)............. 203 203 203 Paid-in capital...................................... 1,295 49,758 100,041 Accumulated deficit.................................. (107,149) (107,149) (107,374) --------- --------- --------- Total shareholders' deficit....................... (105,651) (57,188) (7,130) --------- --------- --------- Total capitalization......................... $ 35,494 $ 35,494 $ 36,455 ========= ========= =========
- --------------- (1) See "Unaudited Pro Forma Combined Condensed Financial Statements." (2) Excludes approximately 10,154 shares of Common Stock reserved for issuance upon the exercise of options at exercise prices ranging from $0.045 to $285.65 per share, outstanding at March 31, 1998, of which shares were subject to options which will be exercisable upon completion of the Offering. 18 20 UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS Pursuant to the terms of a Purchase, Contribution and Exchange Agreement dated April 29, 1998, by and among Kirkland's, Inc. and each of the Company's shareholders and warrantholders, immediately prior to completion of the Offering as a part of the Pre-Offering Transactions: (i) all of the outstanding shares of Class A Preferred Stock and Class B Preferred Stock of Kirkland's, Inc. and the Kirkland Companies will be recapitalized into or exchanged for an aggregate of 42,689 shares of Common Stock, and (ii) all of the outstanding shares of common stock of the Kirkland Companies will be contributed to Kirkland's, Inc., resulting in the Kirkland Companies becoming wholly-owned subsidiaries of Kirkland's, Inc. Subsequently, but prior to completion of the Offering, the warrantholders of Kirkland's, Inc., and the Kirkland Companies will exercise their warrants to purchase 11,905 shares of common stock of Kirkland's, Inc. and each of the Kirkland Companies, and the Kirkland Companies' common stock issued upon such exercise will be contributed to Kirkland's, Inc. See "Certain Transactions - Pre-Offering Transactions." Also pursuant to the agreement, Kirkland's, Inc. will purchase or redeem from current shareholders all of the outstanding shares of Class C Preferred Stock of Kirkland's, Inc. and each of the Kirkland Companies that has Class C Preferred Stock outstanding, using a portion of the net proceeds of the Offering. The pro forma combined condensed balance sheet as of March 31, 1998 and the pro forma combined condensed statements of operations for the fiscal year 1997 and the three months ended March 31, 1998 which follow give effect to: (i) the Pre-Offering Transactions, and (ii) the Offering and the application of the estimated net proceeds therefrom as if such transactions had occurred as of the beginning of the period. In the opinion of the Company all adjustments necessary to present fairly such pro forma combined condensed statements of operations have been made. These unaudited pro forma combined condensed statements of operations are not necessarily indicative of what actual results would have been had the transactions occurred at the beginning of the respective periods nor do they purport to indicate the results of future operations of the Company. These unaudited pro forma financial statements should be read in conjunction with the accompanying notes. 19 21 UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET MARCH 31, 1998 (IN THOUSANDS)
PRE-OFFERING OFFERING PRO FORMA HISTORICAL ADJUSTMENTS ADJUSTMENTS AS ADJUSTED ---------- ----------------- ----------------- ----------- ASSETS Current assets: Cash and cash equivalents............................. $ 2,177 $ 2,177 Inventories........................................... 22,546 22,546 Other current assets.................................. 2,760 2,760 -------- -------- Total current assets................................ 27,483 27,483 Property and equipment, net............................. 12,894 12,894 Noncurrent deferred income taxes........................ 201 201 Debt issue costs, net................................... 4,018 4,018 -------- -------- Total assets........................................ $ 44,596 $ 44,596 ======== ======== LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' DEFICIT Current liabilities: Current maturities of long-term debt.................. $ 4,588 $ 4,588 Accounts payable and accrued liabilities.............. 9,102 $ (576) (c) 8,141 (385) (e) -------- ------- ------- -------- Total current liabilities........................... 13,690 (961) 12,729 Senior credit facility.................................. 50,887 (12,200) (d) 38,687 Subordinated debt....................................... 19,775 (19,775) (c) -- Other indebtedness...................................... 310 310 Class C Preferred Stock................................. 17,122 (17,122) (e) -- Common stock warrants................................... 879 $ (879) (a) -- -------- ------- ------- -------- Total liabilities................................... 102,663 (879) (50,058) 51,726 -------- ------- ------- -------- Redeemable convertible preferred stock: Class A............................................... 35,223 (35,223) (b) -- Class B............................................... 12,361 (12,361) (b) -- -------- ------- ------- -------- 47,584 (47,584) -- -------- ------- ------- -------- Shareholders' deficit: Common stock.......................................... 203 203 Paid-in capital....................................... 1,295 879 (a) 50,283 (f) 100,041 47,584 (b) Accumulated deficit................................... (107,149) (225) (c) (107,374) -------- ------- ------- -------- Total shareholders' deficit......................... (105,651) 48,463 50,058 (7,130) -------- ------- ------- -------- Total liabilities, redeemable preferred stock and shareholders' deficit............................. $ 44,596 $ -- $ -- $ 44,596 ======== ======= ======= ========
- --------------- (a) Represents the exercise by the warrantholders of Kirkland's, Inc. and Kirkland Companies of their warrants to purchase 11,905 shares of common stock of Kirkland's, Inc. and each of the Kirkland Companies, and the contribution to Kirkland's, Inc. of the Kirkland Companies' common stock issued upon such exercise. (b) Represents the issuance of 42,689 shares of Common Stock upon the recapitalization or exchange of all outstanding Class A Preferred Stock and Class B Preferred Stock of Kirkland's Inc. and the Kirkland Companies. (c) Represents the full repayment of the subordinated debt and accrued interest thereon from the estimated net proceeds of the Offering. The accretion of $225,000 of debt discount associated with the early extinguishment of the subordinated debt is also reflected. See "Use of Proceeds." (d) Represents the repayment of approximately $12.2 million of senior indebtedness from the estimated net proceeds of the Offering. See "Use of Proceeds." (e) Represents the purchase or redemption of mandatorily redeemable Class C Preferred Stock for $17.5 million (including $385,000 of accrued amounts classified as interest associated with such preferred stock) from the estimated net proceeds of the Offering. See "Use of Proceeds." (f) Represents the sale of the shares of Common Stock offered hereby at an assumed initial public offering price of $ per share, less underwriting discounts and commissions and estimated offering expenses. 20 22 UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF INCOME (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) FOR THE YEAR ENDED DECEMBER 31, 1997
PRE-OFFERING OFFERING PRO FORMA HISTORICAL ADJUSTMENTS ADJUSTMENTS AS ADJUSTED ---------- ------------ ----------- ----------- Net sales................................................... $153,584 $153,584 Cost of sales (including store occupancy costs)............. 96,998 96,998 -------- ------- ------- -------- Gross profit.............................................. 56,586 56,586 Operating expenses.......................................... 35,004 35,004 Severance charge............................................ 756 756 Depreciation and amortization............................... 4,142 4,142 -------- ------- ------- -------- Operating income.......................................... 16,684 16,684 Interest expense: Senior credit facility and other indebtedness............. 5,506 $(1,159)(d) 4,347 Subordinated debt......................................... 2,484 (2,484)(c) -- Class C Preferred Stock................................... 1,800 (1,800)(e) -- Accretion of common stock warrants........................ 389 $ (389)(a) -- Interest income............................................. (80) (80) Other income, net........................................... (154) (154) -------- ------- ------- -------- Income before income taxes.............................. 6,739 389 5,443 12,571 Income tax provision........................................ 2,817 2,151(f) 4,968 -------- ------- ------- -------- Net income.............................................. 3,922 389 3,292 7,603 Accretion of redeemable preferred stock and dividends accrued................................................... 3,755 (3,755)(b) -- -------- ------- ------- -------- Net income allocable to common stock........................ $ 167 $ 4,144 $ 3,292 $ 7,603 ======== ======= ======= ======== Income per common share: Basic..................................................... $ 1.67 $ ======== ======== Diluted................................................... $ 1.35 $ ======== ======== Weighted average number of common shares outstanding: Basic..................................................... 100,000 ======== ======== Diluted................................................... 123,590 ======== ========
FOR THE THREE MONTHS ENDED MARCH 31, 1998
PRE-OFFERING OFFERING PRO FORMA HISTORICAL ADJUSTMENTS ADJUSTMENTS AS ADJUSTED ---------- ------------ ----------- ----------- Net sales................................................. $30,615 $30,615 Cost of sales (including store occupancy costs)........... 21,110 21,110 ------- ----- ----- ------- Gross profit............................................ 9,505 9,505 Operating expenses........................................ 9,178 9,178 Depreciation and amortization............................. 1,156 1,156 ------- ----- ----- ------- Operating loss.......................................... (829) (829) Interest expense: Senior credit facility and other indebtedness........... 1,354 $(287)(d) 1,067 Subordinated debt....................................... 576 (576)(c) -- Class C Preferred Stock................................. 385 (385)(e) -- Interest income........................................... (2) (2) Other income, net......................................... (64) (64) ------- ----- ----- ------- Income (loss) before income taxes..................... (3,078) 1,248 (1,830) Income tax provision (benefit)............................ (920) 373(f) (547) ------- ----- ----- ------- Net loss.............................................. (2,158) 875 (1,283) Accretion of redeemable preferred stock and dividends accrued................................................. 998 $(998)(b) -- ------- ----- ----- ------- Net loss allocable to common stock........................ $(3,156) $ 998 $ 875 $(1,283) ======= ===== ===== ======= Income (loss) per common share: Basic................................................... $(34.04) $ ======= ======= Diluted................................................. $(34.04) $ ======= ======= Weighted average number of common shares outstanding: Basic................................................... 92,714 ======= ======= Diluted................................................. 92,714 ======= =======
- --------------- (a) Represents the reduction in accretion resulting from the exercise of detachable put warrants to purchase 11,905 shares of common stock of Kirkland's, Inc. and each of the Kirkland Companies, and the contribution to Kirkland's, Inc. of the Kirkland Companies' common stock issued upon such exercise. The holders of these warrants agreed to terminate the put as of January 1, 1998. (b) Represents the reduction in accretion and dividends accrued resulting from the issuance of 42,689 shares of Common Stock upon the recapitalization or exchange of all outstanding Class A Preferred Stock and Class B Preferred Stock of Kirkland's, Inc. and the Kirkland Companies. (c) Represents the interest and amortization expense reduction resulting from repayment of approximately $20.0 million of subordinated debt and accrued interest from the estimated net proceeds of the Offering. See "Use of Proceeds." (d) Represents the interest and amortization expense reduction resulting from repayment of approximately $12.2 million of senior indebtedness from the estimated net proceeds of the Offering. See "Use of Proceeds." (e) Represents the interest expense reduction resulting from repayment of all outstanding mandatorily redeemable Class C Preferred Stock and amounts classified as interest associated with such preferred stock from the estimated net proceeds of the Offering. See "Use of Proceeds." (f) Represents the tax effect of the foregoing adjustments at effective tax rates of approximately 39.5%, excluding the accretion of common stock warrants for 1997, and 29.9%, for the three months ended March 31, 1998. 21 23 SELECTED COMBINED FINANCIAL DATA The selected statement of income data for each of the three years in the period ended December 31, 1997 and the selected balance sheet data as of December 31, 1996 and 1997 have been derived from the audited combined financial statements of the Company included elsewhere in this Prospectus. The selected balance sheet data and the selected statement of income data as of and for the years ended December 31, 1996 and 1997 have been derived from the Company's financial statements for such periods audited by Price Waterhouse LLP, independent public accountants. The selected statement of income data for the year ended December 31, 1995 have been derived from the Company's financial statements for such period audited by KPMG Peat Marwick LLP, independent public accountants. The selected balance sheet data as of December 31, 1993, 1994 and 1995 and the selected statement of income data for the years ended December 31, 1993 and 1994 have been derived from the audited combined financial statements of the Company not included in this Prospectus. The selected financial data presented below as of March 31, 1997 and 1998 and for the three-month periods then ended have been derived from the unaudited combined financial statements of the Company, which, in management's opinion, include all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the information set forth therein. The results of operations for the three months ended March 31, 1998 are not necessarily indicative of results to be expected for the entire year. The other data and selected store data for all periods presented below have been derived from internal records of the Company's operations. The data set forth below should be read in conjunction with the Combined Financial Statements and notes thereto, and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Prospectus.
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, -------------------------------------------------- ------------------- 1993 1994 1995 1996 1997 1997 1998 ------- ------- -------- -------- -------- -------- -------- (IN THOUSANDS) STATEMENT OF INCOME DATA: Net sales......................... $85,326 $99,901 $112,035 $127,946 $153,584 $26,178 $30,615 Gross profit...................... 33,080 38,088 43,200 47,508 56,586 7,559 9,505 Operating expenses................ 17,177 19,572 24,192 27,915 35,004 7,392 9,178 Severance charge(1)............... -- -- -- -- 756 -- -- Recapitalization expenses......... -- -- -- 854 -- -- -- Owners' compensation(2)........... 12,314 15,123 13,926 -- -- -- -- Depreciation and amortization..... 1,581 1,847 2,362 3,383 4,142 1,003 1,156 ------- ------- -------- -------- -------- ------- ------- Operating income(loss)............ 2,008 1,546 2,720 15,356 16,684 (836) (829) Interest expense: Senior, subordinated and other notes payable................ 777 940 1,415 5,114 7,990 1,961 1,930 Class C Preferred Stock......... -- -- -- 990 1,800 450 385 Accretion of common stock warrants(3).................. -- -- -- 190 389 97 -- Interest income................... (58) (126) (162) (47) (80) -- (2) Other income, net................. (184) (255) (221) (147) (154) (57) (64) Income tax provision (benefit).... -- -- -- 2,693 2,817 (923) (920) ------- ------- -------- -------- -------- ------- ------- Net income(loss).................. 1,473 987 1,688 6,563 3,922 (2,364) (2,158) Accretion of redeemable preferred stock and accrual of dividends(4).................... -- -- -- 2,313 3,755 939 998 ------- ------- -------- -------- -------- ------- ------- Net income (loss) allocable to common stock.................... $ 1,473 $ 987 $ 1,688 $ 4,250 $ 167 $(3,303) $(3,156) ======= ======= ======== ======== ======== ======= =======
22 24
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, ----------------------------------------------- ------------------- 1993 1994 1995 1996 1997 1997 1998 ------- ------- ------- ------- ------- -------- -------- (IN THOUSANDS, EXCEPT SELECTED STORE DATA) OTHER DATA: EBITDA(5)................................. $16,087 $18,771 $19,229 $19,740 $21,736 $ 224 $ 391 Net cash provided by (used in) operating activities.............................. 3,422 2,040 1,269 11,065 8,669 (7,564) (7,874) Net cash (used in) investing activities... 2,818 2,652 (4,130) (4,205) (5,479) (735) (903) Net cash provided by (used in) financing activities.............................. 772 1,320 3,278 (982) (3,537) (617) 73 SELECTED STORE DATA: Comparable store net sales increase(6).... 7.1% 4.4% 0.7% 1.4% 5.2% 4.8% 3.7% Number of stores at end of period......... 80 91 104 120 138 120 140 Average net sales per store (in thousands)(7)........................... $ 1,159 $ 1,159 $ 1,145 $ 1,147 $ 1,178 $ 216 $ 220 Average gross square footage per store(8)................................ 3,753 3,821 3,942 4,091 4,186 4,174 4,382
DECEMBER 31, ------------------------------------------------ MARCH 31, 1993 1994 1995 1996 1997 1998 ------- ------- ------- --------- --------- --------- (IN THOUSANDS) BALANCE SHEET DATA: Working capital........................... $11,147 $12,494 $15,017 $ 17,173 $ 15,792 $ 13,793 Total assets.............................. 22,518 25,461 32,584 45,636 49,884 44,596 Total long-term and short-term debt, including mandatorily redeemable Class C Preferred Stock......................... 9,491 10,479 13,291 92,134 88,597 92,682 Common stock warrants..................... -- -- -- 490 879 879 Redeemable convertible preferred stock (Class A and Class B Preferred Stock)... -- -- -- 46,836 50,591 47,584 Shareholders' equity (deficit)............ $ 8,405 $ 9,724 $11,879 $(102,655) $(102,488) $(105,651)
- --------------- (1) The 1997 severance charge represents the total salary continuation payments which the Company is required to make to a former management employee who resigned in 1997. (2) Owners' compensation represents distributions to the Company's shareholders during the periods when Kirkland's, Inc. and the Kirkland Companies were Subchapter S corporations, prior to the Recapitalization. Such distributions ceased upon the Recapitalization. See "Certain Transactions - Recapitalization." (3) Reflects accretion to the fair value of detachable put warrants to purchase Common Stock, issued by the Company in connection with its issuance of subordinated debt. The holders of these warrants agreed to terminate the put as of January 1, 1998. (4) Reflects the accretion of the Class A Preferred Stock and Class B Preferred Stock to its redemption value and the accrual of dividends on such preferred stock at 8% annually. (5) The term EBITDA as used herein represents income before income taxes, net interest expense, depreciation and amortization expense, owners' compensation and non-recurring charges. While EBITDA should not be considered in isolation or as a substitute for net income, cash flow from operations or any other measure of income or cash flow that is prepared in accordance with generally accepted accounting principles or as a measure of a company's profitability or liquidity, EBITDA has been presented because the Company believes it is commonly used in this or a similar format by investors to analyze and compare operating performance as well as to provide additional information with respect to the ability of the Company to meet its future debt service, capital expenditure and working capital requirements. EBITDA may differ in method of calculation from similarly titled measures used by other companies. This information should be read in conjunction with the Combined Statement of Cash Flows contained in the Combined Financial Statements and notes thereto included elsewhere in this Prospectus. (6) For periods ended on or before December 31, 1996, comparable stores were defined as those stores opened prior to January 1 of the preceding fiscal year. Effective January 1, 1997, in response to increased expansion and remodeling activity, the Company modified the way comparable store net sales are calculated to more accurately reflect the Company's ongoing expansion and remodeling program. Commencing January 1, 1997, the Company excluded from comparable store net sales calculations each store that was expanded, remodeled or relocated during the applicable period. Each such store is returned to the comparable store base on January 1 of the first year following the one-year anniversary of the expansion, remodeling or relocation. (7) Calculated using net sales of all stores open at both the beginning and the end of the period. (8) Calculated using gross square footage of all stores open at both the beginning and the end of the period. Gross square footage includes the storage, receiving and office space that generally occupies approximately 30% of total store space. 23 25 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS A number of the matters and subject areas discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business" and elsewhere in this Prospectus are not limited to historical or current facts and deal with potential future circumstances and developments, and are accordingly "forward-looking statements." Prospective investors are cautioned that such forward-looking statements, which may be identified by words such as "anticipate," "believe," "expect," "estimate," "intend," "plan" and similar expressions, are only predictions and that actual events or results may differ materially. OVERVIEW Kirkland's opened its first store in 1966 and has generated operating income in each year of its operations. The Company has expanded its business steadily over the years, focusing originally on middle markets in the Southeast, and more recently opening stores in markets of varying size and geography. The Company accelerated its expansion beginning in 1990, more than doubling its store base from 50 stores at the end of 1990 to 104 stores at the end of 1995. During this same period, which preceded the Recapitalization (as defined below), the Company's net sales and operating income before owners' compensation grew at compounded annual rates of 20.3% and 24.3%, respectively. In 1995, the Company's operating income before owners' compensation as a percentage of net sales was 14.9%. On June 12, 1996, the Company completed a leveraged recapitalization (the "Recapitalization") which included the following principal components: (i) the creation of two classes of redeemable convertible preferred stock - Class A Preferred Stock and Class B Preferred Stock; (ii) the creation of a class of mandatorily redeemable preferred stock - Class C Preferred Stock; (iii) the distribution of all of the Class B Preferred Stock and Class C Preferred Stock to the existing shareholders of the Company; (iv) the sale of newly issued shares of common stock and all of the Class A Preferred Stock for cash of $30.8 million to a group of new investors led by Advent International Corporation ("Advent"); (v) the issuance of $20.0 million of senior subordinated notes due June 2003; (vi) the issuance of $52 million of variable rate senior debt under the Company's senior credit facility, with quarterly principal and interest payments through June 2002; (vii) the repurchase and cancellation of 68.4% of the aggregate common stock of the existing shareholders of the Company for cash of $83.1 million; and (viii) the repayment of existing indebtedness of the Company totaling $19.2 million. Total transaction - related fees for the Recapitalization amounted to approximately $6.3 million. Of this amount, financing costs of approximately $5.9 million associated with the senior subordinated notes and the senior debt were deferred and are being amortized over the life of this debt. The Company will apply a portion of the net proceeds of the Offering to repay the senior subordinated notes and a portion of the senior debt. See "Use of Proceeds." Moreover, the Company expects to enter into a new credit facility upon completion of the Offering to refinance the existing senior credit facility and, in such event, the Company will write off the remaining unamortized portion of the senior debt financing costs ($4.0 million at March 31, 1998) in the quarter in which the refinancing occurs. In connection with the Recapitalization, the Company entered into employment agreements with three key management employees and a consulting agreement with another individual, all of whom were existing shareholders of the Company. On January 7, 1998, the Company redeemed and retired the stock of one of these management employees in connection with his November 1997 resignation. As a result of his resignation, the Company incurred a severance charge of $756,000 in 1997, representing the total salary continuation payments which the Company is required to make to this former management employee through June 2000. See "Certain Transactions - January 1998 Redemption." Prior to June 12, 1996, the Company elected to be taxed as a Subchapter S corporation for federal income tax purposes. As a result, the Company recorded no taxes and shareholders paid tax on their respective shares of taxable income, even if such income was not distributed. The Company's typical practice was to pay, on an annual basis, a substantial portion of the Company's income to shareholders as owners' compensation. Until the Pre-Offering Transactions, which will take place immediately prior to completion of the Offering, Kirkland's, Inc. and the Kirkland Companies will continue to receive certain tax benefits ("surtax exemptions") due to graduating tax rates applicable to each separate corporate entity. The benefits 24 26 derived from such surtax exemptions amounted to approximately 10% of income before income taxes in 1996 and 1997. These benefits will no longer be available to the Company after the Kirkland Companies become wholly-owned subsidiaries of the Company pursuant to the Pre-Offering Transactions. As a result of the Recapitalization, the Company has incurred an expense related to the accretion of common stock warrants based on the increase in their fair market value through 1997. As discussed in "Description of Capital Stock - Warrants," these warrants will be exercised in connection with the Offering. Following the exercise of the warrants, no further accretion expense will be incurred. The Recapitalization also included the issuance of the Class A Preferred Stock and Class B Preferred Stock. The Class A Preferred Stock and Class B Preferred Stock each carry an 8% annual dividend, which reduces net income allocable to common stock. The accrual of such dividends and the related accretion of the preferred stock to its redemption value will terminate in connection with the conversion or exchange of such preferred stock into or for Common Stock pursuant to the Pre-Offering Transactions. Since the Recapitalization, the Company has continued to expand, opening 17 new stores in 1996 and 20 new stores in 1997. The Company also has made considerable investments in management and infrastructure to support an increased rate of expansion in the future. These investments have included management personnel additions within the areas of finance, real estate and merchandising. Further, in 1997, a new regional management structure was implemented to augment the Company's existing district management structure. The Company also made a strategic decision to increase the number of salaried assistant managers in its stores in order to strengthen store-level operations as well as to identify and train future store manager candidates. In addition, in March 1998 the Company commenced an expansion of its headquarters facility to a total of approximately 40,000 square feet, at an estimated cost of $2.2 million to be funded from cash flow from operations. In 1997, the Company had net sales of $153.6 million and its operating income (before severance charge) as a percentage of net sales was 11.4%, one of the highest among comparable specialty retailers. 25 27 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, combined statement of income data expressed as a percentage of net sales:
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, ----------------------- -------------- 1995 1996 1997 1997 1998 ----- ----- ----- ----- ----- Net sales.................................. 100.0% 100.0% 100.0% 100.0% 100.0% Cost of sales (including store occupancy costs)................................... 61.4 62.9 63.2 71.1 69.0 ----- ----- ----- ----- ----- Gross profit............................. 38.6 37.1 36.8 28.9 31.0 Operating expenses......................... 21.6 21.8 22.8 28.2 30.0 Severance charge(1)........................ -- -- 0.5 -- -- Recapitalization expenses.................. -- 0.7 -- -- -- Owners' compensation(2).................... 12.4 -- -- -- -- Depreciation and amortization.............. 2.1 2.6 2.7 3.8 3.8 ----- ----- ----- ----- ----- Operating income (loss).................. 2.5 12.0 10.8 (3.1) (2.8) Interest expense: Senior, subordinated and other notes payable............................... 1.3 4.0 5.2 7.5 6.3 Class C Preferred Stock(3)............... -- 0.8 1.2 1.7 1.3 Accretion of common stock warrants....... -- 0.1 0.3 0.4 -- Interest income............................ (0.1) -- (0.1) -- -- Other income, net.......................... (0.2) (0.1) (0.1) (0.2) (0.2) ----- ----- ----- ----- ----- Income (loss) before income taxes........ 1.5 7.2 4.3 (12.5) (10.2) Income tax provision (benefit)............. -- 2.1 1.8 (3.5) (3.1) ----- ----- ----- ----- ----- Net income (loss)........................ 1.5 5.1 2.5 (9.0) (7.1) Accretion of redeemable preferred stock and accrual of dividends (Class A and B Preferred Stock)......................... -- 1.8 2.4 3.6 3.2 ----- ----- ----- ----- ----- Net income (loss) allocable to common stock.................................... 1.5 3.3 0.1 (12.6) (10.3) ===== ===== ===== ===== =====
- --------------- (1) The 1997 severance charge represents the total salary continuation payments which the Company is required to make to a former management employee who resigned in 1997. (2) Owners' compensation represents distributions to the Company's shareholders during the periods when Kirkland's, Inc. and the Kirkland Companies were Subchapter S corporations, prior to the Recapitalization. Such distributions ceased upon the Recapitalization. (3) The mandatorily redeemable Class C Preferred Stock is reflected as debt, and the amounts paid by the Company with respect to such preferred stock are classified as interest expense, in the Company's Combined Financial Statements. See Note 6 of "Notes to Combined Financial Statements." Three Months Ended March 31, 1998 Compared to Three Months Ended March 31, 1997 Net sales increased by 16.9% to $30.6 million for the three months ended March 31, 1998 from $26.2 million for the three months ended March 31, 1997. This increase resulted primarily from the opening of three new Kirkland's stores and an increase in comparable store net sales of 3.6%, offset in part by the closing of two stores in 1997 and one store in the first quarter of 1998. The increase in comparable store net sales was due primarily to a higher average transaction size. The increase in average transaction size resulted primarily from the Company's strategy of increasing its average product prices and deemphasizing lower-priced products. Comparable store net sales were adversely impacted by the shift in the timing of the Easter holiday to April in 1998 from March in 1997. As a result of this shift, there were fewer holiday shopping days in March 1998 than in March 1997. Gross profit was $9.5 million, or 31.0% of net sales, in the first three months of 1998 as compared to $7.6 million, or 28.9% of net sales, in the first three months of 1997. The increase in gross profit as a percentage of net sales resulted from an improvement in product gross margin, offset somewhat by an increase in store occupancy costs as a percentage of net sales. 26 28 Operating expenses were $9.2 million, or 30.0% of net sales, in the first three months of 1998 as compared to $7.4 million, or 28.2% of net sales, in the first three months of 1997. This increase as a percentage of net sales was primarily attributable to an increase in store salary expense, due principally to the Company's strategic decision in late 1996 to increase the number of salaried assistant store managers. This decision, which was implemented over the course of the year in 1997, led to a higher number of salaried assistant store managers in the first three months of 1998 as compared to the prior year period. In addition, the increase as a percentage of net sales resulted from an increase in corporate salary expense, primarily due to the implementation of a new store operations regional management structure during 1997 in anticipation of future store growth. To a lesser extent, the percentage increase also resulted from an increase in the amount of local warehouse space leased by the Company. Depreciation and amortization expense was $1.2 million, or 3.8% of net sales, in the first three months of 1998 as compared to $1.0 million, or 3.8% of net sales, in the first three months of 1997. The increase in the dollar amount of this expense resulted primarily from an increase in depreciable assets due to the Company's new store openings during 1997. Interest expense on senior, subordinated and other notes payable decreased slightly to $1.9 million in the first three months of 1998 from $2.0 million in the first three months of 1997. Average debt balances were lower in the first three months of 1998 as compared to the prior year period due to amortization payments made during 1997. Interest expense associated with mandatorily redeemable Class C Preferred Stock issued in connection with the Recapitalization (reflected as debt on the Company's Combined Financial Statements) decreased to $385,000 in the first three months of 1998 from $450,000 in the first three months of 1997, reflecting the redemption in January 1998 of the Class C Preferred Stock of a former management employee. Income tax provision was a benefit of $920,000 in the first three months of 1998 as compared to a benefit of $923,000 in the first three months of 1997. The income tax provision expressed as a percentage of income before income taxes for the first three months of 1998 and 1997 was 29.9% and 28.1%, respectively. Net loss allocable to common stock decreased slightly to $3.2 million in the first three months of 1998 from $3.3 million in the first three months of 1997, resulting principally from the above factors. Year Ended December 31, 1997 Compared to Year Ended December 31, 1996 Net sales increased by 20.0% to $153.6 million for the year ended December 31, 1997 from $127.9 million for the year ended December 31, 1996. This increase resulted primarily from the opening of 20 new Kirkland's stores, including the Company's first outlet store, and an increase in comparable store net sales of 5.2%, offset in part by the closing of one store in 1996 and two stores in 1997. The Company's net sales also benefited from the operation of the Company's first two temporary stores during the fourth quarter. The increase in comparable store net sales was due primarily to a higher average transaction size as compared to the prior year. Gross profit was $56.6 million, or 36.8% of net sales, in 1997 as compared to $47.5 million, or 37.1% of net sales, in 1996. The decline in gross profit as a percentage of net sales resulted primarily from an increase in store occupancy costs as a percentage of net sales in 1997. Operating expenses were $35.0 million, or 22.8% of net sales, in 1997 as compared to $27.9 million, or 21.8% of net sales, in 1996. This increase as a percentage of net sales was primarily attributable to an increase in store salary expense. In particular, the Company made strategic decisions in late 1996 to increase the salary levels of store managers and to increase, over the course of the year in 1997, the overall number of salaried assistant store managers. To a lesser extent, the increase as a percentage of net sales also resulted from an increase in corporate salary expense in anticipation of future store growth. The Company incurred no recapitalization expenses in 1997, as compared to $854,000 of such expenses, or 0.7% of net sales, in 1996 in connection with the Recapitalization. A severance charge of $756,000, or 0.5% of net sales, was recorded in 1997 representing the remaining obligations of the Company under an employment agreement with a former management employee who resigned during the year. Depreciation and amortization expense was $4.1 million, or 2.7% of net sales, in 1997 as compared to $3.4 million, or 2.6% of net sales, in 1996. This increase as a percentage of net sales resulted from a full year of amortization of debt issuance costs associated with the Recapitalization. 27 29 Interest expense on senior, subordinated and other notes payable increased to $8.0 million in 1997 from $5.1 million in 1996, primarily due to a full year of interest on the additional debt incurred in connection with the Recapitalization completed in June 1996. Interest expense associated with mandatorily redeemable Class C Preferred Stock increased to $1.8 million in 1997 from $1.0 million in 1996, due to a full year on this obligation incurred in connection with the Recapitalization. Further, expense relating to the accretion of common stock warrants increased to $389,000 in 1997 from $190,000 in 1996. The Company had $20.1 million of debt outstanding immediately prior to the Recapitalization and $94 million of debt outstanding upon completion of the Recapitalization. Income tax provision increased to $2.8 million for 1997 from $2.7 million in 1996. The income tax provision expressed as a percentage of income before income taxes in 1997 and 1996 was 41.8% and 29.1%, respectively. The 1997 effective tax rate was higher than the 1996 effective tax rate due to a charge of 10.4% related to a valuation allowance recorded in 1997 regarding the realization of net operating loss carry-forwards that originated in 1997 on a separate return basis. In addition, the 1996 effective tax rate was reduced by a one-time benefit of $379,000 in connection with the termination of Subchapter S corporation status, which took place in connection with the Recapitalization. Net income allocable to common stock decreased to $167,000, or 0.1% of net sales, in 1997 from $4.3 million, or 3.3% of net sales, in 1996. This decrease resulted from the above factors as well as the increase in accretion of redeemable convertible Class A and Class B Preferred Stock and dividends accrued to $3.8 million, or 2.4% of net sales, in 1997 from $2.3 million, or 1.8% of net sales, in 1996, due to the preferred stock being outstanding for a full year in 1997. Year Ended December 31, 1996 Compared to Year Ended December 31, 1995 Net sales increased by 14.2% to $127.9 million for the year ended December 31, 1996 from $112.0 million for the year ended December 31, 1995. This increase resulted primarily from the opening of 17 new Kirkland's stores and an increase in comparable store net sales of 1.4%, offset in part by the closing of one Kirkland's store during 1996. The increase in comparable store net sales was due primarily to a higher average transaction size, reflecting higher average unit prices as compared to the prior year. Gross profit was $47.5 million, or 37.1% of net sales, in 1996 as compared to $43.2 million, or 38.6% of net sales, in 1995. The decline in gross profit as a percentage of net sales resulted primarily from an increase in store occupancy costs as a percentage of net sales and, to a lesser extent, from a decrease in the Company's product gross margin. In 1995, product gross margin was particularly high due to strong sell-through and the attendant lower mark-down rates. Operating expenses were $27.9 million, or 21.8% of net sales, in 1996 as compared to $24.2 million, or 21.6% of net sales, in 1995. This increase as a percentage of net sales was primarily due to the minimum wage increase and an increase in the amount of local store warehouse space leased by the Company. The Company incurred recapitalization expenses of $854,000, or 0.7% of net sales, in 1996 in connection with the Recapitalization. There were no recapitalization expenses in 1995. The Company incurred no owners' compensation expenses in 1996, as compared to $13.9 million of such expenses, or 12.4% of net sales, in 1995. Depreciation and amortization expense was $3.4 million, or 2.6% of net sales, in 1996 as compared to $2.4 million, or 2.1% of net sales, in 1995. This increase as a percentage of net sales resulted primarily from the amortization of debt issuance costs associated with the Recapitalization, which expense was not incurred in 1995. In addition, depreciation expense also increased as a percentage of net sales due to additional depreciable assets from new stores. Interest expense on senior, subordinated and other notes payable increased to $5.1 million in 1996 from $1.4 million in 1995, primarily due to interest on the debt incurred in connection with the Recapitalization. Interest expense associated with mandatorily redeemable Class C Preferred Stock was $1.0 million in 1996. No Class C Preferred Stock was outstanding during 1995. Additionally, the accretion of common stock warrants totaled $190,000 in 1996. No such accretion was recorded in 1995 as no warrants were outstanding in 1995. Income tax provision in 1996 was $2.7 million, or 29.1% of income before income taxes. Prior to the Recapitalization of June 1996, the Company elected to be taxed as a Subchapter S corporation for federal 28 30 income tax purposes. As a result, in 1995 the Company recorded no taxes and instead shareholders paid tax on their respective shares of taxable income, even if such income was not distributed. The Company's typical practice was to pay, on an annual basis, a substantial portion of the Company's income to shareholders as owners' compensation. This practice ceased with the Recapitalization, in connection with which the Company's S corporation status was terminated. Net income allocable to common stock increased to $4.3 million, or 3.3% of net sales, in 1996 from $1.7 million, or 1.5% of net sales, in 1995. This increase resulted from the above factors, offset in part by the accretion of redeemable convertible Class A and Class B Preferred Stock and dividends accrued of $2.3 million. No preferred stock and no warrants were outstanding in 1995. SEASONALITY AND QUARTERLY FLUCTUATIONS The Company has historically experienced and expects to continue to experience substantial seasonal fluctuations in its net sales and operating income. The Company believes this is the general pattern typical of its segment of the retail industry and, as a result, expects that this pattern will continue in the future. The Company's quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of new store openings. Consequently, comparisons between quarters are not necessarily meaningful and the results for any quarter are not necessarily indicative of future results. The following table sets forth certain unaudited financial and operating data for the Company in each quarter during 1996 and 1997. The unaudited quarterly information includes all normal recurring adjustments which management considers necessary for a fair presentation of the information shown.
1996 ------------------------------------------------------------ THREE MONTHS ENDED ---------------------------------------------- YEAR ENDED MARCH 31 JUNE 30 SEPT. 30 DEC. 31 DEC. 31 --------- -------- --------- -------- ---------- (IN THOUSANDS, EXCEPT STORE DATA) Net sales.............................. $21,742 $24,358 $27,635 $54,211 $127,946 Gross profit........................... 6,709 8,386 9,382 23,031 47,508 Operating income(1).................... 3 645 2,085 12,623 15,356 Stores open at period end.............. 104 111 113 120 120 Comparable store net sales increase (decrease)(3)........................ 4.0% 4.0% (1.1)% 0.3% 1.4%
1997 ------------------------------------------------------------ THREE MONTHS ENDED ---------------------------------------------- YEAR ENDED MARCH 31 JUNE 30 SEPT. 30 DEC. 31 DEC. 31 --------- -------- --------- -------- ---------- (IN THOUSANDS, EXCEPT STORE DATA) Net sales.............................. $26,178 $30,316 $33,120 $63,970 $153,584 Gross profit........................... 7,559 9,980 11,381 27,666 56,586 Operating income (loss)(2)............. (836) 1,228 1,760 14,532 16,684 Stores open at period end.............. 120 127 135 138 138 Comparable store net sales increase(3).......................... 4.8% 11.3% 6.7% 1.2% 5.2%
- --------------- (1) Operating income for the third quarter of 1996 reflects $854,000 of recapitalization expenses incurred in connection with the Recapitalization. (2) Operating income for the fourth quarter of 1997 reflects a severance charge of $756,000 representing the total salary continuation payments which the Company is required to make to a former management employee who resigned in 1997. (3) For periods ended on or before December 31, 1996, comparable stores were defined as those stores opened prior to January 1 of the preceding fiscal year. Effective January 1, 1997, in response to increased expansion and remodeling activity, the Company modified the way comparable store net sales are calculated to more accurately reflect the Company's ongoing expansion and remodeling program. Commencing January 1, 1997, the Company excluded from comparable store net sales calculations each store that was expanded, remodeled or relocated during the applicable period. Each such store is returned to the comparable store base on January 1 of the first year following the one-year anniversary of the expansion, remodeling or relocation. 29 31 LIQUIDITY AND CAPITAL RESOURCES Most of the Company's capital requirements relate to new store openings and seasonal working capital. The Company's working capital requirements are for inventory purchases, which typically reach their peak in the fourth quarter of the year. Historically, the Company has funded its store expansion program and met its working capital requirements from internally generated funds and borrowings under its credit facilities. During 1995, 1996 and 1997, net cash provided by operating activities was $1.3 million, $11.1 million and $8.7 million, whereas $7.9 million was used in operating activities in the first quarter of 1998. During 1995, 1996, 1997 and the first quarter of 1998, net cash used in investing activities was $4.1 million, $4.2 million, $5.5 million and $903,000, respectively, consisting primarily of capital expenditures related to new stores and expansions or remodels of existing stores. In 1995, financing activities provided net cash of $3.3 million, due primarily to proceeds from the issuance of long-term debt. In 1996 and 1997, $1.0 million and $3.5 million, respectively, was used in financing activities. In the first quarter of 1998, net cash of $73,000 was provided by financing activities. In 1996, the principal sources of cash from financing activities were proceeds from the issuance of long-term debt and the Class A Preferred Stock and Common Stock in connection with the Recapitalization, whereas the principal uses of cash used in financing activities in 1996 were the repurchase of a portion of shareholders' Common Stock and repayment of long-term debt in connection with the Recapitalization. In 1997, the cash used in financing activities was for repayment of long-term debt. In the first quarter of 1998, the principal sources of cash in financing activities were proceeds from the issuance of long-term debt, offset by the payment of $6.9 million for the redemption of stock. See "Certain Transactions -- January 1998 Redemption." The Company expects to open approximately 25 new stores during 1998, three of which were opened during the first quarter of 1998. Capital expenditures, including leasehold improvements and furniture and fixtures, for the 20 new stores opened during 1997 averaged approximately $185,000 (net of landlord allowances), and initial gross inventory requirements (which were partially financed by trade credit) averaged approximately $230,000 per store. Opening inventory requirements at new stores vary significantly depending upon the time of year when the store is opened, expected sales volume and store size. The Company's cash needs for opening new stores in 1998 are expected to total $8.4 million, $4.6 million of which is budgeted for capital expenditures and $3.8 million of which is budgeted for initial inventory. During the first quarter of 1998, the Company incurred $600,000 in capital expenditures for new stores and $550,000 in initial inventory purchases relating to stores opened during the quarter. The Company intends to expand six stores in 1998 and to remodel an additional six stores in 1998. Capital expenditures for the Company's 1998 expansions and remodels are expected to total $2.5 million, of which $300,000 was incurred in the first quarter. The Company's total planned capital expenditures for 1998 are $11.1 million. In addition to providing for new stores, expanded stores and remodeled stores, these planned capital expenditures include $2.2 million for the Company's planned corporate headquarters expansion and $1.5 million for the upgrade of the Company's POS computer system. The Company's principal sources of capital are internally generated funds and borrowings under its credit facilities. In accordance with the agreement governing the Company's senior credit facility, the Company has a $20 million revolving line of credit. The line of credit has a maturity date of June 30, 2001 and bears interest at the Company's option either at (i) 3.25% plus LIBOR or (ii) the higher of the prime rate plus 2.25% or the federal funds rate plus 2.75%. The line of credit requires a thirty-day consecutive zero balance between December 1 and March 1 of each year. In addition, the line of credit requires the maintenance of certain specified financial ratios, restricts levels of capital expenditures and restricts the incurrence of debt and payments in respect of capital stock and junior indebtedness. As of March 31, 1998, the Company had no outstanding borrowings under the line of credit and availability to borrow up to $20 million. The Company is in negotiations to obtain a $40 million senior term loan and a $30 million five-year revolving credit facility which the Company plans to enter into upon completion of the Offering, to replace its existing senior credit facility. The new revolving credit facility is expected to replace the Company's current 30 32 line of credit facility. Borrowings under the new revolving credit facility are expected to be subject to certain customary conditions and contain customary events of default. There can be no assurance that the new revolving credit facility will be successfully negotiated. The Company believes that it can adequately fund its planned capital expenditures and working capital requirements through the end of 1999 from net cash provided by operations and availability under revolving credit facilities. INFLATION The Company does not believe that its operating results have been materially affected by inflation during the preceding three years. There can be no assurance, however, that the Company's operating results will not be adversely affected by inflation in the future. IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board issued FAS 130, Reporting Comprehensive Income ("SFAS No. 130"). This statement establishes standards for reporting comprehensive income and its components in a full set of general-purpose financial statements. SFAS No. 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income 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. Currently, the Company does not have any items that are required to be recognized as components of comprehensive income. In June 1997, the Financial Accounting Standards Board issued FAS 131, Disclosure about Segments of an Enterprise and Related Information ("SFAS No. 131"). This statement revises the current requirements for reporting business segments by redefining such segments as the way management disaggregates the business for purposes of making operating decisions and allocating internal resources. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997, and although management believes that SFAS No. 131 will not impact the Company's presentation, the Company will adopt SFAS No. 131 in fiscal 1998. YEAR 2000 ISSUE An issue exists for all companies that rely on computers as the year 2000 approaches. The "Year 2000" issue is the result of past practice in the computer industry of using two digits rather than four to identify the applicable year. This practice will result in incorrect results when computers perform arithmetic operations, comparisons or data field sorting involving years later than 1999. The Company anticipates that it will be able to test its entire system for Year 2000 compliance using its internal programming staff and outside computer consultants and intends to make the necessary modifications to prevent disruption to its operations. The Company does not expect costs in connection with any such modifications to be material. Independent of the Year 2000 issue, in 1998 the Company intends to install a new POS system which will be Year 2000 compliant at a cost of approximately $1.5 million. As a fundamental business consideration, the Company depends heavily on its vendors to meet the purchasing requirements dictated by the Company's business needs. To that end, the Company is in the process of exploring with each of its key vendors the impact the Year 2000 issue will have on their ability to source products for the Company and process purchase orders with delivery requirements and terms involving years later than 1999. As an ongoing measure, the Company will continue to address this risk with each new vendor to ensure similar safeguards. Finally, the Company recognizes the potential impact the Year 2000 issue may have on its customers, creditors and other service providers. The Company has reviewed its exposure to business interruption or substantial loss in these areas and believes no risk of material adverse consequences presently exists. 31 33 BUSINESS THE COMPANY Kirkland's is a leading specialty retailer of decorative home accessories and gifts. The Company's stores offer a broad selection of distinctive merchandise, including framed art, candles, lamps, picture frames, rugs, garden accessories and artificial plants, as well as an extensive assortment of holiday merchandise. The Company's stores are designed to provide style-conscious customers, the majority of whom are women age 25 and older, with a distinctive shopping experience characterized by a diverse, ever-changing merchandise selection at surprisingly attractive prices. Management believes that the Company's exclusive focus on decorative home accessories and gifts has led to its emergence as a leader in its retail category and a destination store for many mall shoppers. Kirkland's has generated operating income in each year since opening its first store in 1966, and currently maintains one of the highest operating margins among comparable specialty retailers. The Company's 141 stores in 25 states average approximately 4,400 square feet per store and are located primarily in enclosed malls. Although originally focused in the Southeast, the Company has expanded beyond that region. Currently, 58 of the Company's stores are located outside the Southeast, including 11 of the 20 new stores opened during 1997. In addition to operating in many middle markets, Kirkland's also has stores in major metropolitan markets such as Atlanta, Houston, Chicago, and Dallas, as well as in smaller markets such as Paducah, Kentucky, Florence, Alabama and Lancaster, Pennsylvania. The Company has been able to operate stores successfully across a broad range of demographic and geographic markets. Kirkland's has developed and refined a merchandising strategy that differentiates it from other retailers of products for the home. The Company's merchandising strategy is to (i) offer distinctive, high quality home accessories and gifts at affordable prices, (ii) maintain a breadth of product categories, (iii) provide a carefully edited selection of the best-selling items within each category, rather than merchandising complete product collections, and (iv) present merchandise in a visually appealing manner to create an inviting atmosphere which inspires decorating ideas. The Company believes that this strategy creates a shopping experience which appeals to the style-conscious as well as the price-conscious shopper. INDUSTRY OVERVIEW Kirkland's competes in the large market for decorative home accessories and gifts, which encompasses such varied product groups as candles, decorative pillows and rugs, framed art, pottery and holiday merchandise. According to published industry data, the U.S. retail market for home furnishings, housewares, bedding, bath and tabletop merchandise was estimated to have exceeded $66 billion in 1996. Furthermore, purchases of gifts, including gifts of decorative home accessories, were estimated to have represented approximately $36 billion (a portion of which is included in the broader retail category discussed above). The market for decorative home accessories and gifts is highly fragmented, with competition coming from a variety of retailers including department stores, discount stores, other specialty stores and catalog retailers. Management believes that the decorative home accessories and gift markets are benefitting from certain favorable demographic trends. First, the "cocooning" trend continues to have a significant impact on the market. As consumers retreat to their homes to spend time at home with family and friends, they buy products to enhance their home environment. Second, the U.S. Bureau of the Census reports that the percentage of the U.S. population represented by people between the ages of 35 and 64 is currently 38% and is expected to increase to approximately 40% by 2005. As this percentage increases, the target customer base for retailers of home accessories and gifts will likewise increase. Furthermore, people typically realize their peak earnings potential within this age bracket, which in turn will enable them to spend greater amounts on purchases for the home. These demographic patterns, along with the prevailing environment of low interest rates, have produced a discernible shift in the composition of general merchandise, apparel and furniture ("GAF") sales away from apparel to home furnishings. From 1990 to 1996, apparel purchases as a percentage of GAF declined by approximately 11%, while home furnishings as a percentage of GAF increased by approximately 10%. 32 34 The Company believes that these favorable demographic trends and the shift in consumer spending patterns toward home furnishings provide a substantial opportunity for a well-positioned specialty retailer like Kirkland's. BUSINESS STRATEGY The Company's goal is to be the leading specialty retailer of decorative home accessories and gifts in each of its markets. The following elements of the Company's business strategy, which have evolved over 32 years of successful operations, differentiate Kirkland's from its competitors and position the Company for continued growth: Distinctive, Item-Focused Merchandising. While a Kirkland's store contains items covering a broad range of complementary product categories, the store emphasizes only the best-selling items within each category. The Company does not seek to dictate a design theme to its customers, nor does it necessarily seek to dominate any particular product category. The Company instead takes a disciplined approach to identifying fashionable merchandise reflecting the latest trends, selecting and test-marketing products, and monitoring and reacting to individual item sales. No single merchandise category accounted for more than 15% of net sales in 1997. Changing Merchandise Mix. The merchandise mix in a Kirkland's store changes frequently throughout the year, in response to both market and sales trends and changes in seasons. The Company's information systems permit close tracking of individual item sales, enabling management to react quickly to both fast-selling and slow-moving items. In addition, the Company strategically increases selling space devoted to gifts and holiday merchandise during peak selling seasons such as Christmas and Easter. The Company believes that its ever-changing mix of merchandise creates an exciting environment for customers, encouraging frequent return visits to its stores. Visually Appealing Store Environment. Kirkland's distinguishes itself through its stores' "interior design" look, achieved by its emphasis on visual merchandising. Using multiple types of fixtures, the Company groups complementary merchandise creatively throughout the store, rather than displaying products strictly by category or product type. This visual presentation helps customers to picture the merchandise in their own homes and thus inspires decorating ideas. As a result, this strategy provides the opportunity for add-on sales and also encourages customers to browse for longer periods of time. Competitive Pricing. Kirkland's merchandise ranges in price from approximately $5 to approximately $250, with most items selling for under $30. Kirkland's shoppers regularly experience the satisfaction of paying noticeably less for items similar or identical to those sold by other retailers or through catalogs. Consequently, the Company does not routinely engage in promotions or sales and typically holds only two regular sales events each year. Management believes that the Company's competitive pricing is an important element in making Kirkland's a destination store for many mall shoppers. Flexible Real Estate Strategy. The Company's stores are predominantly located in enclosed malls in middle, metropolitan and smaller markets. The Company believes that its stores' broad appeal makes Kirkland's a desirable tenant for community, regional and super-regional malls targeting both middle and upper-income customers as well as for selected non-mall venues. The flexibility of the Kirkland's concept enables the Company to select the most promising real estate opportunities that meet requisite economic and demographic criteria within the Company's target markets. GROWTH STRATEGY The Company's growth strategy includes opening new stores, expanding and remodeling existing stores and introducing new retail formats. Open New Stores. The Company intends to continue opening new stores both in existing and new markets, emphasizing mall locations in both middle markets and metropolitan markets. The broad appeal of the Kirkland's concept has enabled it to operate successfully in diverse geographic and demographic markets, 33 35 thereby increasing the number of potential sites available to the Company. The Company believes that there are currently more than 500 additional malls in the United States that could provide attractive locations for the Kirkland's concept. Of the 20 new stores opened in 1997, 11 were opened outside of the Southeast and one was located in a state in which the Company previously had no stores. The Company intends to open approximately 25 stores in 1998, of which two are expected to be in states in which the Company does not already operate, and approximately 30 stores in 1999. During the first quarter of 1998, the Company opened three new stores and signed leases for an additional 13 stores, including additional locations in Florida, Indiana, Iowa, Louisiana, North Carolina, Ohio, Pennsylvania, Texas and Virginia as well as locations in two new markets, New York and Wisconsin. Expand and Remodel Existing Stores. The Company has an ongoing expansion and remodeling program which will continue to be an important part of the Company's strategy. The expansion initiative targets stores with proven high sales volumes that management believes could operate more effectively and produce higher sales with more square footage and mall frontage. Depending on the circumstances, an expansion may take place in a store's existing location or may accompany a relocation within the same mall. Expanded stores have been among the Company's best performing stores. Since 1993, the Company has expanded 22 stores from an average size of approximately 3,500 square feet to a larger size of approximately 5,100 square feet, remodeling them in the process. The average cost of expanding and remodeling each of these stores was approximately $210,000. In addition, the Company's 64 new stores opened since 1994 have averaged approximately 4,600 square feet. The Company intends to expand a total of six stores in 1998 and seven stores in 1999. The Company's remodeling initiative improves fixtures and displays, and strengthens the visual impact of the store, without expanding its square footage. Since 1993, the Company has remodeled four existing stores without concurrent increases in store size. The average cost of remodeling each of these stores was approximately $150,000. The Company intends to remodel (without expanding) a total of six stores in 1998 and seven stores in 1999. The following table provides a history of the Company's store openings and closings, as well as its expansion and remodeling program for the past five years and the first quarter of 1998.
MARCH 31, 1993 1994 1995 1996 1997 1998 ----- ----- ----- ----- ----- --------- Stores open at beginning of period...... 67 80 91 104 120 138 New stores opened(1).................... 13 11 13 17 20 3 Stores closed........................... 0 0 0 1 2 1 Stores open at end of period............ 80 91 104 120 138 140 Stores expanded and remodeled........... 2 3 5 3 6 3 Stores remodeled........................ 0 0 2 0 2 4 Average gross square footage per store(2).............................. 3,753 3,821 3,942 4,091 4,186 4,382
- --------------- (1) Excludes two temporary stores opened in 1997 during the holiday season only. (2) Calculated using gross square footage of all stores open at both the beginning and the end of the period. Gross square footage includes the storage, receiving and office space that generally occupies approximately 30% of total store space. Introduce New Retail Formats. The Company has developed several new retail formats which it believes have significant potential. These alternative formats leverage Kirkland's expertise in home accessory and gift merchandising and create new channels through which to reach and expand Kirkland's target customer base. - Temporary Stores. During the 1997 Christmas season, the Company operated two stores in malls under short-term lease arrangements. This strategy enabled the Company to capture incremental sales and profits during the peak holiday selling season, while avoiding the expense of constructing and fixturing a permanent store. Due to the success of this initial test, the Company intends to increase its use of temporary stores during the 1998 holiday season. In addition to providing an incremental profit 34 36 opportunity, these stores will enable the Company to test new markets where it is considering opening permanent stores. - Outlet Stores. Management believes that the strong price/quality relationship in a Kirkland's store makes Kirkland's an attractive tenant for certain outlet malls. In November 1997, the Company opened its first outlet store in the Grapevine Mills outlet center in Dallas, Texas. The store, which contains a mix of core Kirkland's merchandise as well as certain merchandise purchased exclusively for the outlet mall customer, capitalizes on the Company's ability to recognize and capture special purchasing opportunities, such as vendor overstocks or closeouts. Based on the initial success of its first outlet store, the Company anticipates opening one new outlet store in 1998 and is targeting four new sites for additional outlet stores in 1999. - Strip Center Stores. Management continues to evaluate the attractiveness of opening Kirkland's stores in non-mall, community strip and selected power centers. The Company currently operates two stores in such strip centers, one in Memphis, Tennessee and one in Kansas City, Missouri, and will open a third store in a power center in Louisville, Kentucky in 1998. - Upscale "the Kirkland Collection" Stores. Management has developed a more upscale version of the traditional Kirkland's store specifically to address the needs of certain more exclusive, high-end malls. The first of these stores is scheduled to open in Houston, Texas in May 1998, offering an upscale mix of certain core Kirkland's merchandise supplemented by selected higher end merchandise that will not be found in traditional Kirkland's stores. MERCHANDISING Merchandising Strategy. The Company's merchandising strategy is to (i) offer distinctive, high quality home accessories and gifts at affordable prices, (ii) maintain a breadth of product categories, (iii) provide a carefully edited selection of the best-selling items within each category, rather than merchandising complete product collections, and (iv) present merchandise in a visually appealing manner to create an inviting atmosphere which inspires decorating ideas. The Company believes that this strategy creates a shopping experience which appeals to the style-conscious as well as the price-conscious shopper. Kirkland's does not attempt to dictate fashion to its customers. Rather, the Company identifies and capitalizes on existing or developing trends when selecting merchandise for sale. The Company continuously introduces new products to its merchandise assortment in order to (i) maintain customer interest through the freshness of its product selections, (ii) enhance Kirkland's reputation as a leader in identifying high quality, fashionable products and (iii) allow merchandise which has peaked in sales to be discontinued and replaced by new items. In addition, the Company strategically increases selling space devoted to gifts and holiday merchandise during peak selling seasons such as Christmas and Easter. Management estimates that approximately 10% of the Company's merchandise assortment is designed exclusively for Kirkland's. The Company packages some of its merchandise using its exclusive Cedar Creek private label brand. Management estimates that approximately 20% of the Company's merchandise assortment is sold under the Cedar Creek private brand name. The Company's stores generally carry 1,500 to 3,000 different items of inventory, or "SKUs," depending on store size. The Company offers an affordable assortment of the best-selling items within a category as well as new items which management believes could generate significant consumer interest, rather than offering complete product collections. As a result, the Company is able to reduce the accumulation of slow-moving inventory and resulting markdowns. Regional differences in home decor are addressed by tailoring inventories to local tastes or market opportunities. Product Categories. The Company's major merchandise categories include framed art, candles, lamps, picture frames, rugs, garden accessories and artificial plants, as well as an extensive assortment of holiday merchandise. No single merchandise category accounted for more than 15% of net sales in 1997. Consistent with the Company's item-focused strategy, a vital part of the product mix is a wide variety of decorative home accessories and other assorted merchandise that does not necessarily fit into a designated category. Decorative 35 37 accessories consist of such varied products as pillows, sconces and porcelain items. Other merchandise includes flags, dolls and angels. Christmas holiday merchandise accounted for approximately 12% of net sales in both 1996 and 1997. Pricing. Kirkland's merchandise ranges in price from approximately $5 to approximately $250, with most items selling for under $30. The average sale at the Company's stores in 1997 was $17.22, up from $16.74 in 1996 and $16.27 in 1995. The Company's merchandising strategy does not depend on price discounting. Kirkland's stores typically have only two regular annual sale events, one in January and one in July. Visual Merchandising. Kirkland's distinguishes itself through its stores' "interior design" look, achieved by its emphasis on visual merchandising. The Company employs a Director of Visual Merchandising and seven specialists who support the stores' merchandising efforts. The Visual Merchandising team provides store managers with recommended display directives such as photographs and drawings, weekly placement guides and display manuals. In addition, each store manager has some flexibility to creatively highlight those products that are expected to have the greatest appeal to local shoppers. THE KIRKLAND'S STORE Format. The prototype Kirkland's store is between 4,200 and 5,200 square feet, of which approximately 70% typically represents selling space. Merchandise is generally displayed according to display guidelines and directives given to each store from the Visual Merchandising team with input from purchasing and operations personnel. This procedure ensures uniform display standards and efficient allocation of products throughout the Company's stores. Using multiple types of fixtures, the Company groups complementary merchandise creatively throughout the store, rather than displaying products strictly by category or product type. This visual presentation helps customers to picture the merchandise in their own homes and thus inspires decorating ideas. As a result, this strategy provides the opportunity for add-on sales and also encourages customers to browse for longer periods of time. The check-out counter is generally located towards the center of the store, and virtually all stores offer complimentary gift wrapping at the rear of the store, a customer service feature which is not typical in mall-based shops. Shopping Experience. Kirkland's stores are designed to provide customers with a distinctive shopping experience characterized by a diverse, ever-changing merchandise selection at surprisingly attractive prices. Consistent with its item-focused merchandising strategy, the Company continually evaluates new merchandise and assesses the sales trends of items already in the stores. This active management of the merchandise mix leads to frequent introduction of new items, which in turn encourages shoppers to visit the stores frequently. Kirkland's shoppers regularly experience the satisfaction of paying noticeably less for items similar or identical to those sold by other retailers or through catalogs. Management believes that Kirkland's exclusive focus on decorative home accessories and gifts has led to its emergence as a leader in its retail category and a destination store for many mall shoppers. Store Operations. Kirkland's stores are open seven days a week during mall hours. The Company's store operations are managed by two Vice Presidents of Store Operations, five regional managers and 25 district managers who generally have responsibility for six to 10 stores within a geographic district. Individual stores are managed by a store manager and one or two assistant store managers. The store manager is responsible for the day-to-day operation of the store, including inventory receipt and merchandise display, personnel functions, store security and sales. A typical store has one or two full-time sales associates and six to twelve part-time sales associates, depending on the season. Additional part-time sales associates are typically hired to assist with increased traffic and sales volume in the fourth quarter. Kirkland's compensates its district and store managers with a base salary plus a performance bonus based on store sales, expense control and loss prevention. Sales associates are compensated on an hourly basis. The Company believes that its continued success is dependent in part on its ability to attract, retain and motivate quality employees. In particular, the success of the Company's expansion program will be dependent on its ability to promote and/or recruit qualified district and store managers and maintain quality sales associates. To date, the majority of the Company's district managers were previously Kirkland's store managers. Store managers, many of whom are selected from among the Company's sales associates, currently 36 38 complete a formal training program before taking responsibility for a store. Store managers are responsible for the hiring and training of new sales associates, assisted where appropriate by two full-time recruiters. The Company is continuing to develop enhanced training programs for its store managers, assistant managers and sales associates. The Company constantly looks for motivated and talented people to promote from within Kirkland's, in addition to recruiting from outside the Company. Site Selection. Kirkland's seeks to locate its stores in malls which are destinations for large numbers of shoppers and which reinforce the Company's quality image. To assess potential new mall locations, management reviews financial and demographic criteria and analyzes the quality of tenants and competitive factors, square footage availability, frontage space and location and other relevant criteria to determine the overall acceptability of a mall and the optimal locations within it. The Company prefers to locate its stores in regional or super-regional malls with a history of high sales per square foot and multiple national department stores as anchors, and seeks approximate store frontage of 35 to 40 feet on average. The Company believes that it is a desirable tenant to mall developers because of its long and successful operating history, sales productivity, ability to attract customers and its strong position in the decorative home accessory and gift categories. PURCHASING, ALLOCATION AND DISTRIBUTION Purchasing. Management believes that its disciplined approach to purchasing, its relationships with its suppliers and its strong buying power contribute to its successful purchasing strategy. The Company buys inventory on a centralized basis to take advantage of volume purchase discounts and improve its ability to control inventory product mix. The Company's 10-person centralized buying group is responsible for all purchasing decisions and price negotiations with vendors. Kirkland's purchases merchandise on a product by product basis, rather than based upon category classifications. The Company manages its total purchases based upon annual budgets which are set at the beginning of the year and updated throughout the year. The Company purchases its products from approximately 140 vendors. In 1997, approximately 55% of the Company's total purchases were from importers of merchandise manufactured primarily in the Far East, Mexico and India, with the balance purchased from domestic manufacturers and wholesalers. For its purchases of merchandise manufactured abroad, the Company believes that buying from importers instead of directly from foreign manufacturers enables it to maximize flexibility and minimize risks. Kirkland's believes that its executive management and buyers are more effective by focusing on managing the retail business and allowing importers to handle the procurement and shipment of foreign-manufactured merchandise for its stores. The purchase of approximately 45% of its products from domestic manufacturers and wholesalers enables the Company to reduce the lead time between ordering products and displaying them in the Company's stores. Allocation and Distribution. The Company continually strives to improve its merchandising, distribution, planning and allocation methods to manage its inventory more efficiently. The Company closely watches inventory levels on a per store basis to ensure that sufficient merchandise quantities are on hand at each store location. Each Kirkland's store is internally classified for merchandising purposes based on certain criteria including store sales, size, location and historical performance. Although all Kirkland's stores carry similar merchandise, the variety and depth of products in a given store may vary depending on the store's rank and classification. Inventory purchases and allocation are also tailored based on regional or demographic differences between stores. Information from the Company's POS computer system is regularly reviewed and analyzed to assist in making merchandise allocation and distribution decisions. Kirkland's operates a hybrid distribution system employing both drop-shipping procedures and certain elements of centralized distribution. The Company views its hybrid distribution system as a significant component of its expansion strategy and its ability to maintain a low cost operating structure. Most of the Company's inventory is drop-shipped directly to the stores by the Company's suppliers, typically on a daily basis, to avoid costly investments in central warehouse infrastructure and distribution management. This method allows for the quick and efficient delivery of merchandise to the Company's stores. Merchandise shipped directly to the stores is inspected and ticketed at the store (other than approximately 30% of such 37 39 merchandise which is pre-ticketed by the vendor), displayed on the store floor by store personnel and later entered into the main computer system at the Company's headquarters. To accommodate this practice, each store leases local warehouse facilities on a short-term basis to store surplus inventory and holiday items. The Company also operates a leased 110,000-square-foot distribution center in Jackson, Tennessee. This facility is used to receive, process and store inventory for new stores before they are opened as well as to warehouse and distribute a limited amount of holiday, private brand and bulk merchandise in advance of the holiday selling season and certain private brand and bulk merchandise throughout the year. The storage and handling of certain holiday merchandise at the Jackson distribution center allows management to better allocate inventory shipments during the Christmas season. The Company has achieved operating efficiencies with the central distribution of Christmas merchandise and is in the process of expanding this practice for future years. Management is currently evaluating using additional centralized distribution for certain high volume merchandise items. The Company plans to lease an additional distribution center in the second quarter of 1998 in order to allow the existing distribution center to be used exclusively for the staging of new store openings and to warehouse inventory for the Company's temporary stores. The Company believes that adequate additional distribution center space will be available in the future on acceptable terms as may be needed in order to accommodate the Company's expansion plans. MANAGEMENT INFORMATION SYSTEMS The Company historically has placed emphasis on its management information and inventory control systems. The Company believes that its systems are an important factor in enabling it to achieve its goals of effective merchandising and store execution. The Company's management information systems include automated POS merchandising and financial applications. Merchandise is bar-coded, enabling the Company to manage and control inventory. Sales are updated daily in the merchandise reporting systems by polling sales information from each store's POS terminals. The Company's POS system consists of registers providing price look-up and scanning of bar-coded labels on an item basis. Through automated dial-up electronic communication to each store, sales item information is uploaded to the main system nightly. Information obtained from such daily polling is used to implement merchandising decisions and to identify the required merchandise reorders for each store. Inventory is counted in the stores through a year-end complete physical count utilizing hand-held scanning equipment. The Company's management information and control systems enable the Company's corporate headquarters to regularly identify sales trends, replenish depleted store inventories, reprice merchandise, monitor merchandise mix and determine inventory shrinkage at individual stores and throughout the Company's store network. Management believes that these systems provide a number of benefits, including improved store inventory management, better in-stock availability, higher operating efficiency and fewer markdowns. During 1998, the Company intends to install a new POS system which will include a new, more advanced cash register software system. This system, which will be Year 2000 compliant and will be compatible with the Company's existing hardware systems, will allow for future expansion to accommodate the Company's growth plans. See "Risk Factors - Impact of Year 2000 Issue." ADVERTISING AND PROMOTION Historically, the Company has not engaged in extensive advertising because it believes that it has benefited from its strategic locations in high-traffic shopping malls and valuable "word-of-mouth" advertising by its customers. Many shopping mall leases require some advertising, although an industry shift to "media funds" has largely been implemented, whereby a retailer contributes at agreed levels to the shopping mall's advertising fund based on the square footage of the store. The Company places local newspaper advertisements on occasion to promote specific items in its stores. 38 40 Kirkland's stores have two planned annual sale events, one in January and one in July. These special events enable the Company both to sell merchandise that the Company has purchased at particularly advantageous prices and to clear previously marked-down inventory. In order to boost traffic in typical periods of weakness for retailers, the Company occasionally holds special promotional sales for a particular merchandise category, such as framed art. TRADEMARKS The Company has registered its "Kirkland's" logo with the United States Patent and Trademark Office on the Principal Register. In addition, the Company holds several trademark registrations in connection with its Cedar Creek private label brand as well as a registration for the mark "Now That's Real Style!" The Company is in the process of applying for a trademark registration of "the Kirkland Collection." The Company is not aware of any claims of infringement or other challenges to the Company's right to use its marks in the United States. COMPETITION The retail market for gifts and decorative home accessories is highly competitive. Accordingly, the Company competes with a variety of specialty stores, department stores, discount stores and catalog retailers that carry merchandise in one or more categories also carried by the Company. The Company believes that its stores compete primarily on the basis of merchandise quality and selection, price, visual appeal of the merchandise and the store and the convenience of location. Although the Company faces competition from a broad range of retailers, the Company believes that its direct competitors are few, if any. Specialty retailers tend to have higher prices and a more narrow assortment of products than Kirkland's. Department stores typically have higher prices than Kirkland's for similar merchandise. Wholesale clubs may have lower prices than Kirkland's, but the product assortment is generally more limited. The Company believes that it competes effectively with other retailers due to its experience in identifying a broad collection of distinctive merchandise, pricing it to be appealing to the target Kirkland's customer, and presenting it in a visually appealing manner. In addition to competing for customers, the Company competes with other retailers for suitable store locations and qualified management personnel. Many of the Company's competitors are larger and have substantially greater financial, marketing and other resources than the Company does. See "Risk Factors - Competition." PROPERTIES The Company currently leases all of its store locations and expects that its policy of leasing rather than owning will continue as the Company grows. The Company's leases typically provide for 10-year terms, many with the ability for the Company to terminate the lease in the middle of the term if sales at the leased premises do not reach a certain annual level. The leases typically provide for payment of percentage rent (i.e., a percentage of sales in excess of a specified level) and the rate of increase in ancillary charges is generally capped. As current leases expire, the Company believes that it will be able either to obtain lease renewals if desired for present store locations or to obtain leases for equivalent or better locations in the same general area. To date, the Company has not experienced unusual difficulty in either renewing leases for existing locations or securing leases for suitable locations for new stores. A majority of the Company's store leases contain provisions that would permit the landlord to terminate the lease upon a change in control of the Company. The Offering and the Pre-Offering Transactions may give rise to a change in control under certain of the Company's leases. Based primarily on the Company's belief that it maintains good relations with its landlords, that most of its leases are at market rents and that it has historically been able to secure leases for suitable locations, management believes that these provisions will not have a material adverse effect on the business or financial condition of the Company, although no assurance can be made in this regard. 39 41 The Company's corporate headquarters, located in Jackson, Tennessee, is owned by the Company and currently consists of approximately 18,000 square feet of office space. The Company has commenced an expansion of its headquarters facility to a total of approximately 40,000 square feet, at an estimated cost of $2.2 million to be incurred in 1998, funded from cash flow from operations. EMPLOYEES The Company employed approximately 500 full-time and approximately 1,300 part-time employees at March 31, 1998. Of these, approximately 75 were corporate and warehouse center personnel and 1,725 were store employees. The number of part-time employees fluctuates with seasonal needs. None of the Company's employees is covered by a collective bargaining agreement. The Company believes that its relationship with its employees is good. LEGAL PROCEEDINGS The Company is involved in various routine legal proceedings incidental to the conduct of its business. The Company believes that any resulting liability from existing legal proceedings, individually or in the aggregate, will not have a material adverse effect on its operations or financial condition. 40 42 MANAGEMENT DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES The following table and biographies set forth information concerning the individuals who serve as directors, executive officers and key employees of the Company:
YEAR OF EXPIRATION NAME AGE POSITION OF TERM AS DIRECTOR ---- --- -------- ------------------- DIRECTORS AND EXECUTIVE OFFICERS: Carl Kirkland...................... 57 Chief Executive Officer and Chairman of the Board of Directors Robert E. Alderson................. 51 President, Chief Operating Officer and Director Reynolds C. Faulkner............... 34 Senior Vice President, Chief Financial Officer and Director Steven J. Collins.................. 29 Director of Finance and -- Treasurer David M. Mussafer(a)(b)............ 35 Director R. Wilson Orr, III(a).............. 35 Director John P. Oswald (b)................. 38 Director Alexander S. McGrath(a)............ 36 Director KEY EMPLOYEES: James W. Harris.................... 51 Vice President of Operations -- and Personnel Chris T. LaFont.................... 37 Vice President of Merchandise -- Janna B. Alford.................... 36 Vice President of Operations --
- --------------- (a) Member of Compensation Committee (b) Member of Audit Committee DIRECTORS AND EXECUTIVE OFFICERS Carl Kirkland has been the Chief Executive Officer since he founded the Company in 1966, and he served as President from 1966 through November 1997. Mr. Kirkland has been Chairman of the Board since June 1996. He has over 30 years of experience in the retail industry. Mr. Kirkland also serves on the board of directors of Hibbett Sporting Goods, Inc. Robert E. Alderson has been President and Chief Operating Officer of the Company since November 1997 and prior to that served as Senior Vice President of the Company since joining in 1986. He also served as Chief Administrative Officer from 1986 to 1997. Prior to joining the Company, he was a senior partner at the law firm of Menzies, Rainey, Kizer & Alderson. Reynolds C. Faulkner has been a Director of the Company since September 1996 and joined as Senior Vice President and Chief Financial Officer in February 1998. Prior to joining the Company, from July 1989 to January 1998, Mr. Faulkner was an investment banker in the corporate finance department of The Robinson- Humphrey Company, LLC, most recently serving as a Managing Director and head of the retail practice group. In this capacity, Mr. Faulkner was involved in numerous public and private financings and mergers and acquisitions of companies in the retail industry. Steven J. Collins joined the Company and has been the Director of Finance since January 1997. From January 1997 to February 1998, he also served as the Company's Chief Financial Officer. From 1995 to 1997 he was an associate with Advent, a private equity investment firm. See "Principal Shareholders." Prior to that, he worked in the mergers and acquisitions department of Merrill Lynch & Co. and was an accountant with Coopers & Lybrand. 41 43 Alexander S. McGrath has been a director of the Company since June 1996. Mr. McGrath is currently a general partner of Capital Resource Partners II, L.P., a mezzanine and private equity investment firm which is the general partner of Capital Resource Lenders II, L.P., a warrantholder of and subordinated lender to the Company. He joined Capital Resource Lenders in 1988 as an associate, and has been a general partner of Capital Resource Partners II, L.P. since 1993. Prior to that, he was an associate at Investments Orange Nassau Inc., a private equity investment firm. See "Principal Shareholders." David M. Mussafer has been a Director of the Company since June 1996. Mr. Mussafer is currently a Managing Director of Advent, a private equity investment firm which beneficially owns Common Stock of the Company through its interests in certain members of Kirkland Holdings L.L.C., one of the Company's principal shareholders. Mr. Mussafer joined Advent in 1991 and has been a principal of the firm since 1993. See "Principal Shareholders." R. Wilson Orr, III has been a Director of the Company since June 1996. Since 1993, Mr. Orr has been a principal of SSM Corporation, a private equity investment firm and an affiliate of SSM/Kirkland Equity Partners, L.P. which is a member of Kirkland Holdings L.L.C., one of the Company's principal shareholders. He joined SSM Corporation in 1988 as a Vice President and partner. From 1984 to 1988, he worked in corporate lending at Chemical Bank. See "Principal Shareholders." John P. Oswald has been a Director of the Company since June 1996. Since 1994, Mr. Oswald has been a partner of the Capital Trust Group, a private equity investment firm and an affiliate of CT/Kirkland Equity Partners, L.P., which is a member of Kirkland Holdings L.L.C., one of the Company's principal shareholders. Mr. Oswald is a beneficial owner of Capital Trust Investments, Ltd., a warrantholder of and subordinated lender to the Company. He is also President and Chief Executive Officer of Bridge East Capital, a private equity investment partnership, an affiliate of the Capital Trust Group. Prior to that he was a partner with the law firm of Lord, Day & Lord from 1986 to 1994 and an associate with Arthur Andersen LLP from 1984 to 1986. See "Principal Shareholders." KEY EMPLOYEES Chris T. LaFont has been Vice President of Merchandise since September 1997. Mr. LaFont is responsible for all merchandise buying decisions for the Company. From 1988 to September 1997, he served as Vice President of Visual Merchandising. Mr. LaFont started his career with Kirkland's in 1981 as a management trainee. James W. Harris has been Vice President of Operations and Personnel since 1987. Mr. Harris is responsible for store personnel recruitment and training as well as general store operations. Prior to joining the Company, Mr. Harris was with Goldsmith's, a division of Federated Department Stores, from 1972 to 1987, where he held various positions in store operations. Janna B. Alford has been Vice President of Operations since February 1997. From April 1995 to February 1997, Ms. Alford held the positions of Director of Loss Prevention and Director of Store Operations for the Company. Prior to that she was with County Seat, a retailer of youth-oriented apparel, where she held positions in loss prevention and operations from 1989 to 1995. CLASSIFIED BOARD OF DIRECTORS Upon completion of the Offering, the Board of Directors of the Company will be divided into three classes of directors each containing, as nearly as possible, an equal number of directors. Directors within each class are elected to serve three-year terms and approximately one-third of the directors sit for election at each annual meeting of the Company's shareholders. The year of expiration of the term of each of the Company's directors is set forth in the table above under the caption "Directors, Executive Officers and Key Employees." A classified board of directors may have the effect of deterring or delaying any attempt by any group to obtain control of the Company by a proxy contest since such third party would be required to have its nominees elected at two separate annual meetings of the Board of Directors in order to elect a majority of the members of the Board of Directors. Directors who are elected to fill a vacancy (including vacancies created by an 42 44 increase in the number of directors) must be confirmed by the shareholders at the next annual meeting of shareholders whether or not such director's term expires at such annual meeting. See "Risk Factors - Charter and Bylaw Provisions; Anti-Takeover Effect of Tennessee Laws." DIRECTOR COMPENSATION To date, directors who are affiliated with the Company or any of the Company's shareholders have not received separate compensation for their services in that capacity. The Company intends in the future to compensate its directors who are not also employees of the Company. The amount of such compensation has not been determined but will be consistent with amounts paid by comparable public companies. COMMITTEES OF THE BOARD Following completion of this Offering, the Board of Directors will have an Audit Committee, composed of Messrs. Mussafer and Oswald, and a Compensation Committee, composed of Messrs. McGrath, Mussafer and Orr. The principal functions of the Audit Committee will include making recommendations to the Board regarding the selection of independent public accountants to audit annually the books and records of the Company, reviewing the proposed scope of each audit and reviewing the recommendations of the independent public accountants as a result of their audit of the Company. The Audit Committee will also periodically review the activities of the Company's accounting staff and the adequacy of the Company's internal controls. The Compensation Committee will be responsible for establishing the salaries of the executive officers of the Company, incentives and other forms of compensation and for administering the Company's employee benefit plans. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Compensation Committee of the Company's Board of Directors will be formed upon completion of the Offering. Messrs. McGrath, Mussafer and Orr, who were not at any time officers or employees of the Company, will be the only members of the Compensation Committee. No executive officer of the Company serves as a member of the Board of Directors or Compensation Committee of another entity which has one or more executive officers who serve as a member of the Company's Board of Directors or Compensation Committee. 43 45 EXECUTIVE COMPENSATION The following table sets forth certain compensation information with respect to the Company's Chief Executive Officer and the other executive officers of the Company whose salary and bonus exceeded $100,000 for the year ended December 31, 1997 (the "Named Executive Officers"): SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION AWARDS ANNUAL COMPENSATION ------------ ----------------------------------------- SECURITIES ALL OTHER OTHER ANNUAL UNDERLYING COMPENSATION NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) COMPENSATION ($) OPTIONS (#) (1)($) - --------------------------- ---- ---------- --------- ---------------- ------------ ------------ Carl Kirkland........... 1997 275,000 250,000 712,500(3) 2,381 3,472 Chief Executive Officer(2) Robert E. Alderson...... 1997 275,000 250,000 149,500(3) 2,381 2,747 President, Chief Operating Officer and Chief Administrative Officer(4) Bruce Moore............. 1997 275,000 -- 259,000(3) 2,381 2,548 Senior Vice President,General Merchandise Manager and Chief Operating Officer(5) Steven J. Collins....... 1997 75,000 35,000 -- 230 -- Chief Financial Officer and Director of Finance(6)
- --------------- (1) Includes $1,552, $1,552 and $1,552 contributed under the Company's 401(k) Plan for the benefit of Messrs. Kirkland, Alderson and Moore, respectively. Also includes $1,920, $1,195 and $976 of premiums paid for term life insurance for Messrs. Kirkland, Alderson and Moore, respectively. (2) Mr. Kirkland also served as the Company's President until November 1997. (3) Represents amounts classified as interest associated with the Class C Preferred Stock held by the executives, which will be redeemed upon the completion of the Offering, at which time such payments will terminate. (4) Mr. Alderson became the Company's President and Chief Operating Officer in November 1997. (5) Mr. Moore resigned as an executive officer of the Company in November 1997 and his employment with the Company terminated on January 7, 1998. In connection with such termination, all of his options to purchase Common Stock were canceled. See "Certain Transactions - January 1998 Redemption." (6) Mr. Collins served as the Company's Chief Financial Officer until February 1998. 44 46 STOCK OPTIONS GRANTED TO CERTAIN EXECUTIVE OFFICERS DURING 1997 The following table sets forth certain information regarding options for the purchase of Common Stock that were awarded to the Company's Named Executive Officers during the year ended December 31, 1997: OPTION GRANTS IN 1997
POTENTIAL REALIZABLE VALUE AT ASSUMED PERCENT OF ANNUAL RATES OF STOCK NUMBER OF TOTAL PRICE SECURITIES OPTIONS APPRECIATION FOR UNDERLYING GRANTED EXERCISE OR OPTION TERM ($) OPTIONS TO EMPLOYEES BASE PRICE EXPIRATION ---------------------- NAME GRANTED (#) IN 1997 ($/SH) DATE 5% 10% ---- ----------- ------------ ----------- ---------- --------- --------- Carl Kirkland........... -- -- -- -- -- -- Robert E. Alderson...... -- -- -- -- -- -- Bruce Moore............. -- -- -- -- -- -- Steven J. Collins(1).... 230 7.4% $95.00 6/23/07 $154.74 $246.41
- --------------- (1) Granted under the Company's 1996 Executive Incentive and Non-Qualified Stock Option Plan. The option vested as to one-half of the underlying shares on August 1, 1997 and will vest as to the balance on August 1, 1998. STOCK OPTIONS EXERCISED BY CERTAIN EXECUTIVE OFFICERS DURING 1997 AND YEAR-END OPTION VALUES. The following table sets forth certain information regarding options for the purchase of Common Stock that were exercised and/or held by the Named Executive Officers during the year ended December 31, 1997. AGGREGATED OPTION EXERCISES IN YEAR ENDED DECEMBER 31, 1997 AND YEAR-END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT OPTIONS AT DECEMBER 31, 1997 DECEMBER 31, 1997 SHARES ---------------------- -------------------- ACQUIRED ON VALUE # EXERCISABLE/ $ EXERCISABLE/ NAME EXERCISE REALIZED UNEXERCISABLE UNEXERCISABLE(1) ---- ----------- -------- ---------------------- -------------------- Carl Kirkland(2)...................... -- -- 0/2,381 $ /$ Robert E. Alderson(2)................. -- -- 0/2,381 $ /$ Bruce Moore(3)........................ -- -- 0/2,381 $ /$ Steven J. Collins..................... -- -- 115/115 $ /$
- --------------- (1) Value based on the $ per share assumed initial public offering price less the per share exercise price. (2) The options held by Messrs. Kirkland and Alderson will become fully vested upon completion of the Offering. (3) Mr. Moore's options were canceled in connection with the redemption of his preferred and common stock on January 7, 1998. See "Certain Transactions - January 1998 Redemption." EMPLOYEE BENEFIT PLANS 1996 Executive Incentive and Non-Qualified Stock Option Plan The Company maintains the Kirkland's, Inc. 1996 Executive Incentive and Non-Qualified Stock Option Plan (as amended, the "Stock Option Plan"). The Company believes that the Stock Option Plan will promote the long-term growth and profitability of the Company by providing key employees with incentives to improve shareholder value and to contribute to the growth and financial success of the Company. Moreover, the Company believes that the Stock Option Plan will help the Company to attract, retain and reward quality employees. 45 47 The Stock Option Plan is administered by the Board of Directors or the Compensation Committee. The plan administrator has exclusive authority to: (i) grant Awards (as defined below) under the Stock Option Plan, including determining individuals to whom Awards are granted, the amount of such Awards, any applicable vesting terms and any other terms of an Award; and (ii) make all interpretations and determinations affecting the Stock Option Plan. Participation in the Stock Option Plan is limited to employees of the Company or any of its subsidiaries (the "Participants"). Awards under the Stock Option Plan may be in the form of incentive stock options ("ISOs") that meet the requirements of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), or "non-qualified" stock options ("NQSOs") (collectively, "Awards"). ISOs may only be granted to individuals who are employees of the Company at the date of grant. Awards under the Stock Option Plan are not transferable by the Participants, except upon death. The Stock Option Plan provides for the grant of stock options to purchase up to an aggregate of 12,304 shares of Common Stock. In the event of any stock split, reverse stock split, stock dividend, recapitalization, reclassification or other similar event, appropriate proportional adjustments may be made to the number of shares reserved for issuance under the Stock Option Plan and the number, kind and price of shares covered by outstanding Awards. Stock options may not be exercised more than 10 years after the date of grant (five years after the date of grant with respect to an ISO granted to any person who owns stock of the Company possessing 10% or more of the total voting power of all the Company's stock at the time of the grant). The Board has the discretion to award stock options to Participants as either ISOs or as NQSOs. The exercise price of an ISO must be not less than the fair market value of the Common Stock on the date the option is granted. Although the Stock Option Plan permits the exercise price of an NQSO to be less than the fair market value of the Common Stock on the date the option is granted, the exercise price of all NQSOs granted under the Stock Option Plan to date have been equal to the fair market value of the Common Stock on the date of grant. As of the date of this Prospectus, options to purchase 10,154 shares of Common Stock are outstanding, including options for 2,381 shares held by each of Carl Kirkland and Robert E. Alderson and an option for 2,283 shares held by Reynolds C. Faulkner. Options granted with respect to the remaining 3,109 shares of Common Stock (the "Employee Options") are held by approximately 225 employees other than executive officers (other than an option for 230 shares which was granted to Mr. Collins). The Employee Options generally expire upon termination of employment and become exercisable on July 1, 2000 (except for the option granted to Mr. Collins, which became exercisable with respect to 115 shares in August 1997 and will become exercisable with respect to the remainder of the shares in August 1998). Generally, if the holder of an Employee Option terminates employment because of death or disability, any Award exercisable at the date of such termination may be exercised for a period of one year from the date of termination or until the expiration of the stated term of the Award, whichever period is shorter. An additional 2,150 shares of Common Stock are available for issuance in connection with future grants under the Stock Option Plan. 1998 Incentive Plan Prior to the completion of the Offering, the Company intends to adopt the Kirkland's, Inc. 1998 Incentive Plan (the "Incentive Plan"). The Incentive Plan will provide for the award of up to 8,000 shares of Common Stock to the Company's employees, directors, consultants and other individuals who perform services for the Company. The Compensation Committee of the Board of Directors will administer the Incentive Plan. Under the terms of the Incentive Plan, the Compensation Committee will be required to be composed of two or more directors. The Compensation Committee will have the authority to interpret the Incentive Plan and to determine and designate the persons to whom options or awards are made and the terms, conditions and restrictions applicable to each option or award (including, but not limited to, the exercise price, any vesting schedule or provisions for the acceleration thereof and any forfeiture provisions). 46 48 The Incentive Plan contains provisions for granting various stock-based awards, including ISOs, NQSOs, stock appreciation rights ("SARs") and restricted stock (all as further described below). The term of the Incentive Plan is ten years, subject to earlier termination or amendment. The Compensation Committee will have the power to select award recipients and their allotments and to determine the price, terms and vesting schedule for awards granted. While there are no predetermined performance formulas or measures or other specific criteria used to determine recipients of awards under the Incentive Plan, awards will be based generally upon consideration of the grantee's position and responsibilities, the nature of services provided, the value of the services to the Company, the present and potential contribution of the grantee to the success of the Company, the anticipated number of years of service remaining and other factors which the Board or the Compensation Committee may deem relevant. Stock Options. The Incentive Plan provides for the grant of ISOs to employees of the Company. The Incentive Plan also provides for the grant of NQSOs to employees of the Company, directors of the Company, and consultants and other individuals who perform services for the Company but are not employed by the Company. The exercise price of any ISO granted under the Incentive Plan may not be less than 100% of the fair market value of the Company's Common Stock on the date of grant. Options granted under the Incentive Plan may be exercised for cash or in exchange for shares of Common Stock owned by the option holder having a fair market value on the date of exercise equal to the option exercise price. The aggregate fair market value, determined on the date of grant, of the shares with respect to which ISOs are exercisable for the first time by an employee during any calendar year may not exceed $100,000. Under the Incentive Plan, each option will be exercisable at such time and to such extent as specified in the pertinent option agreement between the Company and the option recipient. However, no award shall be exercisable with respect to any shares of Common Stock later than ten years after the date of such award. Unless otherwise specified by the Compensation Committee with respect to a particular option, all options will be non-transferable, except upon death. The shares subject to expired options or terminated options which remain unexercised will become available for future grants. Stock Appreciation Rights. The Incentive Plan also provides for the grant of SARs, either alone or in tandem with ISOs or NQSOs. A SAR entitles its holder to a cash payment of the excess of the fair market value of Common Stock of the Company on the date of exercise, over the fair market value of the Common Stock on the date of grant. If an option or SAR recipient ceases to be employed by, or to render services to, the Company for any reason other than retirement, death, disability or termination for cause, unless otherwise specified by the Compensation Committee with respect to a particular option, any option or SAR exercisable on the date of such termination generally may be exercised for a period of one month from the date of such termination or until the expiration of the stated term of the option or SAR, whichever period is shorter. In the event of termination of employment or service by reason of retirement, death or disability, unless otherwise specified by the Compensation Committee with respect to a particular option or SAR, any option exercisable at the date of such termination generally may be exercised for a period of one year (in the case of death) or six months (in the case of disability or retirement) from the date of termination or until the expiration of the stated term of the option or SAR, whichever period is shorter. If a participant's employment or service is terminated for cause, unless otherwise specified by the Compensation Committee with respect to a particular option or SAR, any option or SAR not exercised prior to the date of such termination will be automatically and immediately forfeited. In anticipation of a change of control of the Company, the Compensation Committee, in its discretion, may: (i) cause all outstanding options and SARs to become immediately exercisable, (ii) provide for the cancellation of options and SARs and a cash payment to the holders of such canceled awards or (iii) provide for the cancellation of options and the substitution of options to purchase shares in a successor corporation. Restricted Stock. "Restricted Stock" are shares of the Company's Common Stock granted to an employee for no cash consideration, which will be forfeited to the Company if, during a restriction period specified by the Compensation Committee at the time of the grant of the Restricted Stock, (i) the grantee 47 49 ceases to be an employee of the Company, or (ii) certain individual or corporate performance goals are not met. In the event of death or disability: (i) restrictions based on employment will lapse with respect to a percentage of Restricted Stock held by the grantee equal to the percentage of the restriction period that had elapsed as of the date of death or commencement of disability, and (ii) restrictions based on performance will lapse to the extent determined by the Compensation Committee. In the event of a change of control of the Company, the Compensation Committee may, in its discretion, cause all restrictions on shares of Restricted Stock to lapse. Shares of Common Stock underlying any award that is forfeited under the Incentive Plan will become available for future grants. Employee Stock Purchase Plan Prior to the completion of the Offering, the Company intends to adopt an Employee Stock Purchase Plan (the "Purchase Plan"), which will allow substantially all full-time employees of the Company, subject to certain limitations, to purchase shares of the Company's Common Stock at a discount from the prevailing market price at the time of purchase. Such shares will either be issued by the Company from its authorized and unissued Common Stock or purchased by the Company on the open market. Any employee owning five percent or more of the voting power or value of the Company will not be eligible to participate in the Purchase Plan. A maximum of 2,700 shares of the Company's Common Stock will be available for purchase under the Purchase Plan. An eligible employee will be able to specify, before the commencement of each quarter, an amount to be withheld from his or her paycheck and credited to an account established for him or her (the "Participation Account"). Amounts in the Participation Account will be applied to the purchase of shares of the Company's Common Stock on the last day of each quarter. The price of such shares will be equal to % of the average of the high and low sales prices per share of the Company's Common Stock on the principal national securities exchange on which the Common Stock is listed or admitted to trading or, if not listed or traded on any such exchange, on the Nasdaq National Market. Only whole shares of Common Stock will be purchased under the Purchase Plan. Amounts withheld from an employee's paycheck and not applied to the purchase of whole shares of Common Stock will, at the election of the employee, either remain credited to the employee's Participation Account or be returned to the employee. Upon termination of an employee's employment, all amounts credited to such employee's Participation Account will be returned to him or her. The Purchase Plan will be administered by the Compensation Committee of the Board of Directors. The Board of Directors may amend or terminate the Purchase Plan. The Purchase Plan is intended to comply with the requirements of Section 423 of the Code. 401(k) Plan The Company maintains the Kirkland's, Inc. Retirement Plan ("401(k) Plan") for the benefit of its eligible employees. The 401(k) Plan is intended to be qualified under Code section 401(a) and consists of a 401(k) component, a 401(m) matching component and a profit-sharing component. Employees eligible to participate in the 401(k) Plan are those employees who have completed at least one year of service and attained age of 21. Under the 401(k) component, participants may elect to defer up to $10,000 per year (as adjusted by the Internal Revenue Service) to the 401(k) Plan, subject to other limits of the Code. Under the 401(m) matching component, the Company, in its discretion, may match each participant's elective deferrals, up to 5% of compensation. Currently, the Company matches 25% of each participant's elective deferrals. Under the profit-sharing component, the Company may make additional contributions in amounts to be determined by the Company in its sole discretion. Such Company profit-sharing contributions will be allocated among eligible participants in proportion to each such participant's compensation. Matching contributions and profit-sharing contributions vest ratably over six years, or earlier upon attainment of the appropriate retirement age, upon retirement for disability, upon death, or upon termination 48 50 of the 401(k) Plan. All assets of the 401(k) Plan are currently invested, subject to participant-directed elections, in annuity contracts underwritten by Aetna Life Insurance and Annuity Company. Payment of 401(k) Plan benefits are made in cash in the form of a single lump sum, periodic installments or an annuity. Distribution of a participant's vested interest generally occurs on the earlier of (i) termination of employment (including by reason of retirement, death or disability) or (ii) the April 1 following the calendar year in which the participant attains age 70 1/2. Supplemental Executive Retirement Plan Following the completion of the Offering, the Company intends to adopt a non-qualified deferred compensation plan known as a supplemental executive retirement plan ("SERP"). Only a select group of highly compensated management employees chosen by the Board of Directors will be eligible to participate in the SERP. Pursuant to the SERP, participants will be entitled to elect, in advance, to reduce salary or bonus income and have that reduction credited to an account under the SERP. To the extent all or a portion of the participant's deferral relates to amounts that could have been contributed to the SERP, but for the application of certain legal restrictions, the Company will also credit a matching contribution amount to the SERP equal to what would have been contributed to the SERP, in the absence of those restrictions. EMPLOYMENT AGREEMENTS In connection with the Recapitalization, the Company entered into employment agreements with Carl Kirkland, Robert Alderson and Bruce Moore. Under the terms of these employment agreements, Mr. Kirkland was employed as Chairman and Chief Executive Officer, Mr. Alderson was employed as Chief Administrative Officer and Mr. Moore was employed as Chief Operating Officer and General Merchandise Manager. The term of these employment agreements expires on June 12, 2000. The employment agreements provide for an annual salary of $987,500 for Mr. Kirkland, $424,500 for Mr. Alderson and $534,000 for Mr. Moore, of which amounts $712,500, $149,500 and $259,000, respectively, represent interest paid in connection with the mandatorily redeemable Class C Preferred Stock. These agreements provide for each executive to receive an annual bonus beginning with the fiscal year ended December 31, 1996. The bonus includes a performance based component of up to $175,000 based on the Company's achievement of the projected EBITDA targets established by the Board, as well as a discretionary component of up to $75,000. The Board may consider performance measures such as team leadership, new store openings and customer satisfaction in determining the discretionary bonus component. Mr. Moore's employment with the Company, and his employment agreement, terminated on January 7, 1998. See "Certain Transactions - January 1998 Redemption." The employment agreements with Messrs. Kirkland and Alderson automatically terminate upon the occurrence of certain events such as a sale of the Company, a change of control or a public offering of Common Stock generating gross proceeds of at least $30 million (a "Qualified Public Offering"). The employment agreements provide that upon the occurrence of any of the aforementioned events, the Company and the executives will enter into new employment agreements which will provide for a $275,000 annual salary, retain the equivalent bonus and non-competition provisions of the existing employment agreements, and coincide with the remaining term of the existing employment agreements. As a result of the Offering, the existing employment agreements will automatically terminate, and the Company will enter into new employment agreements with each of Mr. Kirkland and Mr. Alderson consistent with the foregoing terms. In February 1998, the Company entered into an employment agreement with Reynolds C. Faulkner. Under the terms of that agreement, Mr. Faulkner serves as the Company's Senior Vice President and Chief Financial Officer at an annual salary of $225,000, and will be eligible to receive an annual bonus of up to $100,000 at the discretion of the Board. The term of Mr. Faulkner's agreement extends until February 2, 2001, or until earlier termination of employment; provided, however, that Mr. Faulkner will be entitled to a severance payment equal to 12 months' salary and benefits, and a pro-rated annual bonus if his employment is terminated prior to February 2, 2001 by the Company without cause or by Mr. Faulkner under specified circumstances. 49 51 Each of Messrs. Kirkland and Alderson received an option for 2,381 shares of Common Stock at a per share exercise price of $0.045 in connection with the Recapitalization. The terms of the options granted to Messrs. Kirkland and Alderson provide that those options will vest immediately prior to completion of the Offering. On February 2, 1998, Mr. Faulkner received an option for 2,283 shares of Common Stock of the Company under the Stock Option Plan at a per share exercise price of $285.65. Each of the three employment agreements described above also contains non-competition provisions prohibiting the executive from competing against the Company during the term of the employment agreement and for three years thereafter without the prior written consent of the Company. The executives are also entitled to certain additional benefits (beyond those generally available to employees of the Company) including an automobile allowance and additional life insurance. In February 1997, the Company entered into an employment agreement with Steven J. Collins pursuant to which Mr. Collins was appointed the Company's Chief Financial Officer and Director of Finance. The employment agreement provides for an annual salary of $75,000 with an annual year-end performance-based bonus of up to $35,000. The employment agreement is terminable by either party at any time and contains non-competition and confidentiality provisions. In June 1997, Mr. Collins received a stock option to purchase 230 shares of Common Stock, at a per share exercise price of $95.00, which vested as to one-half of the underlying shares on August 1, 1997 and will vest as to the balance on August 1, 1998. In February 1998, Mr. Collins' employment agreement was amended to reflect that Mr. Collins would cease to be the Company's Chief Financial Officer and would continue to serve as the Company's Director of Finance. 50 52 CERTAIN TRANSACTIONS RECAPITALIZATION On June 12, 1996, the Company completed the recapitalization pursuant to which Advent became the largest beneficial owner of the equity of the Company. The Company completed the Recapitalization to permit the founding and management shareholders, consisting of Carl Kirkland, Robert E. Kirkland, Robert E. Alderson and Bruce Moore (collectively, the "Principal Shareholders") to realize a portion of the value of their interest in the Company. In connection with the Recapitalization (i) Advent (through affiliated entities) together with other investors (collectively, "the 1996 Investors") purchased 68,400 shares of common stock and 68,400 shares of Class A Preferred Stock from Kirkland's, Inc. and each of the Kirkland Companies for a purchase price of $30.8 million, (ii) a portion of the common stock of Kirkland's, Inc. and each of the Kirkland Companies held by the Principal Shareholders was redeemed at a total redemption price of $80.2 million and all such common stock held by shareholders other than the Principal Shareholders, consisting principally of employees of the Company and family members of the Principal Shareholders (collectively, the "Minority Shareholders"), was redeemed at a total redemption price of $2.9 million, (iii) the Company paid bonuses to certain of the Minority Shareholders in the total amount of $432,000, (iv) certain shares of common stock of Kirkland's, Inc. and each of the Kirkland Companies held by the Principal Shareholders were reclassified into 31,600 shares of Class B Preferred Stock and 20,000 shares of Class C Preferred Stock of Kirkland's, Inc. and each of the Kirkland Companies, (v) the Company borrowed $55.3 million of senior debt under a credit facility from a group of banks, (vi) the Company borrowed $20 million of subordinated debt from a group of institutional lenders and issued warrants to such lenders to purchase 16,722 shares of common stock of Kirkland's, Inc. and each of the Kirkland Companies, (vii) the Company repaid $19.2 million of its existing indebtedness and (viii) the Company paid certain related expenses, including investment banking and financial advisory fees, in the total amount of $6.3 million. The $6.3 million of expenses paid in connection with the Recapitalization included investment banking /advisory fees of $1.0 million paid to Advent, $2.9 million paid to Lehman Brothers Inc. and $1.0 million paid to The Robinson-Humphrey Company, LLC. Lehman Brothers Inc. and The Robinson-Humphrey Company, LLC are Underwriters in the Offering. Concurrent with the consummation of the Recapitalization, the Company issued an aggregate of $20 million of subordinated notes to a group of institutional lenders. As of March 31, 1998, approximately $8.0 million, $6.4 million, $3.8 million and $1.8 million were outstanding to Capital Resource Lenders II, L.P., Allied Capital Corporation, Marlborough Capital Investment Fund, L.P. and Capital Trust Investments Ltd., respectively. In 1996 and 1997 and the first quarter of 1998, the Company paid an aggregate of $1.4 million, $2.5 million and $576,000, respectively, in interest to these lenders in proportion to the principal amount of the notes held by each lender. In connection with the issuance of the notes, the Company also issued warrants to purchase an aggregate of 16,722 shares of common stock of Kirkland's, Inc. and each of the Kirkland Companies to the lenders. Of the total warrants issued, warrants to purchase 4,817 shares of such common stock only become exercisable if the Company fails to meet specific valuation targets as of the date of the Offering. As the applicable valuation targets will be met upon completion of the Offering, these contingent warrants will be canceled upon completion of the Offering. The remainder of the warrants (for 11,905 shares) will be exercised at a per share price of $0.01 upon completion of the Offering by Capital Resource Lenders II, L.P., Allied Capital Corporation, Marlborough Capital Investment Fund, L.P. and Capital Trust Investments Ltd. for 4,762 shares, 3,810 shares, 2,262 shares and 1,071 shares of common stock of Kirkland's, Inc. and each of the Kirkland Companies, respectively. In connection with the Recapitalization, the Company and its current shareholders and warrantholders entered into a Shareholders Agreement. The agreement, which expires by its terms upon completion of the Offering, provided for the nomination and election of each of the Company's current directors. Certain of the directors of the Company are affiliated with some of the subordinated lenders to and warrantholders of the Company and with other entities that participated in the Recapitalization: Mr. Mussafer is a Managing Director of Advent; Mr. Oswald is affiliated with CT/Kirkland Equity Partners, L.P. (a member of Kirkland Holdings L.L.C., one of the Company's principal shareholders) and Capital Trust Investments, Ltd. (a subordinated lender and warrantholder); Mr. McGrath is a general partner of Capital Resource Partners II, 51 53 L.P., the general partner of Capital Resource Lenders II, L.P. (a subordinated lender and warrantholder); and Mr. Orr is affiliated with SSM/Kirkland Equity Partners, L.P. (a member of Kirkland Holdings L.L.C.) PRE-OFFERING TRANSACTIONS Kirkland Companies. Historically, the Company has operated all of the Kirkland's stores through separate corporations (the "Kirkland Companies"), and Kirkland's, Inc. has served as a management company for the Kirkland Companies. As of March 31, 1998, there were 140 such corporations in existence in addition to Kirkland's, Inc. The shareholders of the Kirkland Companies are the same as the shareholders of Kirkland's, Inc. The percentage ownership of Kirkland's, Inc. and in each of the Kirkland Companies is the same. Preferred Stock. Prior to the Offering, Kirkland's, Inc. and substantially all of the Kirkland Companies had three classes of preferred stock outstanding. The Class A Preferred Stock and Class B Preferred Stock entitled the holders to cash dividends equal to 8% of the stated value of such preferred stock annually. No dividends have been paid on the Class A Preferred Stock or Class B Preferred Stock to the holders of such preferred stock. The Company accrued and paid amounts classified as interest to the holders of Class C Preferred Stock at an annual rate equal to 9% of the stated value of such preferred stock. Upon completion of the Offering, the Class A Preferred Stock and Class B Preferred Stock will become convertible at the election of the holders and redeemable at the election of the Company, and the Class C Preferred Stock will become mandatorily redeemable. Purchase, Contribution and Exchange Agreement. Pursuant to the terms of a Purchase, Contribution and Exchange Agreement dated April 28, 1998, by and among Kirkland's, Inc. and each of the Company's shareholders and warrantholders, immediately prior to completion of the Offering and as a part of the Pre- Offering Transactions, all of the outstanding shares of Class A Preferred Stock and Class B Preferred Stock of Kirkland's, Inc. and the Kirkland Companies will be recapitalized into or exchanged for an aggregate of 42,679 shares of Common Stock, and all of the outstanding shares of common stock of the Kirkland Companies will be contributed to Kirkland's, Inc., resulting in the Kirkland Companies becoming wholly-owned subsidiaries of the Company. Subsequently, the warrantholders of Kirkland's, Inc. and the Kirkland Companies will exercise their warrants to purchase 11,905 shares of common stock of Kirkland's, Inc. and each of the Kirkland Companies, and the Kirkland Companies common stock issued upon such exercise will be contributed to Kirkland's, Inc. Also pursuant to the agreement, although not part of the Pre-Offering Transactions, Kirkland's, Inc. will purchase or redeem from current shareholders all of the outstanding shares of Class C Preferred Stock of Kirkland's, Inc. and each of the Kirkland Companies that has Class C Preferred Stock outstanding for an aggregate of $18.0 million (including approximately $900,000 of amounts classified as interest associated with the Class C Preferred Stock), to be paid from the net proceeds of the Offering. See "Use of Proceeds." JANUARY 1998 REDEMPTION By agreement dated December 26, 1997, the Company redeemed all of the preferred and common stock of the Company held by Bruce Moore, the Company's former Senior Vice President, Chief Operating Officer and General Merchandise Manager. Pursuant to the agreement, on January 7, 1998 the Company paid Mr. Moore approximately $6.9 million in redemption of all shares of Class B Preferred Stock, Class C Preferred Stock and common stock of Kirkland's, Inc. and each of the Kirkland Companies held by Mr. Moore, together with a one-time compensation payment of $259,000. In addition, under the terms of the agreement, Mr. Moore's stock options were canceled. Pursuant to the agreement, the Company will make salary continuation payments to Mr. Moore in the annual amount of $275,000 and provide Mr. Moore with certain additional benefits through June 12, 2000 as provided for in his employment agreement with the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." 52 54 CONSULTING AGREEMENT In connection with the Recapitalization, the Company entered into a consulting agreement with Robert E. Kirkland, a shareholder of the Company and a cousin of the Company's Chief Executive Officer. Under the provisions of the consulting agreement, Mr. Kirkland provides consulting services and advice regarding purchasing and marketing of merchandise, leasing, store selection, operations, internal management and other matters mutually agreed upon as directed by the Board of the Company. The agreement provides for an annual consulting fee of $679,000 and a term expiring in June 2003. The consulting agreement automatically terminates upon the occurrence of certain events, including a sale of the Company, a change of control or a Qualified Public Offering. The Offering will constitute a Qualified Public Offering, and, accordingly, Mr. Kirkland's consulting agreement will automatically terminate upon its completion. INVENTORY PURCHASES FROM SIGNIFICANT SHAREHOLDER The Company purchases inventory from CBK, Inc., a wholesaler owned by Robert E. Kirkland, a shareholder of the Company. See "Principal Shareholders." These purchases aggregated approximately $3.3 million, $2.3 million, $1.4 million and $244,000 during the years ended December 31, 1995, 1996 and 1997 and the first quarter of 1998, respectively. INVENTORY PURCHASES FROM AN AFFILIATE OF A SIGNIFICANT SHAREHOLDER The Company purchases inventory from Homemaker Industries, Inc., a manufacturer in which Advent is a significant shareholder. These purchases aggregated approximately $610,109, $297,774, $216,847 and $142,000 during the years ended December 31, 1995, 1996 and 1997 and the first quarter of 1998, respectively. David M. Mussafer and John P. Oswald are directors of the Kirkland's, Inc. and are also members of the Board of Directors of Homemaker Industries, Inc. Mr. Mussafer and Mr. Oswald are also affiliated with members of Kirkland Holdings L.L.C., one of the Company's principal shareholders. See "Principal Shareholders." CHARTER OF AIRPLANES For the years ended December 31, 1995, 1996 and 1997 and the first quarter of 1998, the Company spent $44,076, $29,136, $75,898 and $14,789, respectively, for the rental of aircraft for business travel from Kirkland Aviation, Inc., an entity owned by Carl Kirkland. In addition, for the years ended December 31, 1995, 1996 and 1997 and the first quarter of 1998, the Company spent $15,292, $18,311, $13,404 and $2,539, respectively, for the rental of aircraft for business travel from Alderson Aviation, Inc., an entity owned by Robert E. Alderson. RELATIONSHIP WITH THE ROBINSON-HUMPHREY COMPANY, LLC Reynolds C. Faulkner, a director of the Company since September 1996 and the Company's Senior Vice President and Chief Financial Officer since February 1998, was a Managing Director at The Robinson-Humphrey Company, LLC prior to joining the Company as an executive officer. The Robinson-Humphrey Company, LLC is one of the Underwriters in the Offering and has from time to time provided investment banking services to the Company, including services rendered in connection with the Recapitalization, and may continue to provide such services in the future. In addition, R-H Capital Partners, L.P., an affiliate of The Robinson-Humphrey Company, LLC, is a member of Kirkland Holdings L.L.C., one of the Company's principal shareholders. The Company considers the terms of its transactions with CBK, Inc., Homemaker Industries, Inc., Kirkland Aviation, Inc., Alderson Aviation, Inc. and The Robinson-Humphrey Company, LLC to be at arms length and reasonably equivalent to terms it could obtain through negotiations with an unaffiliated third party under similar economic conditions. In the future, the Company will not enter into any transactions with officers, directors or other affiliates unless the terms are as favorable to the Company as those generally available from unaffiliated third parties and the transactions are approved by a majority of the Company's disinterested directors. 53 55 PRINCIPAL SHAREHOLDERS The following table sets forth certain information regarding the beneficial ownership of the Company's Common Stock at March 31, 1998, assuming that the Pre-Offering Transactions had occurred as of such date, by (i) each director and Named Executive Officer, (ii) each person known to the Company to beneficially own more than 5% of the Common Stock, and (iii) all directors and executive officers as a group, both before and after giving effect to the sale of Common Stock in the Offering. As of such date, and based on the foregoing assumption, there were 146,683 shares of Common Stock outstanding before giving effect to the sale of Common Stock in the Offering.
SHARES BENEFICIALLY OWNED --------------------------------- PERCENT OF CLASS -------------------- NUMBER BEFORE AFTER NAME OF SHARES OFFERING OFFERING - ---- --------- -------- -------- Carl Kirkland(1)............................................ 8,042 5.4 c/o Kirkland's, Inc. 805 N. Parkway Jackson, TN 38305 Robert E. Alderson(2)....................................... 19,842 13.3 c/o Kirkland's, Inc. 805 N. Parkway Jackson, TN 38305 Reynolds C. Faulkner(3)..................................... 2,283 1.5 Steven J. Collins(3)........................................ 230 * David M. Mussafer(4)........................................ 64,321 43.9 c/o Advent International Corporation 101 Federal Street Boston, MA 02110 R. Wilson Orr, III(5)....................................... 15,615 10.6 c/o SSM Venture Partners, L.P. 845 Crossover Lane, Suite 140 Memphis, TN 38117 John P. Oswald(6)........................................... 14,083 9.6 c/o CT Capital International, Inc. 575 Fifth Avenue, 40th Floor New York, NY 10017 Alexander S. McGrath(7)..................................... 4,762 3.2 Bruce Moore................................................. -- -- Kirkland Holdings L.L.C.(8)................................. 100,095 65.0 101 Federal Street Boston, MA 02110 Robert E. Kirkland.......................................... 11,561 7.9 c/o Kirkland's, Inc. 805 N. Parkway Jackson, TN 38305 All executive officers and directors as a group (8 persons)(9)............................................ 129,178 83.9
- --------------- * Represents less than 1% of the outstanding shares of Common Stock. (1) Includes 2,381 shares of Common Stock issuable upon exercise of stock options granted by the Company. Also includes 2,000 shares held by Mr. Kirkland as Trustee for the benefit of the children of Robert E. Alderson. If the 54 56 Underwriters' over-allotment option is exercised in full, of the shares owned by Mr. Kirkland will be sold, as a result of which he will beneficially own shares of Common Stock, or % of the Common Stock then outstanding, following the Offering. (2) Includes 2,381 shares of Common Stock issuable upon exercise of stock options granted by the Company. Also includes 7,900 shares held by Mr. Alderson as Trustee for the benefit of the children of Carl Kirkland. If the Underwriters' over-allotment option is exercised in full, of the shares owned by Mr. Alderson will be sold, as a result of which he will beneficially own shares of Common Stock, or % of the Common Stock then outstanding, following the Offering. (3) All of the shares of Common Stock beneficially owned by Messrs. Reynolds and Collins are issuable upon exercise of stock options granted by the Company. (4) Mr. Mussafer may be deemed to beneficially own 64,321 shares of Common Stock which Advent beneficially owns as the general partner of Advent Direct Investment Program Limited Partnership, Global Private Equity II Limited Partnership and Advent Partners Limited Partnership, which are members of Kirkland Holdings L.L.C. Mr. Mussafer, a director of the Company, is a Managing Director of Advent. If the Underwriters' over-allotment option is exercised in full, of the shares beneficially owned by Advent will be sold, as a result of which Mr. Mussafer may be deemed to beneficially own shares of Common Stock, or % of the Common Stock then outstanding, following the Offering. (5) Mr. Orr may be deemed to beneficially own 15,615 shares of Common Stock which SSM/Kirkland Equity Partners, L.P. beneficially owns as a member of Kirkland Holdings L.L.C. Mr. Orr, a director of the Company, is a partner of SSM Corporation which is an affiliate of SSM/Kirkland Equity Partners, L.P. If the Underwriters' over-allotment option is exercised in full, of the shares owned by SSM/Kirkland Equity Partners, L.P. will be sold, as a result of which Mr. Orr may be deemed to beneficially own shares of Common Stock, or % of the Common Stock then outstanding, after the offering. (6) Mr. Oswald may be deemed to beneficially own the 1,071 shares of Common Stock beneficially owned by Capital Trust Investments, Ltd. and 13,012 shares of Common Stock which CT/Kirkland Equity Partners, L.P. beneficially owns as a member of Kirkland Holdings L.L.C. Mr. Oswald, a director of the Company, is a partner of CT Capital International which is an affiliate of Capital Trust Investments, Ltd. and CT/Kirkland Equity Partners, L.P. If the Underwriters' over-allotment option is exercised in full, of the shares owned by CT/Kirkland Equity Partners, L.P. will be sold, as a result of which Mr. Oswald may be deemed to beneficially own shares of Common Stock, or % of the Common Stock then outstanding, following the Offering. (7) Mr. McGrath may be deemed to beneficially own the 4,762 shares of Common Stock beneficially owned by Capital Resource Lenders II, L.P. Mr. McGrath, a director of the Company, is a general partner of Capital Resource Partners II, L.P., the general partner of Capital Resource Lenders II, L.P. (8) The members of Kirkland Holdings L.L.C. and their beneficial ownership of the shares of Common Stock held by Kirkland Holdings L.L.C. (expressed as a percentage) are Advent Direct Investment Program Limited Partnership (17.58%), Global Private Equity II Limited Partnership (45.06%), Advent Partners Limited Partnership (1.62%), SSM/Kirkland Equity Partners, L.P. (15.60%), CT/Kirkland Equity Partners, L.P. (13.00%), TCW/Kirkland Equity Partners, L.P. (1.62%), Marlborough/Kirkland Equity Partners, L.P. (0.65%) and R-H Capital Partners, L.P. (4.87%), an affiliate of The Robinson-Humphrey Company, LLC, one of the Underwriters. In its capacity as the manager of the following venture capital funds: Advent Direct Investment Program Limited Partnership, Global Private Equity II Limited Partnership and Advent Partners Limited Partnership, Advent exercises sole voting and investment power with respect to the 64,321 shares held by these funds and, accordingly, Advent may be deemed to beneficially own such shares. In addition, Advent, as general partner of Advent Partners Limited Partnership, which is a limited partner of SSM/Kirkland Equity Partners, L.P., CT/Kirkland Equity Partners, L.P., TCW/Kirkland Equity Partners, L.P. and Marlborough/Kirkland Equity Partners, L.P., has an economic interest in the Common Stock held by such entities. If the Underwriters' over-allotment option is exercised in full, of the shares beneficially owned by Kirkland Holdings L.L.C. will be sold, as a result of which it will beneficially own shares of Common Stock, or % of the Common Stock then outstanding, following the Offering. (9) Includes 7,275 shares of Common Stock issuable upon exercise of stock options granted by the Company. If the Underwriters' over-allotment option is exercised in full, of the shares subject thereto beneficially owned by the directors and executive officers of the Company will be sold, as a result of which they will beneficially own shares of Common Stock, or % of the Common Stock then outstanding, following the Offering. 55 57 DESCRIPTION OF CAPITAL STOCK GENERAL Upon completion of the Offering, the Company will be authorized to issue up to 50,000,000 shares of Common Stock, no par value, and 10,000,000 shares of Preferred Stock, no par value. Upon completion of the Offering, there will be no Preferred Stock outstanding, as all of the outstanding Preferred Stock will be converted into shares of Common Stock or will be redeemed with a portion of the net proceeds of the Offering. See "Use of Proceeds" and "Certain Transactions - Pre-Offering Transactions." Upon the completion of the Offering, there will be shares of Common Stock issued and outstanding and 10,154 shares of Common Stock reserved for issuance under the Company's employee benefits plans, including shares issuable upon the exercise of options which will be outstanding upon the completion of the Offering. As of the date of this Prospectus, the Company has 92,100 shares of Common Stock, 68,400 shares of Class A Preferred Stock, 23,700 shares of Class B Preferred Stock and 17,122 shares of Class C Preferred Stock issued and outstanding. Pursuant to the Pre-Offering Transactions which will take place immediately prior to completion of the Offering, all of the outstanding shares of Class A Preferred Stock and Class B Preferred Stock will be converted into or exchanged for shares of Common Stock. All of the outstanding shares of the Class C Preferred Stock will be purchased or redeemed with a portion of the net proceeds of the Offering. See "Use of Proceeds" and "Certain Transactions - Pre-Offering Transactions." COMMON STOCK The holders of Common Stock are entitled to one vote for each share held of record on each matter submitted to a vote of shareholders. All holders of Common Stock are entitled to share equally in dividends declared on the Common Stock. See "Dividend Policy." Stock dividends may be paid on Common Stock, whether or not there are shares of Preferred Stock outstanding. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Company, after payment has been made to the holders of shares of Preferred Stock, if any, for the full amount to which they are entitled, the holders of the shares of Common Stock are entitled to share equally in the assets available for distribution. The Company will be selling Common Stock pursuant to the Offering. All currently outstanding shares of Common Stock are, and upon issuance as set forth herein, the shares of Common Stock being sold by the Company will be, duly authorized, validly issued, fully paid and non-assessable. The rights, preferences and privileges of holders of Common Stock are subject to, and may be adversely affected by, the rights of the holders of shares of any series of Preferred Stock which the Company may designate and issue in the future. See "Risk Factors - Charter and Bylaws Provisions; Anti-Takeover Effect of Tennessee Laws." Prior to the Offering, the Common Stock was divided into two series consisting of Voting Common Stock and Non-Voting Common Stock, and the holders of Voting Common Stock were entitled, as a group, to elect a total of four nominees to the Board of Directors. Pursuant to an amendment to the Charter, upon the completion of the Offering, the provisions dividing the Common Stock into two series will be eliminated, and the holders of Common Stock will be entitled to elect the entire Board of Directors. PREFERRED STOCK Pursuant to an amendment to the Charter to be filed prior to the completion of the Offering, the Board of Directors will be authorized, without further action by the shareholders, to issue up to 10,000,000 shares of Preferred Stock in one or more series or classes and to establish the designations, preferences, qualifications, privileges, limitations, restrictions, options, conversion rights and other special or relative rights of any series of Preferred Stock so issued. The issuance of shares of Preferred Stock could adversely affect the voting power and other rights of holders of Common Stock. Because the terms of the Preferred Stock may be fixed by the Board of Directors of the Company without shareholder action, the Preferred Stock could be issued quickly with terms designed to defeat a proposed takeover of the Company, or to make the removal of management of 56 58 the Company more difficult. The authority to issue Preferred Stock or rights to purchase Preferred Stock could be used to discourage a change in control of the Company. Management of the Company is not aware of any such threatened transaction to obtain control of the Company, and the Board of Directors has no current plans to designate and issue any shares of Preferred Stock. WARRANTS In connection with the issuance of subordinated notes for $20 million to certain institutional lenders in the Recapitalization, the Company issued warrants for 16,722 shares of Common Stock to these subordinated lenders. Purchase warrants for 11,905 shares of Common Stock are currently exercisable and will be automatically exercised in connection with the Offering. Contingent warrants for the remaining 4,817 shares of Common Stock will be canceled in connection with the Offering as a result of the Company meeting certain valuation targets. The exercise price for the purchase warrants and the contingent warrants is $0.01 per share, subject to certain anti-dilution adjustment provisions. See "Certain Transactions - Recapitalization." LIMITATION OF DIRECTORS' LIABILITY The Amended and Restated Charter provides that no director of the Company will be personally liable to the Company or any of its shareholders for monetary damages for breach of any fiduciary duty except for liability arising from (i) any breach of a director's duty of loyalty to the Company or its shareholders, (ii) any acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, or (iii) any unlawful distributions. The Company believes that this provision will assist it in securing and maintaining the services of qualified directors who are not employees of the Company. REGISTRATION RIGHTS Pursuant to a registration rights agreement dated June 12, 1996 (the "Registration Rights Agreement"), at any time after the Offering, Kirkland's Holding L.L.C. and Messrs. Carl Kirkland, Robert E. Kirkland and Robert E. Alderson ("Non-Mezzanine Holders") and the beneficial owners of 11,905 shares of Common Stock ("Mezzanine Holders") are entitled to require the Company to register their shares of Common Stock for resale under the Securities Act, provided, in each case, that the anticipated gross proceeds of the related offering exceed $5 million. The Registration Rights Agreement provides for up to one demand by the Mezzanine Holders and up to two demands by Non-Mezzanine Holders. The Company may, at the good faith discretion of its Board, delay up to four months a demand registration request if it is preparing, or within 30 days of such request prepares, to register a public offering. The Non-Mezzanine Holders and Mezzanine Holders are also entitled to unlimited piggyback registrations (except with respect to certain registrations in connection with stock options or benefit plans). Their registration rights with respect to the Offering have been waived. In addition, the Non-Mezzanine Holders and Mezzanine Holders may require the Company to register their shares an unlimited number of times on a Form S-2 or S-3, once the Company has qualified for use of such forms, but the Company will not be obligated to effect these registrations during the 90 days prior to or for 180 days following the effective date of a registration statement relating to a public offering. To the extent permitted by applicable federal and state laws and regulations, the Company is required to bear the expenses of all such registrations (except underwriting discounts and commissions attributable to shares sold). The Registration Rights Agreement includes customary indemnification and contribution provisions among the Company and the Mezzanine Holders, and the Non-Mezzanine Holders. ANTI-TAKEOVER EFFECT OF CHARTER AND BYLAW PROVISIONS AND TENNESSEE LAWS The Company's Amended and Restated Charter (the "Charter") and Restated Bylaws (the "Bylaws") as well as Tennessee law contain various other provisions intended to (i) promote stability of Kirkland's shareholder base and (ii) render more difficult certain unsolicited or hostile attempts to take over Kirkland's which could disrupt Kirkland's, divert the attention of Kirkland's directors, officers and employees and adversely affect the independence and integrity of Kirkland's business. A summary of these provisions of the Charter, Bylaws and Tennessee law is set forth below. 57 59 Classified Board; Removal of Directors. Pursuant to the Charter, the number of directors of Kirkland's will be between three and fifteen directors as determined by a majority vote of the Company's Board of Directors. The directors will be divided into three classes, each class to consist as nearly as possible of one-third of the directors. Directors elected by shareholders at an annual meeting of shareholders will be elected by a plurality of all votes cast at such annual meeting. Initially, the terms of office of the three classes of directors will expire, respectively, at the annual meeting of shareholders in 1999, 2000 and 2001. After the expiration of the terms of the initial classified Board of Directors, the terms of the successors of each of the three classes of directors will expire three years from the year of their respective election. The Charter provides that except as otherwise provided for or fixed by or pursuant to an amendment to the Charter setting forth the rights of the holders of any class or series of preferred stock, newly created directorships resulting from any increase in the number of directors and any vacancies on the Board of Directors of Kirkland's resulting from death, resignation, disqualification, removal or other cause will be filled by the affirmative vote of a majority of the remaining directors then in office, even though less than a quorum of the Board, or by a sole remaining director. Any director elected in accordance with the preceding sentence will hold office for the full term of the class of directors in which the new directorship was created or the vacancy occurred and until such director's successor shall have been duly elected and qualified. No decrease in the number of directors constituting the Board of Directors of Kirkland's will shorten the term of any incumbent director. Subject to the rights of holders of any preferred stock, any director may be removed from office only for cause by the affirmative vote of the holders of at least 80% of the voting power of all the outstanding capital stock of Kirkland's entitled to vote generally in the election of directors (the "Voting Power"), voting together as a single class. These provisions of the Charter would preclude a third party from removing incumbent directors and simultaneously gaining control of the Board of Directors of Kirkland's by filling the vacancies created by removal with its own nominees. Under the classified board provisions described above, it would take at least two elections of directors for any individual or group to gain control of the Board of Directors of Kirkland's. Accordingly, these provisions could discourage a third party from initiating a proxy contest, making a tender offer or otherwise attempting to gain control of the Company. Special Shareholders' Meetings and Right to Act by Written Consent. The Charter and the Bylaws provide that a special meeting of shareholders may be called only by the Chairman of the Board or the President of the Company or upon a resolution adopted by a majority of the entire Board of Directors of Kirkland's. Shareholders are not generally permitted to call, or to require that the Board of Directors call, a special meeting of shareholders pursuant to the terms of the Charter. Moreover, the business permitted to be conducted at any special meeting of shareholders is limited to the business brought before the meeting pursuant to the notice of the meeting given by Kirkland's. Tennessee law provides that shareholders may act by written consent if all shareholders entitled to vote are parties to the written consent. The affirmative vote of the number of shares necessary to authorize shareholder action, evidenced by such written consent, constitutes the act of the shareholders. Procedures for Shareholder Nominations and Proposals. The Bylaws establish an advance notice procedure for shareholders to nominate candidates for election as directors and to propose any new business at any annual meeting ("Shareholder Notice Procedure"). Only persons nominated in accordance with the Shareholder Notice Procedure are eligible to serve as directors, and only business brought before the annual meeting in accordance with the Shareholder Notice Procedure may be conducted at the annual meeting. Under the Shareholder Notice Procedure, notice of shareholder nominations and proposals for new business at the annual meeting must be delivered to the Secretary of Kirkland's 120 days before the month and day that the Company's proxy statement to its shareholders was mailed to shareholders the previous year. For nominations and proposals for any special meetings, the Bylaws require notice not more than 90 days nor less than 60 days before the special meeting. The Bylaws provide that notice to the Secretary of Kirkland's with respect to any shareholder nomination or proposal must include certain information regarding the nominee, the proposal and the shareholder nominating a director or proposing business. According to the Bylaws, the Chairman of the Board has the power to determine whether a shareholder nomination or proposal was brought in accordance with the Shareholder Notice Procedure. 58 60 By requiring advance notice of nominations by shareholders, the Shareholder Notice Procedure will afford the Board of Directors an opportunity to consider the qualifications of the proposed nominees and, to the extent deemed necessary or desirable by the Board of Directors, to inform shareholders about such qualifications. By requiring advance notice of other proposed business, the Shareholder Notice Procedure will provide a more orderly procedure for conducting annual meetings of shareholders and, to the extent deemed necessary or desirable by the Board of Directors, will provide the Board of Directors with an opportunity to inform shareholders, prior to such meetings, of the Board of Directors' position regarding action to be taken with respect to such business, so that shareholders can better decide whether to attend such a meeting or to grant a proxy regarding the disposition of any such business. Although the Bylaws do not give the Board of Directors any power to approve or disapprove shareholder nominations for the election of directors or proposals for action, the Chairman of the Board has the power to determine compliance with the Shareholder Notice Procedure. The Bylaws also may have the effect of precluding a contest for the election of directors or the consideration of shareholder proposals if the proper procedures are not followed, and of discouraging or deterring a third party from conducting a solicitation of proxies to elect its own slate of directors or to approve its own proposal, without regard to whether consideration of such nominees or proposals might be harmful or beneficial to Kirkland's and its shareholders. Amendment of Kirkland's Charter and Bylaws. The Charter provides that, unless previously approved by the Board of Directors, the affirmative vote of at least 80% of the Voting Power, voting together as a single class, would be required to (i) amend or repeal the provisions of the Charter with respect to the election of directors and the right to call a special shareholders' meeting, (ii) adopt any provision inconsistent with such provisions and (iii) amend or repeal the provisions of the Charter with respect to amendments to the Charter or the Bylaws. In addition, the Bylaws provide that the amendment or repeal by shareholders of any Bylaws made by the Board of Directors would require the affirmative vote of at least 80% of the Voting Power. Tennessee Corporate Takeover Acts. Tennessee has enacted several corporate takeover acts for the purpose of protecting its substantial interest in domestic corporations conducting a significant amount of business within the state. Business Combination Act. Tennessee's Business Combination Act provides that a party (such party is called an "interested shareholder") owning 10% or more of the stock in a "resident domestic corporation" (which Kirkland's is) cannot engage in a business combination with the resident domestic corporation unless the combination (i) takes place at least five years after the interested shareholder first acquired 10% or more of the resident domestic corporation, and (ii) either (A) is approved by at least two-thirds of the non-interested voting shares of the resident domestic corporation or (B) satisfies certain fairness conditions specified in the Business Combination Act. These provisions apply unless one of two events occurs. A business combination with an entity can proceed without delay when approved by the target corporation's board of directors before that entity becomes an interested shareholder, or the resident domestic corporation may enact a charter amendment or bylaw to remove itself entirely from the Business Combination Act. This charter amendment or bylaw must be approved by a majority of the shareholders who have held shares for more than one year prior to the vote. It may not take effect for at least two years after the vote. The Company has not adopted a charter or bylaw amendment removing the Company from coverage under the Business Combination Act. The Business Combination Act further provides an exemption from liability for officers and directors of resident domestic corporations who do not approve proposed business combinations or charter amendments and bylaws removing their corporations from the Business Combination Act's coverage as long as the officers and directors act in "good faith belief" that the proposed business combination would adversely affect their corporation's employees, customers, suppliers or the communities in which their corporation operates and such factors are permitted to be considered by the board of directors under the applicable charter. Investor Protection Act. Tennessee's Investor Protection Act ("Investor Protection Act") applies to tender offers directed at corporations (called "offeree companies") that have "substantial assets" in Tennessee and that are either incorporated in or have a principal office in Tennessee. The Company satisfies 59 61 both of these requirements. The Investor Protection Act requires an offeror making a tender offer for an offeree company to file with the Commissioner of Commerce and Insurance (the "Commissioner") a registration statement. When the offeror intends to gain control of the offeree company, the registration statement must indicate any plans the offeror has for the offeree. The Commissioner may require additional information material concerning the takeover offer and may call for hearings. The Investor Protection Act does not apply to an offer that the offeree company's board of directors recommends to shareholders. In addition to requiring the offeror to file a registration statement with the Commissioner, the Investor Protection Act requires the offeror and the offeree company to deliver to the Commissioner all solicitation materials used in connection with the tender offer. The Investor Protection Act prohibits "fraudulent, deceptive, or manipulative acts or practices" by either side, and gives the Commissioner standing to apply for equitable relief to the Chancery Court of Davidson County, Tennessee, or to any other chancery court having jurisdiction whenever it appears to the Commissioner that the offeror, the offeree company or any of its respective affiliates has engaged in or is about to engage in a violation of the Investor Protection Act. Upon proper showing, the chancery court may grant injunctive relief. The Investor Protection Act further provides civil and criminal penalties for violations. Greenmail Act. The Tennessee Greenmail Act ("Greenmail Act") applies to any corporation chartered under the laws of Tennessee which has a class of voting stock registered or traded on a national securities exchange or registered with the Securities and Exchange Commission pursuant to Section 12(g) of the Exchange Act. The Greenmail Act provides that it is unlawful for any corporation or subsidiary to purchase, either directly or indirectly, any of its shares at a price above the market value, as defined in the Greenmail Act, from any person who holds more than 3% of the class of the securities purchased if such person has held such shares for less than two years, unless either the purchase is first approved by the affirmative vote of a majority of the outstanding shares of each class of voting stock or the corporation makes an offer of at least equal value per share to all holders of shares of such class. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the Common Stock is BankBoston, N.A. SHARES ELIGIBLE FOR FUTURE SALE Upon completion of the Offering, the Company will have shares of Common Stock outstanding. Of these shares, the shares of Common Stock offered hereby will be freely tradeable without restriction or further registration, except for shares purchased by "affiliates" or "underwriters" of the Company (as those terms are defined under the Securities Act), which will become eligible for sale in the public market subject to compliance with Rule 144 under the Securities Act. The remaining 146,683 outstanding shares of Common Stock are restricted securities (the "Restricted Shares") and may not be sold unless they are registered under the Securities Act or are sold pursuant to an exemption from registration, such as the exemption provided by Rule 144 under the Securities Act. All of the Restricted Shares will be subject to the 180-day "lock-up" agreements described below. Upon expiration of such lock-up agreements, 105,293 of the Restricted Shares will become eligible for sale, subject to compliance with the volume limitations and manner of sale requirements of Rule 144. The remaining 41,390 Restricted Shares will become eligible for sale commencing one year after the date of this Prospectus. Holders of all of these Restricted Shares have the right to require the Company to register the shares for sale under the Securities Act in certain circumstances and have the right to include those shares in a Company-initiated registration. In general, Rule 144 allows a person who has beneficially owned Restricted Shares for at least one year, including persons who may be deemed affiliates of the Company, to sell, within any three-month period, up to the number of Restricted Shares that does not exceed the greater of (i) 1% of the then outstanding shares of Common Stock and (ii) the average weekly trading volume during the four calendar weeks preceding the date on which notice of the sale is filed with the Commission. A person who is not deemed to have been an affiliate of the Company at any time during the three months preceding a sale and who has beneficially owned his or 60 62 her Restricted Shares for at least two years would be entitled to sell such Restricted Shares without regard to the volume limitations described above and certain other conditions of Rule 144. Under Rule 701, any employee, officer or director or consultant to the Company who purchased shares pursuant to a written compensatory plan or contract, including the 1996 Executive Incentive and Non-Qualified Stock Option Plan, who is not an affiliate of the Company, is entitled to sell such shares without having to comply with the public information, holding period, volume limitation or notice provisions of Rule 144 commencing 90 days after the date of effectiveness (the "Effective Date") of the Registration Statement of which this Prospectus is a part (the "Registration Statement"). In addition, under Rule 701, any affiliate who purchased shares pursuant to a written compensatory plan or contract is entitled to sell such shares without having to comply with the Rule 144 holding period restrictions commencing 90 days after the Effective Date, subject to the "lock-up" agreements described above. The shares underlying certain options which will be exercisable upon completion of the Offering will also, upon exercise of the options, become eligible for sale subject to the applicable "lock-up" agreements, as described above, and compliance with Rule 144. An additional shares underlying options which will become exercisable periodically beginning in August 1998 will become eligible for sale subject to compliance with Rule 144. In addition, the Company may issue up to an 12,850 additional shares of Common Stock pursuant to the 1996 Executive Incentive and Non-Qualified Stock Option Plan, the 1998 Incentive Plan and the Purchase Plan. See "Management - Employee Benefit Plans." The Company intends to file one or more registration statements under the Securities Act to register Common Stock to be issued pursuant to these plans, which would allow the shares issued thereunder to be freely tradeable without restriction or further registration, except for shares purchased by "affiliates" or "underwriters" of the Company. Prior to this Offering, there has been no public market for the securities of the Company. No predictions can be made of the effect, if any, that the sale or availability for sale of shares of additional Common Stock will have on the market price of the Common Stock. Nevertheless, sales of a substantial number of such shares by existing shareholders or by shareholders purchasing in the Offering could have an adverse effect on the market price of the Common Stock. 61 63 UNDERWRITING Under the terms of and subject to the conditions contained in an underwriting agreement (the "Underwriting Agreement"), among the Company and each of the underwriters named below (the "Underwriters"), for whom Lehman Brothers Inc., The Robinson-Humphrey Company, LLC, BancAmerica Robertson Stephens and Morgan Keegan & Company, Inc. are acting as representatives (the "Representatives"), each of the several Underwriters has agreed to purchase from the Company, and the Company has agreed to sell to each Underwriter, the aggregate number of shares of Common Stock set forth opposite the name of such Underwriter below:
NUMBER OF UNDERWRITERS COMMON SHARES ------------ ------------- Lehman Brothers Inc. ................................. The Robinson-Humphrey Company, LLC.................... BancAmerica Robertson Stephens........................ Morgan Keegan & Company, Inc. ........................ ----------- Total....................................... ===========
The Underwriting Agreement provides that the obligations of the Underwriters to purchase shares of Common Stock are subject to the approval of certain legal matters by counsel and to certain other conditions and that, if any of the shares of Common Stock are purchased by the Underwriters pursuant to the Underwriting Agreement, all the shares of Common Stock agreed to be purchased by the Underwriters pursuant to the Underwriting Agreement must be so purchased. The Company has been advised by the Representatives that the Underwriters propose to offer shares of Common Stock directly to the public initially at the public offering price set forth on the cover page of this Prospectus and to certain selected dealers (who may include the Underwriters) at such public offering price less a selling concession not to exceed $ per share. The selected dealers may reallow a concession not to exceed $ per share. After the initial offering of the Common Stock, the offering price, the concession to selected dealers and the reallowance to other dealers may be changed by the Underwriters. The Company and its directors, executive officers and existing shareholders have agreed not to, directly or indirectly, (i) offer for sale, sell, pledge or otherwise dispose of (or enter into any transaction or device which is designed to, or could reasonably be expected to, result in the disposition by any person at any time in the future of) any shares of Common Stock or securities convertible into or exchangeable for Common Stock, or sell or grant options, rights or warrants with respect to any shares of Common Stock or securities convertible into or exchangeable for Common Stock (except that such restrictions will not apply to the shares offered pursuant to this Offering, shares offered directly by the Company pursuant to the Company's existing employee benefit plans or as consideration for future acquisitions, and shares offered in private transactions provided that the transferee agrees to the restrictions discussed herein) or (ii) enter into any swap or other derivatives transaction that transfers to another, in whole or in part, any of the economic benefits or risks of ownership of such shares of Common Stock, whether any such transaction described in clause (i) or (ii) above is to be settled by delivery of Common Stock or other securities, in cash or otherwise, in each case for a period of 180 days from the date of this Prospectus without the prior written consent of Lehman Brothers Inc. Carl Kirkland, Robert E. Alderson and Kirkland Holdings L.L.C. (the "Option Shareholders") have granted to the Underwriters an option to purchase up to an additional shares of Common Stock at the initial public offering price to the public, less the underwriting discounts and commissions shown on the cover page of this Prospectus, solely to cover over-allotments, if any. See "Principal Shareholders" and "Certain Transactions." The option may be exercised at any time up to 30 days after the date of this Prospectus. To the extent that the Underwriters exercise such option, each of the Underwriters will be committed (subject to certain conditions) to purchase a number of additional shares proportionate to such Underwriter's initial commitment as indicated in the preceding table. 62 64 The Company, each of its operating subsidiaries and the Option Shareholders have agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act, and to contribute to payments which the Underwriters may be required to make in respect thereof. Until the distribution of the shares of Common Stock offered hereby is completed, rules of the Commission may limit the ability of the Underwriters and certain selling group members to bid for and purchase the Common Stock. As an exception to these rules, the Representatives are permitted to engage in certain transactions that stabilize the price of the Common Stock. Such transactions may consist of bids or purchases for the purpose of pegging, fixing or maintaining the price of the Common Stock. If the Underwriters create a short position in the Common Stock in connection with the Offering (i.e., if they sell more shares of Common Stock than are set forth on the cover page of this Prospectus), the Representatives may reduce that short position by purchasing the Common Stock in the open market. The Representatives may also elect to reduce any short position by exercising all or part of the over-allotment option described herein. The Representatives also may impose a penalty bid on certain Underwriters and selling group members. This means that if the Representatives purchase Common Stock in the open market to reduce the Underwriters' short position or to stabilize the price of the Common Stock, they may reclaim the amount of the selling concession from the Underwriters and selling group members who sold those shares of Common Stock as part of the Offering. In general, purchases of a security for the purposes of stabilization or to reduce a syndicate short position could cause the price of the security to be higher than it might otherwise be in the absence of such purchases. The imposition of a penalty bid might have an effect on the price of a security to the extent that it were to discourage resales of the security by purchasers in the applicable offering. Neither the Company nor any of the Underwriters makes any representation or prediction as to the direction or magnitude of any effect that the transactions described above may have on the price of the Common Stock. In addition, neither the Company nor any of the Underwriters makes any representation that the Representatives will engage in such transactions or that such transactions, once commenced, will not be discontinued without notice. Prior to the Offering, there has been no public market for the Common Stock. The initial public offering price will be negotiated between the Company and the Representatives. Among the factors to be considered in determining the initial public offering price, in addition to prevailing market conditions, will be the market values of publicly traded companies that the Underwriters believe to be somewhat comparable to the Company, the demand for the Common Stock and for similar securities of companies comparable to the Company and other factors deemed relevant. There can, however, be no assurance that an active trading market will develop for the Common Stock or that the prices at which the Common Stock will sell in the public market after the Offering will not be lower than the price at which it will be sold in the Offering. At the request of the Company, the Underwriters have reserved up to 5% of the shares of Common Stock offered hereby for sale at the initial public offering price to employees of the Company and other persons associated with the Company. The number of shares of Common Stock available for sale to the general public in the Offering will be reduced to the extent such persons purchase such reserved Common Stock. Any reserved shares of Common Stock not so purchased will be offered by the Underwriters to the general public on the same basis as the Common Stock offered hereby. The Representatives have informed the Company that the Underwriters do not intend to confirm sales of shares of Common Stock offered hereby to accounts over which they exercise discretionary authority without the prior specific written approval of such customers. R-H Capital Partners, L.P., an affiliate of The Robinson-Humphrey Company, LLC, one of the Underwriters in the Offering, is a member of Kirkland Holdings L.L.C., one of the Company's principal shareholders. In addition, as of April 15, 1998, Lehman Commercial Paper Inc. ("Lehman"), an affiliate of Lehman Brothers Inc., one of the Underwriters in the Offering, was the lender under one of the tranches of the 63 65 Company's senior credit facility for approximately $22.1 million of the $38.4 million then outstanding under that tranche. Upon completion of the Offering, the Company expects to use approximately $12.2 million of the net proceeds to repay a portion of this tranche, approximately $7.5 million of which will be used to repay Lehman's proportionate share. As a result of Lehman, an affiliate of Lehman Brothers Inc., receiving greater than 10% of the net proceeds of the Offering, the National Association of Securities Dealers, Inc. ("NASD") requires, among other things, under Rule 2720 of the NASD's Conduct Rules, that the initial public offering price be no higher than that recommended by a "qualified independent underwriter," who must participate in the preparation of the registration statement and the prospectus and who must exercise the usual standards of "due diligence" with respect thereto. The Robinson-Humphrey Company, LLC is acting as a qualified independent underwriter in this Offering, and the initial public offering price of the shares is not higher than the price recommended by The Robinson-Humphrey Company, LLC, which price was determined based on the factors discussed above. In accordance with such Rule 2720, the Underwriters will not make sales of shares of Common Stock offered hereby to customers' discretionary accounts without the prior specific written approval of such customers. Certain of the Underwriters have also, from time to time, provided investment banking services to the Company for which they have received customary fees. See "Certain Transactions - The Recapitalization." LEGAL MATTERS The validity of the shares of Common Stock offered hereby is being passed upon for the Company by Pepper Hamilton LLP and the Underwriters are being represented by Cravath, Swaine & Moore, New York, New York. EXPERTS The combined financial statements as of December 31, 1997 and 1996 and for each of the years then ended included in this Prospectus and in the Registration Statement have been so included in reliance upon the report of Price Waterhouse LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. The combined financial statements for the year ended December 31, 1995 included in this Prospectus and in the Registration Statement have been included in reliance upon the report of KPMG Peat Marwick LLP, independent public accountants, given on the authority of said firm as experts in accounting and auditing. AVAILABLE INFORMATION The Company is not currently subject to the informational requirements of the Securities Exchange Act. As a result of the Offering, the Company will be required to file reports and other information with the Securities and Exchange Commission (the "Commission") pursuant to the informational requirements of the Securities Exchange Act. The Company has filed with the Commission a Registration Statement on Form S-1 under the Securities Act with respect to the securities offered hereby. As permitted by the rules and regulations of the Commission, this Prospectus, which is part of the Registration Statement, omits certain information, exhibits, schedules and undertakings set forth in the Registration Statement. For further information pertaining to the Company and the securities offered hereby, reference is made to such Registration Statement and the exhibits and schedules thereto. Statements contained in this Prospectus as to the contents or provisions of any documents referred to herein are not necessarily complete, and in each instance, reference is made to the copy of the document, if applicable, filed as an exhibit to the Registration Statement. The Company will issue annual and quarterly reports. Annual reports will include audited financial statements prepared in accordance with accounting principles generally accepted in the United States and a report of the Company's independent auditors with respect to the examination of such financial statements. In addition, the Company will issue to its security holders such other unaudited quarterly or other interim reports as it deems appropriate. 64 66 The Registration Statement may be inspected without charge at the office of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. Copies of the Registration Statement may be obtained from the Commission at prescribed rates from the Public Reference Section of the Commission at such address, and at the Commission's regional offices located at 7 World Trade Center, 13th Floor, New York, New York 10048, and at Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. In addition, registration statements and certain other filings made with the Commission through its Electronic Data Gathering, Analysis and Retrieval ("EDGAR") system are publicly available through the Commission's site on the Internet's World Wide Web, located at http://www.sec.gov. The Registration Statement, including all exhibits thereto and amendments thereof, has been filed with the Commission through EDGAR. 65 67 KIRKLAND'S, INC. AND AFFILIATES INDEX TO COMBINED FINANCIAL STATEMENTS
PAGE ---- Report of Independent Public Accountants.................... F-2 Independent Auditors' Report................................ F-3 Combined Balance Sheet as of December 31, 1996 and 1997 and March 31, 1998............................................ F-4 Combined Statement of Income for the years ended December 31, 1995, 1996 and 1997 and the three months ended March 31, 1997 and 1998......................................... F-5 Combined Statement of Changes in Shareholders' Equity (Deficit) for the years ended December 31, 1995, 1996 and 1997 and the three months ended March 31, 1998............ F-6 Combined Statement of Cash Flows for the years ended December 31, 1995, 1996 and 1997 and the three months ended March 31, 1997 and 1998............................. F-7 Notes to Combined Financial Statements...................... F-8
F-1 68 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Kirkland's, Inc. and Affiliates The transaction described in Note 13 in the combined financial statements has not been consummated. When it has been consummated, we will be in a position to furnish the following report: "In our opinion, the accompanying combined balance sheet and the related combined statements of income, of changes in shareholders' equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Kirkland's, Inc. and Affiliates at December 31, 1996 and 1997, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above." PRICE WATERHOUSE LLP Memphis, Tennessee February 13, 1998, except for Note 8 which is as of April 27, 1998 and Note 13 which is as of , 1998 F-2 69 When the transaction referred to in Note 13 of the Notes to Combined Financial Statements has been consummated, we will be in a position to render the following report. KPMG Peat Marwick LLP INDEPENDENT AUDITORS' REPORT The Board of Directors Kirkland's, Inc. and Affiliates: We have audited the accompanying combined statements of income, changes in shareholders' equity (deficit) and cash flows of Kirkland's, Inc. and Affiliates (formerly Kirkland's Retail Organization) for the year ended December 31, 1995. These combined financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these combined financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the combined financial statements referred to above present fairly, in all material respects, the results of operations and the cash flows of Kirkland's, Inc. and Affiliates for the year ended December 31, 1995, in conformity with generally accepted accounting principles. Memphis, Tennessee March 26, 1996, except as to Note 13, which is as of , 1998 F-3 70 KIRKLAND'S, INC. AND AFFILIATES COMBINED BALANCE SHEET (IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
PRO FORMA INDEBTEDNESS AND EQUITY DECEMBER 31, (NOTE 1) ---------------------- MARCH 31, MARCH 31, 1996 1997 1998 1998 --------- --------- ----------- ------------ (UNAUDITED) (UNAUDITED) ASSETS Current assets: Cash and cash equivalents......................... $ 11,228 $ 10,881 $ 2,177 Inventories....................................... 16,985 20,036 22,546 Prepaid expenses and other current assets......... 822 1,005 1,009 Income taxes refundable........................... -- -- 1,059 Deferred income taxes............................. 552 596 692 --------- --------- --------- Total current assets....................... 29,587 32,518 27,483 Property and equipment, net......................... 10,613 12,895 12,894 Noncurrent deferred income taxes.................... 165 201 201 Debt issue costs, net............................... 5,271 4,270 4,018 --------- --------- --------- Total assets............................... $ 45,636 $ 49,884 $ 44,596 ========= ========= ========= LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' DEFICIT Current liabilities: Current maturities of long-term debt.............. $ 3,583 $ 4,421 $ 4,588 Accounts payable.................................. 1,315 1,696 2,878 Income taxes payable.............................. 1,565 1,774 -- Accrued liabilities............................... 5,951 8,835 6,224 --------- --------- --------- Total current liabilities.................. 12,414 16,726 13,690 --------- --------- --------- Long-term debt: Senior credit facility............................ 48,281 44,051 50,887 38,687 Subordinated debt................................. 19,721 19,764 19,775 -- Mandatorily redeemable preferred stock (Class C).............................................. 20,000 20,000 17,122 -- Other notes payable............................... 549 361 310 310 --------- --------- --------- -------- 88,551 84,176 88,094 38,997 --------- --------- --------- -------- Common stock warrants............................... 490 879 879 -- --------- --------- --------- -------- Total liabilities.......................... 101,455 101,781 102,663 51,726 --------- --------- --------- -------- Commitments and contingencies (Notes 7 and 11)...... Redeemable convertible preferred stock, no par value: Class A........................................... 31,899 34,468 35,223 -- Class B........................................... 14,937 16,123 12,361 -- --------- --------- --------- -------- 46,836 50,591 47,584 -- --------- --------- --------- -------- Shareholders' deficit: Common stock, at stated value; 100,000, 100,000 and 92,100 shares issued and outstanding at December 31, 1996, 1997 and March 31, 1998, respectively... 235 210 203 203 Paid-in capital..................................... 6,157 2,293 1,295 100,041 Accumulated deficit................................. (109,047) (104,991) (107,149) (107,374) --------- --------- --------- -------- Total shareholders' deficit................ (102,655) (102,488) (105,651) (7,130) --------- --------- --------- -------- Total liabilities, redeemable preferred stock and shareholders' deficit.......... $ 45,636 $ 49,884 $ 44,596 $ 44,596 ========= ========= ========= ========
See accompanying notes to combined financial statements. F-4 71 KIRKLAND'S, INC. AND AFFILIATES COMBINED STATEMENT OF INCOME (IN THOUSANDS, EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31 ------------------------------------- -------------------------- 1995 1996 1997 1997 1998 -------- ---------- ----------- ----------- ----------- (UNAUDITED) Net sales................ $112,035 $ 127,946 $ 153,584 $ 26,178 $ 30,615 Cost of sales (including store occupancy costs)................. 68,835 80,438 96,998 18,619 21,110 -------- ---------- ----------- ----------- ----------- Gross profit... 43,200 47,508 56,586 7,559 9,505 Operating expenses....... 24,192 27,915 35,004 7,392 9,178 Severance charge......... -- -- 756 -- -- Recapitalization expenses............... -- 854 -- -- -- Owners' compensation..... 13,926 -- -- -- -- Depreciation and amortization........... 2,362 3,383 4,142 1,003 1,156 -------- ---------- ----------- ----------- ----------- Operating income (loss)....... 2,720 15,356 16,684 (836) (829) Interest expense: Senior, subordinated and other notes payable............. 1,415 5,114 7,990 1,961 1,930 Class C Preferred Stock............... -- 990 1,800 450 385 Accretion of common stock warrants...... -- 190 389 97 -- Interest income.......... (162) (47) (80) -- (2) Other income, net........ (221) (147) (154) (57) (64) -------- ---------- ----------- ----------- ----------- Income (loss) before income taxes........ 1,688 9,256 6,739 (3,287) (3,078) Income tax provision (benefit).............. -- 2,693 2,817 (923) (920) -------- ---------- ----------- ----------- ----------- Net income (loss)....... 1,688 6,563 3,922 (2,364) (2,158) Accretion of redeemable preferred stock and accrual of dividends (Class A and B Preferred Stock)....... -- 2,313 3,755 939 998 -------- ---------- ----------- ----------- ----------- Net income (loss) allocable to common stock.................. $ 1,688 $ 4,250 $ 167 $ (3,303) $ (3,156) ======== ========== =========== =========== =========== Income (loss) per common share: Basic.................. $ 16,880 $ 76.18 $ 1.67 $ (33.03) $ (34.04) ======== ========== =========== =========== =========== Diluted................ $ 16,880 $ 67.47 $ 1.35 $ (33.03) $ (34.04) ======== ========== =========== =========== =========== Weighted average number of common shares outstanding: Basic.................. 100 55,789 100,000 100,000 92,714 ======== ========== =========== =========== =========== Diluted................ 100 62,987 123,590 100,000 92,714 ======== ========== =========== =========== ===========
See accompanying notes to combined financial statements. F-5 72 KIRKLAND'S, INC. AND AFFILIATES COMBINED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT) (IN THOUSANDS, EXCEPT FOR SHARE AMOUNTS)
COMMON STOCK ACCUMULATED ---------------- PAID-IN EARNINGS SHARES AMOUNT CAPITAL (DEFICIT) TOTAL ------- ------ ------- ----------- --------- Balance at December 31, 1994.............. 100 $ 639 $ 2,637 $ 6,449 $ 9,725 Sale of common stock in affiliated corporations............................ 13 13 Owners' contributions..................... 453 453 Net income................................ 1,688 1,688 ------- ----- ------- --------- --------- Balance at December 31, 1995.... 100 652 3,090 8,137 11,879 Sale of common stock in affiliated corporations............................ 17 17 Discontinuance of Subchapter S corporation election................................ 8,013 (8,013) -- Distribution to shareholders.............. (1,534) (1,534) Distribution of redeemable preferred stock to common shareholders: Class C................................. (20,000) (20,000) Class B................................. (14,206) (14,206) Issuance of additional shares to existing common shareholders..................... 31,568 -- Sale of common stock to investors......... 68,400 31 31 Repurchase and cancellation of common stock............................ (68) (465) (1,099) (81,528) (83,092) Accretion of redeemable preferred stock and dividends accrued................... (2,313) (2,313) Net income................................ 6,563 6,563 ------- ----- ------- --------- --------- Balance at December 31, 1996.... 100,000 235 6,157 (109,047) (102,655) Retirement of common stock in affiliated corporations............................ (25) (109) 134 -- Accretion of redeemable preferred stock and dividends accrued................... (3,755) (3,755) Net income................................ 3,922 3,922 ------- ----- ------- --------- --------- Balance at December 31, 1997.... 100,000 210 2,293 (104,991) (102,488) Redemption of stock from former shareholder (unaudited)................. (7,900) (7) (7) Accretion of redeemable preferred stock and dividends accrued (unaudited)....... (998) (998) Net loss (unaudited)...................... (2,158) (2,158) ------- ----- ------- --------- --------- Balance at March 31, 1998 (unaudited)................... 92,100 $ 203 $ 1,295 $(107,149) $(105,651) ======= ===== ======= ========= =========
See accompanying notes to combined financial statements. F-6 73 KIRKLAND'S, INC. AND AFFILIATES COMBINED STATEMENT OF CASH FLOWS (IN THOUSANDS)
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, ------------------------------ ------------------- 1995 1996 1997 1997 1998 ------- -------- ------- -------- ------- (UNAUDITED) CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss).................... $ 1,688 $ 6,563 $ 3,922 $ (2,364) $(2,158) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation of property and equipment....................... 2,362 2,790 3,141 753 904 Amortization of debt issue costs........................... -- 593 1,001 250 252 Accretion of common stock warrants........................ -- 190 389 97 -- Loss on disposal of property and equipment....................... 3 52 56 -- -- Deferred tax benefit.............. -- (717) (80) 218 (96) Changes in assets and liabilities: Inventories..................... (4,816) 319 (3,051) (4,206) (2,510) Prepaid expenses and other assets....................... (124) (143) (183) -- (4) Accounts payable................ 1,728 (2,196) 381 1,658 1,182 Income taxes payable............ -- 1,565 209 (2,408) (2,833) Accrued liabilities............. 428 2,049 2,884 (1,562) (2,611) ------- -------- ------- -------- ------- Net cash provided by (used in) operating activities... 1,269 11,065 8,669 (7,564) (7,874) ------- -------- ------- -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of property and equipment......................... 10 52 12 -- -- Capital expenditures................. (4,140) (4,257) (5,491) (735) (903) ------- -------- ------- -------- ------- Net cash used in investing activities................. (4,130) (4,205) (5,479) (735) (903) ------- -------- ------- -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings (repayments) under notes payable to banks............ 224 (448) -- -- -- Proceeds from issuance of long-term debt.............................. 5,804 79,124 -- -- 7,000 Debt issue costs..................... -- (5,864) -- -- -- Principal payments on long-term debt.............................. (3,216) (19,533) (3,537) (617) (37) Redemption of stock from former shareholder....................... -- -- -- -- (6,890) Proceeds from issuance of redeemable convertible preferred stock (Class A), net........................... -- 30,317 -- -- -- Proceeds from issuance of common stock............................. 13 48 -- -- -- Repurchase of common stock........... -- (83,092) -- -- -- Owners' contributions (distributions)................... 453 (1,534) -- -- -- ------- -------- ------- -------- ------- Net cash provided by (used in) financing activities... 3,278 (982) (3,537) (617) 73 ------- -------- ------- -------- ------- Cash and cash equivalents Net increase (decrease)...... 417 5,878 (347) (8,916) (8,704) Beginning of year............ 4,933 5,350 11,228 11,228 10,881 ------- -------- ------- -------- ------- End of year.................. $ 5,350 $ 11,228 $10,881 $ 2,312 $ 2,177 ======= ======== ======= ======== ======= Supplemental Disclosures: Interest paid........................ $ 1,195 $ 5,045 $ 9,041 $ 2,565 $ 2,193 ======= ======== ======= ======== ======= Income taxes paid.................... $ -- $ 1,298 $ 2,687 $ 1,267 $ 2,010 ======= ======== ======= ======== =======
See accompanying notes to combined financial statements. F-7 74 KIRKLAND'S, INC. AND AFFILIATES NOTES TO COMBINED FINANCIAL STATEMENTS NOTE 1 -- DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES Description of Business Kirkland's Inc. and Affiliates (the "Company") is comprised of a service organization and affiliated retail specialty stores (138 at December 31, 1997). The Company is a leading specialty retailer of decorative home accessories and gifts with stores in 25 states. Kirkland's, Inc. operates the retail specialty stores through separate corporations under common ownership. Basis of Presentation The combined financial statements include the accounts of Kirkland's, Inc. and its affiliated corporations. The statements are presented on a combined basis due to common ownership, common management and the integrated nature of business activities/operations. Significant intercompany accounts and transactions are eliminated. Reclassifications Certain prior years' amounts have been reclassified to conform to the 1997 presentation. Cash Equivalents Cash equivalents consist of investments with maturities of 90 days or less at the date of purchase. Inventories Inventories are stated at the lower of cost or market with cost being determined using the average cost method which approximates current cost. Property and Equipment Property and equipment are stated at cost. Tenant allowances provided by the lessors for reimbursement and construction costs incurred in connection with store openings are recorded as reductions to the basis of the respective tenant improvements. Depreciation is computed on a straight-line basis over the estimated useful lives of the respective assets. Furniture, fixtures and equipment are depreciated over 5-7 years. Buildings are depreciated over 40 years. Leasehold improvements are amortized over the shorter of the useful life of the asset or the lease term. Maintenance and repairs are expensed as incurred and improvements are capitalized. Debt Issue Costs Debt issue costs are amortized by the straight-line method over the life of the debt and are shown net of accumulated amortization of $593,000 and $1,594,000 at December 31, 1996 and 1997, respectively. Use of the straight-line method of amortization approximates the results of the application of the interest method. Preopening Expenses Preopening expenses, which consist primarily of payroll and occupancy costs, are expensed as incurred. Advertising Expenses Advertising is expensed as incurred. Advertising expense was $628,000, $771,000 and $802,000 in 1995, 1996 and 1997, respectively. F-8 75 KIRKLAND'S, INC. AND AFFILIATES NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) Income Taxes Prior to June 12, 1996, the Company elected to be taxed as a Subchapter S corporation for federal income tax purposes. As a result, no income taxes were recorded until that date. Instead, the shareholders paid tax on their respective shares of taxable income, even if such income was not distributed. Effective June 12, 1996, the Company discontinued its election to be treated as an S corporation. As a result of this change, the Company capitalized its retained earnings as of that date ($8,013,000) into Paid-in capital. The Company accounts for income taxes under the liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The initial adoption of the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes ("SFAS 109"), resulted in a deferred tax benefit of $379,000. Authorized Capital The Kirkland's, Inc. authorized capital at December 31, 1997 consisted of 500,000 shares of common stock, 68,400 shares of Class A Preferred Stock and 31,600 shares of Class B Preferred Stock. The number of shares of Class A and Class B Preferred Stock discussed elsewhere in these financial statements represents the aggregate combined shares of Kirkland's, Inc. and each of its affiliated corporations. See Note 8 for a description of the terms of each issue. Stock Options and Warrants The Company applies APB Opinion 25 in accounting for its stock compensation plans. No compensation expense is recognized for stock options issued to employees when the option's exercise price is greater than or equal to the fair value of the Company's common stock on the grant date. Otherwise, compensation expense is recorded, over the vesting period, in an amount equal to the difference between the fair value of the common stock on the grant date and the exercise price. The Company has provided pro forma disclosures of net income as if the fair value based method of accounting for the plan, as prescribed by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, had been applied (see Note 9). Pro forma disclosures include the effects of employees' stock options granted during the years ended December 31, 1996 and 1997. The fair value of detachable put warrants issued in connection with the issuance of debt is initially recorded as a discount to the related debt and amortized to interest expense, using the effective interest method, over the term of the related debt. The warrants are adjusted to their current fair value (as defined in the applicable debt agreement) for each subsequent period through the accretion of common stock warrants account in the combined statements of income. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingencies at the date of the financial statements and the related reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Fair Value of Financial Instruments At December 31, 1996 and 1997, the Company did not have any outstanding financial derivative instruments. Financial instruments include cash, accounts payable, a revolving credit agreement and long-term debt. The carrying amounts of these financial instruments, except long-term debt, approximate fair value F-9 76 KIRKLAND'S, INC. AND AFFILIATES NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) because of their short maturities. Long-term debt approximates fair value based on the short periods of interest rate repricing for variable rate long-term debt and estimates based on the current borrowing rates available to the Company for bank loans with similar terms and average maturities for fixed rate long-term debt. Interim Data The interim financial data is unaudited; however, in the opinion of the Company this interim data includes all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results of the interim periods. Pro Forma Information (unaudited) The pro forma information at March 31, 1998 adjusts the historical March 31, 1998 balances of long-term debt and the equity accounts to give effect to the recapitalization and exchange of the Class A and B Preferred Stock into or for common stock, the exercise of common stock warrants by warrantholders and the purchase or redemption of Class C Preferred Stock and other debt upon the closing of an anticipated initial public offering of common stock (the "Offering"). Noncash Supplemental Disclosure The following noncash transactions have been excluded from the Statement of Cash Flows (in thousands): (unaudited)
1996 ------- Accretion of redeemable Class A and B Preferred Stock and - - dividends accrued........................................... $ 2,313 - - Distribution of redeemable Class B and C Preferred Stock.... 34,206 Issuance of common stock warrants in connection with senior - - subordinated debt........................................... 300 1997 ------- Accretion of redeemable Class A and B Preferred Stock and - - dividends accrued........................................... $ 3,755
New Accounting Pronouncements Statement of Financial Accounting Standards ("SFAS") No. 130 -- In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. SFAS No. 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. Currently, the Company does not have any items that are required to be recognized as components of comprehensive income. SFAS No. 131 -- In June 1997, the FASB issued SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information. SFAS No. 131 revises the current requirements for reporting business segments by redefining such segments as the way management disaggregates the business for purposes of making operating decisions and allocating internal resources. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997, and although management believes that SFAS No. 131 will not impact the Company's presentation, the Company will adopt SFAS No. 131 in fiscal 1998. F-10 77 KIRKLAND'S, INC. AND AFFILIATES NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) Earnings Per Share Earnings per share is calculated in accordance with the provisions of SFAS No. 128 Earnings Per Share. SFAS No. 128 requires the Company to report both basic earnings per share and diluted earnings per share. Basic earnings per share is computed by dividing net income allocable to common stock by the weighted average number of shares outstanding during the period. Diluted earnings per share are computed using the weighted average number of shares determined for the basic computations plus the number of shares of common stock that would be issued assuming all potentially issuable shares having a dilutive effect on earnings per share were outstanding for the period.
WEIGHTED (IN THOUSANDS) AVERAGE PER SHARE INCOME SHARES AMOUNT ---------------- ---------- --------- DECEMBER 31, 1997 Basic income........................................ $ 167 100,000 $ 1.67 Effect of dilutive securities: Warrants......................................... 16,452 Options.......................................... 7,138 ------ ---------- ------- Dilutive income..................................... $ 167 123,590 $ 1.35 ------ ---------- ------- DECEMBER 31, 1996 Basic income........................................ $4,250 55,789 $ 76.18 Effect of dilutive securities: Warrants......................................... 7,198 ------ ---------- ------- Dilutive income..................................... $4,250 62,987 $ 67.47 ------ ---------- ------- DECEMBER 31, 1995 Basic income........................................ $1,688 100 $16,880 ------ ---------- ------- Dilutive income..................................... $1,688 100 $16,880 ------ ---------- -------
At December 31, 1996 and 1997, 7,797,000 shares of Class A Preferred Stock and 3,602,400 shares of Class B Preferred Stock were outstanding. The holders of both classes of stock may convert their shares into common stock upon the occurrence of an initial public offering at the rate of the liquidation value divided by the initial public offering price (see Note 8). These shares were not included in the calculation of earnings per share for 1996 and 1997 due to the antidilutive effect they would have on earnings per share if converted. Stock options to acquire 7,143 shares of common stock of the Company at $0.045 per share were granted during 1996. The options had no dilutive impact on earnings per share during the year ended December 31, 1996. Contingent common stock warrants reserved for the holders of the subordinated notes (see Note 6) entitling them to purchase 3.5% of the fully diluted equity of the Company were included in the calculation of diluted earnings per share for the years ended December 31, 1996 and 1997 due to certain valuation thresholds not being met as of the applicable date. Stock options to acquire 3,769 shares of common stock of the Company at $95.00 per share were granted during 1997. The options were not included in the calculation of earnings per share for the year ended December 31, 1997 because the options' exercise price was greater than the average fair market value of the common stock. F-11 78 KIRKLAND'S, INC. AND AFFILIATES NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE 2 -- LEVERAGED RECAPITALIZATION On June 12, 1996, the Company completed a leveraged recapitalization (the "Recapitalization") which included the following principal components: - The creation of two new classes of redeemable convertible preferred stock ("Class A Preferred Stock" and "Class B Preferred Stock") (See Note 8). - The creation of a new class of mandatorily redeemable preferred stock ("Class C Preferred Stock") (See Note 6). - The distribution of 100% of the Class B Preferred Stock and Class C Preferred Stock to the existing shareholders of the Company. - The sale of newly issued shares of common stock and 100% of the Class A Preferred Stock for cash of $30,780,000 to the new investors ("Investors"). - The issuance of $20 million of senior subordinated note due June 2003 ("Senior Subordinated Note") (See Note 6). - The issuance of $52 million of variable rate Senior Debt, under the Company's bank credit facility, with quarterly principal and interest payments through June 2002 (the "Senior Debt") (See Note 6). - The repurchase and cancellation of 68.4% of the aggregate common stock of the existing shareholders for cash of $83,092,000. - The repayment of existing indebtedness of the Company totaling $19,193,000. Total transaction-related fees for the Recapitalization amounted to approximately $6,296,000. Of this amount, financing costs of $5,864,000 associated with the Senior Subordinated Notes and the Senior Debt were deferred and are being amortized over the life of this debt. NOTE 3 -- PROPERTY AND EQUIPMENT Property and equipment comprised the following (in thousands):
DECEMBER 31, ------------------ 1996 1997 ------- ------- Land..................................................... $ 300 $ 300 Buildings................................................ 965 965 Equipment................................................ 18,151 21,556 Leasehold improvements................................... 5,795 6,482 ------- ------- 25,211 29,303 Less accumulated depreciation............................ 14,598 16,408 ------- ------- $10,613 $12,895 ======= =======
F-12 79 KIRKLAND'S, INC. AND AFFILIATES NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE 4 -- ACCRUED LIABILITIES Accrued liabilities comprised the following (in thousands):
DECEMBER 31, ---------------- 1996 1997 ------ ------ Accrued compensation....................................... $ 925 $1,661 Sales taxes payable........................................ 1,857 2,234 Percentage rent accrual.................................... 472 552 Gift certificates and store credits........................ 720 997 Accrued interest payable................................... 1,689 2,358 Other...................................................... 288 1,033 ------ ------ $5,951 $8,835 ====== ======
NOTE 5 -- INCOME TAXES As discussed in Note 1, prior to June 12, 1996, the Company had elected to be treated as a Subchapter S corporation for federal income tax purposes. Accordingly, the financial statements do not reflect a provision for federal income taxes prior to June 12, 1996. The provision for income taxes for 1996 and 1997 consists of the following (in thousands):
1996 1997 ------ ------ Current Federal.................................................. $2,634 $2,324 State.................................................... 776 573 ------ ------ 3,410 2,897 ------ ------ Deferred Federal.................................................. (277) (64) State.................................................... (61) (16) Adoption of SFAS 109 due to discontinuance of S corporation election.................................. (379) -- ------ ------ (717) (80) ------ ------ $2,693 $2,817 ====== ======
F-13 80 KIRKLAND'S, INC. AND AFFILIATES NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) Significant components of the Company's deferred tax assets as of December 31, 1996 and 1997 respectively, are as follows (in thousands):
1996 1997 ---- ------ Current deferred tax assets Inventory valuation methods............................. $192 $ 211 Accruals................................................ 360 385 ---- ------ 552 596 Noncurrent deferred tax assets Property and equipment.................................. 165 201 Net operating loss carryforwards........................ -- 741 ---- ------ 717 1,538 Deferred valuation allowance.............................. -- (741) ---- ------ $717 $ 797 ==== ======
The deferred valuation allowance at December 31, 1997 is based on management's conclusion that sufficient positive evidence, as defined in SFAS 109, regarding realization of certain tax carryforward items does not exist due to potential separate return limitations on the use of such items. A reconciliation of the provision for income taxes to the amount computed by applying the federal statutory tax rate of 35% to income before income taxes for 1996 and 1997, respectively, is as follows:
1996 1997 ----- ----- Statutory Federal income tax rate.......................... 35.0% 35.0% State income taxes, net of Federal income tax effect....... 5.4 5.2 Benefit from termination of S corporation election......... (4.0) -- Benefit from surtax exemptions............................. (10.0) (10.3) Recording of valuation allowance........................... -- 10.4 Other...................................................... 2.7 1.5 ----- ----- 29.1% 41.8% ===== =====
F-14 81 KIRKLAND'S, INC. AND AFFILIATES NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE 6 -- INDEBTEDNESS Long-term debt Long-term debt consists of the following ($ in thousands):
DECEMBER 31, ------------------ 1996 1997 ------- ------- Senior Credit Facility: Senior Debt (Tranche A), principal and interest payable quarterly at varying amounts through June 2001, interest at a negotiated rate, as defined in the debt agreement (average rate of 9.3% in 1997)............... $19,750 $16,750 Senior Debt (Tranche B), principal and interest payable quarterly at varying amounts through June 2002, interest at a negotiated rate, as defined in the debt agreement (average rate of 9.5% in 1997)............... 31,922 31,531 ------- ------- 51,672 48,281 Senior Subordinated Notes, interest payable quarterly, principal due in June 2003, interest at 12.25% in 1996 and 1997, 12.50% thereafter, net of unamortized debt discount of $236,000 ($279,000 in 1996)............................ 19,721 19,764 Various notes payable, with interest rates varying from prime to prime plus 1%, principal and interest payable quarterly or annually, maturing through 2003 (average rate of 9.4% in 1997).......................................... 741 552 ------- ------- 72,134 68,597 Less current portion........................................ 3,583 4,421 ------- ------- Total long-term............................................. $68,551 $64,176 ======= =======
The principal maturities of long-term debt outstanding at December 31, 1997 in years subsequent to 1998 are as follows: $5,672,000 in 1999; $6,480,000 in 2000; $22,347,000 in 2001; $9,913,000 in 2002 and $19,764,000 thereafter. On June 12, 1996, the Company entered into a senior credit facility (the "Senior Debt Agreement") with a syndicate bank group providing for up to $52 million of senior term debt. Borrowings under the Senior Debt Agreement (Tranche A) bear interest at a negotiated rate, a floating rate (the higher of the federal funds rate plus .5% or the prime rate) plus 2.25% or a Eurodollar Rate, as defined in the Senior Debt Agreement, plus 3.25%. Borrowings under the Senior Debt Agreement (Tranche B) bear interest at a negotiated rate, a floating rate (the higher of the federal funds rate plus .5% or the prime rate) plus 2.75%, or a Eurodollar Rate, as defined, plus 3.75%. In accordance with the Senior Debt Agreement, the Company has a $20 million revolving credit agreement ("Line of Credit") with the same syndicate bank group. The Line of Credit has a maturity date of June 30, 2001 and bears interest at a negotiated rate, a floating rate (the higher of the federal funds rate plus .5% or the prime rate) plus 2.25%, or a Eurodollar Rate, as defined in the Senior Debt Agreement, plus 3.25%. The Line of Credit requires a 30-day consecutive zero balance between December 1 and March 1 of each year. There were no borrowings outstanding under the Line of Credit at December 31, 1996 and 1997. The Company is required to pay a commitment fee to the bank at a rate per annum equal to .5% on the unused portion of the Line of Credit. On June 12, 1996, the Company also entered into a Senior Subordinated Note and Warrant Purchase Agreement (the "Subordinated Note Agreement"). The holders of the subordinated notes also received warrants to purchase, for $0.01 per share, 11,905 shares of common stock of the Company. Additional warrants ("Incentive Warrants") are reserved for the holders of the notes, entitling them to purchase, for $0.01 per share, an additional 4,817 shares of common stock in the event certain valuation targets are not met. F-15 82 KIRKLAND'S, INC. AND AFFILIATES NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) The Incentive Warrants will be based on the net valuation of the Company at a sale of the Company's common stock or an initial public offering, as defined in the Subordinated Note Agreement. Under the original provisions of this agreement, these warrants could be sold back (i.e., put) to the Company at the holders' option on the maturity date of the debt for fair market value, as defined in the Subordinated Note Agreement. The holders agreed to terminate the put as of January 1, 1998. An initial value of $300,000 was allocated to the warrants and recorded as debt discount. The debt discount is being amortized over the life of the notes. Prior to June 12, 1996, the Company had operating lines of credit of approximately $15.6 million with various banks. The lines had varying maturities and bore interest at rates ranging from 8.25% to 9.5%. Under the most restrictive covenants of these agreements, the Company is required to maintain stated levels of earnings and net worth. These agreements are secured by substantially all of the Company's assets. Mandatorily redeemable preferred stock In connection with the Recapitalization, the Company distributed all of the 1,740,000 authorized shares of no par value Class C Preferred Stock. The Class C Preferred Stock has a liquidation preference to the Class A Preferred Stock and the Class B Preferred Stock and had a liquidation value of $20 million at December 31, 1996 and 1997. The Class C Preferred Stock has no conversion privileges, is non-voting and can be redeemed in whole or in part at the option of the Company at any time, and shall be mandatorily redeemable in whole at the earliest to occur of July 2003 or change in control or refinancing. In connection with the Class C Preferred Stock, the Company pays an annual amount equal to 9% of the outstanding balance to the holders which has been reflected in interest expense in the accompanying combined statement of income. NOTE 7 -- LONG-TERM LEASES The Company leases retail store facilities under noncancelable operating leases with terms ranging from five to ten years and expiring at various dates through 2009. Most of these agreements include renewal options and provide for minimum rentals and contingent rentals based on sales performance in excess of specified minimums. Rent expense under operating leases was $7,615,000, $9,296,000 and $11,363,000 in 1995, 1996 and 1997, respectively, and contingent rental expense was $459,000, $468,000 and $539,000 in 1995, 1996 and 1997, respectively. Future minimum lease payments under all operating leases with initial terms of one year or more are as follows: $12,045,000 in 1998; $11,452,000 in 1999; $10,871,000 in 2000; $10,470,000 in 2001; $10,121,000 in 2002; and $32,559,000 thereafter. NOTE 8 -- CAPITAL STRUCTURE On April 27, 1998, the charters of the Company and each affiliated corporation were amended to establish the capital structure described below. Common Stock The Kirkland's, Inc. authorized capital includes 500,000 shares of voting common stock. The holders of the common stock have one vote per share and are entitled to elect a total of four directors to the Board of Directors of the Company. A director elected by the holders of the stock cannot be removed except for cause unless the removal receives approval by a majority vote. The holders of the stock are not entitled to cumulative voting in the election of directors. F-16 83 KIRKLAND'S, INC. AND AFFILIATES NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) Redeemable Convertible Preferred Stock The Class A Preferred Stock and the Class B Preferred Stock have voting privileges on par with common shareholders and have liquidation values of $30,749,000 and $14,206,000, respectively, plus accrued dividends. The dividends accrue at 8% compounded annually through July 1999 and 10% compounded annually thereafter. The Class A Preferred Stock and Class B Preferred Stock can be redeemed in whole or in part at the option of the Company once all Class C Preferred Stock has been redeemed. The Class A Preferred Stock and Class B Preferred Stock are mandatorily redeemable at the earliest to occur of July 2004 or a liquidity event as defined, including a qualified public offering. Class A Preferred Stock and Class B Preferred Stock must be redeemed in equal proportions. Additionally, the holders of Class A Preferred Stock and Class B Preferred Stock may convert their shares into common stock upon the occurrence of an initial public offering of the Company's common stock at a rate of the liquidation value divided by the initial public offering price. NOTE 9 -- EMPLOYEE BENEFIT PLANS Stock Options On June 12, 1996, the Company adopted the "1996 Executive Incentive and Non-Qualified Stock Option Plan" (the "1996 Plan") which provides employees and officers with opportunities to purchase an aggregate of 12,304 shares of the Company's common stock. The 1996 Plan requires that incentive stock options be issued at exercise prices which are at least 100% of the fair market value of the stock at the date of the grant. On June 12, 1996, the Company granted incentive stock options to purchase 7,143 shares of common stock of the Company. The options were granted under the Plan to three of the Company's key management employees who are also substantial stockholders. The options vest over eight years and provide for accelerated vesting immediately prior to the closing of a sale of the Company or an initial public offering of the Company's common stock. The exercise price is $0.045 per share. Subsequent to December 31, 1997, the options granted to one of the key management employees were canceled in connection with his resignation from the Company and the redemption of his stock (see Note 12). On June 27, 1997, the Company granted non-qualified stock options to various employees under the 1996 Plan to purchase 3,769 shares of the common stock of the Company. The exercise price for the options is $95.00 per share. This exercise price is not less than the fair value of the Company's common stock as determined by the Company's Board of Directors. The options generally become exercisable on July 1, 2000 provided that the optionee is an employee of the Company on that date. Transactions under the Company's stock option plans in each of the two years in the period ended December 31, 1997 are as follows:
NUMBER WEIGHTED AVERAGE OF SHARES EXERCISE PRICE ----------- ---------------- Outstanding at December 31, 1995 -- -- Granted........................................ 7,143 $ 0.045 Exercised...................................... -- -- Canceled....................................... -- -- ------ ------- Outstanding at December 31, 1996................. 7,143 0.045 Granted........................................ 3,769 95.00 Exercised...................................... -- -- Canceled....................................... (660) 95.00 ------ ------- Outstanding at December 31, 1997................. 10,252 $ 28.84 ====== =======
F-17 84 KIRKLAND'S INC. AND AFFILIATES NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) The weighted average fair value of options granted during the year ended December 31, 1996 and 1997 was determined to be $0.025 and $32.06 per share, respectively. None of the options are exercisable at December 31, 1997. Had compensation expense for the Company's stock option plan been determined based on the fair values at the grant date for stock option awards granted during the years ended December 31, 1996 and 1997, in accordance with the method of accounting prescribed by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, the Company's net income would have been reduced to the pro forma amounts indicated below (in thousands, except per share amounts):
YEAR ENDED ---------------------------- DECEMBER 31, DECEMBER 31, 1996 1997 ------------ ------------ Net income allocable to common stock, as reported......................................... $4,250 $ 167 Pro forma.......................................... 4,250 147 Net income per common share, as reported: Basic............................................ $76.18 $1.67 Fully diluted.................................... $67.47 $1.35 Pro forma: Basic............................................ $76.18 $1.47 Fully diluted.................................... $67.47 $1.19
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model based upon the following assumptions: expected volatility of 55% in 1996 and 1997; risk-free interest rates of 6.5% in 1996 and 5.5% in 1997; expected lives of 5 years for 1996 and 1997 and no expected dividend payments. The weighted average remaining contractual life of the options was 7.5 years at December 31, 1996 and 5.1 years at December 31, 1997. 401(k) Savings Plan The Company retains a defined contribution 401(k) employee benefit plan which covers all employees meeting certain age and service requirements. Up to 5% of the employee's compensation may be matched at the Company's discretion. This discretionary percentage has been maintained at 25% of an employee's contribution subject to Plan maximums. The Company's matching contributions were approximately $39,000, $50,000 and $57,000 in 1995, 1996 and 1997, respectively. The Company has the option to make additional contributions to the Plan on behalf of covered employees; however, no such contributions were made in 1995, 1996 or 1997. NOTE 10 -- RELATED PARTIES Inventory is purchased in the ordinary course of business from an entity owned by a substantial shareholder of the Company. It is management's opinion that these purchases are made on substantially the same terms as those prevailing at the time for comparable transactions with other entities. Purchases approximated $3.3 million, $2.3 million and $1.4 million in 1995, 1996 and 1997, respectively. The Company purchases inventory from a manufacturer in which one of the Investors also has a significant ownership interest. Purchases from this manufacturer totaled $610,109, $297,774 and $216,847 in 1995, 1996 and 1997, respectively. The Company also paid other substantial shareholders approximately $59,000, $47,000 and $89,000 in 1995, 1996 and 1997, respectively, for rental of aircraft in connection with business travel. F-18 85 KIRKLAND'S, INC. AND AFFILIATES NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE 11 -- COMMITMENTS AND CONTINGENCIES Concentration of Credit Risk Financial instruments which potentially subject the Company to concentration of risk are primarily cash and cash equivalents. The Company places its cash and cash equivalents in insured depository institutions and attempts to limit the amount of credit exposure to any one institution within the covenant restrictions imposed by the Company's debt agreements. At December 31, 1996 and 1997, the Company's uninsured cash balance totaled $10.4 million and $10.1 million, respectively. Employment Agreements In July 1996, the Company entered into employment agreements with three key management employees and a consulting agreement with another individual, all of whom were shareholders of the Company. The management agreements have terms of four years and require annual payments of $825,000. Additionally, these employees own all of the outstanding Class C Preferred Stock. These employment agreements also require the Company to pay an annual amount equal to 9% of the outstanding balance of this preferred stock (see Note 6). The consulting agreement has a term of seven years and requires an annual payment of $679,000. Subsequent to December 31, 1997, one of the management employees resigned and his stock was redeemed (see Note 12). Litigation The Company is party to pending legal proceedings and claims. Although the outcome of such proceedings and claims cannot be determined with certainty, the Company's management is of the opinion that it is unlikely that these proceedings and claims will have a material effect on the financial condition or operating results of the Company. NOTE 12 -- SUBSEQUENT EVENT During the fourth quarter of 1997, a management employee of the Company resigned and the Company began negotiations to settle his employment agreement and repurchase his stock. The final settlement became effective on January 7, 1998. The redemption was financed through $7 million in additional borrowings under the Company's Tranche B Senior Debt. The total amount paid to the former management employee amounted to $6,888,566, which represents the stated value of his Class B Preferred Stock, Class C Preferred Stock and common stock. In connection with the redemption, the options previously granted to the former officer under the 1996 Plan to purchase 2,381 shares of common stock of the Company were canceled. The former management employee's employment agreement had approximately two and one-half years remaining and stipulated annual payments to the former management employee of $534,000. A portion of the payments will continue to be made in the future. The Company recorded an aggregate charge of $756,000 of which $676,000 was accrued as of December 31, 1997 to provide for the balance of the required payments to be made subsequent to that date. This amount is included within severance charge on the combined statement of income. NOTE 13 -- EFFECT OF CONTEMPLATED TRANSACTION As noted elsewhere in this Prospectus, prior to the closing of the Offering, all of the outstanding common stock of each affiliated corporation (collectively, the "Kirkland Companies") will be contributed to Kirkland's, Inc. (the "Contribution"). As of December 31, 1997, Kirkland's, Inc. had 100,000 shares of common stock outstanding and, in the aggregate, the Kirkland Companies had 11,328,000 common shares outstanding. F-19 86 KIRKLAND'S, INC. AND AFFILIATES NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) As a result of the Contribution, the outstanding common shares will be 100,000, before the effect the redemption of 7,900 shares from a former management employee described in Note 12 (92,100 after such redemption). The accompanying combined financial statements, including all common share and per common share information therein, give retroactive effect to the Contribution as if the Contribution occurred as of the beginning of the earliest period. F-20 87 ====================================================== NO PERSON IS AUTHORIZED IN CONNECTION WITH ANY OFFERING MADE HEREBY TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN AS CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR BY ANY OF THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITY OTHER THAN SHARES OF COMMON STOCK OFFERED HEREBY, NOR DOES IT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSONS IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION TO SUCH PERSON. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCE CREATE ANY IMPLICATION THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF. ------------------ TABLE OF CONTENTS
PAGE Summary............................... 3 Risk Factors.......................... 8 Use of Proceeds....................... 16 Dividend Policy....................... 16 Dilution.............................. 17 Capitalization........................ 18 Unaudited Pro Forma Combined Condensed Financial Statements................ 19 Selected Combined Financial Data...... 22 Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 24 Business.............................. 32 Management............................ 41 Certain Transactions.................. 51 Principal Shareholders................ 54 Description of Capital Stock.......... 56 Shares Eligible for Future Sale....... 60 Underwriting.......................... 62 Legal Matters......................... 64 Experts............................... 64 Available Information................. 64 Index to Combined Financial Statements.......................... F-1
UNTIL , 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. ====================================================== ====================================================== SHARES KIRKLAND'S, INC. COMMON STOCK ------------------------ PROSPECTUS , 1998 ------------------------ LEHMAN BROTHERS THE ROBINSON-HUMPHREY COMPANY BANCAMERICA ROBERTSON STEPHENS MORGAN KEEGAN & COMPANY, INC. ====================================================== 88 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following table sets forth an itemization of all estimated expenses, all of which will be paid by the Company, in connection with the issuance and distribution of the securities being registered:
NATURE OF EXPENSE AMOUNT ----------------- -------- SEC Registration Fee...................................... $ 18,659 Nasdaq National Market Listing Fee........................ 83,500 NASD Fee.................................................. 6,825 Printing and engraving fees............................... 100,000 Registrant's counsel fees and expenses.................... * Accounting fees and expenses.............................. 150,000 Officers and Directors Liability Insurance................ 150,000 Blue Sky expenses and counsel fees........................ 5,000 Transfer agent and registrar fees......................... 5,000 Miscellaneous............................................. * -------- TOTAL................................................... $750,000 ========
- --------------- * To be filed by amendment. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. The Tennessee Business Corporation Act ("TBCA") sets forth in Sections 48-18-502 through 48-18-508 the circumstances governing the indemnification of directors, officers, employees and agents of a corporation against liability incurred in the course of their official capacities. Section 48-18-502 of the TBCA provides that a corporation may indemnify any director against liability incurred in connection with a proceeding if (i) the director acted in good faith, (ii) the director reasonably believed, in the case of conduct in his or her official capacity with the corporation, that such conduct was in the corporation's best interest, or, in all other cases, that his or her conduct was not opposed to the best interests of the corporation and (iii) in connection with any criminal proceeding, the director had no reasonable cause to believe that his or her conduct was unlawful. In actions brought by or in the right of the corporation, however, the TBCA provides that no indemnification may be made if the director or officer is adjudged to be liable to the corporation. Similarly, the TBCA prohibits indemnification in connection with any proceeding charging improper personal benefit to a director, if such director is adjudged liable on the basis that a personal benefit was improperly received. In cases where the director is wholly successful, on the merits or otherwise, in the defense of any proceeding instigated because of his or her status as a director of a corporation, Section 48-18-503 of the TBCA mandates that the corporation indemnify the director against reasonable expenses incurred in the proceeding. Notwithstanding the foregoing, Section 48-18-505 of the TBCA provides that a court of competent jurisdiction, upon application, may order that a director or officer be indemnified for reasonable expense if, in consideration of all relevant circumstances, the court determines that such individual is fairly and reasonably entitled to indemnification, whether or not the standard of conduct set forth above was met. Officers, employees, and agents who are not directors are entitled, through the provisions of Section 48-18-507 of the TBCA to the same degree of indemnification afforded to directors under Sections 48-18-503 and 48-18-505. The Amended and Restated Charter (the "Charter") and Amended and Restated Bylaws (the "Bylaws") of the Company will provide that the Company will indemnify from liability, and advance expenses to, any present or former director or officer of the Company to the fullest extent allowed by the TBCA, as amended from time to time, or any subsequent law, rule, or regulation adopted. Additionally, the Charter provides that no director of the Company will be personally liable to the Company or any of its shareholders for monetary damages for breach of any fiduciary duty except for liability arising from (i) any breach of a II-1 89 director's duty of loyalty to the Company or its shareholders, (ii) any acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) any unlawful distributions, or (iv) receiving any improper personal benefit. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. Since May 1, 1995, the Company has sold the following securities (giving retroactive effect to a - for-one stock split to be effected in connection with the Pre-Offering Transactions described in the Prospectus) without registration under the Securities Act: 1. In June 1996, in connection with the Recapitalization, the Company issued an aggregate of 68,400 shares of Common Stock and 68,400 shares of Class A Preferred Stock to Kirkland Holdings, L.L.C., an accredited investor, in exchange for a $30.8 million investment in the Company by Holdings. 2. In June 1996, in connection with the Recapitalization, certain of the outstanding shares of Common Stock of the Company held by four accredited investors were recapitalized into 31,600 shares of Class B Preferred Stock and 20,000 shares of Class C Preferred Stock. 3. In June 1996, in connection with the Recapitalization, the Company granted incentive stock options for 2,381 shares of Common Stock of the Company to each of three executive officers under the Company's 1996 Executive Incentive and Non-Qualified Stock Option Plan (the "1996 Option Plan"), pursuant to the terms of the employment agreements between the Company and each officer. The per share exercise price of these stock options is $0.045. 4. In June 1997, the Company granted stock options to approximately 225 of its employees to purchase an aggregate of 3,769 shares of Common Stock under the 1996 Option Plan at an exercise price of $95.00 per share. 5. In February 1998, the Company granted a stock option for 2,283 shares of Common Stock to an executive officer under the 1996 Option Plan. The per share exercise price of this stock option is $285.65. The Company believes that the transactions described in paragraphs 1 through 5 above were exempt from registration under Section 3(b) or 4(2) of the Securities Act because the subject securities were either (i) issued pursuant to a compensatory benefit plan pursuant to Rule 701 under the Securities Act or (ii) sold to a limited group of persons, each of whom was believed to have been a sophisticated investor or to have had a preexisting business or personal relationship with the Company or its management and to have been purchasing for investment without a view to further distribution. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) Exhibits:
EXHIBIT NO. DESCRIPTION - ----------- ----------- *1.1 Form of Underwriting Agreement 2.1 Recapitalization Agreement dated June 12, 1996, by and among Kirkland Holdings L.L.C., Kirkland's, Inc., Certain Companies Affiliated with Kirkland's, Inc., Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson (Certain exhibits and schedules have been omitted in accordance with Item 601(b)(2) of Regulation S-K. A copy of such exhibits and schedules shall be furnished supplementally to the Securities and Exchange Commission upon request.)
II-2 90
EXHIBIT NO. DESCRIPTION - ----------- ----------- 2.2 Contribution, Redemption and Purchase Agreement dated as of April 29, 1998 by and among Kirkland's, Inc., Affiliates of Kirkland's, Inc., Kirkland Holdings L.L.C., Members of Kirkland Holdings L.L.C., Capital Resource Lenders II, L.P., Allied Capital Corporation, Allied Capital Corporation II, the Marlborough Capital Investment Fund, L.P., Capital Trust Investments, Ltd., the Allison Leigh Alderson Trust, the Amy Katherine Alderson Trust, the Carl T. Kirkland Grantor Retained Annuity Trust 97-1, Carl Kirkland, Robert Kirkland, and Robert Alderson (Certain exhibits and schedules have been omitted in accordance with Item 601(b)(2) of Regulation S-K. A copy of such exhibits and schedules shall be furnished supplementally to the Securities and Exchange Commission upon request.) 3.1 Amended and Restated Charter of Kirkland's, Inc. 3.2 Form of Amended and Restated Charter of Kirkland's, Inc. (to become effective immediately prior to completion of the Offering) 3.3 Bylaws of Kirkland's, Inc. 3.4 Form of Amended and Restated Bylaws of Kirkland's, Inc. (to become effective immediately prior to completion of the Offering) 4.1 Form of Specimen Stock Certificate *5.1 Opinion of Pepper Hamilton LLP 10.1 Credit Agreement dated as of June 12, 1996, among Kirkland's Holdings, L.L.C., the entities listed on Schedule 1.1A thereto, the several banks and other financial institutions or entities from time to time parties to the agreement, the First National Bank of Boston, and Lehman Commercial Paper Inc. (with 3 amendments) 10.2 Senior Subordinated Note Due 2003 in the amount of $8,000,000 dated June 12, 1996 issued to Capital Resource Lenders II, L.P. (Identical Senior Subordinated Notes Due 2003, except as to the payee and the amount of the notes, were issued to The Marlborough Capital Investment Fund, L.P. ($3,800,000), Allied Capital Corporation ($3,600,000), Allied Capital Corporation II ($2,800,000), and Capital Trust Investments, Ltd. ($1,800,000) 10.3 Advent Fee Agreement dated as of June 12, 1996, by and among Advent International Corporation, Kirkland's, Inc., and Affiliates of Kirkland's, Inc. 10.4 Registration Rights Agreement dated as of June 12, 1996, by and among Kirkland Holdings L.L.C., Kirkland's, Inc., Capital Resource Lenders II, L.P., Allied Capital Corporation, Allied Capital Corporation II, the Marlborough Capital Investment Fund, L.P., Capital Trust Investments, Ltd., Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson 10.5 Consulting Agreement by and between the Company and Robert Kirkland dated June 12, 1996 10.6 Employment Agreement by and between the Company and Carl Kirkland dated June 12, 1996 (Identical Employment Agreements, except as to the employee and the annual salary, were entered into with Robert Alderson ($424,500) and Bruce Moore ($534,000)) *10.7 Employment Agreement by and between the Company and Reynolds Faulkner dated as of February 2, 1998 10.8 Employment Agreement by and between the Company and Steven J. Collins dated February 1,1997 10.9 1996 Executive Incentive and Non - Qualified Stock Option Plan, as amended 10.10 1998 Incentive Plan
II-3 91
EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.11 Employee Stock Purchase Plan 10.12 401(k) Plan 10.13 Shareholders Agreement dated as of June 12, 1996, by and among Kirkland Holdings L.L.C., Kirkland's, Inc., Capital Resource Lenders II, L.P., Allied Capital Corporation, Allied Capital Corporation II, the Marlborough Capital Investment Fund, L.P., Capital Trust Investments, Ltd., Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson 10.14 Redemption Agreement dated December 26, 1997 by and among Kirkland's, Inc., Certain Companies Affiliated with Kirkland's, Inc., and Bruce Moore 23.1 Consent of Price Waterhouse LLP 23.2 Consent of KPMG Peat Marwick LLP *23.3 Consent of Pepper Hamilton LLP (included in Exhibit 5.1) 24.1 Power of Attorney (included on Signature Pages) 27.1 Financial Data Schedule 27.2 Financial Data Schedule 27.3 Financial Data Schedule 27.4 Financial Data Schedule 27.5 Financial Data Schedule
- --------------- * To be filed by amendment. (b) Financial Statement Schedules: All schedules have been omitted because they are not applicable, not required or the required information is included in the Financial Statements or the notes thereto. ITEM 17. UNDERTAKINGS. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The undersigned registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. (2) For purposes of determining any liability under the Securities Act, each post - effective amendment that contains a form of prospectus shall be deemed to be a new registration statement II-4 92 relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. The undersigned registrant hereby undertakes to provide to the underwriters at the closing specified in the underwriting agreement certificates in such denominations and registered in such names as required by the underwriter to permit prompt delivery to each purchaser. II-5 93 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-1 and has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Jackson, State of Tennessee, on the 29th day of April, 1998. KIRKLAND'S, INC. By: /s/ CARL KIRKLAND ------------------------------------ Carl Kirkland Chief Executive Officer POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Robert E. Alderson and Reynolds C. Faulkner, and each or any of them, his true and lawful attorney-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Registration Statement, or any registration statement for the same offering that is to be effective upon filing pursuant to Rule 462(b) under the Securities Act of 1933, as amended, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, 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 in and about the premises, 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. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ CARL KIRKLAND Chief Executive Officer; Director April 29, 1998 - ------------------------------------------ (principal executive officer) Carl Kirkland /s/ REYNOLDS C. FAULKNER Senior Vice President and Chief Financial April 29, 1998 - ------------------------------------------ Officer; Director (principal financial Reynolds C. Faulkner officer) /s/ STEVEN J. COLLINS Director of Finance and Treasurer April 29, 1998 - ------------------------------------------ (principal accounting officer) Steven J. Collins /s/ ROBERT E. ALDERSON Director April 29, 1998 - ------------------------------------------ Robert E. Alderson /s/ ALEXANDER S. MCGRATH Director April 29, 1998 - ------------------------------------------ Alexander S. McGrath /s/ DAVID M. MUSSAFER Director April 29, 1998 - ------------------------------------------ David M. Mussafer
II-6 94
SIGNATURE TITLE DATE --------- ----- ---- /s/ R. WILSON ORR, III Director April 29, 1998 - ------------------------------------------ R. Wilson Orr, III /s/ JOHN P. OSWALD Director April 29, 1998 - ------------------------------------------ John P. Oswald
II-7 95 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION - ----------- ----------- 2.1 Recapitalization Agreement dated June 12, 1996, by and among Kirkland Holdings L.L.C., Kirkland's, Inc., Certain Companies Affiliated with Kirkland's, Inc., Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson 2.2 Contribution, Redemption and Purchase Agreement dated as of April 29, 1998 by and among Kirkland's, Inc., Affiliates of Kirkland's, Inc., Kirkland Holdings L.L.C., Members of Kirkland Holdings L.L.C., Capital Resource Lenders II, L.P., Allied Capital Corporation, Allied Capital Corporation II, the Marlborough Capital Investment Fund, L.P., Capital Trust Investments, Ltd., the Allison Leigh Alderson Trust, the Amy Katherine Alderson Trust, the Carl T. Kirkland Grantor Retained Annuity Trust 97-1, Carl Kirkland, Robert Kirkland, and Robert Alderson 3.1 Amended and Restated Charter of Kirkland's, Inc. 3.2 Form of Amended and Restated Charter of Kirkland's, Inc. (to become effective immediately prior to completion of the Offering) 3.3 Bylaws of Kirkland's, Inc. 3.4 Form of Amended and Restated Bylaws of Kirkland's, Inc. (to become effective immediately prior to completion of the Offering) 4.1 Form of Specimen Stock Certificate 10.1 Credit Agreement dated as of June 12, 1996, among Kirkland's Holdings, L.L.C., the entities listed on Schedule 1.1A thereto, the several banks and other financial institutions or entities from time to time parties to the agreement, the First National Bank of Boston, and Lehman Commercial Paper Inc. (with 3 amendments) 10.2 Senior Subordinated Note Due 2003 in the amount of $8,000,000 dated June 12, 1996 issued to Capital Resource Lenders II, L.P. (Identical Senior Subordinated Notes Due 2003, except as to the payee and the amount of the notes, were issued to The Marlborough Capital Investment Fund, L.P. ($3,800,000), Allied Capital Corporation ($3,600,000), Allied Capital Corporation II ($2,800,000), and Capital Trust Investments, Ltd. ($1,800,000)) 10.3 Advent Fee Agreement dated as of June 12, 1996, by and among Advent International Corporation, Kirkland's, Inc., and Affiliates of Kirkland's, Inc. 10.4 Registration Rights Agreement dated as of June 12, 1996, by and among Kirkland Holdings L.L.C., Kirkland's, Inc., Capital Resource Lenders II, L.P., Allied Capital Corporation, Allied Capital Corporation II, the Marlborough Capital Investment Fund, L.P., Capital Trust Investments, Ltd., Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson 10.5 Consulting Agreement by and between the Company and Robert Kirkland dated June 12, 1996 10.6 Employment Agreement by and between the Company and Carl Kirkland dated June 12, 1996 (Identical Employment Agreements, except as to the employee and the annual salary, were entered into with Robert Alderson ($424,500) and Bruce Moore ($534,000)) 10.8 Employment Agreement by and between the Company and Steven J. Collins dated February 1,1997 10.9 1996 Executive Incentive and Non - Qualified Stock Option Plan, as amended 10.10 1998 Incentive Plan 10.11 Employee Stock Purchase Plan
96
EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.12 401(k) Plan 10.13 Shareholders Agreement dated as of June 12, 1996, by and among Kirkland Holdings L.L.C., Kirkland's, Inc., Capital Resource Lenders II, L.P., Allied Capital Corporation, Allied Capital Corporation II, the Marlborough Capital Investment Fund, L.P., Capital Trust Investments, Ltd., Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson 10.14 Redemption Agreement dated December 26, 1997 by and among Kirkland's, Inc., Certain Companies Affiliated with Kirkland's, Inc., and Bruce Moore 23.1 Consent of Price Waterhouse LLP 23.2 Consent of KPMG Peat Marwick LLP 24.1 Power of Attorney (included on Signature Pages) 27.1 Financial Data Schedule 27.2 Financial Data Schedule 27.3 Financial Data Schedule 27.4 Financial Data Schedule 27.5 Financial Data Schedule
EX-2.1 2 RECAPITALIZATION AGREEMENT DATED JUNE 12, 1996 1 EXHIBIT 2.1 EXECUTION COPY RECAPITALIZATION AGREEMENT AMONG KIRKLAND HOLDINGS L.L.C., KIRKLAND'S, INC., CERTAIN COMPANIES AFFILIATED WITH KIRKLAND'S, INC., CARL KIRKLAND, ROBERT KIRKLAND, BRUCE MOORE, AND ROBERT ALDERSON 2 TABLE OF CONTENTS Part Page - ---- ---- Preambles.................................................................. 1 ARTICLE 1 - DEFINITIONS.................................................... 2 ARTICLE 2 - BORROWING OF NEW DEBT; PAYMENTS TO FORMER LENDERS........................................................... 18 2.1. Borrowing of New Debt....................................... 18 2.2. Pre-Closing Debt............................................ 18 2.3. Cash Register Financing Line................................ 18 ARTICLE 3 - PRELIMINARY RECAPITALIZATION; INVESTMENT IN SHARES BY HOLDINGS AND CERTAIN SHAREHOLDERS................................ 18 3.1. Preliminary Recapitalization................................ 18 3.2. Purchase and Sale of Purchased Shares....................... 19 3.3. Purchase Price.............................................. 19 3.4. Kirkland's to Receive Purchase Price and Other Payments in Trust....................................... 19 3.5. Tax Stamps.................................................. 20 3.6. Purchase of Shares by Certain Shareholders.................. 20 ARTICLE 4 - REDEMPTION OF SHARES........................................... 20 4.1. Redemption of Minority Redeemed Shares...................... 20 4.2. Redemption of Majority Redeemed Shares...................... 21 4.3. Post-Closing Adjustments.................................... 21 4.4. Compliance with Corporate Law............................... 23 ARTICLE 5 - RECAPITALIZATION OF THE COMPANIES.............................. 24 5.1. Recapitalization............................................ 24 5.2. Conversion of Common Stock.................................. 24 5.3. Common Stock................................................ 26 5.4. Class A Preferred Stock..................................... 26 5.5. Class B Preferred Stock..................................... 28 5.6. Class C Preferred Stock..................................... 28 5.7. By-laws of the Companies.................................... 29 ARTICLE 6 - SCHEDULES AND COLLATERAL DOCUMENTS............................. 30 6.1. Delivery of Schedules....................................... 30 6.2. Right of Termination........................................ 30 6.3. Delivery of Collateral Documents............................ 30 -i- 3 Part Page - ---- ---- ARTICLE 7 - REPRESENTATIONS AND WARRANTIES OF SHAREHOLDERS................. 31 7.1. Organization, Power and Authority........................... 31 7.2. Authorization............................................... 31 7.3. Capitalization of the Companies............................. 32 7.4. Subsidiaries................................................ 33 7.5. Conflict with other Instruments; Absence of Restrictions................................................ 33 7.6. Government and Third-Party Approvals........................ 34 7.7. Title to Properties; Adequacy of Properties................. 34 7.8. Other Representations Regarding Company Assets.............. 34 7.9. Financial Statements and Related Information................ 38 7.10. Permits.................................................... 39 7.11. Foreign Corrupt Practices Act of 1977...................... 39 7.12. Corporate Records.......................................... 39 7.13. Litigation................................................. 39 7.14. Conduct of Business........................................ 39 7.15. Absence of Changes......................................... 39 7.16. Contracts, Leases, Etc..................................... 41 7.17. Warranties and Liabilities................................. 43 7.18. Product Matters............................................ 43 7.19. Insurance.................................................. 44 7.20. Licensing Arrangements, Joint Ventures, Etc................ 44 7.21. Transactions with Affiliates............................... 44 7.22. Compensation to Employees, etc............................. 45 7.23. Overtime, Back Wages, Vacation, Discrimination, and Occupational Safety Claims......................... 46 7.24. Benefit Matters............................................ 46 7.25. Hazardous Substances....................................... 50 (a) Compliance.......................................... 50 (b) Discharges, Etc..................................... 51 (c) Disposal; Conditions................................ 51 (d) Spillage, Etc....................................... 51 7.26. Solvency................................................... 52 7.27. Title to Redeemed Shares................................... 52 7.28. Brokerage and Expenses..................................... 52 7.29. Statements and Other Documents Not Misleading.............. 53 ARTICLE 8 - TAX RELATED MATTERS............................................ 54 8.1. Representations and Warranties.............................. 54 (a) S Election.......................................... 54 (b) Corporate Returns................................... 54 (c) Audit Information................................... 54 -ii- 4 Part Page - ---- ---- 8.2. Majority Shareholders' Indemnifications..................... 55 8.3. The Companies' Indemnifications............................. 56 8.4. Indemnity Priority.......................................... 56 8.5. Restoration of S Status..................................... 56 8.6. Filing of Returns........................................... 56 8.7. Future Tax Contests......................................... 57 8.8. Conduct of Proceedings...................................... 58 8.9. Cooperation and Record Retention............................ 59 ARTICLE 9 - REPRESENTATIONS AND WARRANTIES OF HOLDINGS..................... 59 9.1. Organization and Good Standing.............................. 59 9.2. Legal Power and Authority................................... 59 9.3. Conflict With Articles, Contracts or Regulations............ 60 9.4. Compliance with Securities Laws............................. 60 9.5. Brokerage and Expenses...................................... 61 9.6. Veracity of Statements...................................... 61 ARTICLE 10 - ACTIVITIES OF THE COMPANIES PRIOR TO CLOSING DATE.............................................................. 61 10.1. Operation of Business...................................... 61 (a) Organizational Documents............................ 61 (b) Corporate Name...................................... 62 (c) Compensation........................................ 62 (d) Management.......................................... 62 (e) Mergers, Acquisitions, Etc.......................... 62 (f) New Companies....................................... 62 (g) Disposition of Assets............................... 62 (h) Indebtedness........................................ 62 (i) Payables............................................ 62 (j) Maintenance of Assets............................... 63 (k) Insurance............................................ 63 (l) Contracts and Permits............................... 63 (m) Goodwill............................................ 63 (n) Litigation, Etc..................................... 63 (o) Interim Financial Statements........................ 63 (p) Commitment.......................................... 63 (q) Dividends and Distributions......................... 63 10.2. Access to Information...................................... 63 10.3. Benefit Plans.............................................. 64 (a) Plan Changes........................................ 64 (b) Contributions and Payments.......................... 64 -iii- 5 Part Page - ---- ---- 10.4. Taxes...................................................... 65 10.5. Delivery of Unaudited Closing Date Financial Statements............................................. 65 10.6. Notice of Change........................................... 65 10.7. Best Efforts; No Discussions............................... 65 ARTICLE 11 - ACTIVITIES OF HOLDINGS PRIOR TO CLOSING DATE.................. 65 11.1. Notice of Change........................................... 65 11.2. Best Efforts............................................... 66 ARTICLE 12 - CONDITIONS PRECEDENT TO THE CLOSING........................... 66 12.1. Obligation of Companies and Majority Shareholders to Close.................................. 66 (a) Representations and Warranties; Compliance with Agreement.................................. 67 (b) Secretary's Certificate............................. 67 (c) Opinion of Counsel of Holdings...................... 67 (d) Litigation Affecting Closing........................ 68 (e) Bank Debt, Mezzanine Debt and Revolving Line of Credit....................................... 68 (f) Approval of Counsel; Corporate Matters.............. 68 (g) Approval of Collateral Documents.................... 68 (h) Other Documents..................................... 68 12.2. Obligation of Holdings to Close............................ 68 (a) Representations and Warranties; Compliance with Agreement.................................. 68 (b) Secretary's Certificate............................. 69 (c) Opinion of Counsel for the Companies and the Majority Shareholders........................... 69 (d) Litigation Affecting Closing........................ 70 (e) Required Consents................................... 70 (f) Bank Debt, Mezzanine Debt and Revolving Line of Credit....................................... 70 (g) No Material Adverse Effect Suffered by Business........................................ 70 (h) Approval of Counsel; Corporate Matters.............. 72 (i) Title Insurance..................................... 72 (j) Survey.............................................. 72 (k) Working Capital..................................... 72 (l) Due Diligence Investigation......................... 73 -iv- 6 Part Page - ---- ---- (m) Solvency............................................ 73 (n) Approval of Collateral Documents.................... 73 (o) Other Documents..................................... 73 ARTICLE 13 - INDEMNIFICATION............................................... 73 13.1. By Majority Shareholders................................... 73 13.2. By Holdings................................................ 74 13.3. Direct Liability........................................... 74 13.4. Third-Party Claim.......................................... 75 13.5. Limitation of Indemnity.................................... 76 13.6. Non-Exclusive Remedy; Right of Set-Off..................... 77 13.7. Majority Shareholders' Claims Against any of the Companies.............................................. 78 ARTICLE 14 - SURVIVAL OF REPRESENTATIONS, - WARRANTIES, GUARANTEES, AND COVENANTS......................................... 79 ARTICLE 15 - THE CLOSING................................................... 80 15.1. Time and Place............................................. 80 15.2. Conduct of Closing......................................... 80 ARTICLE 16 - CONDUCT OF THE PARTIES AFTER CLOSING.......................... 82 ARTICLE 17 - TERMINATION................................................... 82 17.1. Events of Termination...................................... 82 (a) Mutual Consent...................................... 82 (b) Prior to Closing Date............................... 82 (c) After Specified Date by Holdings.................... 82 (d) After Specified Date by the Companies and the Majority Shareholders........................... 83 (e) Under Article 6..................................... 83 17.2. Survival................................................... 83 ARTICLE 18 - GENERAL....................................................... 83 18.1. Entire Agreement; Amendments............................... 83 18.2. Headings................................................... 83 18.3. Gender; Number............................................. 84 18.4. Schedules.................................................. 84 18.5. Severability............................................... 84 18.6. Reliance................................................... 84 18.7. Notices.................................................... 84 -v- 7 Part Page - ---- ---- 18.8. Waiver..................................................... 85 18.9. Assignment................................................. 85 18.10. Successors and Assigns.................................... 86 18.11. Governing Law............................................. 86 18.12. No Benefit to Others...................................... 86 18.13. Agreement to Vote......................................... 86 18.14. Publicity................................................. 86 18.15. Scope of Representations and Warranties................... 86 18.16. Counterparts.............................................. 87 18.17. November 30, 1995 Agreement............................... 87 COLLATERAL DOCUMENTS Form of Consulting Agreement Form of Management Agreement: Carl Kirkland Form of Management Agreement: Bruce Moore Form of Management Agreement: Robert Alderson Form of Minority Shareholder Redemption Agreement Form of 1996 Stock Option Plan Form of Option Agreement Form of Shareholder Release Form of Shareholders Agreement Form of Trademark Assignment SCHEDULES 1 Corporations Affiliated with Kirkland's 1P Percentage Values 4 Redemption Schedule 7.1 States of Incorporation and Foreign Qualification Jurisdictions; Officers and Directors 7.3 Capitalization 7.6 Government and Third Party Approvals 7.7 Title to Properties: Adequacy of Properties 7.8(b) Cash Accounts 7.8(f) Owned Real Property 7.8(g) Leased Real Property 7.8(h) Owned or Leased Real Property: Legal Issues 7.8(i) Intellectual Property Claims 7.13 Litigation 7.16 Contracts, Leases, Etc. 7.19 Insurance 7.20 Licensing Arrangements, Joint Ventures, Etc. 7.21 Transactions With Affiliates 7.22 Compensation to Employees, Etc. 7.24 Benefit Plan Issues 7.25 Hazardous Substance: Compliance -vi- 8 Part Page - ---- ---- 8.1(a) Tax Status 8.1(b) Corporate Returns 8.1(c) Audit Information 10.1(e) New Store Openings -vii- 9 RECAPITALIZATION AGREEMENT This Recapitalization Agreement (the "Agreement") is made this 26th day of April, 1996, by and among KIRKLAND HOLDINGS L.L.C., a limited liability company formed under Delaware law ("Holdings"), KIRKLAND'S, INC., a corporation incorporated under Tennessee law ("Kirkland's"), the 111 other corporations listed on the signature pages hereto (such other corporations, together with "Kirkland's, being herein referred to individually as an "Existing Company" and collectively as the "Existing Companies"), CARL KIRKLAND, ROBERT KIRKLAND, BRUCE MOORE and ROBERT ALDERSON (Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson being herein referred to collectively as the "Majority Shareholders"). BACKGROUND WHEREAS, the Companies are mall-based specialty retailers of gifts and home accessories; and WHEREAS, Majority Shareholders together own a majority or all of the outstanding capital stock of all of the Companies, except for #103 - Kirkland's of Tennessee, Inc.; and WHEREAS, the Companies have determined to redeem a portion of the outstanding capital stock of certain of the Companies owned by the Majority Shareholders and all of the outstanding capital stock of each of the Companies owned by the Minority Shareholders (as defined below), as more particularly set forth herein; and WHEREAS, the Companies have determined to refinance certain existing bank debt, as more particularly set forth herein; and WHEREAS, in order to fund the redemptions and debt refinancing described above, the Companies have determined to borrow $45 million in bank debt and $20 million in mezzanine debt, and to obtain revolving line of credit financing in the amount of $15 million, as more particularly set forth herein; and WHEREAS, certain of the Majority Shareholders have determined to purchase shares of common stock in those Companies in which they currently own no shares of common stock, as more particularly set forth herein; and WHEREAS, Holdings has agreed to purchase from the Companies, and the Companies have agreed to sell to Holdings, $30,780,000 of equity in the Companies, as more particularly set forth herein; and WHEREAS, the Companies have determined to recapitalize their capital structure following the transactions described 10 above in order to authorize and issue three classes of preferred stock and one class of common stock; and WHEREAS, the parties are entering into this Agreement to evidence their agreement with respect to the foregoing and the other matters described herein, all on the terms and subject to the conditions more particularly set forth herein; NOW, THEREFORE, in consideration of the foregoing and of the mutual promises, covenants, representations, warranties, and agreements herein contained, and intending to be legally bound, the parties hereby agree as follows: ARTICLE 1 DEFINITIONS As used in this Agreement, the following terms shall have the meanings set forth below. "Accounts Receivable" shall mean the accounts receivable of the Companies. "Advisors" of a party shall mean such party's accountants, counsel and other representatives. "Affiliate" of a Person shall mean any Person which, directly or indirectly, controls, is controlled by, or is under common control with such Person. The term "control" (including, with correlative meaning, the terms "controlled by" and "under common control with"), as used with respect to any Person, shall mean the possession, directly or indirectly, of the power to elect a majority of the board of directors or to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities, by contract or otherwise. "Agreement" shall mean this Recapitalization Agreement. "Aggregate Net Equity" shall mean the Preliminary Redemption Proceeds, plus Fourteen Million Two Hundred Twenty Thousand Dollars ($14,220,000), minus the aggregate amount paid by the Majority Shareholders to purchase shares pursuant to Section 3.6 and minus the 1995 Pre-Tax Income of all Companies. "Allowable Store Expenses" shall mean the amount of capital expenditures incurred through the day preceding the Closing Date related to the opening of the store owned by each New Company or related to the refurbishing of the store owned by each Remodeled Company, together with the 1996 Net Losses of the stores owned by each New Company and each Remodeled Company. -2- 11 "Audited Closing Date Balance Sheet" shall mean the combined balance sheet of the Companies included in the Audited Closing Date Financial Statements. "Audited Closing Date Financial Statements" shall mean the audited combined financial statements of the Companies consisting of a balance sheet and the related income statement and statement of changes in financial position for the period from January 1, 1996 through the day immediately preceding Closing Date, together with the notes thereto and accompanied by an unqualified opinion thereon of Kirkland's Accountants. "Audited Historical Financial Statements" shall mean the audited combined financial statements of the Companies consisting of balance sheets dated December 31, 1993, 1994 and 1995 and the related income statements and statements of changes in financial position for the years then ended, together with the notes thereto and accompanied by an unqualified opinion thereon of Kirkland's Accountants. "Bank Debt" shall mean no less than Forty Five Million Dollars ($45,000,000) in debt financing to be loaned to the Companies in connection with the Closing, such financing to be senior in priority to the Mezzanine Debt and to be secured by a first priority perfected security interest in all of the Companies' assets (other than accounts receivable) and a first mortgage on the Owned Real Property. "Benefit Plan" shall mean a plan, program, trust, contract, policy or arrangement (a) which is sponsored by any of the Companies or to which any Company contributes, (b) in which Employees participate and (c) that provides any pension, profit sharing, thrift, deferred compensation, stock purchase, group insurance, accident, sickness, medical, dental, life, health, disability, savings, stock option, stock appreciation, retirement, severance payments, fringe benefits, incentive compensation, vacation pay, holiday pay, sick pay or other employee benefits whether or not such plan, program, trust, contract, policy or arrangement is an "employee benefit plan" within the meaning of Section 3(3) of ERISA. "Books and Records" shall mean all records, documents and lists pertaining to the Business including, without limitation, stock ledgers, minute books, lists of the Companies' customers, suppliers and personnel, all product, business and marketing plans and all books, ledgers, files and business and financial records of, or relating to, the Business. "Business" shall mean the Companies' business as a mall-based specialty retailer of gifts and home accessories, and any other business conducted by any of the Companies. -3- 12 "Business Day" shall mean any calendar day which is not a Saturday, Sunday or public holiday under the laws of Tennessee. "C Year" shall mean one or more of the taxable years of any Company ending after the Closing Date. "Cash Register Financing Line" shall mean that certain debt financing of the Companies with First American Bank, Nashville, Tennessee, used to finance the purchase of cash registers for use in the operation of the Business, pursuant to which approximately $865,000 is outstanding and owed by the Companies on the date hereof, including without limitation any applicable prepayment fee required to be paid by the Companies to the Former Lenders in connection with the prepayment at the Closing of the Cash Register Financing Line, if such prepayment is required in accordance with Section 2.3 hereof. "Change in Control" shall mean the acquisition of more than fifty percent (50%) of the outstanding shares of common stock of Companies representing a majority of the Percentage Values by a Person or group of Persons, who are not on the date hereof, or are not at Closing, shareholders of any of the Companies. "Closing" and "Closing Date" shall have the meaning set forth in Section 15.1 of this Agreement. "Closing Date Adjusted Working Capital" shall mean the working capital (e.g. current assets minus current liabilities) of the Companies on a combined basis as of the close of business on the day preceding the Closing Date, excluding for purposes of the calculation any indebtedness owed to any of the Former Lenders (as determined in accordance with GAAP), before giving effect to any of the transactions contemplated hereby, but reduced by the sum of the 1995 Pre-Tax Income and 1996 Pre-Tax Income in each case to the extent not distributed prior to Closing, and adjusted as set forth in Section 7.28 hereof. "Code" shall mean the Internal Revenue Code of 1986, as amended, and the rules and regulations promulgated thereunder or with respect thereto. "Collateral Documents" shall mean collectively, the Minority Shareholder Redemption Agreement, the Trademark Assignment, the Management Agreements, the Consulting Agreement, the Fee Letter, the Shareholders Agreement, the Shareholders Releases, the 1996 Stock Option Plan for the benefit of the Management Shareholders, the Option Agreements and each of the other documents, agreements and instruments to be executed, delivered and performed in connection with this Agreement. -4- 13 "Commitment" shall mean a commitment for title insurance for the Owned Real Property, naming Kirkland's as an insured. "Companies" shall mean the Existing Companies as well as any corporation incorporated after the date of this Agreement and prior to the Closing in connection with the Business, any shares of which are owned by any of the Majority Shareholders. "Company Net Equity" shall mean , for any Company other than a Group D Company, the sum of (i) the product of (A) the Aggregate Net Equity less the Group D Net Equity, times (B) the Percentage Value for that Company, plus (ii) the 1995 Pre-Tax Income of that Company; and for any Group D Company, Ten Dollars ($10). "Condition" shall mean the assets, Liabilities, business, operations, results of operations or financial condition of the Companies and the Business. "Confidential Information" shall have the meaning set forth in Section 11.3 of this Agreement. "Consulting Agreement" shall mean the Consulting Agreement pursuant to which Robert Kirkland will be engaged to provide consulting services on behalf of the Companies following the Closing. "Contract" shall mean any written or oral contract, agreement, commitment, note, bond, pledge, lease, mortgage, deed, guaranty, indenture, license, consulting agreement, supply contract, repair contract, distribution agreement, purchase order, joint venture agreement, franchise, technology and know-how agreement, employment agreement, instrument or any other contractual commitment that is binding on any Company or its property, and any amendment thereto. "Copyrights" shall mean registered copyrights, copyright applications and unregistered copyrights. "Court Order" shall mean any judgment, decree, writ, injunction, order or ruling of any Governmental Entity. "Default" shall mean (1) a breach of or default under any Contract, (2) the occurrence of an event which with the passage of time or the giving of notice or both would constitute a breach of or default under any Contract, or (3) the occurrence of an event that (with or without the passage of time or the giving of notice or both) would give rise to a right of damages, specific performance, termination, renegotiation or acceleration under any Contract. -5- 14 "Due Diligence Investigation" shall have the meaning set forth in Section 10.2 of this Agreement. "Employees" shall mean employees of each of the Companies at any time prior to or up to the Closing. "Environmental Claim" shall mean any written or oral demand, claim, suit, lien, action, expense (and counsel fees) cause of action, investigation or notice by any Person (whether asserted or arising before or after the Closing) alleging actual or potential liability (including, without limitation, potential or actual liability for investigatory costs, cleanup costs, governmental response costs, national resources damages, property damages, personal injuries or penalties) arising out of or relating to the presence, migration, leak, discharge, handling, removal, transport, disposal, spill, emission, injection, escape, dumping or release, threat of release or exposure, of any kind whatsoever of any Materials of Environmental Concern occurring on or prior to the Closing Date. "Environmental Laws" shall mean all federal, state and local laws and regulations relating to pollution or protection of human health or the environment (including, without limitation, ambient air, surface water, groundwater, land surface or subsurface strata), including, without limitation, the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA"), 42 U.S.C.A. Sections 9601 et seq., the Occupational Safety and Health Act, 29 U.S.C. Section 651, et seq., the Resource Conversation and Recovery Act ("RCRA"), 42 U.S.C.A. Sections 6901 et seq., the Clean Water Act, 33 U.S.C.A. Sections 1251 et seq., the Clean Air Act 42 U.S.C.A. Sections 7401 et seq., and all similar state and local environmental laws as well as Laws and Regulations relating to emissions, spills, leaks, discharges, releases or threatened releases of Materials of Environmental Concern, or otherwise relating to the manufacture, possession, distribution, use, treatment, storage, disposal, transport or handling of Materials of Environmental Concern. "Equipment" shall mean the furniture, fixtures, machinery, equipment, motor vehicles, office equipment, computers, tools and replacement parts currently used in the operation of the Business. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended, and the rules and regulations promulgated thereunder or with respect thereto. "ERISA Affiliate" shall mean any member of any "controlled group", as defined in Section 414(b) of the Code of which any Company is a member, all trades or businesses, whether or not incorporated, under common control (within the meaning of Section 414(c) of the Code) and of which any Company is a member, -6- 15 and all affiliated service groups (within the meaning of Section 414(m) of the Code) of which any Company is a member. "Excess Working Capital" shall mean the amount equal to (a) the Closing Date Adjusted Working Capital less Eleven Million Dollars ($11,000,000) (which difference may be a negative number), plus (b) the Allowable Store Expenses. "Fee Letter" shall mean that certain letter agreement to be entered into at Closing between the Companies and Advent International Corporation ("Advent"), pursuant to which the Companies will pay Advent a fee in the aggregate amount of $1,000,000 in consideration of the services rendered by Advent to the Companies in connection with the structuring of the transactions contemplated by this Agreement. "Financial Statements" shall mean the Audited Historical Financial Statements and the Interim Financial Statements. "Former Lenders" shall mean First American Bank, First Union Bank, Union Planters Bank, Volunteer Bank, First Citizens Bank, Bank of Canada, Bank of Sharon, First State Bank, and such other institutional lenders to which amounts are owed for borrowed money at the Closing Date. "Future Payment Obligations" shall have the meaning given in Section 13.6 hereof. "GAAP" shall mean generally accepted accounting principles consistently applied, as applied in the United States of America. "Governmental Entity" shall mean any government and political subdivisions thereof, court, arbitral tribunal, administrative agency, tribunal or commission or any other governmental or regulatory body, instrumentality or authority, whether domestic (federal, state or local) or foreign. "Group A Companies" shall mean Company Nos. 100, 123, 125, 126 and 128 through 204, such Companies being those commencing business prior to May 1, 1995 in which Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson own 37.5%, 37.5%, 15% and 10%, respectively, of the issued and outstanding common stock (measured prior to giving effect to any of the transactions contemplated by this Agreement). "Group B Companies" shall mean Company Nos. 205 through 214, such Companies being those commencing business after April 30, 1995 but before January 1, 1996 in which Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson own 37.5%, 37.5%, 15% and 10%, respectively, of the issued and outstanding -7- 16 common stock (measured prior to giving effect to any of the transactions contemplated by this Agreement). "Group C Companies" shall mean Company Nos. 101 through 104, 107, 109 through 111, 115 through 120, 122 and 127, which are all of the Companies other than Group A, B or D Companies. Group C Companies are the Companies in which the shares of the Majority Shareholders are not owned in the same percentages as the shares of the Group A, B or D Companies. "Group D Companies" shall mean Company Nos. 215 through 221, such Companies being those commencing business in 1996. "Group D Net Equity" shall mean the product of the number of Group D Companies times Ten Dollars ($10). "Holdback Amount" shall mean the ten percent of the Redemption Price held back from a Minority Shareholder pursuant to Section 4.1 hereof. "Holdings' Accountants" shall mean Price Waterhouse LLP. "Indemnifiable Losses" shall have the respective meanings given in Sections 13.1 and 13.2 hereof. "Intellectual Property and Information" shall mean collectively, all Copyrights, Patents, Trademarks, tradenames, brand names, brand marks, logos, licenses, mask work rights, computer software, computer systems and related proprietary documentation, trade secrets and related data, inventions, inventer's work papers and notebooks, disclosure of inventions, proprietary technology, formulae, processes, research and development in progress, know-how, designs, and all other proprietary information and similar intangible rights. "Interim Financial Statements" shall mean monthly combined financial statements of the Companies for each completed month commencing with January 1996, a balance sheet, a statement of income and a statement of changes in financial position. "Inventory" shall mean the inventories of finished goods for resale. "IRS" shall mean the Internal Revenue Service. "Kirkland's Accountants" shall mean KPMG Peat Marwick. "Known" or "know" or "to the knowledge" or "to the best knowledge" or words of similar import with respect to any -8- 17 Company or any Shareholder shall mean the knowledge of any Management Shareholder or any of the corporate managers working in the Companies' Jackson, Tennessee offices (currently consisting of Betsy Weiss, James Harris, Connie Scoggins, Chris LaFont and Toni Warren). "Law" shall mean any applicable law, statute, ordinance, governmental regulation, order, decree or edict. "Lease" shall mean any Contract under which any Company is a lessee of Leased Real Property, and any amendment thereto. "Leased Real Property" shall mean all Real Property presently leased by or otherwise used by any of the Companies in the operation of the Business other than the Owned Real Property. "Leasehold Improvements" shall mean all leasehold improvements, fixtures and appurtenances owned by the Companies and attached to any Leased Real Property. "Legal Expenses" of a person shall mean any and all out-of-pocket fees, costs and expenses of any kind incurred by such person and its counsel in investigating, preparing for, defending against or providing evidence, producing documents or taking other action with respect to any threatened or asserted claim. "Lenders" shall mean the lenders financing the Bank Debt, the Mezzanine Debt and the Revolving Line of Credit. "Liability" shall mean any direct or indirect liability, loss, damage, cost, contingent liability, loss contingency, indebtedness, obligation, unpaid expense, claim, deficiency, guaranty or endorsement of or by any person whether or not ascertainable. "Lien" shall mean any mortgage, lien, security interest, pledge, negative pledge, encumbrance, assessment, title retention agreement, restriction or restraint on transfer, defect of title, charge in the nature of a lien or security interest, or option (whether consensual, statutory or otherwise). "Litigation" shall mean any action, lawsuit, arbitration, criminal prosecution, tax audit, or any legal, administrative or other proceeding or investigation, or any inquiry asserting a violation of any Regulation, by, before or for any Governmental Entity. "Losses" shall mean any and all damages, losses, obligations, deficiencies, Liabilities, claims, encumbrances, -9- 18 penalties, fines, costs and expenses, including, without limitation, any diminution in value of any real or personal property and reasonable attorneys' fees. Any Losses incurred by any Company shall be deemed to result in Losses to each of the shareholders of such Company in an amount equal to the product of: (A) the amount of Losses incurred by such Company, multiplied by (B) each such shareholder's percentage ownership of the common stock of such Company after the Closing. "Majority Redeemed Shares" shall mean the number of shares of common stock of each Company owned by each Majority Shareholder which will be redeemed by each Company at the Closing, as determined in accordance with Schedule 4 hereto. "Majority Shareholders" shall mean Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson. "Management Agreements" shall mean the Management Agreements pursuant to which Carl Kirkland, Bruce Moore and Robert Alderson, respectively, will be employed by the Companies following the Closing and pursuant to which each of them will agree to a non-competition covenant as set forth more fully therein. "Management Shareholders" shall mean Carl Kirkland, Bruce Moore and Robert Alderson. "Material Adverse Effect" shall mean an event, change or effect which is or would be materially adverse to the Business, operations, properties, assets, Liabilities, financial condition or results of operation, of the Companies or Holdings, as the case may be. "Materials of Environmental Concern" shall mean any toxic, reactive, corrosive, carcinogenic, flammable or hazardous pollutant or other substance, including, but not limited to, any "hazardous substance," or "hazardous waste," as defined in Environmental Laws, petroleum and petroleum products, natural gas or synthetic gas, material that is a source, special nuclear or by-product material, as defined by the Atomic Energy Act of 1954, 42 U.S.C.A. Sections 3011 et seq., and the regulations promulgated thereto and "hazardous chemical" as defined in 29 C.F.R. Part 1910. "Mezzanine Debt" shall mean no less than Twenty Million Dollars ($20,000,000) in debt financing to be loaned to the Companies in connection with the Closing, such financing to be subordinated to the Bank Debt and to be unsecured. "Minority Redeemed Shares" shall mean the number of shares of common stock of each Company owned by each Minority -10- 19 Shareholder which will be redeemed by each Company at the Closing, as determined in accordance with Schedule 4 hereto. "Minority Shareholder Redemption Agreement" shall mean that certain Minority Shareholder Redemption Agreement to be executed and delivered at the Closing by the Companies and each of the Minority Shareholders. "Minority Shareholders" shall mean Ken Kirkland, John Kirkland, Chris Kirkland, Bill Butler, Anita Fletcher, Toni Warren, Russell Kirkland, Bedford Kirkland and Macy Kirkland, constituting all of the shareholders of the Companies other than the Majority Shareholders. The Minority Shareholders are shareholders in only certain of the Companies. "Negative Adjustment Amount" shall have the meaning given in Section 4.3(e) hereof. "New Company" shall mean each Company which commenced operations after December 31, 1995. "1995 Balance Sheet" shall mean the combined balance sheet of the Companies as at December 31, 1995 and included in the Audited Historical Financial Statements. "1995 Pre-Tax Income" shall mean either the taxable income of a particular Company for the year ended December 31, 1995 or the taxable income of all of the Companies for the year ended December 31, 1995 on a combined basis, as the context requires, in each case as shown on Schedule K of the 1995 Forms 1120S of the Company or Companies by aggregating all items of income, loss and deduction. "1996 Net Losses" shall mean an amount equal to the actual net losses (excluding depreciation and amortization) incurred by each New Company or Remodeled Company from the date on which each such New Company opens for business or each such Remodeled Company closes for or commences remodeling, and in each case continuing until the close of business on the date immediately preceding Closing. "1996 Pre-Tax Income" shall mean either the taxable income of a particular Company for the period beginning January 1, 1996 and ended on the day immediately preceding the Closing Date or the taxable income of all of the Companies for the period beginning January 1, 1996 and ended on the day immediately preceding the Closing Date on a combined basis, as the context requires, in each case as shown on Schedule K of the 1996 Forms 1120S of the Company or Companies by aggregating all items of income, loss and deduction. -11- 20 "Notified Shareholder" shall mean any Majority Shareholder receiving notice of an intention to audit or of a Proposed Adjustment pursuant to Section 8.7 hereof. "Option Agreement" shall mean an Option Agreement to be entered into among the Management Shareholders, on the one hand, and the Companies, on the other hand, providing for the grant of an option to purchase shares of capital stock in the Companies. "Owned Real Property" shall mean all Real Property presently owned of record or beneficially by any of the Companies. "Patents" shall mean all letters patent and pending applications for patents of the United States and all countries foreign thereto, including regional patents, certificates of invention and utility models, rights of license or otherwise to or under letters patent, certificates of intention and utility models which have been opened for public inspection and all reissues, divisions, continuations and extensions thereof. "Percentage Interest" shall mean, with respect to each of the following Shareholders, the amount indicated next to his or her name below: Carl Kirkland 38.4898% Robert Kirkland 36.6799% Bruce Moore 13.9925% Robert Alderson 8.0738% Chris Kirkland 0.1133% Bedford Kirkland 0.1133% Macy Kirkland 0.1133% Ken Kirkland 0.4506% John Kirkland 0.2705% Anita Fletcher 0.5994% Russell Kirkland 0.1812% Toni Warren 0.5426% Bill Butler 0.3798% "Percentage Value" shall mean the values of the Companies expressed as a percentage of the total values of all of the Companies, as set forth on Schedule 1P attached hereto. "Permits" shall mean any and all licenses, franchises, permits, easements, rights, consents, orders, approvals, variances and other authorizations of or issued by any Governmental Entity to or in favor of the Companies. -12- 21 "Permitted Liens" shall mean (i) Liens for current taxes not yet delinquent for which appropriate reserves in accordance with GAAP have been created, (ii) statutory liens imposed by law which are incurred in the ordinary course of business for obligations not yet due to carriers, warehousemen, laborers and materialmen, and (iii) other Liens specifically described and reflected on the Financial Statements, (iv) any other liens set forth on Schedule 7.7 of this Agreement; provided, however, that if any Lien described in clause (i), (ii) or (iii) above, individually or in the aggregate, materially detracts or will detract from or interferes or will interfere with the Business or any Company's right to dispose of any property, the use of such property or their business or operations, as presently conducted, then such Lien shall not be considered to be a Permitted Lien. "Permitted Title Exceptions" shall mean those Liens and other matters to which the title of the Owned Real Property is subject which, in the sole discretion of Holdings, will not prevent or materially interfere with or adversely affect the Companies' operation of the Business consistent with past practice or materially detract from the value or the marketability of the Owned Real Property. Any exception for (i) Liens for labor or materials, whether or not of record, (ii) for parties in possession (other than tenants under tenant leases as tenants only), (iii) unrecorded easements, (iv) taxes or special assessments not shown by public records other than taxes or special assessments, the payment of which is not yet due on the Closing Date, or (v) any state of facts which a current survey would disclose, shall not constitute Permitted Title Exceptions. "Person" shall mean an individual, a sole proprietorship, a corporation, a partnership, a joint venture, an association, a trust, or any other entity or organization, including a government or a political subdivision, agency or instrumentality thereof. "Positive Adjustment Amount" shall have the meaning given in Section 4.3(e) hereof. "Pre-Closing Debt" shall mean all principal, interest and other amounts owed by the Companies to the Former Lenders for borrowed money on the Closing Date (other than any portion of the Bank Debt, the Mezzanine Debt or the Revolving Line of Credit which is owed to any Former Lenders and other than the Cash Register Financing Line). "Preliminary Recapitalization" shall mean the recapitalization of the Companies prior to the transactions set forth in this Agreement, as a result of which a portion of the outstanding common stock of the Group A and B Companies will be -13- 22 converted into Class C Preferred Stock, all as set forth in Section 3.1 hereof. "Preliminary Redemption Price" shall mean the preliminary payment to be made by the Companies to each Shareholder, based on the Preliminary Redemption Proceeds. "Preliminary Redemption Proceeds" shall mean the amount of the Redemption Proceeds as computed by reference to the Unaudited Closing Date Balance Sheet. "Proposed Adjustment" shall mean any adjustment proposed by any Governmental Entity to an item of income, deduction, gain, loss or credit on any Return or on any Majority Shareholder's federal or state tax return, which item is attributable to the operations of any Company. "Protected Amounts" shall mean the portions of the Annual Salary (as defined in the Management Agreements) payable to Robert Alderson, Carl Kirkland and Bruce Moore pursuant to their respective Management Agreements which are not expressly subordinated to the Bank Debt and the Mezzanine Debt pursuant to Section 10 of such Management Agreements, and which will not be subject to the offset provisions of Section 13.6 hereof. "Purchase Price" shall have the meaning given in Section 3.3 hereof. "Purchased Shares" shall mean the shares to be purchased by Holdings from the Companies pursuant to Section 3.2 hereof. "Qualified Public Offering" shall mean the sale of shares of the Companies' capital stock in a registered underwritten public offering resulting in gross proceeds to the Companies of at least Thirty Million Dollars ($30,000,000). "Real Property" shall mean any real estate, together with all buildings, improvements, fixtures, easements, options to acquire real estate, rights to unpaid insurance proceeds in respect of Losses to real estate, rights to unpaid condemnation awards and all other rights in or appurtenant thereto. "Recapitalization" shall mean the recapitalization of the Companies, as a result of which the outstanding common stock of each Company will be converted as described in Article 5 hereof. "Redeemed Shares" shall mean the Minority Redeemed Shares and the Majority Redeemed Shares. -14- 23 "Redemption" shall mean the redemption of the Redeemed Shares effected pursuant to Article 4 hereof. "Redemption Price" shall mean the amount to be received by each Shareholder from all of the Companies on an aggregate basis, pursuant to the Redemption. "Redemption Proceeds" shall mean an amount equal to the sum of (a) $90,780,000 less the Pre-Closing Debt, plus (b) the 1995 Pre-Tax Income (to the extent not distributed prior to Closing), plus (c) 1996 Pre-Tax Income (to the extent not distributed prior to Closing), plus (d) the Excess Working Capital, plus (e) the aggregate amount paid by the Majority Shareholders to purchase shares pursuant to Section 3.6 hereof. "Refinancing" shall mean any refinancing of the Companies' indebtedness for borrowed money after the Closing, in connection with which the Companies repurchase or redeem any capital stock for value. "Regulation" shall mean any statute, law, ordinance, regulation, order, rule, decree or other requirement of any Governmental Entity, including, but not limited to, those covering environmental, safety, health, transportation, bribery, recordkeeping, zoning, employment, tax, anti-discrimination, antitrust, wage and hour and price and wage control matters. "Remodeled Company" shall mean each Company which owns a store which was closed for any period during 1996 for renovations. "Required Consents" shall mean any and all licenses, waivers, consents or approvals of or from any Governmental Entity, including the expiration of any periods of time under statutory and regulatory notice provisions without action on the part of any Governmental Entity, and any and all approvals, consents or waivers from other parties to leases, licenses, franchises, permits, indentures, Contracts and other instruments necessary to consummate the transaction contemplated hereby. "Returns" shall mean all returns, reports, claims for refunds or other information required or permitted to be supplied to or filed with any Governmental Entity by any Company in connection with Taxes (including, without limitation, information returns and declarations of estimated tax). "Revolving Line of Credit" shall mean a revolving line of credit in the amount of no less than Fifteen Million Dollars ($15,000,000) to be made available to the Companies in connection with the Closing. -15- 24 "S Year" shall mean one or more of the taxable years of any Company falling within the period commencing on the date of incorporation of such Company and ending as of the close of business on the day preceding the Closing Date. "Sale" shall mean the sale of all or a majority in value of the Companies' assets. "Schedules" shall mean the schedules referenced in, and delivered pursuant to this Agreement. "Shareholder Releases" shall mean the Shareholder Releases which are to be executed by the Shareholders, which include a general release by each Shareholder of each of the Companies and the officers, directors and shareholders of each of the Companies. "Shareholders" shall mean the Minority Shareholders and the Majority Shareholders. "Shareholders Agreement" shall mean a Shareholders Agreement to be entered into among the Majority Shareholders and Holdings relating to their holding and disposition of their shares of capital stock in the Companies. "Start Date" shall mean the first date that a Company had shareholders or assets or began doing business. "Straddle Period" shall mean any taxable period of a Company which begins before the Closing Date and ends after the Closing Date. "Sub Debt Warrants" shall mean warrants to purchase shares of common stock of the Companies to be issued to the lenders of the Mezzanine Debt. "Subsidiary" shall mean with respect to any party, any entity, the majority of whose voting stock (or any class of stock having the power to elect directors) is owned directly or indirectly by such party. "Survey" shall have the meaning given in Section 12.2(k) hereof. "Survival Date" shall mean that date which is two years after the Closing Date. "Tax Claim" shall mean a claim for Taxes which if successful might result in an indemnity payment pursuant to Article 8 hereof. -16- 25 "Taxes" shall mean all taxes, charges, fees, levies or other assessments, whether federal, state, local or foreign based upon or measured by income, capital, net worth or gain and any other tax including but not limited to all net income, gross income, gross receipts, sales, use, ad valorem, transfer, franchise, profits, withholding, payroll (including withholding), employment, social security, unemployment, FICA, FUTA, excise, estimated, stamp, occupation, property or other taxes, customs duties, fees, assessments or charges of any kind whatsoever, including all interest and penalties thereon, and additions to tax or additional amounts imposed by any Governmental Entity, domestic or foreign. "Title Company" shall have the meaning set forth in Section 12.2(j) of this Agreement. "Trademark Assignment" shall mean the Trademark Assignment, pursuant to which Carl and Robert Kirkland will convey all or their right, title and interest in and to the Trade Name to Kirkland's. "Trademarks" shall mean registered trademarks, registered service marks, trademark and service mark applications and unregistered trademarks and service marks. "Trade Name" shall mean the name "Kirkland's," which is currently owned by Carl and Robert Kirkland and will be conveyed to Kirkland's at the Closing pursuant to the Trademark Assignment. "Unaudited Closing Date Balance Sheet" shall mean the unaudited combined balance sheet of the Companies projected as of the close of business on the day preceding the Closing Date and included in the Unaudited Closing Date Financial Statements. "Unaudited Closing Date Financial Statements" shall mean the unaudited combined financial statements of the Companies consisting of the Unaudited Closing Date Balance Sheet and the related unaudited income statement and unaudited statement of changes in financial position for the period from January 1, 1996 projected through the close of business on the day preceding the Closing Date, before giving effect to the other transactions contemplated hereby. "Warranties" shall mean all warranty obligations, whether express or implied, of the Companies for the return, repair or replacement of products sold by the Companies. -17- 26 ARTICLE 2 BORROWING OF NEW DEBT; PAYMENTS TO FORMER LENDERS 2.1. Borrowing of New Debt. On the Closing Date, the Companies will borrow the Bank Debt and the Mezzanine Debt. A portion of the proceeds of the Bank Debt and the Mezzanine Debt will be used to pay the Pre-Closing Debt to the Former Lenders in accordance with Sections 2.2 and 2.3 hereof. 2.2. Pre-Closing Debt. On the Closing Date, the Companies shall pay the Pre-Closing Debt to the Former Lenders, to discharge any and all indebtedness owed to the Former Lenders on the Closing Date (other than any portion of the Bank Debt and the Mezzanine Debt which is owed to the Former Lenders). 2.3. Cash Register Financing Line. The Cash Register Financing Line shall not be required to be repaid to the Former Lenders on the Closing Date unless required by the Lenders. If such prepayment is required, then, on the Closing Date, the Companies shall pay all principal, interest and other amounts outstanding under the Cash Register Financing Line to the Former Lenders, to discharge any and all indebtedness owed to the Former Lenders in respect of the Cash Register Financing Line on the Closing Date. ARTICLE 3 PRELIMINARY RECAPITALIZATION; INVESTMENT IN SHARES BY HOLDINGS AND CERTAIN SHAREHOLDERS 3.1. Preliminary Recapitalization. On the Closing Date, prior to the purchase of the Purchased Shares by Holdings, the Group A Companies and the Group B Companies will file amendments to their charters with their respective states of incorporation in order to effect a recapitalization of their capital stock as described in this Section 3.1 (the "Preliminary Recapitalization"). The amended charters shall provide that the authorized capital of each recapitalized Company shall include, in addition to the common stock currently provided by each such charter, 20,000 shares of Class C Preferred Stock ("Class C Preferred Stock"). In the Preliminary Recapitalization, a percentage of the outstanding shares of common stock of each recapitalized Company shall be converted into 20,000 shares of Class C Preferred Stock. Such percentage shall be, (i) in the case of each Group A Company, equal to $15,000,000 divided by the aggregate Company Net Equity of all Group A Companies, and (ii) -18- 27 in the case of each Group B Company, equal to $5,000,000 divided by the aggregate Company Net Equity of all Group B Companies. The total shares of each recapitalized Company so converted shall be allocated among the Majority Shareholders as follows: Carl Kirkland -- 39.5839%, Robert Kirkland -- 37.7225%, Bruce Moore -- 14.3903% and Robert Alderson -- 8.3033%. The Class C Preferred Stock shall not bear dividends. The aggregate stated value and liquidation preference of the shares of Class C Preferred Stock to be issued by all Group A Companies and Group B Companies to the Majority Shareholders in the Preliminary Recapitalization will be $20,000,000, and such aggregate amounts of stated value and liquidation preference shall be allocated $15,000,000 to the Group A Companies in accordance with the relative Percentage Values of such Companies and $5,000,000 to the Group B Companies in accordance with the relative Percentage Values of such Companies. 3.2. Purchase and Sale of Purchased Shares. On the Closing Date, prior to the Redemption, Holdings shall purchase from each of the Companies, and each of the Companies shall sell to Holdings, free and clear of all Liens, 68,400 shares of Class A Preferred Stock and that number of shares as will equal 68.4% of the total number of shares of common stock of such Company as will be outstanding after giving effect to the Preliminary Recapitalization, the Redemptions and the purchase of shares of common stock in certain of the Companies pursuant to Section 3.6 hereof. 3.3. Purchase Price. The purchase price for the Purchased Shares (the "Purchase Price") shall be $30,780,000 which shall be paid in cash at the Closing by Holdings, by means of a wire transfer of immediately available Federal funds to an account designated by Kirkland's no less than three days prior to the Closing Date. The Purchase Price to be paid by Holdings shall be allocated among the Companies so as to achieve a purchase price per share of Class A Preferred Stock and common stock of a Company which will be as close as possible to the price at which common shares of such Company are redeemed pursuant to Section 4.1 (based on the Preliminary Redemption Proceeds). 3.4. Kirkland's to Receive Purchase Price and Other Payments in Trust. Each of the Companies hereby authorizes Kirkland's to accept, on behalf of the Companies, the proceeds of the Bank Debt and the Mezzanine Debt, amounts paid by Holdings for the Purchased Shares and any amounts paid by the Majority Shareholders to purchase shares pursuant to Section 3.6 hereof, and Kirkland's agrees to receive such amounts in trust and to disburse all such amounts on behalf of the Companies in accordance with the terms of this Agreement. -19- 28 3.5. Tax Stamps. The cost of original issue tax stamps, if any, in connection with the issuance and delivery of the Purchased Shares by the Companies to Holdings shall be borne by the Companies. 3.6. Purchase of Shares by Certain Shareholders. On the Closing Date, prior to the Redemption, each of the Majority Shareholders will purchase from each of the Companies in which he is not a shareholder, and each such Company shall sell to each such Majority Shareholder, such number of shares of common stock as may be required so that the purchasing Majority Shareholder will own the same number of shares of common stock of each such Company as will be owned by each other Majority Shareholder, in each case after giving effect to the Preliminary Recapitalization and the Redemption. The shares of a Company so purchased shall be purchased at the same price as the shares of such Company are redeemed in the Redemptions (based on the Preliminary Redemption Proceeds). ARTICLE 4 REDEMPTION OF SHARES The balance of the proceeds of the Bank Debt and the Mezzanine Debt which were not used to pay the Pre-Closing Debt to the Former Lenders in accordance with Article 2 hereof, together with the Purchase Price and any other available funds of the Companies, will be used to pay the Redemption Proceeds to the Shareholders in accordance with this Article 4. The Redemption Proceeds will be allocated among the Companies in accordance with Schedule 4 attached hereto. 4.1. Redemption of Minority Redeemed Shares. (a) On the Closing Date, prior to the Recapitalization, each of the Companies in which a Minority Shareholder owns shares shall purchase and redeem from each Minority Shareholder all of his or her Minority Redeemed Shares, in consideration of the payment by the Companies to each Minority Shareholder of an amount determined in accordance with Schedule 4 (his or her "Redemption Price"). Ninety percent (90%) of the Preliminary Redemption Price for each Minority Shareholder shall be paid in cash at the Closing by means of a wire transfer of immediately available Federal funds to accounts designated by each Minority Shareholder no less than three days prior to the Closing Date, and the other ten percent (10%) (the Holdback Amount) shall be applied as provided for in Section 4.3 hereof. Adjustments to each Minority Shareholder's Preliminary Redemption Price shall be made following the Closing, if required pursuant to Section 4.3 hereof. -20- 29 (b) The redemption of the Minority Shareholders described in this Section 4.1 shall be effected pursuant to the Minority Shareholder Redemption Agreement, which shall be executed and delivered by the Companies listed on Schedule 4 and each of the Minority Shareholders. 4.2. Redemption of Majority Redeemed Shares. On the Closing Date, prior to the Recapitalization, the Companies shall purchase and redeem from each Majority Shareholder his Majority Redeemed Shares, in consideration of the payment by the Companies to each Majority Shareholder of an amount determined in accordance with Schedule 4 (his "Redemption Price"). A Preliminary Redemption Price payable to each Majority Shareholder shall be paid in cash at the Closing by means of a wire transfer of immediately available Federal funds to accounts designated by each Majority Shareholder no less than three days prior to the Closing Date. Adjustments to each Majority Shareholder's Preliminary Redemption Price shall be made following the Closing, if required pursuant to Section 4.3 hereof. 4.3. Post-Closing Adjustments. (a) Audited Closing Date Financial Statements. As promptly as reasonably practicable following the Closing Date, the Management Shareholders shall cause the Unaudited Closing Date Financial Statements to be delivered to Holdings pursuant to Section 10.5 hereof to be audited by Kirkland's Accountants, it being understood that there will be no physical inventory taken in connection with such audit if a physical inventory is not required in order for Kirkland's Accountants to render an unqualified opinion on the Audited Closing Date Financial Statements. A copy of the Audited Closing Date Financial Statements shall be delivered to Holdings and the Majority Shareholders. (b) Notice of Disagreement. The Audited Closing Date Financial Statements shall become final and binding upon the parties hereto unless Holdings gives written notice of its disagreement (a "Notice of Disagreement") to the Majority Shareholders within twenty (20) days following the delivery to Holdings of the Audited Closing Date Financial Statements. A Notice of Disagreement shall specify in reasonable detail the nature of any disagreement so asserted. During a period of ten (10) days following the receipt by the Majority Shareholders of a Notice of Disagreement from Holdings, the parties shall attempt to resolve in writing any differences they may have with respect to any matters specified in the Notice of Disagreement. If at the end of the aforesaid 10-day period, the parties have reached written agreement with respect to all matters covered by a Notice of Disagreement, the Audited Closing Date Financial Statements shall be adjusted to reflect such written agreement and shall become final and binding upon the parties hereto. -21- 30 (c) Disputed Matters. If at the end of the aforesaid 10-day period, the parties shall have failed to reach written agreement with respect to all matters covered by a Notice of Disagreement, then all such matters as to which written agreement has been reached shall become final and binding upon the parties hereto and all such matters as to which written agreement has not been reached (the "Disputed Matters") shall be submitted to and reviewed by the Washington, D.C. office of Deloitte & Touche LLP (the "Arbitrator"). (d) Arbitration. The Arbitrator shall consider only the Disputed Matters. The Arbitrator shall act promptly to resolve all Disputed Matters and its decision with respect to all Disputed Matters shall be final and binding upon the parties hereto. Upon resolution by the Arbitrator of all Disputed Matters, the Arbitrator shall prepare and shall deliver to Holdings and the Majority Shareholders a conclusion letter reflecting any written agreement between the parties with respect to adjustments to be made to the Audited Closing Date Financial Statements and reflecting any determination of the Arbitrator with respect to any Disputed Matters, and the Audited Closing Date Financial Statements as adjusted based on the conclusion letter shall be final and binding upon the parties hereto. The fees and expenses of the Arbitrator shall be borne equally by Holdings, on the one hand, and the Majority Shareholders, on the other hand, unless the Arbitrator determines that one of the parties has not proceeded in good faith with respect to the Disputed Matters, in which case such party shall bear fully the fees and expenses of the Arbitrator. (e) Post-Closing Adjustment. (i) Not later than five Business Days subsequent to the date the Audited Closing Date Financial Statements become final and binding upon the parties hereto in accordance with the preceding paragraphs of this Section 4.3, a post-closing adjustment will be made, and payments will be made by the Companies to the Shareholders or by the Shareholders to the Companies, as follows: (A) The Redemption Proceeds shall be recalculated by reference to the Audited Closing Date Financial Statements, as adjusted pursuant to the provisions of paragraphs (b) through (d) of this Section 4.3. (B) If the Preliminary Redemption Proceeds paid or credited to Shareholders at the Closing, including the Holdback Amount, exceed the Redemption Proceeds as calculated in accordance with paragraph (A) above, such excess shall constitute the "Negative Adjustment Amount." If the Redemption Proceeds as so computed exceed the Preliminary -22- 31 Redemption Proceeds paid to Shareholders at the Closing, such excess shall constitute the "Positive Adjustment Amount." (C) The Positive Adjustment Amount or Negative Adjustment Amount, as the case may be, shall be allocated among the Shareholders in proportion to each Shareholder's Percentage Interest. (ii) Any Negative Adjustment Amount allocated (A) to each Majority Shareholder shall be paid to the Companies by such Majority Shareholders in cash (i.e. by ordinary check), and (B) to each Minority Shareholder shall be applied against the Holdback Amount and the balance of the Negative Adjustment Amount thereafter remaining shall be paid by each Minority Shareholder to the Companies in cash (i.e., by ordinary check). Any Holdback Amount not so applied shall be paid by the Companies to the Minority Shareholders in cash (i.e., by ordinary check). The portion of any Negative Adjustment Amount to be allocated to each Company shall be determined by the Board of Directors of each Company at the time of receipt. (iii) Any Positive Adjustment Amount allocated to each Shareholder shall be paid by the Companies to such Shareholders in cash (i.e. by ordinary check), and at the same time, the Companies shall pay the Holdback Amount to the Minority Shareholders in cash (i.e. by ordinary check). The portion of any Positive Adjustment Amount to be paid by each Company shall be determined by the Board of Directors of each Company at the time of payment. 4.4. Compliance with Corporate Law. The Redemption is subject to the restrictions governing the right of a corporation to purchase its own capital stock under applicable corporate law and such other pertinent Regulations as are now, or may hereafter become, effective. If any of the Companies does not on the Closing Date have sufficient capital available to permit it lawfully to redeem the Minority Redeemed Shares or Majority Redeemed Shares which it is required pursuant to this Article 4 to redeem, the parties shall enter into such amendments to this Agreement as shall reasonably be required in order to provide: (a) for the Companies to redeem fewer Majority Redeemed Shares than currently required pursuant to this Article 4, such that following the Redemption (as so adjusted) and the purchase of shares of common stock by Holdings from the Majority Shareholders as discussed in clause (b) below, the Shareholders shall have received the same net proceeds as would have been the case had the Redemption been able to be consummated in full without regard to this Section 4.4, and (b) for Holdings to purchase fewer shares of common stock from the Companies than is currently required pursuant to Article 3 hereof and for Holdings to purchase such number of shares of common stock directly from the -23- 32 Majority Shareholders such that following the purchase of the Purchased Shares by Holdings from the Companies and the purchase of shares by Holdings from the Majority Shareholders, Holdings and the Majority Shareholders shall own the same relative percentage interests of the common stock of each Company as would have been the case had the Redemption been able to be consummated in full without regard to this Section 4.4. ARTICLE 5 RECAPITALIZATION OF THE COMPANIES 5.1. Recapitalization. On or by the Closing Date, the Companies will file amendments to their charters with their respective states of incorporation in order to effect the Recapitalization as described in this Article 5. The amended charters shall provide that the authorized capital of each Company shall consist of 500,000 shares of common stock and 100,000 shares of preferred stock, of which preferred stock 68,400 shares will be designated as Class A Preferred Stock ("Class A Preferred Stock") and 31,600 shares will be designated as Class B Preferred Stock ("Class B Preferred Stock"); except that the amended charters of all Group A Companies and Group B Companies shall include an additional 20,000 shares of preferred stock which will be designated as Class C Preferred Stock ("Class C Preferred Stock"), for a total number of shares of preferred stock of Group A Companies and Group B Companies of 120,000 per Company. The 500,000 shares of authorized common stock shall be designated as Voting Common Stock ("Voting Common Stock") and Non-Voting Common Stock ("Non-Voting Common Stock"), depending on whether the Company is a Group A Company, Group B Company, Group C Company or Group D Company, as follows: for Group A Companies and Group B Companies, 498,700 shares of common stock will be designated as Voting Common Stock and 1,300 shares will be designated as Non-Voting Common Stock; and for Group C Companies and Group D Companies, 484,200 shares of common stock will be designated as Voting Common Stock and 15,800 shares will be designated as Non-Voting Common Stock. Of the total of 31,600 shares of authorized Class B Preferred Stock of all Group C Companies and Group D Companies, 21,800 shall be designated as Voting Class B Preferred Stock ("Voting Class B Preferred Stock") and 9,800 shall be designated as Non-Voting Class B Preferred Stock ("Non-Voting Class B Preferred Stock"). The 31,600 shares of authorized Class B Preferred Stock of all Group A Companies and Group B Companies shall be designated simply as Class B Preferred Stock. 5.2. Conversion of Common Stock. (a) In the Recapitalization, the outstanding shares of common stock of each Company held by Majority Shareholders shall be converted so that the -24- 33 total outstanding stock will be all of the authorized stock designated in the charters amended pursuant to Section 5.1. Any Class C Preferred Stock and Class A Preferred Stock outstanding prior to the Recapitalization will remain outstanding and will not be affected by the Recapitalization. (b) The Class A Preferred Stock and the Class B Preferred Stock shall accrue cumulative dividends at the rate of eight percent (8%) per year, payable upon redemption if not earlier paid. The Class C Preferred Stock shall not bear dividends. No dividends shall be paid on the Class A Preferred Stock, Class B Preferred Stock or Common Stock, unless all amounts then due under the Management Agreements have been paid. (c) The common stock of each Company following the Recapitalization shall be issued and outstanding such that Holdings owns 68.4% of the outstanding common stock and each of the Majority Shareholders owns 7.9% of the outstanding common stock. All of the common stock outstanding after the Recapitalization will be Voting Common Stock, except for the following number of shares of the common stock to be issued to each of Bruce Moore and Robert Alderson, which will be Non-Voting Common Stock: 650 shares for each Group A Company and Group B Company and 7,900 shares for each Group C Company and Group D Company. (d) The Class A Preferred Stock of each Company shall be owned by Holdings, and the Class B Preferred Stock of each Company shall be owned by the Majority Shareholders according to the following percentages: Robert Alderson, 25%; Carl Kirkland, 25%; Bruce Moore, 25%; and Robert Kirkland, 25%. All of the Class B Preferred Stock outstanding after the Recapitalization by the Group C Companies and the Group D Companies will be Voting Class B Preferred Stock, except for 4,900 shares of the Class B Preferred Stock to be owned by each of Bruce Moore and Robert Alderson, which will be Non-Voting Class B Preferred Stock. (e) The aggregate stated value and liquidation preference of the shares of Class A Preferred Stock to be issued by all of the Companies to Holdings will be $30,472,200, the aggregate stated value and liquidation preference of the shares of Class B Preferred Stock to be issued by all of the Companies to the Majority Shareholders will be $14,077,800, and such aggregate amounts of stated value and liquidation preference shall be allocated as follows: Group A Companies -- 74%, Group B Companies -- 25%, Group C Companies -- 0.999% and Group D Companies -- 0.001%. The amounts of stated value and liquidation preference allocated to the Group A Companies, the Group B Companies and the Group C Companies pursuant to the preceding sentence shall be further allocated among each of the Companies within each such Group in accordance with their relative Percentage Values, and the amount of stated value and liquidation -25- 34 preference allocated to the Group D Companies pursuant to the preceding sentence shall be allocated equally among the Group D Companies. The aggregate stated value and liquidation preference of the shares of Class C Preferred Stock to be issued by all of the Group A Companies and Group B Companies to the Majority Shareholders will be $20,000,000, and such aggregate amounts of stated value and liquidation preference shall be allocated $15,000,000 to the Group A Companies in accordance with the relative Percentage Values of such Companies and $5,000,000 to the Group B Companies in accordance with the relative Percentage Values of such Companies. In any liquidation of the Companies or any redemption of any preferred stock of the Companies, the holders of the Class C Preferred Stock of each Company with Class C Preferred Stock outstanding shall receive liquidation payments or redemption proceeds, as the case may be, prior to the holders of common stock, Class A Preferred Stock or Class B Preferred Stock, until the full liquidation preference or redemption proceeds, as the case may be, of such Class C Preferred Stock shall have been fully paid. 5.3. Common Stock. The amended and restated Articles or Certificate of Incorporation to be adopted by each of the Companies pursuant to Section 5.1 shall provide that the Voting Common Stock shall have all voting rights accorded to holders of common stock pursuant to the corporate law of the state of incorporation (at the rate of one vote per share), except with respect to the election of directors. Such amended and restated Articles or Certificate of Incorporation shall also provide that the Non-Voting Common Stock shall be equal in all respects to the Voting Common Stock, except that the Non-Voting Common Stock shall not have voting rights. With respect to the election of directors for any Company, the holders of the Voting Common Stock, voting as a separate voting group, shall have the special and exclusive right at all times to elect three (3) directors to the Board of Directors of such Company. Any director elected by the holders of the Voting Common Stock shall not be subject to removal, other than for cause, unless such removal is approved by a majority of all the votes entitled to be cast by the holders of the Voting Common Stock. A majority of the directors elected by the holders of the Voting Common Stock shall have the right to make all determinations concerning the taking of action by the Companies to enforce the Companies' rights under this Agreement. 5.4. Class A Preferred Stock. The designations and preferences of the Class A Preferred Stock to be adopted by each of the Companies pursuant to Section 5.1 shall provide that the Class A Preferred Stock shall not have any voting rights except as set forth in this Section. (a) The holders of a majority of the Class A Preferred Stock of any Company shall have the right at any time -26- 35 to call a special meeting of the shareholders of such Company in order for the shareholders to vote on a proposal to engage in a business combination transaction with one or more other businesses, whether by purchase, sale of substantially all assets, merger, consolidation or otherwise. (b) At any time following the earlier to occur of: (A) such time as it shall be possible for a Company to do so without resulting in a breach of any agreement to which such Company is a party or any event, which with or without the giving of notice or the passage of time, would result in such a breach, or (B) the first anniversary of the Closing Date, the holders of a majority of the Class A Preferred Stock of such Company shall have the right to call a special meeting of the shareholders of such Company in order for the shareholders to vote on a proposal to amend such Company's Articles or Certificate of Incorporation and By-laws as set forth in this paragraph. Such amendment shall eliminate all special voting rights and restrictions of the Class A Preferred Stock, Class B Preferred Stock and Class C Preferred Stock, as the case may be, and shall provide that the Class A Preferred Stock, Class B Preferred Stock and Class C Preferred Stock shall have no voting rights except as provided by applicable law. Such amendment shall eliminate any reference to the special voting rights and restrictions of the common stock and shall provide for the conversion of all Non-Voting Common Stock into Voting Common Stock. Such amendment shall delete from the By-laws the special approval provisions set forth in Section 5.7 hereof. (c) At any shareholders meeting called pursuant to paragraph (a) or (b) above, each share of Class A Preferred Stock shall entitle the holder thereof to one vote on the proposal being voted upon, voting together with the holders of common stock and either Voting Class B Preferred Stock, in the case of Group C Companies and Group D Companies, or Class C Preferred Stock, in the case of Group A Companies and Group B Companies, as one voting group. If the shareholders approve such proposal, the matter shall be submitted to the vote of the Board of Directors of the Company. If the Board of Directors of the Company shall not approve the proposal within five days after the date of the shareholders meeting, then the holders of the Class A Preferred Stock, voting as a separate voting group, shall thereafter have the special and exclusive right at all times to elect two (2) directors to the Board of Directors of such Company. Any director elected by the holders of the Class A Preferred Stock shall not be subject to removal, other than for cause, unless such removal is approved by a majority of all the votes entitled to be cast by the holders of the Class A Preferred Stock. -27- 36 5.5. Class B Preferred Stock. (a) The designations and preferences of the Class B Preferred Stock to be adopted by each of the Group A Companies and Group B Companies pursuant to Section 5.1 shall provide that the Class B Preferred Stock shall not have any voting rights. (b) The designations and preferences of the Class B Preferred Stock to be adopted by each of the Group C Companies and Group D Companies pursuant to Section 5.1 shall provide that the Class B Preferred Stock shall not have any voting rights except as set forth in this paragraph. Except with respect to the election of directors, the holders of the Voting Class B Preferred Stock in Group C Companies and Group D Companies shall have the right to vote on all matters as to which holders of the common stock shall be entitled to vote (at the rate of one vote per share), in the same manner and with the same effect as such holders of common stock, voting together with the holders of common stock as one voting group. With respect to the election of directors for any Company, the holders of such Voting Class B Preferred Stock, voting as a separate voting group, shall have the special and exclusive right at all times to elect four (4) directors to the Board of Directors of such Company. Any director elected by the holders of the Voting Class B Preferred Stock shall not be subject to removal, other than for cause, unless such removal is approved by a majority of all the votes entitled to be cast by the holders of the Voting Class B Preferred Stock. The designations and preferences of the Class B Preferred Stock to be adopted by each of the Group C Companies and Group D Companies in connection with the Recapitalization shall provide that the Non-Voting Class B Preferred Stock shall be equal in all respects to the Voting Class B Preferred Stock, except that the Non-Voting Class B Preferred Stock shall not have voting rights. 5.6. Class C Preferred Stock. The designations and preferences of the Class C Preferred Stock to be adopted by each of the Group A Companies and Group B Companies pursuant to Section 5.1 shall provide that the Class C Preferred Stock shall not have any voting rights except as set forth in this Section. Except with respect to the election of directors, the holders of the Class C Preferred Stock shall have the right to vote on all matters as to which holders of the common stock shall be entitled to vote (at the rate of one vote per share), in the same manner and with the same effect as such holders of common stock, voting together with the holders of common stock as one voting group. With respect to the election of directors for any Company, the holders of the Class C Preferred Stock, voting as a separate voting group, shall have the special and exclusive right at all times to elect four (4) directors to the Board of Directors of such Company. Any director elected by the holders -28- 37 of the Class C Preferred Stock shall not be subject to removal, other than for cause, unless such removal is approved by a majority of all the votes entitled to be cast by the holders of the Class C Preferred Stock. The Class C Preferred Stock shall be redeemable in whole or in part (pro rata if in part) at the option of the Companies at any time, and shall be mandatorily redeemable in whole upon the earlier to occur of the seventh anniversary of the Closing or the closing of any Sale, Change in Control, Qualified Public Offering or Refinancing. In the event that the Companies do not redeem the Class C Preferred Stock when required in accordance with its terms, dividends will accrue and cumulate thereon at an annual rate of nine percent (9%) until the redemption occurs. All redemption and dividend payment obligations will be subordinated to the Bank Debt and the Mezzanine Debt. 5.7. By-laws of the Companies. In connection with the Recapitalization, the By-laws of the Companies shall be amended in order to include a provision requiring the approval of at least one of the directors designated by Holdings pursuant to the terms of the Shareholders Agreement in order for any Company to take any of the following actions: (i) Any sale, lease or assignment of any Company's interest in any assets outside the ordinary course of business. (ii) Any borrowings or incurrence of indebtedness (or series of borrowings or incurrences of indebtedness) within any 12-month period, or any commitment for any of the foregoing, in an amount exceeding $300,000 by any Company or $5 million by all Companies in the aggregate. (iii) Any capital expenditures within any 12-month period in excess of $50,000 by any Company or $1 million by all Companies in the aggregate. (iv) Any sale or other issuance, or any purchase or redemption, of any securities of any Company by any Company. (v) Any merger or consolidation by any Company with any other entity or corporation or liquidation or dissolution. (vi) Any amendment to any Company's Certificate of Incorporation or By-laws. (vii) The removal or election of any corporate officer, or the termination of employment of or hiring of any employee earning annualized compensation of more than $100,000. -29- 38 (viii) Any contract with any Majority Shareholder or any Affiliate of any Majority Shareholder not in the ordinary course of business. ARTICLE 6 SCHEDULES AND COLLATERAL DOCUMENTS 6.1. Delivery of Schedules. The Management Shareholders shall deliver to Holdings, no later than May 2, 1996, all of the Schedules required by the terms of this Agreement to be attached hereto other than any which have been attached hereto on the date hereof. In order for such delivery to satisfy the covenant set forth in the preceding sentence, such Schedules must be accompanied by a certificate executed by the Management Shareholders, stating that such Schedules are being attached hereto pursuant to this Section 6.1. 6.2. Right of Termination. Holdings may terminate this Agreement, if: (i) either (A) any of the Schedules provided by the Management Shareholders pursuant to Section 6.1 hereof shall not be acceptable to Holdings, in Holdings' sole discretion, or (B) the Management Shareholders shall have failed to provide any of the Schedules required to be provided to Holdings pursuant to Section 6.1 by May 2, 1996, and (ii) Holdings provides notice to the Management Shareholders of its election to terminate this Agreement pursuant to this Section 6.2 no later than May 10, 1996. 6.3. Delivery of Collateral Documents. Each of the Majority Shareholders and Holdings agree to negotiate the terms of the Collateral Documents in good faith, with the goal of agreeing to such terms on or before May 15, 1996. After agreement to such terms shall have been reached, each of the Majority Shareholders and Holdings shall sign a certificate reflecting such agreement and setting forth the parties' agreement that the forms of the Collateral Documents as agreed upon shall be the forms in which such Collateral Documents shall be executed and delivered at the Closing, unless otherwise required by the Lenders as a condition to their funding the Bank Debt or the Mezzanine Debt. Any changes to the Collateral Documents required by the Lenders shall be subject to the approval of each of the Majority Shareholders and Holdings. -30- 39 ARTICLE 7 REPRESENTATIONS AND WARRANTIES OF SHAREHOLDERS Each of the Management Shareholders hereby jointly and severally makes the following representations and warranties to Holdings, each of which shall survive the Closing and expire only in accordance with Article 14 hereof, and Robert Kirkland hereby joins in this Article 7 solely for the purpose of making the representations and warranties set forth in Sections 7.2(b), 7.5(b), 7.27(b) and 7.29(b) (individually and not jointly and severally with the Management Shareholders), each of which shall survive the Closing and expire only in accordance with Article 14 hereof: 7.1. Organization, Power and Authority. Each Company is a corporation duly organized, validly existing and in good standing under the laws of its state of incorporation and is duly qualified and in good standing as a foreign corporation authorized to transact business and to own and lease property in each jurisdiction in which the nature of the business conducted by it or the character or location of the properties owned or leased by it requires such qualification in order to avoid liability or disadvantage. All of such states of incorporation and foreign qualification jurisdictions are listed on Schedule 7.1. Each Company has the power and authority to own its property and to carry on its business as presently conducted or contemplated. Correct and complete copies of the Articles or Certificate of Incorporation and By-laws of the Companies, as amended to date have been previously provided to Holdings. None of the Companies is in violation of any term of its Articles or Certificate of Incorporation or By-laws, as amended to date, which violation would have a Material Adverse Effect on any Company. A true and complete list of the officers and directors of the Companies is set forth on Schedule 7.1 hereto, and each such officer and director has been duly elected to such office or directorship. Other than the Majority Shareholders, each of the Companies, and the officers and directors listed on Schedule 7.1 hereto, none of the Companies has any Affiliates. 7.2. Authorization. (a) This Agreement constitutes the valid and binding obligation of each of the Companies and the Management Shareholders, enforceable against each of them in accordance with its terms, and the Collateral Documents will constitute, upon their execution and delivery by the Companies and the Management Shareholders, as the case may be, the valid and binding obligation of each of each of them, enforceable in accordance with their respective terms, except as such enforcement may be limited by applicable bankruptcy, insolvency, moratorium or -31- 40 similar laws affecting the rights of creditors generally. The execution, delivery and performance of this Agreement has been duly authorized by all necessary corporate and shareholder action of each Company. (b) Robert Kirkland represents and warrants (and the Management Shareholders do not represent and warrant) that this Agreement constitutes his valid and binding obligation, enforceable against him in accordance with its terms, and the Collateral Documents to which Robert Kirkland is a party will constitute, upon their execution and delivery by Robert Kirkland, his valid and binding obligations, enforceable in accordance with their respective terms, except as such enforcement may be limited by applicable bankruptcy, insolvency, moratorium or similar laws affecting the rights of creditors generally. 7.3. Capitalization of the Companies. The authorized capital stock of each Company consists of 1,000 shares of common stock, of which 1,000 shares are currently issued and outstanding (except as shown on Schedule 7.3) and are owned of record and beneficially as shown on Schedule 7.3. All of the outstanding shares have been validly issued, fully paid and nonassessable, and are not subject to, nor were they issued in violation of, any preemptive rights. The Purchased Shares are validly issued, fully paid and nonassessable, and will not be subject to, nor will they have been issued in violation of, any preemptive rights. Except for the outstanding shares, the Purchased Shares, the Sub Debt Warrants to be issued at the Closing and the options to be granted to the Management Shareholders pursuant to the Option Agreements at the Closing, or as otherwise provided herein, none of the Companies has issued any other shares of capital stock, there are no outstanding warrants, options or other rights, commitments, agreements or understandings to purchase or acquire any shares of capital stock or other equity securities of any Company, and there are no outstanding debt securities of any Company convertible into equity securities or otherwise containing equity provisions. Except as provided herein, none of the Companies has reserved any of its authorized shares of capital stock for any purpose. Except as disclosed on Schedule 7.3 hereto, (a) there are no restrictions on the transfer of the capital stock of any of the Companies other than those arising from federal and state securities laws, and (b) none of the Companies has any understandings or agreements with any of the Shareholders or any other person or entity respecting its capital stock or other securities. All shares of capital stock, options, warrants, notes, bonds or other equity or debt securities which have ever been offered or sold by the Companies ("Securities") have been exempt from registration pursuant to the registration provisions of the Securities Act of 1933 and applicable state securities laws, and no such Securities were registered under any such Act or laws. No private offering memorandum or other information furnished (whether orally or in -32- 41 writing) to any offeree or purchaser of such Securities contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein not misleading. 7.4. Subsidiaries. None of the Companies has any direct or indirect investments in, and none of the Companies is a party to any agreement, commitment or understanding requiring the Company to purchase or acquire any interest in, the equity of any corporation, trust, partnership or business entity, or debt securities convertible into such securities or otherwise containing equity provisions. 7.5. Conflict with other Instruments; Absence of Restrictions. (a) The execution, delivery and performance of this Agreement by the Companies and the Management Shareholders, and the execution, delivery and performance of the Collateral Documents by the Companies and the Management Shareholders, will not contravene any provision of any Company's Articles or Certificate of Incorporation or by-laws and will not result in a breach of, or constitute a Default under, any agreement or other document to which any Company or any of the Management Shareholders is a party or by which any Company or any of the Management Shareholders is bound, or any Regulation which is binding on any Company or any of the Management Shareholders or on any assets of any Company, or result in the creation or imposition of any mortgage, pledge, lien, charge, assessment, encumbrance, claim or restriction of any nature on any assets of any Company or give to others any interest or rights therein or create in any third party the right to modify, terminate or accelerate (or to make a claim for damages in respect of) any instrument or contract to which any Company or any of the Management Shareholders is a party or by which any Company or any of the Management Shareholders is bound. None of the Companies and none of the Management Shareholders has any reason to believe that the execution, delivery and performance of this Agreement and the Collateral Documents will adversely affect performance by third parties under any supply contracts or distribution agreements to which the Company is a party. As of the date hereof, no Default has occurred under this Agreement by any of the Companies or any of the Management Shareholders. (b) Robert Kirkland represents and warrants (and the Management Shareholders do not represent and warrant) that the execution, delivery and performance of this Agreement by him, and the execution, delivery and performance of the Collateral Documents by him, will not result in a breach of, or constitute a Default under, any agreement or other document to which he is a party or by which he is bound, or any Regulation which is binding -33- 42 on him. As of the date hereof, no Default has occurred under this Agreement by Robert Kirkland. 7.6. Government and Third-Party Approvals. Except as listed on Schedule 7.6 attached hereto, no consent by, approval or authorization of or filing, registration or qualification with any Governmental Entity, corporation, person or other entity (including any party to any contract or agreement with any Company or any of the Majority Shareholders) is required (i) for the execution, delivery and performance of this Agreement by the Companies and the Majority Shareholders, (ii) for the execution, delivery and performance of the Collateral Documents by the Companies and the Majority Shareholders, (iii) in connection with the Companies' and the Majority Shareholders' consummation of the transactions contemplated hereby and thereby or (iv) in order to vest in Holdings good and marketable title in and to all of the Purchased Shares upon the Closing. 7.7. Title to Properties; Adequacy of Properties. Each Company has good and marketable title to its properties and assets, whether tangible or intangible, and whether consisting of real or personal property, including, without limitation Copyrights, Patents, Trademarks and other intangibles which it purports to own, as well as all of the properties and assets reflected in the 1995 Balance Sheet and those acquired since the date thereof (except in each case for properties and assets sold or otherwise disposed of in the ordinary course of business consistent with past practice since the dates thereof), free and clear of all Liens, except as specifically disclosed in Schedule 7.7 attached hereto. All of said properties and assets currently used in the operation of the Business are in good working order and fit for their intended use. The properties and assets of each Company are adequate in all respects to conduct its Business as now conducted. 7.8. Other Representations Regarding Company Assets. (a) Accounts Receivable. All of the Accounts Receivable as of December 31, 1995 are reflected on the 1995 Balance Sheet and all of the Accounts Receivable as of the Closing Date will be reflected on the Unaudited Closing Date Balance Sheet. Each of the Accounts Receivable constitutes a valid claim in the full amount thereof against the debtor charged therewith on the books of the Company, has been acquired in the ordinary course of business, and no such account receivable has arisen from any transaction with the United States or any department or agency thereof. The Accounts Receivable listed on the 1995 Balance Sheet and/or on the Unaudited Closing Date Balance Sheet (i) have arisen or will arise solely in the ordinary course of business of the Company; (ii) represent or will represent, upon their creation, valid obligations due to the Company and are enforceable or will, upon their creation, be -34- 43 enforceable in accordance with their terms; and (iii) are or upon their creation will be collectible on or before the 120th day following the Closing Date in the ordinary course of business in the aggregate recorded amounts thereof in accordance with their terms, less the amount of any reserve for doubtful accounts maintained by the Company in accordance with GAAP. No account debtor has any valid set-off, deduction or defense with respect thereto, and no account debtor has asserted any such set-off, deduction or defense, except as may result from the right of the Companies' customers to return merchandise in accordance with the provisions of the Companies' standard merchandise return policy. (b) Cash Accounts. Schedule 7.8(b) hereto lists (i) the name and city of every bank or other financial institution in which each Company maintains an account (whether checking, savings or otherwise), lock box or safe deposit box, and (ii) the account number of each account. (c) Equipment. The items of Equipment are, and on the Closing Date will be, in good working order and fit for their intended use. (d) Inventory Generally. All items of Inventory reflected in the Financial Statements are, and all items of Inventory to be reflected on the Unaudited Closing Date Balance Sheet will be, in good and merchantable condition and salable in the ordinary course of business. Such Inventory is valued on an average cost basis in accordance with GAAP, and does not include any defective or obsolete items. The Companies do not hold any items of Inventory on consignment or have title to any items of Inventory in the possession of others except for items of Inventory in shipment to the Companies. (e) Leasehold Improvements. The Leasehold Improvements are, and on the Closing Date will be, fit for their intended use. All of the movable trade fixtures may be removed by the Company, as the current lessee, from the premises on which they are attached without giving rise to any obligation on the part of the Company, as the lessee, to compensate the applicable landlord for any diminution in the value of the leased premises as a result of such removal. (f) Owned Real Property. Attached hereto as Schedule 7.8(f) is an accurate list and summary description of all Owned Real Property, together with a brief description of all structures located thereon and any existing title insurance policies which any of the Companies has, and except as set forth on Schedule 7.8(f), there are no options, licenses, leases, rights of first refusal, conditional sales agreements, or similar arrangements respecting the Owned Real Property. Except as set forth in Schedule 7.8(f), Kirkland's has and on the Closing Date will have, free and clear of all Liens except for Permitted -35- 44 Liens, good, valid, record and marketable title to all of the Owned Real Property. Other than the Owned Real Property, the Companies own no Real Property. Since December 31, 1995, there has been no damage, destruction or loss (whether or not covered by insurance), with respect to any Owned Real Property. (g) Leased Real Property. (i) Attached hereto as Schedule 7.8(g) is an accurate list and summary description of all Leased Real Property. The Leased Real Property constitutes all of the Real Property which is leased or used by the Companies other than the Owned Real Property. The lessor of each parcel of Leased Real Property is identified on Schedule 7.8(g), together with the full and accurate mailing address of each such lessor, of which the Companies have notice. The Companies and the Management Shareholders have previously delivered to Holdings the Leases. All of the Leases contain customary commercial terms and, subject to provisions concerning default, afford the Companies peaceful and undisturbed possession of the Leased Real Property. (ii) Except for the occupancy and use of the Leased Real Property by the Company, there are no leases, tenancies, licenses or other rights of occupancy or use for any portion of the Leased Real Property, and no person or entity other than the Companies occupies or uses any portion of the Leased Real Property. (h) Real Property Generally. (i) No assessments for public improvements have been made against any Owned Real Property or, to the best knowledge of the Management Shareholders, any Leased Real Property, and no current installments of such assessments remain unpaid and, to the best knowledge of the Management Shareholders, no such Real Property will be assessed for any street paving or curbing heretofore laid or any other public improvements heretofore made. To the best knowledge of the Management Shareholders, no ordinance authorizing improvements, the cost of which might be assessed against any Owned Real Property or Leased Real Property, is pending or contemplated. (ii) There are no pending or, to the knowledge of any of the Management Shareholders, threatened, (A) condemnations, eminent domain or similar proceedings, or (B) assessments, which could affect any part of the Owned Real Property. To the knowledge of any of the Management Shareholders, there are no pending or threatened condemnations, eminent domain or similar proceedings, or assessments, which could affect any part of the Leased Real Property. From the date of this Agreement through the Closing Date, the Management Shareholders and the Companies agree to notify Holdings -36- 45 immediately upon learning that any assessment, or any condemnation, eminent domain or similar proceeding, has been commenced or is threatened, which could affect any part of the Owned Real Property or Leased Real Property. (iii) Except as listed on Schedule 7.8(h), the zoning, land use, building or safety law or ordinance or other administrative regulation of the city, town, county, village, state or municipality in which any Owned Real Property or, to the knowledge of the Management Shareholders, any Leased Real Property, is located are not violated by existing structures, and are not violated by nor prevent or interfere with or adversely affect, the continued use and operation of the Business for the same purposes and operations as presently exist, none of the Companies has received any notice of any such violation with which it has not fully and timely complied. Except as set forth on Schedule 7.8(h), there is no outstanding notice of violation, order or citation against any Company under any law, ordinance, governmental rule or regulation relating to any of the Leased Real Property, and the Leased Real Property is in good operating condition and in a state of good maintenance and repair sufficient for the efficient operation of the Business. (i) Intellectual Property and Information. To the knowledge of the Management Shareholders, no patent, tradename, trademark, service mark, copyright or license not included in the Intellectual Property and Information is necessary to permit the business of the Company to be conducted as now conducted. Except as set forth on Schedule 7.8(i) hereto, no claim is pending or threatened to the effect that (i) the present or past operations of the Business infringe upon or conflict with the asserted rights of any other person in respect of any of the Intellectual Property and Information or (ii) any Intellectual Property and Information is invalid or unenforceable. To the knowledge of the Management Shareholders, none of the Intellectual Property and Information infringes on the rights of third parties, and the Company is not making unauthorized use of any confidential information or trade secrets of any person. (j) Completeness and Condition of Assets. All of the assets used in the operation of the Business, including the Owned Real Property and Leased Real Property and the structures thereon, are in good operating condition sufficient to operate the Business as presently conducted (reasonable wear and tear excepted) and are fit for the purpose for which they are intended. The Companies has access to all utilities, including water and sewage or subsurface disposal systems, as the case may be, necessary to operate the Business in the normal course as presently operated. Other than the Companies, there are no corporations or other entities which conduct the Business, any shares of which are owned by any of the Majority Shareholders. -37- 46 7.9. Financial Statements and Related Information. (a) Financial Statements. The Audited Historical Financial Statements have been delivered to Holdings. The Audited Historical Financial Statements are based on the Books and Records of the Companies (with adjustments to reflect inventory capitalization and depreciation) and were prepared in accordance with GAAP and, when read together with the notes thereto, present fairly and accurately the financial position and the results of the operations of the Companies as at the respective dates thereof and for the periods reported therein, and the Audited Historical Financial Statements do not reflect the financial position or include the results of operations of any corporation or entity other than the Companies (other than any corporation which has been dissolved). Any Interim Financial Statements delivered in accordance with Section 10.1(n) hereof will be in accordance with the Books and Records of the Companies and will be prepared in accordance with GAAP (other than the absence of adjustments to reflect inventory capitalization and depreciation) and will present fairly and accurately the financial position and the results of the operations of the Companies as at the respective dates thereof and for the periods reported therein. Upon delivery in accordance with Section 10.5 hereof, the Unaudited Closing Date Financial Statements will be in accordance with the Books and Records of the Companies and will be prepared in accordance with GAAP (other than the absence of adjustments to reflect inventory capitalization and depreciation), and will present accurately the financial position and the results of the operations of the Companies as of the date preceding the Closing Date; with the understanding that the financial information respecting the month in which the Closing occurs will be presented by the Management Shareholders based on the Books and Records of the Companies, and that the Management Shareholders agree to use their best efforts to project as accurately as reasonably possible such Closing month financial information. (b) Absence of Undisclosed Liabilities. On December 31, 1995, the Companies had no Liabilities except as and to the extent reflected in the 1995 Balance Sheet or in this Agreement or in any Schedule hereto. The Companies have no Liabilities, and, to the knowledge of the Management Shareholders, no basis for any Liability exists other than (i) any reflected in the 1995 Balance Sheet, the balance sheet included in the most recent Interim Financial Statements, in this Agreement or in any Schedule hereto or (ii) any Liabilities meeting both of the following conditions: (A) such Liabilities arose since December 31, 1995 in the ordinary course of business of the Company and in compliance with the covenants and agreements of the Company herein contained, and (B) such Liabilities are set forth on the Unaudited Closing Date Balance Sheet. -38- 47 (c) Affiliated Relationships. All services rendered by any Company to any of the Shareholders or any Affiliate of any of the Shareholders, and all services rendered by any of the Shareholders or any Affiliate of any of the Shareholders to any Company, have been recorded in the accounts of such Company at their full value, as if they were rendered in arm's length transactions. All goods sold by any Company to any of the Shareholders or any Affiliate of any of the Shareholders, and all goods sold by any of the Shareholders or any Affiliate of any of the Shareholders to any Company, have been recorded in the accounts of such Company at their full value, as if such goods were transferred in arm's length transactions. 7.10. Permits. The Companies have obtained all Permits required by Law. All such Permits are in full force and effect, and the Business is currently being operated in compliance with the terms of all such Permits. 7.11. Foreign Corrupt Practices Act of 1977. None of the Companies and none of the Majority Shareholders on behalf of any Company has made any offer, payment, promise to pay or authorization for the payment of money or an offer, gift, promise to give, or authorization for the giving of anything of value to any person in violation of the Foreign Corrupt Practices Act of 1977. 7.12. Corporate Records. The Books and Records are true and complete in all material respects and fairly record and reflect all transactions material to the operations of the Companies. 7.13. Litigation. Except as set forth on Schedule 7.13, no litigation, arbitration, investigation or other proceeding of or before any court, arbitrator or governmental or regulatory official, body or authority is pending or, to the knowledge of the Management Shareholders, threatened against any Company or the transactions contemplated by this Agreement, and none of the Management Shareholders knows of any basis for any such litigation, arbitration, investigation or proceeding. No Company is a party to or subject to the provisions of any judgment, order, writ, injunction, decree or award of any court, arbitrator or governmental or regulatory official, body or authority. 7.14. Conduct of Business. Between December 31, 1995 and the date hereof, the Business has been conducted only in the ordinary course and in a manner consistent with past practices. 7.15. Absence of Changes. Between December 31, 1995 and the date hereof there has not been: -39- 48 (a) Any Material Adverse Effect, except changes in the ordinary course of business, none of which has resulted or could be reasonably expected to result in a Material Adverse Effect; (b) Any event or condition of any nature whatsoever which individually or in the aggregate has resulted in or could be reasonably expected to result in a Material Adverse Effect; (c) Any Material Adverse Effect which has resulted from or has been threatened in any way as a result of fire, explosion, earthquake, disaster, accident, labor dispute, any action by any governmental authority, flood, drought, embargo, riot, civil disturbance, uprising, activity of armed forces or act of God or public enemy, whether or not covered by insurance. (d) Any claims not covered by applicable policies of liability insurance within the maximum insurable limits of such policies; (f) Any transaction by any Company not in the ordinary course of business as conducted on that date; (g) Any amendment to the Articles or Certificate of Incorporation or By-laws of any Company; (h) The creation or attachment, or notice thereof, of any Lien on the assets of any Company; (i) Any sale or transfer of any of the Companies' assets not in the ordinary course of business (other than the sale of used cash registers and semi-annual discount sales); (j) Any incurrence of any debts, Liabilities or obligations except in the ordinary course, consistent with past practice, or any waiver of any rights of substantial value; (k) Any discharge or satisfaction of any Liens, or any payment of any Liens or Liabilities, except in the ordinary course of business, consistent with past practice; (l) Any increase in the salary or other compensation payable by any Company to any of its executive officers or directors or the declaration, payment, commitment or obligation of any kind for the payment by the Company of a bonus or other additional salary or compensation to any such person; (m) Any dividends or distributions of cash or property by any Company to any of the Shareholders, including, without limitation, any portion of the 1995 Pre-Tax Income; (n) Any sale, transfer or issuance of any capital stock, equity security or debt security of any Company or any -40- 49 option, warrant, right or commitment or agreement entered into requiring or permitting any such sale, transfer or issuance; or (o) Any agreement by any Company to do any act which would render any of the preceding clauses inaccurate, other than the transactions specifically contemplated to occur pursuant to this Agreement. 7.16. Contracts, Leases, Etc. Except as listed and described on Schedule 7.16 or any other Schedule attached hereto, none of the Companies is a party to any Contract of the type described below: (a) agreement or commitment with any present or former shareholder, director, or officer. (b) agreement, commitment or arrangement with any labor union or other representative of Employees; (c) written employment agreement or severance agreement with any Employee involving the payment of more than $10,000 individually during the term thereof. If the Companies are parties to such agreements involving the payment by the Companies of more than $50,000 in the aggregate during the term thereof, then all such Contracts shall be listed and described on Schedule 7.16 without regard to the amount required to be paid under any individual agreement; (d) agreement or commitment for the performance of services by a third party which involves in any one case Fifty Thousand Dollars ($50,000.00) and is not cancelable on thirty (30) days notice or less without penalty. Schedule 7.16 also contains a list of the 20 largest (in terms of dollar amount) outstanding purchase orders for Inventory as of April 5, 1996; (e) agreement or commitment to sell or supply products or to perform services which obligates any Company to sell products or perform services which involves in any one case Fifty Thousand Dollars ($50,000.00) which is not cancelable on thirty (30) days notice or less without penalty; (f) distribution agreement where any Company is acting as supplier or distributor or any agency agreement where any Company is acting as principal or agent; (g) any lease under which the Company is either lessor or lessee of personal property requiring annual lease payments (including rent and any other charges) in excess of $10,000, and any lease under which the Company is either lessor or lessee of Real Property, including any Lease (as defined herein), other than any Lease listed on Schedule 7.8(g); -41- 50 (h) note, debenture, mortgage, pledge, charge, security agreement, bond, conditional sale agreement, equipment trust agreement, letter of credit agreement, loan agreement or other contract or commitment for borrowing or lending of money (including, without limitation, loans to or from officers, directors, Shareholders or any member of their immediate families), agreement or arrangements for a line of credit or guarantee, pledge or undertaking of the indebtedness of any other person; (i) agreement, contract or commitment for any charitable or political contribution; (j) agreement, contract or commitment for any capital expenditure in excess of Twenty Five Thousand Dollars ($25,000.00); (k) agreement, contract or commitment limiting or restraining it from engaging or competing in any lines of business with any person; (l) license, franchise, distributorship or other similar agreement, including those which relate in whole or in part to any patent, trademark, trade name, service mark or copyright or to any ideas, technical assistance or other know-how of or used by it in the operation of its business; (m) agreement with any Governmental Entity; (n) power of attorney granted by any Company in favor of any person or entity, other than any power of attorney contained in any Lease listed on Schedule 7.8(g); (o) other agreement requiring payments or other consideration by or from any Company in excess of Twenty Five Thousand Dollars ($25,000.00) during the remainder of its term; or (p) other material agreement, contract or commitment not made in the ordinary course of business. Each of the Contracts is valid and enforceable in accordance with its terms; the Companies, and to the knowledge of the Management Shareholders, the other parties thereto, are in compliance with the provisions thereof; none of the Companies, and to the knowledge of the Management Shareholders, none of the other parties thereto, is in default in the performance, observance or fulfillment of any obligation, covenant or condition contained therein; and no event has occurred which with or without the giving of notice or lapse of time, or both, would constitute a default thereunder by any Company, or to the knowledge of the Management Shareholders, any other party. -42- 51 Except for the provisions of any Lease which specifically requires the payment of fees in connection with the assignment of the Lease (including a collateral assignment to secure indebtedness) or a change in control of the Company which is the lessee thereunder, none of the Contracts contains any provisions which would cause the Company which is a party thereto to be liable to the other party thereto for any amount (or any increased price for goods or services being provided by the other party thereto) as a result of the consummation of the transactions contemplated hereby. None of the Contracts (other than the Leases) contains any provisions which would cause the Company which is a party thereto to be liable to the other party thereto for any amount in the event that following the Closing, the Company terminates such Contract, so long as such termination does not constitute a breach of such Contract by the applicable Company. None of the terms or provisions of any of the Contracts (other than the Leases) includes a restriction on any Company's ability to compete and none of the terms or provisions of any of the Contracts adversely affects the Condition. Each lease of personal property to which the Company is a party, which provides for total rental payments during the lease term in excess of $25,000, is fully effective and affords the Company peaceful and undisturbed possession of the subject matter of the lease. The Companies and the Majority Shareholders agree to make all of the Contracts available to Holdings prior to the Closing upon the request of Holdings. 7.17. Warranties and Liabilities. Except pursuant to the Companies' standard merchandise return policy, none of the Companies has given or made any warranties to third parties with respect to any products sold or services performed by it, except for warranties arising by operation of law and warranties made in respect of products which are no broader in scope or longer in duration than the respective warranties on such products given to the Company by the manufacturers of such products. 7.18. Product Matters. The Companies and the Management Shareholders have delivered to Holdings a loss run, statistical run and a narrative of incidents, events and claims under all product warranty plans and product liability insurance policies relating to the Companies, certified to be correct by the Management Shareholders or, in the case of insurance policies, the Companies' insurance brokers. Such loss run and narrative is true and correct in all material respects. The Companies are insured under all policies of insurance relating to product liability and listed on Schedule 7.19 for and against any claim for product liability based on any event occurring prior to the Closing Date, and such insurance coverage will continue in effect after the Closing Date unless terminated in accordance with its terms by the Companies. -43- 52 7.19. Insurance. Schedule 7.19 sets forth a list of all policies or binders of fire, liability, product liability, worker's compensation, vehicular or other insurance held by or on behalf of the Companies (specifying for each such insurance policy, except the policies for worker's compensation and vehicular insurance, the insurer, the policy number or covering note number with respect to binders, and each pending claim thereunder of more than $5,000 and setting forth the aggregate amounts paid out under each such policy through the date hereof). Such policies and binders are valid, in full force and effect and sufficient to protect the Companies and their assets against all insured hazards, subject to the deductibles provided in such policies. None of the Companies is in default with respect to any provision contained in any such policy or binder and none of the Companies has failed to give any notice or present any claim of which it has notice under any such policy or binder in a timely fashion. None of the Companies has received or given a notice of cancellation or non-renewal with respect to any such policy or binder. None of the Management Shareholders has any knowledge of any material inaccuracy in any application for such policies or binders, any failure to pay premiums when due or any similar state of facts which might form the basis for termination of any such insurance. None of the Management Shareholders has any knowledge of any state of facts or the occurrence of any event that is reasonably likely to form the basis for any claim against any Company which is not fully covered by the policies referred to on Schedule 7.19. None of the Companies has received written notice from any of its insurance carriers that any insurance premiums will be materially increased in the future or that any insurance coverage listed on Schedule 7.19 will not be available in the future on substantially the same terms as now in effect. 7.20. Licensing Arrangements, Joint Ventures, Etc. Schedule 7.20 attached hereto contains a list of all licensing arrangements, joint ventures and royalty and franchise agreements which any Company has entered into and by which it is bound or will be bound as of the Closing. 7.21. Transactions with Affiliates. Neither any director, officer or shareholder of any Company, nor Betsy Weiss, James Harris, Connie Scoggins, Chris LaFont or Toni Warren, nor any Affiliate of any of the foregoing has during the past two years: (a) received or earned, or (b) had an ownership interest (whether direct or indirect) in any business, corporate or otherwise, which has or had any business arrangement or relationship of any kind under which it has received or earned, payments from any Company in excess of $5,000 in any year (other than salaries, wages and bonuses), except as described in Schedule 7.21 attached hereto. There are no contracts or obligations between any Company and any director, officer, Shareholder or employee of any Company or any Affiliate of any -44- 53 such person except for those identified on Schedule 7.21 or another Schedule hereto, a complete copy of each of which (including all amendments) has been delivered to Holdings. Except as set forth on Schedule 7.21, none of the Companies is indebted to any Shareholder or the Affiliates of any Shareholder (the "Shareholder Loans"), and Schedule 7.21 contains a complete list of all amounts owed to any Company by any Shareholder or by the Affiliates of any Shareholder (the "Shareholder Receivables"). 7.22. Compensation to Employees, etc. (a) Schedule 7.22 lists each of the Employees currently employed by the Companies whose annualized aggregate compensation as salary, wages and bonuses during 1995 exceeded $50,000 ("Highly Paid Employees"), and indicating the amount of the 1995 salary, wages and bonuses for each such Employee. In addition, Schedule 7.22 lists (i) the base salary, as currently in effect, for each of the Highly Paid Employees, (ii) the bonus arrangements, if any, currently in effect for each of the Highly Paid Employees, (iii) the commission arrangements, if any, currently in effect for each of the Highly Paid Employees and (iv) the date on which the most recent salary increase went into effect for each of the Highly Paid Employees and the amount of each such increase. There are no agreements, contracts or collective bargaining agreements covering or applicable to any officer, director, or employee of any Company, except as set forth on Schedule 7.21 or Schedule 7.22. Except as disclosed on Schedule 7.21 or Schedule 7.22, the Company has not agreed to increase the compensation level of any of its officers, directors, Employees or independent contracts or has any understanding respecting such an increase. (b) The Company does not have and for the past three fiscal years has not had (i) any unfair labor practice charge or complaint or other proceeding pending or, to the best knowledge of the Management Shareholders, threatened against any Company before the National Labor Relations Board, and there is no labor strike pending or, to the best knowledge of the Management Shareholders, threatened against or involving any Company, (ii) any labor strike, slowdown or stoppage pending or, to the best knowledge of the Management Shareholders, threatened against or affecting any Company, (iii) any pending collective bargaining negotiations relating to the employees of any Company, (iv) pending petitions for recognition of a labor union or association as the exclusive bargaining agent for any or all of the Employees, and, to the best knowledge of the Management Shareholders, there has not been any general solicitation of representation cards by any union seeking to represent any or all of the Employees as their exclusive bargaining agent, (v) any collective bargaining agreements or (vi) any arbitrations, grievances, suits or administrative proceedings before any -45- 54 Governmental Entity relating to labor or employment matters involving any Employees. 7.23. Overtime, Back Wages, Vacation, Discrimination, and Occupational Safety Claims. Except as set forth in Schedule 7.23, there is no Litigation against any Company (whether under federal or state law, under any employment agreement, or otherwise) asserted by any Employee on account of or for, and to the knowledge of the Management Shareholders, there are no outstanding claims against any Company (whether under federal or state law, under any employment agreement, or otherwise) asserted by any Employee on account of or for, (i) overtime pay, other than overtime pay for work done during the current payroll period; (ii) wages or salary for any period other than the current payroll period; (iii) any amount of vacation pay or pay in lieu of vacation time, other than vacation time or pay in lieu thereof earned in or in respect of the current fiscal year; or (iv) any violation of any statute, ordinance or regulation relating to minimum wages or maximum hours of work, and there are no such claims which have not been asserted. Except as set forth on Schedule 7.23, no person or party (including any governmental agency of any kind) has commenced any Litigation against any Company or, to the best knowledge of the Management Shareholders, threatened to assert any claims against or has any basis for or contemplates any action or proceeding against any Company, under or arising out of, any statute, ordinance or regulation relating to discrimination or occupational safety in employment or employment practices (including, without limitation, the Occupational Safety and Health Act of 1970, as amended, The Fair Labor Standards Act, as amended, Title VII of the Civil Rights Act of 1964, as amended, or the Age Discrimination in Employment Act of 1967, as amended). Except as set forth on Schedule 7.23, the aggregate potential Liability of the Companies under any and all claims against the Companies of the type described in the preceding two sentences which are not the subject of pending Litigation will not exceed $50,000. 7.24. Benefit Matters. (a) Benefit Plans Generally. Schedule 7.24 attached hereto contains a true and complete list of all Benefit Plans, maintained currently or at any time in the past six years by any Company or any ERISA Affiliate or with respect to which contributions are made or have been made at any time in the past six years by any Company or any ERISA Affiliate (including health, life insurance and other benefit plans maintained for retirees), whether or not such plans are "employee benefit plans" within the meaning of Section 3(3) of ERISA, and whether or not such plans, programs and arrangements are in the nature of formal or informal understandings, and whether or not pursuant to any collective bargaining arrangements, but excluding normal payroll practices including, without limitation, the continuation of -46- 55 regular wage payments on account of vacation, holiday, short illness, jury duty or other like absence. (b) Multiemployer Plans Generally. None of the Companies and none of the ERISA Affiliates is or has ever been a party to any pension plan or welfare benefit plan that is a "multiemployer plan" (within the meaning of Section 3(37) of ERISA), a "multiple employer plan" (within the meaning of section 413 of the Code) or a "multiple employer welfare arrangement" (within the meaning of Section 3(40) of ERISA). (c) Pension Plans. None of the Companies and none of the ERISA Affiliates maintains, has ever maintained, or has had any obligation under a plan subject to Title IV of ERISA. (d) Welfare Plans. No Benefit Plan maintained by the Companies or its ERISA Affiliates which is a "welfare plan" within the meaning of Section 3(1) of ERISA has any reserves, assets, surplus, or prepaid premiums. (e) Qualified Plans. With respect to each of the Benefit Plans intended to qualify under Section 401(a) or 403(a) of the Code, the plan has been maintained and administered at all times in material compliance with its terms and applicable laws and regulations and has been so qualified during the period from its adoption to date and the trust forming a part thereof is exempt from taxation pursuant to Section 501(a) of the Code. (f) Collective Bargaining. None of the Companies and none of the ERISA Affiliates is or ever has been a party to any collective bargaining agreement. (g) Compliance. Each Benefit Plan complies in all material respects and has been administered in all material respects in accordance with all applicable laws and regulations including, without limitation, ERISA and the Code. All applicable reporting, disclosure, fiduciary and tax qualification requirements under ERISA and the Code have been fully and timely satisfied. The Companies and the ERISA Affiliates have filed or caused to be filed with the Internal Revenue Service annual reports on form 5500 or 5500C/R, as applicable, for each Benefit Plan for all years and periods for which such reports were required. All statements and disclosures made on documents or forms filed or distributed pursuant to the applicable reporting and disclosure requirements under ERISA and the Code have been true and complete in all material respects and have been filed or distributed timely. No Benefit Plan has been assessed any excise tax liability. To the best knowledge of the Companies and the Management Shareholders, no event has occurred that would likely result in any Benefit Plan incurring such excise tax liability. -47- 56 (h) Contributions. Each of the Companies and ERISA Affiliates, as applicable, has made all payments and contributions to all Benefit Plans on a timely basis as required by the terms of each such plan and any applicable law. All such payments and contributions have been deducted fully by the applicable Companies or ERISA Affiliates for federal income tax purposes. Such deductions have not been challenged or disallowed by any government entity and none of the Companies has any reason to believe that such deductions are not properly allowable. The Companies and ERISA Affiliates have funded or will fund prior to Closing each Benefit Plan in accordance with the terms of each such plan and, with respect to the current plan year for benefits accrued through the Closing Date, including the payment of applicable premiums on any insurance contract funding a Benefit Plan for coverage provided through the date hereof. No Benefit Plan is subject to Section 302 of ERISA or Section 412 of the Code. (i) Prohibited Transactions. To the best knowledge of the Companies and the Management Shareholders: (1) no "prohibited transaction," as defined in Section 406 of ERISA or Section 4975 of the Code, has occurred with respect to any Benefit Plan, for which no statutory, class or other exemption exists and Schedule 7.24 sets forth a complete and accurate list of each such prohibited transaction for which a statutory, class or other exemption applies; (2) no civil or criminal action brought pursuant to part 5 of Title I of ERISA is pending or is threatened in writing or orally against any fiduciary who is an employee or director of any Company; (3) no civil or criminal action brought pursuant to part 5 of Title I of ERISA is pending or is threatened in writing or orally against any fiduciary who is not an employee or director of the Company; and (4) no fiduciary violations, as defined in Section 404 of ERISA, have occurred with respect to which any Company or any ERISA Affiliate could have any present or future liability or obligation. Each Benefit Plan is, and has been, operated and administered substantially in accordance with the appropriate written plan documents or other applicable provisions of the Code. (j) Documentation. The Companies and the Management Shareholders have provided to Holdings correct and complete copies of the following documents: (i) all plan documents, amendments and trust agreements relating to each Benefit Plan including, without limitation, any insurance contracts under which benefits are provided, as currently in effect; (ii) the most recent annual and periodic accountings of plan assets; (iii) the most recent Internal Revenue Service notification letter relating to the pension benefit plans and a list identifying all amendments not covered by such notification letter, regarding such plan, including the date such amendments were adopted and effective; (iv) to the extent such reports were required, all annual reports filed on form 5500 or 5500C/R, as applicable, for -48- 57 the past three years, including accompanying schedules; (v) the current summary plan description, if any was required by ERISA to be prepared and distributed to participants, for each Benefit Plan, as well as other Benefit Plan related employee communications, such as pamphlets, booklets and brochures; and (vi) all insurance contracts, annuity contracts, investment advisory agreements, fidelity bonds and fiduciary liability policies and related applications, and all filings, applications to and correspondence with any Governmental Entity, written disputed claims made by or against any Benefit Plan, administration contracts, investment management agreements, service provider agreements, audit reports, written legal advice relating to any Benefit Plan, prohibited transaction exemptions, and resolutions of the Board of Directors of the Companies relating to any of the foregoing. (k) Continuation Coverage. Each Benefit Plan that is a "group health plan" (within the meaning of Section 607 of ERISA) is and has been operated in compliance with all requirements of Sections 601 through 608 of ERISA and either (i) Section 162(i)(2) and (k) of the Code and the regulations promulgated thereunder (prior to 1989) or (ii) Section 4980B of the Code and the regulations promulgated thereunder (after 1988), as well as all comparable requirements arising under the laws of any state, relating to the continuation of coverage under certain circumstances in which coverage would otherwise cease. Schedule 7.24 attached hereto is a true and complete list of all former Employees of the Companies and their ERISA Affiliates and the beneficiaries of such Employees who, as of the Closing Date, are receiving or who are eligible to elect to receive benefits pursuant to such plans, the provisions of ERISA and the Code, or any state law. (l) Post-Retirement Benefits. No Benefit Plan maintained by the Companies or any ERISA Affiliate provides post-retirement medical benefits, post-retirement death benefits or other post-retirement welfare benefits or has any obligation under any plan that provides such benefits, except to the extent of the continuation coverage rules as provided under the provisions of Section 4980B of the Code and Sections 601 through 608 of ERISA and the provision of certain post-retirement life insurance benefits. (m) Communications. To the best knowledge of the Companies and the Management Shareholders, all communications with respect to each Benefit Plan by any Person having the requisite authority to make such communications reflect and always have reflected accurately the material terms and conditions of each such Benefit Plan, and there have been no written statements or communications, no oral statements or communications made to any Employee of any Company or any ERISA Affiliate in any form by any Person (including, without -49- 58 limitation, any officer, director or other Employee having the requisite authority to do so of any Company or ERISA Affiliate) which provide for or could be construed as a contract or promise by any Company or ERISA Affiliate to provide for any pension, welfare or other insurance type benefits to any such Employee, whether before or after retirement. (n) Additional Payments. None of the Companies and none of the ERISA Affiliates is a party to any Contract, that has resulted or would result from the consummation of the transactions contemplated herein or otherwise, separately or in the aggregate, in: (i) the entitlement of any individual to severance pay, or (ii) the acceleration of the time of payment or vesting of, or an increase in the amount of compensation due to any individual from the Companies or any ERISA Affiliate, or (iii) the payment of an amount subject to the provisions of Code Section 280G. (o) Litigation. There is not and there has not been any pending or, to the best knowledge of the Management Shareholders, threatened, litigation or arbitration concerning or involving any Benefit Plan. No complaints to or by any Governmental Entity have been filed or, to the best knowledge of the Management Shareholders, are threatened or are expected, with respect to any Benefit Plan. No claims have been made or, to the best knowledge of the Management Shareholders, are threatened or expected, with respect to any bond or any fiduciary liability or other similar insurance with regard to the actions of any Person in connection with any Benefit Plan, nor has there been nor, to the best knowledge of the Management Shareholders, is there expected to be any notice to any insurer under any such bond or policy with regard to any Benefit Plan. No application for any bond or fiduciary liability or similar insurance policy with respect to any Benefit Plan has been rejected, nor is any such bond or policy now subject to any qualification, condition or exclusion. 7.25. Hazardous Substances. (a) Compliance. Except as set forth on Schedule 7.25, each of the Companies (i) to the knowledge of the Management Shareholders, is now and has always been in compliance with all Environmental Laws (as hereinafter defined) which compliance includes, but is not limited to, the possession by the Companies of all Permits and other governmental authorizations currently or previously required by the Companies under applicable Environmental Laws, and compliance with the terms and conditions thereof; and (ii) has received no written or oral notice from any Governmental Entity, citizens group, Employee or other Person relating to the Companies' compliance with any Environmental Laws, and is in full compliance with the terms or conditions of all Permits and governmental authorizations. All Permits and -50- 59 other governmental authorizations currently held by any Company which relate to the Environmental Laws are identified on Schedule 7.25 attached hereto. (b) Discharges, Etc. To the knowledge of the Management Shareholders, there are no past or present actions, activities, circumstances, conditions, events or incidents, including, without limitation, the release, emission, discharge or disposal of any Materials of Environmental Concern (as hereinafter defined), that form or could reasonably be expected to form the basis of any Environmental Claim against any Company or against any Person or entity whose liability for any Environmental Claim any Company has or may have retained or assumed either contractually or by operation of law. To the best knowledge of the Management Shareholders, no impact on the operations of any Company, and no restrictions on an expansion of the operations of any Company, could result due to the presence of any environmentally sensitive area. (c) Disposal; Conditions. All on-site and off-site locations where any Company has stored, disposed or arranged for the disposal of Materials of Environmental Concern are identified on Schedule 7.25 attached hereto. There are no pending, or to the best knowledge of the Management Shareholders threatened, claims against any Company arising in respect of any Real Property now or formerly owned, leased or used by any Company. Except as set forth on Schedule 7.25 attached hereto, to the knowledge of the Management Shareholders, at no time have there been above-ground or underground storage tanks located on or in any Real Property now or formerly owned, leased or used by any Company and there is no asbestos or urea formaldehyde foam insulation contained in or forming part of any building, building component, structure or office space located on or in any Real Property now or formerly owned, leased or used by any Company. To the knowledge of the Management Shareholders, no polychlorinated byphenyls (PCBs) are present, in use or stored at any Real Property now or formerly owned, leased or used by any Company. (d) Spillage, Etc. To the knowledge of the Management Shareholders, there have been no spills, discharges, leaks, emissions, injections, escapes, dumpings or releases of any kind whatsoever of any Materials of Environmental Concern in or on the Real Property now or formerly owned, leased or used by any Company. No Company has discharged, leaked, emitted, injected, allowed escape, dumped or released any Materials of Environmental Concern on any Leased Real Property, Owned Real Property or on any other Real Property. Each Company has complied in all material respects with all notice requirements of the Environmental Laws regarding any storage, use, spills, underground storage tanks, discharges, leaks, emissions, injections, escapes, dumpings or releases of any kind whatsoever -51- 60 of any Materials of Environmental Concern in or on all Real Property now or formerly owned or leased by any Company. 7.26. Solvency. Prior to the consummation of the transactions contemplated hereby, each Company is solvent, has assets having a fair value in excess of the amount required to pay its probable liabilities on its existing debts as they become absolute and mature, and has the ability to pay its debts from time to time incurred in connection therewith as such debts mature. 7.27. Title to Redeemed Shares. (a) Each Management Shareholder has good and valid title to his Majority Redeemed Shares, free and clear of all Liens (except for any Liens disclosed on Schedule 7.27, each of which Liens will be discharged at the Closing upon payment of the Pre-Closing Debt pursuant to Article 2 hereof). Upon delivery of such Majority Redeemed Shares to the Companies and payment therefor pursuant hereto, good and valid title to such Majority Redeemed Shares, free and clear of all Liens will pass to the Companies. (b) Robert Kirkland represents and warrants (and the Management Shareholders do not represent and warrant) that he has good and valid title to his Majority Redeemed Shares, free and clear of all Liens (except for any Liens disclosed on Schedule 7.27, each of which Liens will be discharged at the Closing upon payment of the Pre-Closing Debt pursuant to Article 2 hereof). Upon delivery of such Majority Redeemed Shares to the Companies and payment therefor pursuant hereto, good and valid title to such Majority Redeemed Shares, free and clear of all Liens will pass to the Companies. 7.28. Brokerage and Expenses. The Companies shall be responsible for the payment of all fees and expenses incurred or to be incurred by the Companies, Holdings or by the Shareholders in connection with the negotiation, preparation, execution, delivery and performance of this Agreement and the Collateral Documents and the consummation of the transactions contemplated hereby and thereby. The fees and expenses of The Robinson-Humphrey Company, Inc. and J.C. Bradford & Co. pursuant to an engagement letter dated February 23, 1995, and the fees and expenses of the accountants, attorneys and other experts employed by the Companies in connection with the negotiation, preparation and execution of this Agreement and the Collateral Documents and in regard to the Closing documents that are not paid by the Companies prior to the Closing Date but are accrued as a current liability under the Audited Closing Date Financial Statements shall be deducted from the Closing Date Adjusted Working Capital. -52- 61 All other fees and expenses of the transaction that are paid by the Companies prior to the Closing Date or are accrued as a current liability under the Audited Closing Date Financial Statements, including without limitation the costs incurred in connection with acquiring any Required Consents, the fees and expenses of Kirkland's Accountants incurred in connection with the audit of the Closing Date Financial Statements pursuant to Section 4.2(a), the preparation of any Returns for the portion of any Straddle Period ending on and including the day preceding the Closing Date, and the fees and expenses of Baker, Donelson, Bearman & Caldwell (up to a maximum of $20,000) incurred in connection with the charter amendments required by this Agreement and the issuance of the shares of capital stock in the Preliminary Recapitalization and the Recapitalization and the state and local filing fees and charges in regard to the transaction shall be added to the Closing Date Adjusted Working Capital. Other than the fees payable to The Robinson-Humphrey Company, Inc. and J.C. Bradford & Co. described in the preceding sentence, none of the Companies and none of the Majority Shareholders nor anyone on their behalf has made any agreement or taken any action which may cause anyone claiming through any Company or any of the Majority Shareholders to become entitled to a commission as a result of the transactions contemplated pursuant to this Agreement. 7.29. Statements and Other Documents Not Misleading. (a) Neither this Agreement, including all Schedules, nor any other financial statement, document or other instrument heretofore or hereafter furnished by any of the Management Shareholders or the Companies to Holdings in connection with the transactions contemplated hereby contains or will contain any untrue statement of any material fact or omits or will omit to state any material fact required to be stated in order to make such statement, document or other instrument not misleading. There is no fact known to any Company or any of the Management Shareholders which may materially adversely affect the Condition which has not been set forth in this Agreement, the Schedules or the other documents furnished to Holdings on or prior to the date hereof in connection with the transactions contemplated hereby. Except as may be specifically included in the representations and warranties contained in Article 7 (other than this Section 7.29), or Article 8 of this Agreement, the parties understand and agree that the Majority Shareholders are not making any representation or warranty concerning any projection or other forward looking statement (as defined in Section 27A of the Securities Act of 1933, as amended), concerning the Companies' results of operation, cash flow or financial condition, and Holdings acknowledges that it is not relying upon any such projection or forward looking statement, -53- 62 including but not limited to the Confidential Memorandum of the Robinson-Humphrey Company, Inc. dated June 1995. (b) Robert Kirkland represents and warrants (and the Management Shareholders do not represent and warrant) that no financial statement, document or other instrument heretofore or hereafter furnished by Robert Kirkland to Holdings in connection with the transactions contemplated hereby contains or will contain any untrue statement of any material fact or omits or will omit to state any material fact required to be stated in order to make such statement, document or other instrument not misleading. ARTICLE 8 TAX RELATED MATTERS. 8.1. Representations and Warranties. Each of the Management Shareholders hereby jointly and severally makes the following representations and warranties to Holdings, each of which shall survive the Closing and expire only in accordance with Article 14 hereof: (a) S Election. Each Company duly and properly filed an election to be taxed as an S corporation for federal and, except as set forth on Schedule 8.1(a), state income tax purposes and each such election is currently in effect, under Section 1362 of the Code and the rules and regulations promulgated thereunder and the corresponding provisions of state income tax laws. Each Company which is an S corporation for federal or state income tax purposes will continue to be an S corporation for such purposes until the close of business on the day immediately prior to the Closing Date. (b) Corporate Returns. Except as set forth on Schedule 8.1(b), each Company has duly and timely filed all Returns required to be filed on or before the Closing Date (taking into account any extensions) with any Governmental Entity, and all Taxes due and payable by each Company have been paid, withheld or reserved for or, to the extent they relate to periods ending on or prior to December 31, 1995, are reflected as a liability on the 1995 Balance Sheet and will be reflected as a liability on the Unaudited Closing Date Balance Sheet. (c) Audit Information. Except as set forth on Schedule 8.1(c): (i) since the incorporation of each Company and within the six (6) full fiscal years prior to the Closing Date, none of the Returns has ever been audited and none of the Companies has entered into any agreements for an extension of time for the assessment of any Tax or Tax delinquency, nor has it waived or requested a waiver of any statute of limitations with -54- 63 respect to any Tax or Tax delinquency; (ii) since the incorporation of each Company, none of the Companies has received any outstanding and unresolved notices from the Internal Revenue Service or other Governmental Entity of any proposed examination or of any proposed change in reported information which may result either in a deficiency or assessment against any Company or in a change in the calculation of amounts distributed by a Company to its shareholders in respect of tax liabilities attributable to the pass through of Company income to shareholders; (iii) there is no Litigation now pending against any Company in respect of any Taxes; and (iv) none of the Companies and none of their respective authorized representatives acting on their behalf, has executed any extensions or waivers of the statute of limitations that are currently in effect with respect to any Taxes. 8.2. Majority Shareholders' Indemnifications. (a) Subject to paragraphs (b) and (c) below, the Majority Shareholders jointly and severally agree to indemnify the Companies and their successors and hold them harmless from any and all Taxes and related Losses suffered or incurred, resulting from, related to or arising out of an adjustment or change, including any increase in items of income or decrease in items of loss, deduction or credit of the Companies, but only to the extent such change or adjustment consists of (i) an increase in an item of a Company's, or its successor's, income or gain in any C Year and a corresponding decrease in an item of income or gain reported to the Minority Shareholders and Majority Shareholders with respect to an S Year; or (ii) a decrease in an item of loss, deduction or credit reported by a Company or its successors in any C Year and a corresponding increase in an item of loss, deduction or credit with respect to an S Year. Any payment with respect to a Loss for Taxes hereunder shall be paid in cash by the Majority Shareholders no later than 10 days prior to the date that any payment would be required to be made by the Company or their successors with respect to such Taxes. (b) In no event shall the Management Shareholders be required to indemnify the Companies for Taxes and related Losses pursuant to paragraph (a) above in excess of 62.2775% of such Taxes and related Losses. Nothing in this paragraph (b) shall be construed to limit the right of any Management Shareholder to seek contribution from any other Management Shareholder in respect of any such Taxes and related Losses. (c) In no event shall Robert Kirkland be required to indemnify the Companies for Taxes and related Losses pursuant to paragraph (a) above in excess of 37.7225% of such Taxes and related Losses. -55- 64 8.3. The Companies' Indemnifications. Each of the Companies agrees to indemnify the Majority Shareholders and the Minority Shareholders and hold each harmless from any and all Taxes and related Losses suffered or incurred by any Majority Shareholder or Minority Shareholder, resulting from, related to or arising out of an adjustment or change, including any increase in items of income or gain or any decrease in items of loss, deduction or credit, reported to such Shareholders by the Company with respect to an S Year, but only to the extent that such adjustment or change consists of (i) an increase in an item of the Company's income or gain with respect to an S Year and a corresponding decrease in an item of income or gain with respect to a C Year; or (ii) a decrease in an item of loss, deduction or credit of the Company with respect to an S Year and a corresponding increase in an item of loss, deduction or credit with respect to a C Year. Any payment with respect to a Loss for Taxes shall be paid to such Shareholder in cash by the Company no later than ten (10) days prior to the date that any payment would be required to be made by the Shareholder with respect to such Taxes. 8.4. Indemnity Priority. The indemnity provisions of Sections 8.2 and 8.3 shall have priority over the indemnity provisions of Article 13 hereof, and to the extent applicable, indemnification under Sections 8.2 and 8.3 shall be in lieu of indemnification for the same matter under any other Section of this Agreement. 8.5. Restoration of S Status. In the event that the S corporation status of any Company is terminated for any reason other than the Closing hereunder and such termination is applicable to any taxable period or portion thereof ending on or prior to the Closing Date, each of the Majority Shareholders shall take and shall cause the affected Company to take, such steps as are reasonably necessary to request relief from such termination pursuant to Section 1362(f) of the Code and the regulations thereunder. In any audit proceeding, the Majority Shareholders shall not take any position inconsistent with the S corporation status of the Companies which are taxed for federal or state income tax purposes as S corporations. 8.6. Filing of Returns. The Companies shall prepare and timely file with the appropriate authorities, pay all taxes shown due on, and bear all expenses relating to, all Returns required to be filed for taxable periods ending on, prior to or after the Closing Date. All Returns shall be prepared and filed in a manner consistent with prior Returns. All Returns (other than Returns for Straddle Periods) shall be filed on the basis that the relevant taxable period ended as of the close of business on the day prior to the Closing Date, unless the relevant Governmental Entity will not accept a Return filed on that basis. To the extent any Governmental Entity requires the -56- 65 consent of any Majority Shareholders to filing on such basis, the Majority Shareholders shall provide such consent. 8.7. Future Tax Contests. (a) Audits. Any Majority Shareholder receiving either notice of an intention by a Governmental Entity to audit, or any request for information with respect to, any Return of any Company or of any Majority Shareholder which includes any item of income, gain, deduction, loss or credit reported by any of the Companies, with respect to any taxable period beginning on or prior to the Closing Date shall inform Holdings and the Companies, in writing, of the intended audit or information request within 15 days after receipt of such notice and shall, at Holdings' request, keep Holdings informed concerning and consult with Holdings on all aspects of the audit or request. Any Company receiving notice of any intention by a Governmental Entity to conduct such an audit or any such request for information shall inform the Majority Shareholders and Holdings, in writing, of the intended audit or information request within 15 days after receipt of such notice, and unless the Majority Shareholders shall take control of the audit or request pursuant to Section 8.8, shall keep the Majority Shareholders informed concerning and consult with the Majority Shareholders on all aspects of the audit or request. (b) Adjustments. Any Majority Shareholder receiving notice of any Proposed Adjustment must give notice to Holdings, and any Company receiving notice or any Proposed Adjustment must give notice to the Majority Shareholders, of the Proposed Adjustment within 15 days after receipt of a notice of Proposed Adjustment. (c) Procedures. Holdings or the applicable Company may, upon giving written notice to the Notified Shareholder(s), request that the Notified Shareholder(s) contest such audit or Proposed Adjustment. If Holdings or the applicable Company shall request that the audit or Proposed Adjustment be contested, then the Notified Shareholder shall, at the Companies' expense, (insofar as such contest relates to matters which could give rise to a claim by the Notified Shareholder under Section 8.3), contest (or engage representatives to contest) the audit or Proposed Adjustment and allow Holdings, the Companies and their respective representatives, at their expense, to participate therein or shall permit Holdings, the Companies and their respective representatives, at their expense, to contest the Proposed Adjustment (including pursuing all administrative and judicial appeals and processes). The Majority Shareholders shall not make, accept or enter into a settlement or other compromise with respect to any Tax Claims that are the subject of indemnification under Section 8.3 of this Agreement, or forego or terminate any proceeding relating to a Proposed Adjustment -57- 66 without the consent of Holdings, which consent shall not be unreasonably withheld or delayed. 8.8. Conduct of Proceedings. (a) With respect to any Tax Claim that might result in an indemnity payment to the Companies pursuant to Section 13.1 or Section 8.2 hereof or in a direct tax liability to any Majority Shareholder, the Majority Shareholders shall have the right to control and shall bear the costs of all Litigation with a Governmental Entity in connection with such Tax Claim, including selection of counsel, provided that the Majority Shareholders shall keep Holdings informed concerning all aspects of such Litigation and shall permit Holdings and the Company which is the subject of the Litigation to participate therein with counsel and other professionals of their choice. The Majority Shareholders shall make all decisions concerning the settlement or contest of the Litigation which is within their control pursuant to this Section 8.8(a) and Holdings or the Company may object to any such decision provided that such objection is reasonable. In no case shall the Majority Shareholders make, accept or enter into a settlement or other compromise with respect to Tax Claims that are the subject of indemnification under this Agreement, or forego or terminate any proceeding relating to any such Tax Claim without the prior written consent of Holdings, which consent shall not be unreasonably withheld or delayed. Notwithstanding the foregoing, at any time, Holdings and the Company which is the subject of the Litigation may, at their option, take control over any such Litigation if (i) the Majority Shareholders are not using reasonable efforts in pursuing such Litigation, or (ii) any Majority Shareholder is in breach of the covenants undertaken in Section 8.5. (b) With respect to any Tax Claim that might result in an indemnity payment to the Majority or Minority Shareholders pursuant to Section 8.3, the Companies shall have the right to control and shall bear the costs of all Litigation with a Governmental Entity in connection with such Tax Claim (including selection of counsel) provided that the Companies shall keep the Majority or Minority Shareholders, as the case may be, informed concerning all aspects of such Litigation and shall permit the Majority or Minority Shareholders, as the case may be, at their election, with counsel and other professionals of their choice to participate therein. The Companies shall make all decisions concerning the settlement or contest of the Litigation which is within its control pursuant to this Section 8.8(b) and the Majority Shareholders may object to any such decision provided that such objection is reasonable. In no case shall the Companies make, accept or enter into a settlement or other compromise with respect to Tax Claims that are the subject of indemnification under the this Agreement, or forego or terminate -58- 67 any proceeding relating to any such Tax Claim, without the prior written consent of the Majority Shareholders, which consent shall not be unreasonably withheld or delayed. Notwithstanding the foregoing, at any time, the Majority Shareholders may, at their option, take control over any such Litigation if the Companies are not using reasonable efforts in pursuing such Litigation. 8.9. Cooperation and Record Retention. The Companies will retain all relevant Returns, schedules and workpapers, and all related material records or other documents, and the Majority Shareholders will retain all relevant personal Returns until the expiration of the statute of limitations (including extensions) of the taxable years to which such Returns and other documents relate, but in any event for a period of not less than seven years. The Majority Shareholders and Holdings shall each provide the other, and each shall cause the Companies to provide, such assistance as may reasonably be requested by any of them in connection with the preparation of any Return, or any audit or other examination by any Governmental Entity or judicial or administrative proceeding relating to liability for Taxes. The Companies will make available to the Majority Shareholders and Holdings all records and access to employees reasonably requested by them in connection with Taxes. ARTICLE 9 REPRESENTATIONS AND WARRANTIES OF HOLDINGS. Holdings hereby makes the following representations and warranties to each of the Majority Shareholders, each of which shall survive the Closing and expire only in accordance with Article 14 hereof: 9.1. Organization and Good Standing. Holdings is a limited liability company duly organized, validly existing, and in good standing under the laws of the State of Delaware. 9.2. Legal Power and Authority. Holdings has the requisite legal power and authority to enter into this Agreement and the Collateral Documents to which it is a party, and to perform all of Holdings' covenants and undertakings set forth herein and therein, including, without limitation, the full legal power and authority to purchase and take title to the Purchased Shares upon the terms and conditions set forth herein. The execution and delivery of this Agreement and the Collateral Documents and the consummation of the transactions contemplated hereby and thereby have been duly authorized by all necessary action on the part of Holdings and its members, and this Agreement and the Collateral Documents to which it is a party will constitute valid and binding obligations of Holdings, to the extent it is a party thereto, enforceable in accordance with -59- 68 their terms, except as such enforcement may be limited by applicable bankruptcy, insolvency, moratorium or similar laws affecting the rights of creditors generally. 9.3. Conflict With Articles, Contracts or Regulations. The execution and delivery of this Agreement, the Collateral Documents to which Holdings is a party and the consummation of the transactions contemplated hereby and thereby in the manner herein or therein provided will not: (i) contravene any provision of the Articles of Organization or operating agreement of Holdings; (ii) violate, be in conflict with, constitute a Default under, cause the acceleration of any payments pursuant to, or otherwise impair the good standing, validity, and effectiveness of any lease, license, permit, authorization, or approval applicable to Holdings; or (iii) violate any provision of Law, rule, Regulation, order, or Permit applicable to Holdings or (iv) require that Holdings obtain any consent, approval, waiver, authorization, or Permit from, or make any filing or registration with, or provide notification to, any Governmental Entity. 9.4. Compliance with Securities Laws. Holdings acknowledges that the Purchased Shares have not been registered under the Securities Act of 1933 ("1933 Act") or any state securities laws. Holdings is acquiring the Purchased Shares for its own account and not with the intent to distribute the Purchased Shares to an unrelated third party. Holdings has such knowledge and experience in financial and business matters and investments in general that make it capable of evaluating the merits and risks of the ownership and acquisition of the Purchased Shares. Holdings and each of its members is an "accredited investor" within the meaning of Rule 501(a) under the 1933 Act. Holdings acknowledges and agrees that the certificates representing the Purchased Shares will contain the following legend: THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR ANY OTHER STATE OR FEDERAL SECURITIES STATUTE. NO REOFFER, SALE, TRANSFER, PLEDGE OR OTHER DISPOSITION THEREOF MAY BE MADE UNLESS THE SHARES ARE REGISTERED UNDER THE ACT AND ANY OTHER APPLICABLE SECURITIES STATUTE, OR AN EXEMPTION FROM SUCH REGISTRATION REQUIREMENTS IS APPLICABLE TO SUCH TRANSACTION. -60- 69 9.5. Brokerage and Expenses. The Companies shall be solely responsible for payment of all fees and expenses of counsel and accountants and other consultants and experts engaged by Holdings in connection with the negotiation, preparation, execution, delivery and performance of this Agreement and the Collateral Documents and the consummation of the transactions contemplated hereby and thereby. Neither Holdings nor anyone on its behalf has made any agreement or taken any action which may cause anyone claiming through Holdings to become entitled to a commission as a result of the transactions contemplated pursuant to this Agreement, except for the fees and expenses of The Robinson-Humphrey Company, Inc. pursuant to an engagement letter dated November 21, 1995 (relating to the procurement of the Bank Debt and the Mezzanine Debt), for which fees and expenses the Companies shall be solely responsible for payment. 9.6. Veracity of Statements. No representation, warranty or covenant by Holdings contained in this Agreement and no statement contained in any certificate, schedule or other document or instrument furnished to the Companies or the Majority Shareholders pursuant hereto or in connection with the transactions contemplated hereby, contains any untrue statement of a material fact or omits to state a material fact necessary to make it not misleading or necessary to provide the Companies and the Majority Shareholders with proper information as to Holdings. Except as may be specifically included in the representations and warranties contained in Article 9 of this Agreement (other than this Section 9.6), the parties understand and agree that Holdings is not making any representation or warranty concerning any projection or other forward looking statement (as defined in Section 27A of the Securities Act of 1933, as amended), concerning Holdings' or the Companies' results of operation, cash flow or financial condition, and the Majority Shareholders acknowledge that none of them is relying upon any such projection or forward looking statement. ARTICLE 10 ACTIVITIES OF THE COMPANIES PRIOR TO CLOSING DATE 10.1. Operation of Business. Each of the Companies and the Majority Shareholders hereby agrees that from and after the date hereof to the Closing Date, except as otherwise contemplated by this Agreement, the Companies shall conduct the Business solely in the ordinary course and the Companies shall: (a) Organizational Documents. Not amend their Articles or Certificates of Incorporation or By-laws except as required to consummate the Recapitalization; -61- 70 (b) Corporate Name. Not change their corporate names or permit the use thereof by any other Person; (c) Compensation. Not pay or agree to pay to any officer, director, employee or agent of any Company compensation that is in excess of the current compensation level of such employee, officer, or director except for increases in compensation which are both made in the ordinary course of business consistent with past practices and are described on Schedule 7.22 and except for the one-time bonuses which will (i) reduce the amount of Excess Working Capital, (ii) not commit the Companies to pay similar bonuses in the future, and (iii) be paid no later than the day preceding the Closing Date and which will be reflected in the Unaudited Closing Date Financial Statements; (d) Management. Not make any changes in the responsibility, authority and duties of (i) any Management Shareholder, or (ii) Betsy Weiss, James Harris, Connie Scoggins, Chris LaFont and Toni Warren, the corporate managers working in the Companies' Jackson, Tennessee offices. (e) Mergers, Acquisitions, Etc. Not merge or consolidate any Company with any other corporation or other entity or allow any Company to acquire or agree to acquire or be acquired by any corporation, association, partnership, joint venture, or other entity, other than the formation of the New Companies on Schedule 10.1(e); (f) New Companies. Provide to Holdings copies of the organizational Board minutes and the filed charter of each New Company incorporated from the date of this Agreement to the Closing Date, and cause each such New Company to execute and deliver to Holdings a joinder to this Agreement prior to the Closing. (g) Disposition of Assets. Not sell, transfer, or otherwise dispose of any assets, except in the ordinary course of business; (h) Indebtedness. Not create, incur, assume, or guarantee any indebtedness for money borrowed in excess of the Allowable Store Expenses, except in the ordinary course of business; create or suffer to exist any Lien on any of their assets, real or personal, except those in existence on the date hereof and Liens created in connection with the borrowing of funds to use for Allowable Store Expenses; or increase the amount of any indebtedness outstanding under any loan agreement, mortgage, or other borrowing arrangement in existence on the date hereof; (i) Payables. Pay when due, in accordance with past practices, all of their accounts payable and trade obligations; -62- 71 (j) Maintenance of Assets. Maintain their facilities, assets, and properties in good operating repair, order, and condition, reasonable wear and tear excepted, and notify Holdings immediately upon any loss of, damage to, or destruction of any of their assets, which in the aggregate are material, whether or not covered by insurance; (k) Insurance. Maintain in full force and effect insurance coverage of the types and in the amounts set forth in Schedule 7.19 attached hereto and apply the proceeds received under any insurance policy or as a result of any loss or destruction of or damage to any assets to the repair or replacement of such assets; (l) Contracts and Permits. Maintain in full force and effect all Contracts and Permits necessary for or related to the operation of the Business in all respects and in all places as such business is now conducted; (m) Goodwill. Use its best efforts to preserve the Companies' business organizations intact, to keep available the services of their present Employees and to preserve the goodwill of their customers and others having business relations with them; (n) Litigation, Etc. Promptly advise Holdings in writing of the commencement of, any known threat to commence any, and of any developments or changes in any pending, Litigation against any of them; (o) Interim Financial Statements. Deliver to Holdings as soon as available, but in no case later than the 20th day of the following month, Interim Financial Statements of the Companies commencing with the month of January 1996 and for each month thereafter ending prior to the Closing Date. (p) Commitment. Deliver to Holdings as soon as available, but in no case later than May 15, 1996, the Commitment. (q) Dividends and Distributions. Not make any dividends or distributions of cash or property to any of the Shareholders. 10.2. Access to Information. The Companies and the Management Shareholders have cooperated and will continue to cooperate fully with Holdings and have provided and shall provide Holdings and its Advisors, during normal business hours, full access to the books, records, equipment, real estate, Contracts, and other assets of the Companies in order for the orderly conduct of their due diligence investigation of the Companies and the Business from legal, environmental, insurance, valuation and -63- 72 solvency perspectives ("Due Diligence Investigation"). In connection with the Due Diligence Investigation, the Companies and the Management Shareholders will provide Holdings the full opportunity to discuss the Companies' Business, affairs and assets with its officers, employees, and independent accountants, and, with the consent of the Management Shareholders which will not be unreasonably withheld, the Companies' employees, customers, creditors, vendors and suppliers, and the Companies and the Management Shareholders will furnish to Holdings and its representatives copies of such documents, records, and information with respect to the affairs of the Companies as Holdings or its representatives may reasonably request. In connection with the Due Diligence Investigation, Holdings may designate Advisors to observe the operation of the Business and the Companies, which Advisors shall be permitted such access to the Companies' Business and operations as Holdings may reasonably request and shall be fully informed by it concerning all of the Companies' assets, operations, and business affairs. Holdings will use its best efforts to complete its Due Diligence Investigation by May 15, 1996, with the understanding that based on the results of the Due Diligence Investigation through that date and the requirements of the equity owners of Holdings and the Lenders, the Due Diligence Investigation may be required to continue beyond that date. No investigation by Holdings shall diminish any of the representations, warranties, covenants or agreements of the Companies and the Majority Shareholders or Management Shareholders under this Agreement or reduce Holdings' right to pursue such remedies at law or hereunder as it would otherwise have in the absence of having conducted such investigation. 10.3. Benefit Plans. Between the date hereof and the Closing Date, the Companies shall maintain in full force and effect the Benefit Plans as they pertain to the Companies' Employees or former Employees and, in connection therewith: (a) Plan Changes. Except as set forth on Schedule 7.24, except as may be required by Law or as may be necessary to continue the qualified status under Section 401 of the Code, the Companies shall not adopt, terminate, amend, extend, or otherwise change any Benefit Plan without the prior written consent of Holdings, and the Companies and the Management Shareholders shall give Holdings prior written notice of any Company's intention to take any such action required by Law or necessary to continue the qualified status of any Benefit Plans as they pertain to such Company's Employees or former Employees; and (b) Contributions and Payments. No Company shall make, cause to be made, or agree to make any contribution, award, or payment under any Benefit Plans as they pertain to such Company's Employees or former Employees, except at the time and -64- 73 to the extent required by the written terms thereof, without the prior written consent of Holdings. 10.4. Taxes. No Majority Shareholder shall take any position in any Return filed with or otherwise submitted to any Governmental Entity if such position is inconsistent with the representations of the Majority Shareholders pursuant to Article 8 hereof that a Subchapter S election was validly made, was in effect with respect to each Company on the Closing Date and had continuously been in effect with respect to the Company since its date of incorporation. 10.5. Delivery of Unaudited Closing Date Financial Statements. Not less than three days prior to the Closing Date, the Management Shareholders agree to deliver the Unaudited Closing Date Financial Statements to Holdings. 10.6. Notice of Change. The Companies and the Management Shareholders will promptly notify Holdings of the existence or happening of any fact, event or occurrence prior to the Closing Date and of which any of the Management Shareholders or any of their respective representatives has knowledge which may alter the accuracy or completeness of any representation or warranty contained in Articles 7 or 8 of this Agreement. No such notification shall result in a waiver of any of the conditions set forth in Section 12.2 hereof without any express written waiver signed by Holdings. 10.7. Best Efforts; No Discussions. Subject to the other provisions of this Agreement, the Companies and the Management Shareholders will use their best efforts to cause the conditions listed in Section 12.2 hereof to be satisfied on the Closing Date. None of the Companies or Majority Shareholders will enter into, request, solicit or engage in any discussions, negotiations, understandings, or agreements with any Person other than Holdings and its Advisors relating to the sale of the assets or the capital stock of any of the Companies (except for sales of inventory in the ordinary course of business) or any type of business combination with any of the Companies unless this Agreement is terminated pursuant to Article 17 hereof. ARTICLE 11 ACTIVITIES OF HOLDINGS PRIOR TO CLOSING DATE 11.1. Notice of Change. Holdings will promptly notify the Companies and the Majority Shareholders of the existence or happening of any fact, event or occurrence prior to the Closing Date and of which Holdings or any of Holdings' representatives has knowledge which may alter the accuracy or completeness of any representation or warranty contained in Article 9 of this -65- 74 Agreement. No such notification shall be deemed to change any of the representations or warranties of Holdings contained herein or any information contained on the Schedules hereto, nor shall any such notification result in a waiver of any of the conditions set forth in Section 12.1 hereof without any express written waiver signed by the Companies and the Majority Shareholders. 11.2. Best Efforts. Subject to the other conditions of this Agreement, Holdings will use its best efforts to cause the conditions listed in Section 12.1 hereof to be satisfied on the Closing Date. 11.3. Confidentiality. Holdings shall retain in confidence, and shall cause its Advisors to retain in confidence, all information obtained by it pursuant to investigations made by Holdings or its Advisors pursuant to Section 10.2 hereof (the "Confidential Information"). The parties agree that the Confidential Information shall not include information which (i) was or becomes generally available to the public other than as a result of a disclosure by Holdings or its Advisors, (ii) was or becomes available to Holdings or its Advisors on a non- confidential basis from a source other than any of the Companies or the Majority Shareholders or their respective Advisors, provided that such source is not bound by a confidentiality agreement or (iii) was, or in the future is, developed independently by Holdings or its Advisors without reference to the information furnished by any of the Companies or the Majority Shareholders or their respective Advisors. The parties understand and agree that all of the Confidential Information supplied to Holdings or its Advisors is provided on the understanding that such Confidential Information remains the property of the Companies and the Majority Shareholders and that all copies and originals of Confidential Information, and all analyses and pro forma information prepared by Holdings and its Advisors containing Confidential Information, will be returned to the Companies or destroyed promptly upon their request after termination of this Agreement pursuant to Article 17 hereof, subject to the right of Holdings to use such of the Confidential Information as shall be necessary in order to enforce its rights under this Agreement, in accordance with the provisions of Section 17.2 hereof. ARTICLE 12 CONDITIONS PRECEDENT TO THE CLOSING 12.1. Obligation of Companies and Majority Shareholders to Close. The obligation of the Companies and the Majority Shareholders to consummate the transactions contemplated hereby on the Closing Date shall be subject to the satisfaction (or waiver by the Companies and each of the Majority -66- 75 Shareholders, in their sole and absolute discretion) of the following conditions on or prior to the Closing Date: (a) Representations and Warranties; Compliance with Agreement. The representations and warranties of Holdings set forth in this Agreement shall be true and correct as of the date of this Agreement and as of the Closing Date as though made on and as of the Closing Date, and Holdings shall have performed all covenants and agreements to be performed by it under this Agreement on or prior to the Closing Date and Holdings shall have delivered to the Companies and the Majority Shareholders a certificate to such effect, dated the Closing Date and signed by its President, which certificate shall be in form and substance satisfactory to the Companies, the Majority Shareholders and their counsel. (b) Secretary's Certificate. Holdings shall have delivered to the Companies and the Majority Shareholders a certificate or certificates dated the Closing Date and signed on behalf of Holdings by its Secretary to the effect that (i) (A) the copy of Holdings' Articles of Organization attached to the certificate is true, correct and complete, (B) no amendment to Holdings' Articles of Organization has occurred since the date of the last amendment annexed (such date to be specified and a copy of such Articles, as amended, to be annexed to such certificate), (C) a true and correct copy of the Operating Agreement of Holdings as in effect on the date thereof and at all times since the adoption of the resolutions referred to in clause (D) below is annexed to such certificate, (D) the resolutions by the Board of Directors of Holdings authorizing the actions taken and authorizing the officers of Holdings to execute the Collateral Documents, including the execution and delivery of this Agreement, were duly adopted and continue in force and effect (a copy of such resolutions to be annexed to such certificate); (ii) the officers of Holdings executing this Agreement and the Collateral Documents to which Holdings is a party are incumbent officers of Holdings and the specimen signatures on such certificate or certificates are their genuine signatures; and (iii) Holdings is in good standing in all states in which Holdings does business. The certificate referred to above in (iii) shall attach certificates of good standing certified by the Secretaries of State or other appropriate officials of such states, dated as of a date not more than five (5) days prior to the Closing Date. (c) Opinion of Counsel of Holdings. Messrs. Pepper, Hamilton & Scheetz, counsel for Holdings, shall have delivered to the Companies and the Majority Shareholders their opinion, dated the Closing Date and opining as to such matters and otherwise being in form and substance satisfactory to the Companies, the Majority Shareholders and their counsel. In rendering such opinion, such counsel may rely to the extent recited therein on -67- 76 certificates of public officials and of officers of Holdings as to matters of fact, and as to any matter which involves other than federal or Delaware law, such counsel may rely upon the opinion of local counsel of established reputation. (d) Litigation Affecting Closing. On the Closing Date, no proceeding shall be pending or threatened before any court or governmental agency in which it is sought to restrain or prohibit or to obtain damages or other relief in connection with this Agreement or the consummation of the transactions contemplated hereby, and no investigation that might eventuate in any such suit, action or proceeding shall be pending or threatened. (e) Bank Debt, Mezzanine Debt and Revolving Line of Credit. The proceeds of the Bank Debt and the Mezzanine Debt, in an amount not less than Sixty-Five Million Dollars ($65,000,000), shall be on terms acceptable to each of the Majority Shareholders and shall have been fully funded and loaned to the Companies at the Closing; and the Lenders providing the Revolving Line of Credit shall have entered into binding definitive documentation obligating them to fund the Revolving Line of Credit to the Companies during the term thereof in accordance with its terms. (f) Approval of Counsel; Corporate Matters. All actions, proceedings, resolutions, instruments and documents required to carry out this Agreement or incidental hereto and all other related legal matters shall have been approved on the Closing Date by Messrs. Baker, Donelson, Bearman & Caldwell, counsel for the Majority Shareholders and the Companies, in the exercise of their reasonable judgment. (g) Approval of Collateral Documents. Each of the Majority Shareholders and the Companies shall have executed and delivered the certificate referenced in Section 6.3 hereof. (h) Other Documents. The Companies and the Majority Shareholders shall have received all of the documents, agreements and instruments to be delivered to them in accordance with Section 15.2 hereof and shall have been provided with such other documents as they shall have reasonably requested from Holdings. 12.2. Obligation of Holdings to Close. The obligation of Holdings to consummate the transactions contemplated hereby on the Closing Date shall be subject to the satisfaction or the waiver by Holdings, in its sole and absolute discretion, of the following conditions on or prior to the Closing Date: (a) Representations and Warranties; Compliance with Agreement. The representations and warranties of the Majority Shareholders and the Management Shareholders set forth in this Agreement shall be true and correct as of the date of this -68- 77 Agreement and as of the Closing Date as though made on and as of the Closing Date, and the Companies and the Majority Shareholders shall have performed all covenants and agreements to be performed by them under this Agreement on or prior to the Closing Date, and the Companies shall have delivered to Holdings certificates to such effect dated the Closing Date signed on behalf of the Companies by their Presidents and on behalf of the Majority Shareholders and the Management Shareholders, which certificates shall be in form and substance satisfactory to Holdings' counsel. (b) Secretary's Certificate. The Companies shall have delivered to Holdings a certificate or certificates dated the Closing Date and signed on behalf of the Companies by their Secretaries to the effect that (i)(A) the copy of each Company's Articles or Certificate of Incorporation attached to the certificate (or previously delivered to Holdings) is true, correct and complete, (B) no amendment to any Company's Articles or Certificate of Incorporation has occurred since the date of the last amendment annexed (or previously delivered), constituting the amendment effecting the Recapitalization (such date to be specified and a copy of such Articles or Certificate, as amended, to be annexed to such certificate or separately delivered), (C) a true and correct copy of the By-laws of each Company as in effect on the date thereof and at all times since the adoption of the resolutions referred to in clause (D) below is annexed to such certificate (or previously delivered to Holdings), (D) the resolutions by the Board of Directors of each Company authorizing the actions taken in connection with the transactions contemplated by this Agreement, including the execution and delivery of this Agreement and the other Collateral Documents, were duly adopted and continue in force and effect (a copy of such resolutions to be annexed to such certificate (or previously delivered to Holdings)); (ii) the officers of each Company executing this Agreement and the other Collateral Documents to which each such Company is a party are incumbent officers of such Company and the specimen signatures on such certificate or certificates are their genuine signatures; and (iii) each Company is in good standing in all jurisdictions in which the failure to be in good standing would have a Material Adverse Effect upon such Company. The certificate referred to above in (iii) shall attach certificates of good standing certified by the Secretaries of State or other appropriate officials of such states, dated as of a date not more than five days prior to the Closing Date, and certificates of no tax liens with respect to the property of the Companies in such states from each such state which has a practice of issuing certificates of no tax liens. Such certificate or certificates shall be in form and substance satisfactory to Holdings and Holdings' counsel. (c) Opinion of Counsel for the Companies and the Majority Shareholders. Messrs. Baker, Donelson, Bearman & Caldwell, counsel for the Majority Shareholders and the -69- 78 Companies, shall have delivered to Holdings their opinion, dated the Closing Date and opining as to such matters and otherwise being in form and substance satisfactory to Holdings and its counsel. In rendering such opinion counsel may rely to the extent recited therein on certificates of public officials and of the Management or Majority Shareholders and officers of the Companies as to matters of fact, and as to any matter which involves other than federal or local law, such counsel may rely upon the opinion of local counsel of established reputation. In addition, such counsel may assume for purposes of its opinion that to the extent that matters governed by Delaware law are opined upon, the laws of the State of Delaware are the same as those of the State of Tennessee. (d) Litigation Affecting Closing. On the Closing Date, no proceeding shall be pending or threatened before any court or governmental agency in which it is sought to restrain or prohibit or to obtain damages or other relief in connection with this Agreement or the consummation of the transactions contemplated hereby, and no investigation that might eventuate in any such suit, action or proceeding shall be pending or threatened. (e) Required Consents. The holders of any indebtedness of the Companies, the lessors of any real or personal property or assets leased by the Companies, the parties (other than the Companies) to any other Contract, to which any Company is a party, any Governmental Entity or body or any other person, firm or corporation which owns or has authority to grant any franchise, license, Permit, easement, right or other authorization necessary for the Business or operations of the Companies, and any Governmental Entity or regulatory agency having jurisdiction over the Companies, to the extent that their consent or approval is required under the pertinent debt, lease, Contract, commitment or agreement or other document or instrument or under applicable Laws, rules or Regulations for the consummation of the transaction contemplated hereby in the manner herein provided, shall have granted such consent or approval. (f) Bank Debt, Mezzanine Debt and Revolving Line of Credit. The proceeds of the Bank Debt and the Mezzanine Debt, in an amount not less than Sixty Five Million Dollars ($65,000,000), shall be on terms acceptable to Holdings and shall have been fully funded and loaned to the Companies at the Closing; and the Lenders providing the Revolving Line of Credit shall have entered into binding definitive documentation obligating them to fund the Revolving Line of Credit to the Companies during the term thereof in accordance with its terms. (g) No Material Adverse Effect Suffered by Business. Between the date of this Agreement and the Closing Date, there shall not have been: -70- 79 (i) Any Material Adverse Effect, except changes in the ordinary course of business, none of which has resulted or could be reasonably expected to result in a Material Adverse Effect; (ii) Any event or condition of any nature whatsoever which individually or in the aggregate has resulted in or could be reasonably expected to result in a Material Adverse Effect; (iii) Any Material Adverse Effect which has resulted from or has been threatened in any way as a result of fire, explosion, earthquake, disaster, accident, labor dispute, any action by any governmental authority (including any condemnation proceeding), flood, drought, embargo, riot, civil disturbance, uprising, activity of armed forces or act of God or public enemy, whether or not covered by insurance; (iv) Any claims not covered by applicable policies of liability insurance within the maximum insurable limits of such policies; (v) Any transaction by any Company not in the ordinary course of business as conducted on that date; (vi) Any amendment to the Articles or Certificate of Incorporation or By-laws of any Company, other than as contemplated by Article 5 hereof; (vii) The creation or attachment, or notice thereof, of any Lien; (viii) Any sale or transfer of any of the Companies' assets not in the ordinary course of business (other than the sale of used cash registers and semi-annual discount sales); (ix) Any incurrence of any debts, Liabilities or obligations except in the ordinary course, consistent with past practice, or any waiver of any rights of substantial value; (x) Any discharge or satisfaction of any Liens, or any payment of any Liens or Liabilities, except in the ordinary course of business, consistent with past practice; (xi) Any increase in the salary or other compensation payable by any Company to any of its executive officers or directors or the declaration, payment, commitment or obligation of any kind for the payment by the Company of a bonus or other additional salary or compensation to any such person; -71- 80 (xii) Any dividends or distributions of cash or property by any Company to any of the Shareholders; (xiii) Any sale, transfer or issuance of any capital stock, equity security or debt security of any Company or any option, warrant, right or commitment or agreement entered into requiring or permitting any such sale, transfer or issuance, except for the agreement of the Companies to sell the Purchased Shares to Holdings pursuant hereto and except for the purchase by the Majority Shareholders of shares of common stock in certain Companies pursuant to Section 3.6 hereof; or (xiv) Any agreement by any Company to do any act which would render any of the preceding clauses inaccurate, other than the transactions specifically contemplated to occur pursuant to this Agreement. (h) Approval of Counsel; Corporate Matters. All actions, proceedings, resolutions, instruments and documents required to carry out this Agreement or incidental hereto and all other related legal matters shall have been approved on the Closing Date by Messrs. Pepper, Hamilton & Scheetz, counsel for Holdings, in the exercise of their reasonable judgment. (i) Title Insurance. No later than May 2, 1996, Holdings shall have received the Commitment. No later than the Closing, Holdings shall have received an owner's coverage policies of title insurance covering fee title or option rights to the Owned Real Property (and all improvements located thereon) (on ALTA Form 5-1970, Rev. 10-17-84 & 4-6-90) naming Kirkland's as the insured in an amount at least equal to the most recent appraised value of each parcel of Owned Real Property at ordinary rates, issued by a title insurance company of national reputation selected by Holdings ("Title Company"). Such policy shall provide coverage updated through the Closing Date, insuring that Kirkland's has good and marketable title to all Owned Real Property, subject only to Permitted Title Exceptions, and shall contain such additional provisions as shall be reasonably requested by Holdings or its counsel. (j) Survey. To the extent required by the Title Company in order for the Title Company to delete the printed survey exception, except for "shortages in area," in the owner's title policy to be delivered pursuant to this Agreement, the Companies and the Management Shareholders shall have delivered to the Title Company and to Holdings a current on-the-ground staked survey ("Survey"). Any required surveying work shall be done at the expense of the Companies. (k) Working Capital. The Closing Date Adjusted Working Capital, as computed by reference to the Unaudited -72- 81 Closing Date Balance Sheet, shall be no less than Eleven Million Dollars ($11,000,000). (l) Due Diligence Investigation. The Due Diligence Investigation shall have been completed to the satisfaction of Holdings. (m) Solvency. Prior to, upon and as a result of the consummation of the transactions contemplated hereby, each Company shall be solvent and will have assets having a fair value in excess of the amount required to pay its probable liabilities on its existing debts as they become absolute and matured, and will have the ability to pay its debts from time to time incurred in connection therewith as such debts mature. (n) Approval of Collateral Documents. Holdings shall have executed and delivered the certificate referenced in Section 6.3 hereof. (o) Other Documents. Holdings shall have received all of the documents, agreements and instruments to be delivered to it in accordance with Section 15.2 hereof and shall have been provided with such other documents as it shall have reasonably requested from the Companies and the Majority Shareholders, including all information required to enable counsel or title company to effect the reporting requirements under Section 6045(e) of the Code, if applicable, and the Companies and the Majority Shareholders shall have provided a reasonably acceptable indemnity to those responsible for such filing as to the accuracy and completeness of such information. ARTICLE 13 INDEMNIFICATION 13.1. By Majority Shareholders. From and after the Closing Date, each of the Majority Shareholders shall jointly and severally (A) indemnify and hold harmless Holdings and Holdings' officers, directors, employees and members from and against any and all Losses which Holdings or its officers, directors, employees or members may suffer or incur, resulting from, related to, or arising out of (i) any inaccuracy of any representation or warranty of any of the Companies or any of the Shareholders which is contained in or made pursuant to this Agreement or any of the Collateral Documents or any misrepresentation in or omission from any Schedule to this Agreement, certificate, financial statement or any other document furnished or to be furnished to Holdings hereunder by any Company, any of the officers of any Company, or any Majority Shareholder (other than an item which has been recovered by the Companies pursuant to the post-Closing adjustment set forth in Section 4.3(e) hereof); (ii) any breach -73- 82 by any of the Companies or any of the Shareholders of any of their agreements or obligations contained in or made pursuant to this Agreement or any of the Collateral Documents; (iii) any Taxes found to be owing as a result of either the failure of an election to be taxed as an S corporation to be effective or the inadvertent or other termination of the status of any Company as an S corporation, in either case for federal or state tax purposes (other than an item which has been recovered by the Companies pursuant to the post-Closing adjustment set forth in Section 4.3(e) hereof); (iv) any violation of any law, ordinance or governmental rule or regulation by any Company and any failure to obtain, or to adhere to the requirements of, any license, permit or authorization necessary to the ownership of any Company's assets or the operation of the Business; (v) any breach by any officer or director of any of the Companies of any fiduciary duty owed by such officer or director to any shareholder of any of the Companies, which breach occurred prior to, in connection with or as a result of the Closing and the transactions contemplated to take place at Closing; and (vi) any and all Litigation arising out of any of the foregoing; and (B) reimburse Holdings and each of its officers, directors, employees and members for any and all reasonable fees, costs and expenses related thereto (including, without limitation, Legal Expenses) (collectively, "Indemnifiable Losses"). 13.2. By Holdings. From and after the Closing Date, Holdings shall (A) indemnify and hold harmless the Majority Shareholders and their heirs, personal representative, administrators, successors and assigns, from and against any and all Losses, which the Majority Shareholders may suffer or incur, resulting from, related to, or arising out of (i) any inaccuracy of any representation or warranty of Holdings which is contained in or made pursuant to this Agreement or any of the Collateral Documents or any misrepresentation in or omission from any certificate or any other document furnished or to be furnished to the Companies and the Majority Shareholders by Holdings or any of its officers; (ii) any breach by Holdings of any of its agreements or obligations contained in or made pursuant to this Agreement or any of the Collateral Documents; and (iii) any and all Litigation arising out of any of the foregoing; and (B) reimburse the Majority Shareholders and each of its officers, directors and employees for any and all reasonable fees, costs and expenses related thereto (including, without limitation, Legal Expenses) (collectively, "Indemnifiable Losses"). 13.3. Direct Liability. In the event that the person or entity seeking indemnification under this Article 13 (the "Indemnified Party") shall become aware of an event which will give rise to or result in an Indemnifiable Loss, he or it shall, within 30 days thereafter, give written notice to the party from whom indemnification under this Article 13 is sought (the "Indemnifying Party") of the amount of the Indemnifiable Loss, -74- 83 together with sufficient information to enable the Indemnifying Party to determine the accuracy and nature of the claimed Indemnifiable Loss (the "Indemnity Notice"). The failure of the Indemnified Party to give the Indemnifying Party an Indemnity Notice shall not release the Indemnifying Party of liability under this Article 13; provided, however, that the Indemnifying Party shall not be liable for Losses incurred by the Indemnified Party which would not have been incurred but for the delay in the delivery of, or the failure to deliver, the Indemnity Notice. Within 15 business days after the receipt by the Indemnifying Party of the Indemnity Notice, the Indemnifying Party shall either (i) pay to the Indemnified Party an amount equal to the Indemnifiable Loss or (ii) object to such claim, in which case the Indemnifying Party shall give written notice to the Indemnified Party of such objection together with the reasons therefor, it being understood that the failure of the Indemnifying Party to so object shall preclude the Indemnifying Party from asserting any claim, defense or counterclaim relating to the Indemnifying Party's failure to pay any Indemnifiable Loss. 13.4. Third-Party Claim. In the event the facts giving rise to the claim for indemnification under this Article 13 shall involve any action or threatened claim or demand by any third party against the Indemnified Party, or shall involve after Closing the discovery of facts or circumstances which make any of Indemnifying Party's representations or warranties contained in this Agreement materially untrue or misleading, the Indemnified Party, within the earlier of, as applicable, 10 days after receiving notice of the filing of a lawsuit or 30 days after receiving notice of the existence of a claim or demand giving rise to the claim for indemnification, shall send written notice of such claim to the Indemnifying Party (the "Claim Notice"). The failure of the Indemnified Party to give the Indemnifying Party the Claim Notice shall not release the Indemnifying Party of liability under this Article 13; provided, however, that the Indemnifying Party shall not be liable for Losses incurred by the Indemnified Party which would not have been incurred but for the delay in the delivery of, or the failure to deliver, the Claim Notice. Subject to the provision contained in the second sentence immediately following this sentence, the Indemnifying Party shall be entitled to defend such claim in the name of the Indemnified Party at its own expense and through counsel of its own choosing. The Indemnifying Party shall give the Indemnified Party notice in writing within 10 days after receiving the Claim Notice from the Indemnified Party in the event of litigation, or otherwise within 30 days, of its intent to do so. The Indemnified Party may elect, by notice in writing to the Indemnifying Party, to continue to participate through its own counsel, at its expense, but the Indemnifying Party shall have the right to control the defense of the claim or the litigation; provided, that the Indemnifying Party (i) retains counsel -75- 84 satisfactory to the Indemnified Party and pursuant to an arrangement satisfactory to the Indemnified Party and (ii) posts a bond or similar surety in form and substance satisfactory to the Indemnified Party to cover the estimated litigation costs and expenses (including attorneys' fees and expenses) and the estimated indemnification amount; otherwise, the Indemnified Party shall have the right to control the defense of the claim or the litigation. Notwithstanding any other provision contained in this Agreement, the party controlling the defense of the claim or the litigation shall not settle any such claim or litigation without the written consent of the other party; provided, that if the Indemnified Party is controlling the defense of the claim or the litigation and shall have, in good faith, negotiated a settlement thereof, which proposed settlement contains terms that are reasonable under the circumstances, then the Indemnifying Party shall not withhold such consent. In the event that the Indemnifying Party is controlling the defense of the claim or the litigation and shall have negotiated a settlement thereof, which proposed settlement is substantively final and unconditional as to the parties thereto (other than the consent of the Indemnified Party required under this Section 13.4) and contains an unconditional release of the Indemnified Party and does not include the taking of any actions by, or the imposition of any restrictions on the part of, the Indemnified Party and the Indemnified Party shall refuse to consent to such settlement, the liability of the Indemnifying Party under this Article 13, upon the ultimate disposition of such litigation or claim, shall be limited to the amount of the proposed settlement; provided, however, that in the event the proposed settlement shall require that the Indemnified Party make an admission of liability, a confession of judgment, or shall contain any other non-financial obligation which, in the reasonable judgment of the Indemnified Party, renders such settlement unacceptable, then the Indemnified Party's failure to consent shall not give rise to the limitation of the Indemnifying Party's liability as provided for in this Section 13.4, and the Indemnifying Party shall continue to be liable to the full extent of such litigation or claim. 13.5. Limitation of Indemnity. (a) Except with respect to the provisions regarding post-Closing adjustments in Section 4.3(e) hereof and the tax-related indemnification pursuant to clause (iii) of Section 13.1(a) or pursuant to either a breach of any representation and warranty contained in Section 8.1 or pursuant to the provisions of Section 8.2, neither Holdings, on the one hand, nor the Majority Shareholders, on the other hand, shall be required to indemnify the other for any Indemnifiable Losses unless and until the aggregate amount for which Holdings or the Majority Shareholders, as the case may be, would otherwise (but for this provision) be liable on account thereof exceeds Seven Hundred Fifty Thousand Dollars ($750,000) (the "Threshold -76- 85 Amount"); provided, however, that for the purpose of calculating such Threshold Amount, any specific materiality provisions contained in such representations and warranties shall be disregarded; provided further, however, that once the Threshold Amount is reached, the indemnifying party shall be liable for the entire Threshold Amount, less any amounts attributable to breaches of representations and warranties that contain specific materiality provisions which were disregarded for purposes of computing the Threshold Amount. In addition, once the Threshold Amount has been reached, all claims for indemnification shall take into account the specific materiality provisions contained in the representations and warranties. (b) In no event shall the Majority Shareholders be required to indemnify Holdings for Indemnifiable Losses in excess of Twenty Million Dollars ($20,000,000). (c) Notwithstanding anything to the contrary contained herein, except with respect to any inaccuracy of any representation or warranty which is contained in or made pursuant to Sections 7.2(a), 7.27(a) or 7.29(a) of this Agreement, in no event shall the Management Shareholders be required to indemnify Holdings for Indemnifiable Losses in excess of 62.2775% of such Indemnifiable Losses. Nothing in this paragraph (c) shall be construed to limit the right of any Management Shareholder to seek contribution from any other Management Shareholder in respect of any of Holding's Indemnifiable Losses. (d) Notwithstanding anything to the contrary contained herein, except with respect to any inaccuracy of any representation or warranty which is contained in or made pursuant to Sections 7.2(b), 7.27(b) or 7.29(b) of this Agreement, in no event shall Robert Kirkland be required to indemnify Holdings for Indemnifiable Losses in excess of 37.7225% of such Indemnifiable Losses. 13.6. Non-Exclusive Remedy; Right of Set-Off. (a) The parties hereto agree that the availability of indemnification under this Article 13 shall not in any way limit remedies at law or in equity otherwise available to the parties, and the parties further agree that, in the event of any such breach of any representation, warranty or covenant contained herein or in the Collateral Documents, the parties will be entitled to seek a decree of specific performance, mandamus or any other appropriate remedy to enforce such provisions without any requirement that a bond be posted. (b) Holdings shall be entitled, at its option (except as required as set forth in paragraph (ii) below) to recover any Indemnifiable Losses payable by the Majority Shareholders through a reduction of amounts due from the -77- 86 Companies to the Majority Shareholders as set forth in this paragraph, to the extent any amounts are then or will in the future become payable by the Companies to the Majority Shareholders under the terms of any Contracts or the Articles or Certificates of the Companies then in effect, not including any Protected Amounts ("Future Payment Obligations"), with the offset being applied against the earliest Future Payment Obligations first. Each Company agrees that it will make the offset as directed by Holdings in accordance with this Section 13.6. (i) Inasmuch as the offset will be against Future Payment Obligations owed by the Companies, and as a result of the transactions contemplated hereby, Holdings will own less than all of the common stock of the Companies, the amount to be offset against Future Payment Obligations shall be equal to the quotient obtained by dividing (1) the amount of Holdings' Indemnifiable Losses to be offset, by (2) Holdings' percentage ownership of the common stock of the Companies on the date of offset. In addition, in order to compensate for the fact that some or all of the amount to be offset against Future Payment Obligations may be required to be applied against Future Payment Obligations which would otherwise not have become due and payable by the Companies to the Majority Shareholders for some period of time after the date of offset, the amount to be offset against Future Payment Obligations shall be increased by a factor of nine percent (9%) per year (prorated for partial years) with respect to any amounts to be offset against Future Payment Obligations which would otherwise not have become due and payable by the Companies to the Majority Shareholders until after the date of offset. (ii) Unless the Indemnifiable Losses of Holdings are related to an event which Holdings determines in good faith has resulted or is likely to result in (1) a breach of any affirmative or negative covenants contained in any debt financing agreement or (2) insufficient liquidity at any of the Companies (including, without limitation, insufficient availability under the Revolving Line of Credit or any replacement working capital revolving line of credit), the offset provided for in this Section 13.6(b) shall be mandatory to the extent of the Future Payment Obligations. Any Indemnifiable Losses in excess of the Future Payment Obligations which would otherwise be required to be paid by means of an offset against the Future Payment Obligations shall instead be payable to Holdings by the Majority Shareholders in cash. 13.7. Majority Shareholders' Claims Against any of the Companies. The Majority Shareholders agree that none of them will seek, nor will any of them be entitled to, contribution from, or indemnification by, any of the Companies, under any of the Companies' bylaws, this Agreement, applicable corporate laws or other laws or otherwise, in respect of amounts due from the -78- 87 Majority Shareholders to Holdings under this Article 13 or otherwise under this Agreement, and each of the Majority Shareholders will hold each of the Companies and Holdings harmless in respect of all such amounts and shall not seek to join any of the Companies in connection with any suit arising under this Agreement. The Majority Shareholders also agree that they will not make claim against any directors and officers insurance policy maintained or to be maintained by the Companies in respect of amounts due by the Majority Shareholders to Holdings under this Article 13 or otherwise under this Agreement, if the carrier of such insurance policy would have any right of subrogation against either of the Companies in respect of such claim and shall indemnify and hold harmless Holdings from any such action. ARTICLE 14 SURVIVAL OF REPRESENTATIONS, WARRANTIES, GUARANTEES, AND COVENANTS Notwithstanding any investigation made by or on behalf of the Companies, the Majority Shareholders or Holdings prior to or after the Closing Date, except for (i) representations or warranties which were made by a party fraudulently or with intent to defraud or mislead, which representations and warranties shall survive indefinitely, (ii) representations and warranties set forth in Section 7.7 (relating to title to properties) and Section 7.27 (relating to title of Purchased Shares), which shall survive indefinitely, (iii) representations and warranties set forth in Section 7.18 (relating to certain product liability matters), Section 7.24 (relating to certain ERISA matters), Section 7.25 (relating to certain environmental matters) and Article 8 (relating to certain tax matters), which shall survive in accordance with the applicable statute of limitations (as the same may be extended in accordance with applicable Regulations) plus an additional 90 days, all representations and warranties made by the Majority Shareholders and Holdings in this Agreement or pursuant hereto shall survive the Closing hereunder until the Survival Date, and thereafter as to any Indemnifiable Losses with respect to which notice is given prior to the Survival Date. All covenants and other agreements set forth herein shall survive the Closing in accordance with the applicable statute of limitations plus an additional 90 days, except for (1) the indemnification obligations for breaches or misstatements of representations or warranties, which shall survive with respect to a misstatement of a representation or a breach of warranty, and Indemnifiable Losses related thereto, for a period of time equal to the survival period of the particular representation or warranty as provided in this Article 14 (and thereafter as to any Indemnifiable Losses with respect to which notice is given prior to the end of such survival period), and (2) the obligations to -79- 88 perform the covenants and agreements contained in Article 10 hereof which shall survive the Closing until the Survival Date (and thereafter as to any such Indemnifiable Losses with respect to which notice is given prior to the Survival Date). ARTICLE 15 THE CLOSING 15.1. Time and Place. The closing of the transactions (the "Closing") contemplated hereby shall be held at 10:00 A.M. on May 1, 1996, or at such other time and on such other date on or prior to June 7, 1996 as the parties may mutually agree to in writing (the "Closing Date"). The Closing shall be held at the offices of Baker, Donelson, Bearman & Caldwell, or at such other place as the parties may mutually agree to in writing. 15.2. Conduct of Closing. Subject to the fulfillment of all of the conditions set forth in Article 12 and the delivery of all certificates and opinions required thereby, except such conditions as may be waived by the parties, on the Closing Date, each of the parties hereto agrees to execute and deliver each of the documents, agreements, instruments to which he or it is a party or required signatory and which are required to be delivered at the Closing pursuant to the terms of this Agreement and shall make all payments required to be paid at the Closing pursuant to the terms of this Agreement, including, without limitation, the following documents, agreements, instruments and payments: (i) stock certificates representing the Purchased Shares shall be delivered to Holdings and all stock certificates issuable to Holdings and the Majority Shareholders pursuant to the Recapitalization shall be delivered to Holdings and the Majority Shareholders, respectively; (ii) evidence of the wire transfers and other payments provided for in Article 2 and Sections 3.3, 3.6, 4.1(a) and 4.2(a) hereof shall be delivered to the intended recipients of such wire transfers and other payments, if requested by any such recipient; (iii) the Fee Letter shall be delivered to the parties thereto and the fee payment required pursuant thereto shall be paid by the Companies by wire transfer of immediately available Federal funds to a bank account designated by Advent; (iv) the Minority Shareholder Redemption Agreement shall be delivered to the parties thereto; -80- 89 (v) the Shareholders Agreement shall be delivered to the parties thereto; (vi) the Management Agreements shall be delivered to the parties thereto; (vii) the Consulting Agreement shall be delivered to the parties thereto; (viii) the Option Agreements shall be delivered to the parties thereto; (ix) evidence shall be delivered to Holdings demonstrating, to Holdings' satisfaction, that the necessary amendments to the Articles or Certificates of Incorporation of each of the Companies have been filed in the appropriate state's Department of State and have become effective in accordance with each such state's corporation law in order to effect the Recapitalization; (x) closing certificates executed by the Majority Shareholders and the Secretaries of the Companies as required by Sections 12.2(a) and 12.2(b) of this Agreement shall be delivered to Holdings; (xi) closing certificates executed by Holdings as required by Sections 12.1(a) and 12.1(b) of this Agreement shall be delivered to the Companies and the Majority Shareholders; (xii) the opinion of Messrs. Pepper, Hamilton & Scheetz, counsel to Holdings, shall be delivered to the Companies and the Majority Shareholders; (xiii) the opinions of Messrs. Baker, Donelson, Bearman & Caldwell, counsel to the Majority Shareholders and the Companies, shall be delivered to Holdings; (xiv) the Shareholder Releases, executed by the Minority Shareholders and executed by the Majority Shareholders, shall be delivered to the Companies; (xv) all consents and approvals referred to in Section 12.2(f) hereof shall be delivered to Holdings; (xvi) the Trademark Assignment conveying the Trade Name in recordable form shall be delivered to Kirkland's; and (xvii) Such other documents as may be necessary to effectuate the transactions contemplated herein shall be delivered to the appropriate parties. -81- 90 ARTICLE 16 CONDUCT OF THE PARTIES AFTER CLOSING The Majority Shareholders will cooperate with Holdings upon and after the Closing Date in effecting the orderly transfer of control of the Business to Holdings. Without limiting the generality of the foregoing, the Management Shareholders shall, if deemed necessary by Holdings, use their best efforts to cause the United States and each State government, and every agency and department and instrumentality thereof, to agree with the Companies to have contracts between each of them and the Companies novated, and to the execution of appropriate documents thereto. In addition, after the Closing Date, at the request of any party hereto and at the requesting party's expense, but without additional consideration, the other parties shall execute and deliver from time to time such further instruments of assignment, conveyance and transfer, shall cooperate in the conduct of litigation and the processing and collection of insurance claims, and shall take such other actions as may reasonably be required to convey and deliver more effectively to Holdings the Purchased Shares and otherwise to accomplish the consummation of the transactions contemplated hereby. ARTICLE 17 TERMINATION 17.1. Events of Termination. Anything herein or elsewhere to the contrary notwithstanding, this Agreement may be terminated by written notice of termination at any time before the Closing Date only as follows: (a) Mutual Consent. By mutual consent of the Companies, the Majority Shareholders and Holdings; (b) Prior to Closing Date. By the Companies and the Majority Shareholders, on the one hand, or Holdings, on the other hand, if Holdings, on the one hand, or any Company or Majority Shareholder, on the other hand, shall have (a) materially misstated any representation or been in breach of any warranty contained herein or (b) been in material breach of any covenant, undertaking or restriction contained herein; (c) After Specified Date by Holdings. By Holdings, provided that Holdings is not in material default hereunder, if all of the conditions precedent set forth in Section 12.2 hereof have not been met by June 3, 1996. -82- 91 (d) After Specified Date by the Companies and the Majority Shareholders. By the Companies and the Majority Shareholders, provided that the Companies and the Majority Shareholders are not in material default hereunder, if all of the conditions precedent set forth in Section 12.1 hereof have not been met by June 3, 1996. (e) Under Article 6. By Holdings in the manner set forth in Article 6 hereof. 17.2. Survival. If this Agreement is validly terminated pursuant to Section 17.1 and the transactions contemplated hereby are not consummated as described above, this Agreement shall become void and of no further force and effect; provided, however, that if either the Companies and the Majority Shareholders or Holdings terminate this Agreement pursuant to Section 17.1(b), then the terminating party shall have the right to pursue all of its legal remedies for breach of contract and damages; provided further, that if this Agreement is terminated pursuant to the provisions of Section 17.1, Holdings shall maintain in confidence any Confidential Information which it acquired pursuant to the Due Diligence Investigation except as otherwise required by law or to the extent required in order for Holdings to enforce its rights under this Agreement. In connection with the necessary use of any Confidential Information by Holdings in order to enforce its rights under this Agreement pursuant to the preceding sentence, Holdings agrees to request the court or other adjudicating authority to keep all Confidential Information confidential and not available to the public. No party hereto shall have any liability to any other party in respect of a valid termination of this Agreement pursuant to Section 17.1, except to the extent set forth above. ARTICLE 18 GENERAL 18.1. Entire Agreement; Amendments. This Agreement constitutes the entire understanding among the parties with respect to the subject matter contained herein and supersedes any prior understandings and agreements among them respecting such subject matter. This Agreement may be amended and supplemented only by a written instrument duly executed by Holdings and each of the Majority Shareholders, whereupon such amendment or supplement shall be binding upon and enforceable against all of the parties hereto. 18.2. Headings. The headings in this Agreement are for convenience of reference only and shall not affect its interpretation. -83- 92 18.3. Gender; Number. Words of gender may be read as masculine, feminine, or neuter, as required by context. Words of number may be read as singular or plural, as required by context. 18.4. Schedules. Each Schedule referred to herein is incorporated into this Agreement by such reference. 18.5. Severability. If any provision of this Agreement is held illegal, invalid, or unenforceable, such illegality, invalidity, or unenforceability will not affect any other provision hereof. This Agreement shall, in such circumstances, be deemed modified to the extent necessary to render enforceable the provisions hereof. 18.6. Reliance. The Majority Shareholders hereby acknowledge that Holdings is relying upon the representations and warranties of the Majority Shareholders and the Management Shareholders set forth in Articles 7 and 8 and the Schedules applicable thereto in connection with delivering certain representations and warranties to a commercial lender in order to obtain financing for the transactions contemplated herein. 18.7. Notices. All notices and other communications hereunder shall be in writing and shall be given to the person either personally or by sending a copy thereof by first class or express mail, postage prepaid, or by telegram (with messenger service specified), telex or TWX (with answerback received) or courier services, charges prepaid, or by telecopier, to such party's address (or to such party's telex, TWX, telecopier or telephone number). If the notice is sent by mail, telegraph or courier services, it shall be deemed to have been given to the person entitled thereto when deposited in the United States mail or with a telegraph office or courier service for delivery to that person or, in the case of telex of TWX, when dispatched. If to Holdings, to: Kirkland Holdings L.L.C. Advent International Corporation 101 Federal Street Boston, MA 02110 Attention: David M. Mussafer Telecopy No.: 617-951-0566 With a copy to: Pepper, Hamilton & Scheetz 3000 Two Logan Square Philadelphia, PA 19103 Attention: Cary S. Levinson, Esq. Telecopy No.: 215-981-4750 -84- 93 If to any Management Shareholder or any Company, to: Kirkland's, Inc. P.O. Box 7222 Jackson, TN 38303-7222 Telecopy No.: (901) 664-9345 With a copy to: Baker, Donelson, Bearman & Caldwell 20th Floor First Tennessee Building 165 Madison Avenue Memphis, TN 38103 Attention: Robert Walker, Esq. Telecopy No.: (901) 577-2303 If to Robert Kirkland, to: Robert Kirkland CBK Ltd. 600 East Sherwood Drive Union City, TN 38261 Telecopy No.: (901) 885-3857 With a copy to: Wyatt, Tarrant & Combs Crescent Center 6075 Poplar Avenue, Suite 650 Memphis, TN 38177 Attention: R. Nash Nayland, Esq. Telecopy No.: (901) 537-1010 Notice of any change in any such address shall also be given in the manner set forth above. Whenever the giving of notice is required, the giving of such notice may be waived by the party entitled to receive such notice. 18.8. Waiver. The failure of any party to insist upon strict performance of any of the terms or conditions of this Agreement will not constitute a waiver of any of its rights hereunder. 18.9. Assignment. None of the Majority Shareholders may assign any of their rights or delegate any of their obligations hereunder without the prior written consent of Holdings. Holdings may not assign any of its rights or delegate any of its obligations hereunder without the prior written consent of each of the Majority Shareholders, except that Holdings may assign its rights and delegate its obligations -85- 94 hereunder to an Affiliate of Holdings without the consent of any of the Majority Shareholders. 18.10. Successors and Assigns. This Agreement binds, inures to the benefit of, and is enforceable by the successors and assigns of the parties, and does not confer any rights on any other Persons. 18.11. Governing Law. This Agreement shall be construed and enforced in accordance with Delaware law. The parties hereto agree that any action to enforce this Agreement may be properly brought in any court within the State of Delaware or in the United States District Court for the District of Delaware, and the parties hereto agree that the courts of the State of Delaware and the United States District Court for the District of Delaware shall have jurisdiction with respect to the subject matter hereof and the person of the parties hereto. 18.12. No Benefit to Others. The representations, warranties, covenants and agreements contained in this Agreement (including, without limitation, the provisions of Section 18.6 hereof) are for the sole benefit of the parties hereto and their successors and assigns, and they shall not be construed as conferring and are not intended to confer any rights on any other persons. 18.13. Agreement to Vote. Subject to satisfaction of the conditions set forth in Section 12.1 hereof, each of the Majority Shareholders agrees to vote all shares of capital stock which he holds in each of the Companies, and to vote in his capacity as a director of the Companies, to cause each Company to comply with all of the terms of this Agreement, including, without limitation, to effect the debt repayment contemplated by Article 2 hereof, the purchase by Holdings of the Purchased Shares, the Redemption, and the Recapitalization. 18.14. Publicity. Prior to the Closing Date, all notices to third parties and all other publicity relating to the transactions contemplated by this Agreement shall be jointly planned, coordinated and agreed to by Kirkland's and Holdings. Prior to the Closing Date, none of the parties hereto shall act unilaterally in this regard without the prior approval of the Management Shareholders and Holdings; provided, however, that such approval shall not be unreasonably withheld. 18.15. Scope of Representations and Warranties. Each representation and warranty contained herein or in any Collateral Document shall be enforceable according to the plain meaning of the provisions thereof, and the fact that a representation or warranty may deal with a particular matter in a general manner shall not limit the scope of any representation or warranty which deals with one aspect of the same matter in a specific manner. -86- 95 18.16. Counterparts. This Agreement may be executed in any number of counterparts and any party hereto may execute any such counterpart, each of which when executed and delivered shall be deemed to be an original and all of which counterparts taken together shall constitute but one and the same instrument. The execution of this Agreement by any party hereto will not become effective until counterparts hereof have been executed by all the parties hereto. It shall not be necessary in making proof of this Agreement or any counterpart hereof to produce or account for any of the other counterparts. 18.17. November 30, 1995 Agreement. The Majority Shareholders are parties to an agreement dated November 30, 1995 (the "11/30/95 Agreement") that anticipates the negotiation and closing of this Agreement. The Majority Shareholders by execution of this Agreement confirm: (i) the revised Percentage Interest of the Shareholders as contained herein, (ii) their approval of this Agreement in accordance with Paragraph 4 of the 11/30/95 Agreement, (iii) that at the Closing of this Agreement, Page Newman, Jr. is directed to deliver from escrow to each respective Majority Shareholder the releases referred to in Paragraph 6 of the 11/30/95 Agreement, (iv) that Kirkland's is authorized to pay from the funds received by it pursuant to Section 3.4 hereof to Robert Kirkland an additional Six Hundred Seventy-Five Thousand Dollars ($675,000), and in a corresponding manner to reduce the payments to Carl Kirkland, Robert Alderson, and Bruce Moore by Two Hundred Twenty-Five Thousand Dollars ($225,000) each, in satisfaction of the payment obligation in Paragraph 7 of the 11/30/95 Agreement, (v) that Kirkland's is authorized to pay from the funds received by it pursuant to Section 3.4 hereof to Robert Kirkland the expense reimbursement amounts provided for in Paragraph 8 of the 11/30/95 Agreement, and to reduce the payments to each of Carl Kirkland, Robert Kirkland, Robert Alderson and Bruce Moore by twenty-five percent (25%) of such reimbursement payment, and (vi) the consummation of the 11/30/95 Agreement as of the Closing of this Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement under seal on the date first above written. ATTEST: KIRKLAND HOLDINGS L.L.C. By: By: /s/ David M. Mussafer ---------------------------- --------------------------- Title Title: --------------------- [EXECUTIONS CONTINUED] -87- 96 ATTEST: KIRKLAND'S INC. By:/s/ Robert Alderson By: /s/ Carl Kirkland ------------------- ----------------- Title Title: President --------- [CORPORATE SEAL] WITNESS: By: /s/ Betsy Weiss /s/ Carl Kirkland ----------------------- ------------------------ CARL KIRKLAND WITNESS: By: /s/ Sharon Pulley /s/ Robert Kirkland ----------------- ------------------- ROBERT KIRKLAND WITNESS: /s/ Barbara Rowan /s/ Bruce Moore - ----------------------- --------------- BRUCE MOORE WITNESS: /s/ Betsy Weiss /s/ Robert Alderson - ----------------------- ------------------- ROBERT ALDERSON Corporate Name -------------- 101 Kirkland's of Carolina, Inc. 102 Kirkland's of Charlotte, Eastland Mall, Inc. 103 Kirkland's of Tennessee, Inc. 104 K. C. Corp. Inc. 107 Kirkland's of Greensboro, Four Seasons Mall, Inc. 109 Kirkland's of Fayetteville, Cross Creek Mall, Inc. 110 Kirkland's of Wilmington, Independence Mall, Inc. 111 Kirkland's III, Jackson-Metro Center, Inc. 114 Kirkland's of Memphis, Tennessee, Laurelwood Shopping Center, Inc. 115 Kirkland's of Ridgeland, Mississippi, Northpark Mall, Inc. 116 Kirkland's of Knoxville, East Towne Mall, Inc. -88- 97 # Corporate Name - -------------- 117 Kirkland's of Huntsville, Madison Square Mall, Inc. 118 Kirkland's of Valley View Mall, Roanoke, VA, Inc. 119 Kirkland's of Nashville, Hickory Hollow Mall, Inc. 120 Kirkland's of Birmingham, Riverchase Galleria, Inc. 122 Kirkland's of BriarCliffe Mall, Myrtle Beach, South Carolina, Inc. 123 Kirkland's of Pecanland Mall, Monroe, LA, Inc. 125 Kirkland's of Towne Center at Cobb, Atlanta, GA, Inc. 126 Kirkland's of Gwinnett Place, Atlanta, GA, Inc. 127 Kirkland's of Rivergate Mall, Nashville, TN, Inc. 128 Kirkland's of Peachtree Mall, Columbus, GA, Inc. 129 Kirkland's of Cumberland Mall, Atlanta, GA, Inc. 130 Kirkland's of Hamilton Place Mall, Chattanooga, TN, Inc. 131 Kirkland's of Houston Galleria, Houston, TX, Inc. 132 Kirkland's of Mall of Memphis, Memphis, TN, Inc. 134 Kirkland's of Woodland Hills Mall, Tulsa, OK, Inc. 135 Kirkland's of Dayton Mall, Dayton, OH, Inc. 136 Kirkland's of Oxmoor Center, Louisville, KY, Inc. 137 Kirkland's of South Square Mall, Durham, NC, Inc. 138 Kirkland's of Valley View Center, Dallas, TX, Inc. 139 Kirkland's of Chesterfield Towne Center, Richmond, VA, Inc. 140 Kirkland's of Park Plaza, Little Rock, AR, Inc. 141 Kirkland's of Montgomery Mall, Montgomery, AL, Inc. 142 Kirkland's of Southlake Mall, Atlanta, GA, Inc. 143 Kirkland's of Southpark Mall, Richmond, VA, Inc. 144 Kirkland's of Eastland Mall, Evansville, IN, Inc. 145 Kirkland's of Fayette Mall, Lexington, KY, Inc. 146 Kirkland's of Hickory Ridge Mall, Memphis, TN, Inc. 148 Kirkland's of Regency Square Mall, Jacksonville, FL, Inc. 149 Kirkland's of McCain Mall, Little Rock, AR, Inc. 150 Kirkland's of River Ridge Mall, Lynchburg, VA, Inc. 151 Kirkland's of Bel Air Mall, Mobile, AL, Inc. 152 Kirkland's of The Mall at Barnes Crossing, Tupelo, MS, Inc. 153 Kirkland's of Cortana Mall, Baton Rouge, LA, Inc. 154 Kirkland's of Bellevue Center, Nashville, TN, Inc. 155 Kirkland's of Tri-County Mall, Cincinnati, OH, Inc. 156 Kirkland's of The Mall of the Avenues, Jacksonville, FL, Inc. 157 Kirkland's of Eastwood Mall, Birmingham, AL, Inc. 158 Kirkland's of Lakeside Mall, New Orleans, LA, Inc. 159 Kirkland's of Carolina Place, Charlotte, N.C., Inc. 160 Kirkland's of Cary Village Mall, Raleigh, N.C., Inc. 161 Kirkland's of Cool Springs Galleria, Nashville, TN, Inc. 162 Kirkland's of Kenwood Towne Centre, Cincinnati, OH, Inc. 163 Kirkland's of St. Louis Galleria, St. Louis, MO, Inc. 164 Kirkland's of Wiregrass Commons Mall, Dothan, AL, Inc. 165 Kirkland's of Regency Mall, Richmond, VA, Inc. 166 Kirkland's of Florence, Florence, KY, Inc. 167 Kirkland's of Acadiana Mall, Lafayette, LA, Inc. -89- 98 # Corporate Name - -------------- 168 Kirkland's of Padre Staples Mall, Corpus Christi, TX, Inc. 169 Kirkland's of Belden Village, Canton, OH, Inc. 170 Kirkland's of West Oaks Mall, Houston, TX, Inc. 171 Kirkland's of Charleston Town Center, Charleston, W. VA, Inc. 172 Kirkland's of Crestwood Plaza, St. Louis, MO, Inc. 173 Kirkland's of White Marsh Mall, Baltimore, MD, Inc. 174 Kirkland's of Collin Creek Mall, Dallas, TX, Inc. 175 Kirkland's of Baybrook Mall, Houston, TX, Inc. 176 Kirkland's of Governor's Square Mall, Tallahassee, FL, Inc. 178 Kirkland's of Barton Creek Mall, Austin, TX, Inc. 179 Kirkland's of Highland Mall, Austin, TX, Inc. 180 Kirkland's of Battlefield Mall, Springfield, MO, Inc. 181 Kirkland's of Penn Square Mall, Oklahoma City, OK, Inc. 182 Kirkland's of Oak Park Mall, Kansas City, KS, Inc. 183 Kirkland's of Mall St. Vincent, Shreveport, LA, Inc. 184 Kirkland's of Owings Mills Mall, Baltimore, MD, Inc. 185 Kirkland's of Oakwood Center, New Orleans, LA, Inc. 186 Kirkland's of The Mall at Johnson City, Johnson City, TN, Inc. 187 Kirkland's of Glenbrook Mall, Ft. Wayne, IN, Inc. 188 Kirkland's of North Pointe Mall, Atlanta, GA, Inc. 189 Kirkland's of Northpark Mall, Joplin, MO, Inc. 190 Kirkland's of Orlando Fashion Square, Orlando, FL, Inc. 191 Kirkland's of The Mall at Fairfield Commons, Dayton, OH, Inc. 192 Kirkland's of St. Charles Towne Center, Waldorf, MD Inc. 193 Kirkland's of Regency Mall, Florence, AL, Inc. 194 Kirkland's of South Plains Mall, Lubbock, TX, Inc. 195 Kirkland's of The Parks at Arlington, Ft. Worth, TX, Inc. 196 Kirkland's of Parma Town Mall, Cleveland, OH, Inc. 197 Kirkland's of St. Clair Square, St. Louis, MO, Inc. 198 Kirkland's of Turtle Creek Mall, Hattiesburg, MS, Inc. 199 Kirkland's of The Woodlands, Houston, TX, Inc. 200 Kirkland's of Brandon Town Center, Tampa, FL, Inc. 201 Kirkland's of Memorial City Mall, Houston, TX, Inc. 202 Kirkland's of University Mall, Tuscaloosa, AL, Inc. 203 Kirkland's of Santa Rosa Mall, Fort Walton, FL, Inc. 204 Kirkland's of Panama City Mall, Panama City, FL, Inc. 205 Kirkland's of Town East Mall, Mesquite, TX, Inc. 206 Kirkland's of Kentucky Oaks Mall, Paducah, KY, Inc. 207 Kirkland's of Crabtree Valley Mall, Raleigh, N.C., Inc. 208 Kirkland's of Oak Hollow Mall, High Point, N.C., Inc. 209 Kirkland's of Fox Valley Mall, Chicago, IL, Inc. 210 Kirkland's of Hawthorne Mall, Chicago, IL, Inc. 211 Kirkland's of Stratford Square, Chicago, IL, Inc. 212 Kirkland's of Orland Square, Chicago, IL, Inc. 214 Kirkland's of Coastland Mall, Naples, FL, Inc. 215 Kirkland's of Edgewater Mall, Biloxi, MS, Inc. 216 Kirkland's of Town Center Plaza, Kansas City, KS, Inc. 217 Kirkland's of Castleton Square, Indianapolis, IN., Inc. -90- 99 218 Kirkland's of Cordova Mall, Pensacola, FL, Inc. 219 Kirkland's of University Park, South Bend, IN, Inc. 220 Kirkland's of Westgate Mall, Amarillo, TX, Inc. 221 Kirkland's of Westgate Mall, Spartanburg, SC, Inc. 222 Kirkland's of Meridian Mall, Lansing, MI, Inc. 223 Kirkland's of Cottonwood Mall, Albuquerque, NM, Inc. ATTEST: By:/s/ Robert S. Alderson By: /s/ Carl Kirkland ---------------------- ------------------ Title Title: President [CORPORATE SEAL] -91- EX-2.2 3 CONTRIBUTION, REDEMPTION AND PURCHASE AGMT.4-29-98 1 EXHIBIT 2.2 ================================================================ CONTRIBUTION, REDEMPTION AND PURCHASE AGREEMENT AMONG KIRKLAND'S, INC., KIRKLAND HOLDINGS L.L.C., MEMBERS OF KIRKLAND HOLDINGS L.L.C., THE WARRANTHOLDERS, THE ALLISON LEIGH ALDERSON TRUST THE AMY KATHERINE ALDERSON TRUST THE CARL T. KIRKLAND GRANTOR RETAINED ANNUITY TRUST 97-1 CARL KIRKLAND, ROBERT KIRKLAND, AND ROBERT ALDERSON DATED AS OF: APRIL 29, 1998 ================================================================ 2 TABLE OF CONTENTS Page ---- ARTICLE 1 - CHARTER AMENDMENT AND STOCK SPLIT............................. 4 1.1. Consent and Authorization................................. 4 1.2. Ratification.............................................. 4 1.3. Acknowledgment............................................ 4 1.4. Waiver of Notice.......................................... 4 ARTICLE 2 - CONTRIBUTION OF AFFILIATE SHARES AND EXCHANGE OF PREFERRED SHARES.............................................. 4 2.1. Contribution and Exchange................................. 4 2.2. Deliveries................................................ 5 ARTICLE 3 - EXERCISE OF WARRANTS AND CONSENT TO AMENDMENTS................ 5 3.1. Warrant Exercise. ....................................... 5 3.2. Exercise Price............................................ 5 3.3. Contribution of Affiliate Warrant Shares.................. 6 3.4. Deliveries................................................ 6 ARTICLE 4 - PURCHASE AND REDEMPTION OF CLASS C PREFERRED SHARES........... 6 4.1. Affiliate Shares Purchase. .............................. 6 4.2. Company Preferred Redemption.............................. 6 4.3. Payment................................................... 6 4.4. Deliveries................................................ 7 ARTICLE 5 - REPRESENTATIONS AND WARRANTIES OF THE SHAREHOLDERS, THE MEMBERS AND THE WARRANTHOLDERS............................ 7 5.1. Authority................................................. 7 5.2. Title; Third-Party Options................................ 8 5.3. No View to Distribution or Resale......................... 8 5.4. No Transfer Without Registration or Exemption............. 8 5.5. New Common Shares Are Not Registered...................... 8 5.6. Securities Legend......................................... 9 5.7. Investment Risk........................................... 9 5.8. Review of Company's Business and Records.................. 9 5.9. Opportunity to Question; Full Satisfaction................ 9 -i- 3 Page ---- 5.10. Review of Company's Registration Statement............... 10 5.11. Knowledge and Experience................................. 10 5.12. Accredited and Institutional Investor Status............. 10 5.13. No Reliance.............................................. 10 5.14. Definitions.............................................. 10 ARTICLE 6 - REPRESENTATIONS AND WARRANTIES OF THE COMPANY................ 11 6.1. Organization and Standing................................ 11 6.2. Authority................................................ 11 ARTICLE 7 - ORDER OF TRANSACTIONS........................................ 11 7.1. ......................................................... 11 ARTICLE 8 - MISCELLANEOUS................................................ 12 8.1. Consents................................................. 12 8.2. Failure to Deliver Shares................................ 12 8.3. Assignment and Binding Effect............................ 13 8.4. Waiver................................................... 13 8.5. Notices.................................................. 13 8.6. Delaware Law to Govern................................... 13 8.7. No Benefit to Others..................................... 13 8.8. Contents of Agreement.................................... 13 8.9. Cooperation.............................................. 14 8.10. Severability............................................. 14 EXHIBIT A - Members of Kirkland Holdings L.L.C. EXHIBIT B - The Warrantholders and Warrantholder Shares EXHIBIT C - Affiliates of Kirkland's, Inc. EXHIBIT D - Shareholder Ownership EXHIBIT E - Company Charter Schedule 4.12 - "Accredited Investor" Schedule 6.4 - Notices -ii- 4 CONTRIBUTION, REDEMPTION AND PURCHASE AGREEMENT This CONTRIBUTION, REDEMPTION AND PURCHASE AGREEMENT (the "Agreement") is dated as of this 29th day of April, 1998 and is by and among the following parties: KIRKLAND'S, INC., a Tennessee corporation (the "Company"); KIRKLAND HOLDINGS L.L.C., a Delaware limited liability company ("Holdings"), The MEMBERS of Holdings (the "Members") identified on Exhibit A attached hereto, being the holders of one hundred percent (100%) of the interests in Holdings' capital and profits; THE WARRANTHOLDERS (the "Warrantholders"), identified on Exhibit B attached hereto, THE ALLISON LEIGH ALDERSON TRUST (the "ALA Trust"), THE AMY KATHERINE ALDERSON TRUST (the "AKA Trust"), THE CARL T. KIRKLAND GRANTOR RETAINED ANNUITY TRUST 97-1 (the "Kirkland GRAT"), CARL KIRKLAND ("CK"), ROBERT KIRKLAND ("RK"), AND ROBERT ALDERSON ("RA," and together with Holdings, the ALA Trust, the AKA Trust, the Kirkland GRAT, CK, and RK, the "Shareholders") 5 WHEREAS, the Shareholders own all of the outstanding capital stock of the Company and the affiliated corporations (the "Affiliates") identified on Exhibit C hereto, such stock being owned in the amounts set forth on Exhibit D hereto; WHEREAS, the Warrantholders own warrants to acquire the amount of common capital stock of the Company and the Affiliates set forth opposite their names on Exhibit B hereto; WHEREAS, the Company and the Affiliates have filed with the Secretary of the State of Tennessee amendments (the "First Charter Amendment") to their charters (the "Company Charter" and the "Affiliate Charters," respectively) effecting, inter alia, changes in the voting rights, conversion rights, redemption rights, and liquidation preference, if any, of the Common Stock, Class A Preferred Stock, Class B Preferred Stock, and Class C Preferred Stock of the Company and the Affiliates; WHEREAS, the Company has approved further amendments (the "Second Charter Amendment") to the Company Charter authorizing blank check preferred stock, modifying certain corporate governance provisions of the Company, increasing the authorized Common Stock of the Company and effectuating a stock split of the Common Stock of the Company (the "Stock Split") pursuant to which each outstanding share of Common Stock of the Company will be split into a larger number (the "Split Number") of shares of Common Stock of the Company; WHEREAS, the Company intends to conduct an initial public offering of the Common Stock of the Company (the "IPO") on the terms set forth on a registration statement on Form S-1 (the "Registration Statement") to be filed with the United States Securities and Exchange Commission (the "SEC") on or about April 30, 1998, and the time at which such Registration Statement is declared effective by the SEC is herein referred to as the "Effective Time;" WHEREAS, effective upon the time (the "Price Determination") at which the pricing committee of the Company determines the price per share that the common stock of the Company will be offered to the public (the "IPO Price"), the parties hereto desire that the following steps be taken to reorganize the Company: 1. The Shareholders will contribute (the "Affiliate Preferred Contribution") 68,400 shares of Class A Preferred Stock of each of the Affiliates (the "Affiliate Class A Contribution Shares") and 23,700 shares of Class B Preferred Stock of each of the Affiliates (the "Affiliate Class B Contribution Shares"), constituting 100% of each such class of Preferred Stock in each of the Affiliates (collectively, the "Affiliate Preferred Shares") in exchange for newly issued shares of Common Stock of the Company (the "Contributed New Common Shares") having a value equal to the aggregate stated value of the Affiliate Preferred Shares plus the accrued dividends thereon; 2. The Company will recapitalize its outstanding shares of Class A and B Preferred Stock, pursuant to which the Shareholders will exchange (the "Company Preferred Exchange") 68,400 shares of the Class A Preferred Stock of the Company (the "Company -2- 6 Class A Shares") and 23,700 shares of the Class B Preferred Stock of the Company (the "Company Class B Shares," and together with the Company Class A Shares, the "Company Preferred Shares"), constituting 100% of each such class of Preferred Stock of the Company, into newly issued shares of common stock of the Company (the "Exchanged New Common Shares") having a value equal to the aggregate stated value of the Company Class A Shares and Company Class B Shares plus accrued dividend thereon; 3. The Shareholders will contribute (the "Affiliate Common Contribution") 92,100 shares of the common stock of each of the Affiliates (the "Affiliate Common Contribution Shares") to the Company for which no new shares of the Company's common stock shall be issued in light of the fact that the Shareholders own 92,100 shares of Common Stock of the Company in the same proportions as they own the Affiliate Common Contribution Shares. The Affiliate Preferred Contribution and the Affiliate Common Contribution are herein referred to collectively as the "Affiliate Shares Contribution;" 4. The Warrantholders will exercise (the "Warrant Exercise") all of their warrants and receive a number of shares of Common Stock of the Affiliates equal to 11,905 multiplied by the Split Number (the "Affiliate Warrant Shares") and a number of shares of Common Stock of the Company equal to 11,905 multiplied by the Split Number (the "Company Warrant Shares"), and the Warrantholders will contribute (the "Warrant Shares Contribution") their Affiliate Warrant Shares to the Company for which no new shares of the Company's Common Stock shall be issued in light of the fact that the Warrantholders own the Company Warrant Shares in the same proportions as they own the Affiliate Warrant Shares; and WHEREAS, effective simultaneously with and conditioned upon the closing (the "Closing") of the IPO, the parties agree that: 1. The Company will redeem (the "Company Shares Redemption") 17,122 shares of Class C Preferred Stock of the Company (the "Company Class C Shares"), constituting all of the outstanding shares of the Class C Preferred Stock of the Company for $524,542.06; 2. For an aggregate sum of $16,597,457.94, which amount represents the stated value of the shares of Class C Preferred Stock being purchased, the Company will purchase (the "Affiliate Shares Purchase") from the CK, RA and RK ("Class C Shareholders"), an aggregate of 17,122 shares of Class C Preferred Stock of each of the Affiliates having authorized Class C Preferred Stock (the "Affiliate Class C Shares"), such shares constituting 100% of the issued and outstanding Affiliate Class C Shares; WHEREAS, upon completion of the Affiliate Shares Purchase and the Affiliate Shares Contribution, all of the outstanding shares of capital stock of the Affiliates shall be owned by the Company and the Company shall be the parent corporation of the group of companies comprised of the Company and the Affiliates. -3- 7 NOW, THEREFORE, in consideration of the premises and the respective covenants, representations and warranties herein contained, and intending to be legally bound hereby, the parties hereto agree as follows: ARTICLE 1 CHARTER AMENDMENT AND STOCK SPLIT 1.1. Consent and Authorization. The Shareholders and Warrantholders hereby consent to and authorize, acknowledge and agree that the Company shall file the Second Charter Amendment prior to the Price Determination. 1.2. Ratification. The Shareholders and Warrantholders hereby ratify, confirm and consent to the First Charter Amendment. 1.3. Acknowledgment. The Warrantholders further acknowledge and agree that the execution of this Agreement satisfies the prior written consent requirements set forth in Section 7.02(k) of the Note and Warrant Purchase Agreement with respect to the First Charter Amendment and Second Charter Amendment. 1.4. Waiver of Notice. The parties hereto agree and acknowledge that the execution of this Agreement shall constitute a waiver of the requirements of giving or receiving any separate written notice under the terms of the Company Charter with respect to any of the transactions contemplated hereby. ARTICLE 2 CONTRIBUTION OF AFFILIATE SHARES AND EXCHANGE OF PREFERRED SHARES 2.1. Contribution and Exchange. Immediately upon the Price Determination, and without the requirement of any further authorization, the following transactions will occur: 2.1.1. The Shareholders will contribute to the Company the Affiliate Class A Contribution Shares in exchange for a number of fully paid and non-assessable Contributed New Common Shares having a value per share equal to the IPO Price and having an aggregate value equal to the aggregate stated value of the Affiliate Class A Contribution Shares plus accrued dividends thereon. 2.1.2. The Shareholders will contribute to the Company the Affiliate Class B Contribution Shares in exchange for a number of fully paid and non-assessable Contributed New Common Shares having a value per share equal to the IPO Price and having an aggregate value equal to the aggregate stated value of the Affiliate Class B Contribution Shares plus accrued dividends thereon. -4- 8 2.1.3. The Company will recapitalize the Company Class A Shares and Company Class B Shares into shares of Common Stock of the Company. Pursuant to such recapitalization, (i) Holdings will exchange the Company Class A Shares for a number of fully paid and non-assessable Exchanged New Common Shares having a value per share equal to the IPO Price and having an aggregate value equal to the aggregate stated value of the Company Class A Shares exchanged, plus accrued dividends thereon, and (ii) the Class C Shareholders will exchange the Company Class B Shares for a number of fully paid and non-assessable Exchanged New Common Shares having a value per share equal to the IPO Price and having an aggregate value equal to the aggregate stated value of the Company Class B Shares exchanged, plus accrued dividends thereon. 2.1.4. The Shareholders will contribute the Affiliate Common Contribution Shares to the Company as a contribution to the capital to the Company for which no new shares of Common Stock of the Company will be issued. 2.2. Deliveries. The Shareholders will deliver to the Company, and the Company will accept from the Shareholders, the stock certificates representing the Affiliate Preferred Shares, the Company Preferred Shares and the Affiliate Common Contribution Shares duly endorsed or accompanied by appropriate stock powers. The Company will deliver to the Shareholders, and the Shareholders will accept immediately prior to the Closing, stock certificates representing Contributed New Common Shares and Exchanged New Common Shares received upon the Affiliate Preferred Contribution and the Company Preferred Exchange pursuant to this Article 2. ARTICLE 3 EXERCISE OF WARRANTS AND CONSENT TO AMENDMENTS 3.1. Warrant Exercise. Immediately following the transactions set forth in Article 2 hereof and immediately upon the Price Determination, the Warrantholders will exercise all of the outstanding Common Stock Purchase Warrants identified on Exhibit B hereto (the "Warrants") to purchase the Affiliate Warrant Shares and Company Warrant Shares, such aggregate number to be purchased by the individual Warrantholders in the proportions more particularly set forth in Exhibit B attached hereto. 3.2. Exercise Price. The Warrantholders hereby authorize and direct the Company and the Affiliates to apply a portion of the amount payable by the Company and the Affiliates as of the date of Closing under the Senior Subordinated Notes (the "Notes"), as described in Section 1.3 of the Warrants, in payment of the exercise price of the Warrants. The Warrantholders and the Company agree that the exercise price payable for the Company Warrant Shares upon exercise of Warrants issued by the Company will be paid through the surrender of a portion of the amount payable by the Company under the Notes. 3.3. Contribution of Affiliate Warrant Shares. The Warrantholders will contribute to the Company, simultaneously with the transactions set forth in Article 2 hereof, and the Company will receive from the Warrantholders all of the Affiliate Warrant Shares issued upon the exercise of -5- 9 the Warrants as set forth in this Article 3, as a contribution to the capital of the Company for which no additional shares of Common Stock of the Company will be issued. 3.4. Deliveries. The Warrantholders will deliver to the Company, and the Company will accept from the Warrantholders, the stock certificates representing the Affiliate Warrant Shares, duly endorsed or accompanied by appropriate stock powers. ARTICLE 4 PURCHASE AND REDEMPTION OF CLASS C PREFERRED SHARES 4.1. Affiliate Shares Purchase. Effective simultaneously with and conditioned upon the occurrence of the Closing, the Company will purchase from the Class C Shareholders, and such Shareholders will sell to the Company, the Affiliate Class C Shares for the aggregate sum of $16,597,457.94, allocated among the Affiliates in proportion to the aggregate stated value of the issued and outstanding shares of Class C Preferred Stock of each Affiliate owned of record by such Shareholders. No such Shareholder shall be obligated to sell more Affiliate Class C Shares to the Company pursuant to this Section 4.1 than the number of such Shares to which such Shareholder has record ownership. 4.2. Company Preferred Redemption. Effective simultaneously with and conditioned upon the occurrence of the Closing, the Company will redeem from the Class C Shareholders, all outstanding Company Class C Shares, and each holder of shares of Company Class C Shares will receive from the proceeds of the IPO a redemption payment in cash equal to $30.64 per share of Class C Preferred Stock so redeemed for an aggregate payment to such Shareholders of $524,542.06 pursuant to this Section 4.2. 4.3. Payment. The Company will pay to the Class C Shareholders at the Closing, the aggregate amount of $16,597,457.94 pursuant to the Affiliate Shares Purchase set forth in Section 4.1 hereof by wire transfer of immediately available federal funds to such account or accounts of the Class C Shareholders as are designated by them prior to the Closing. The Company will pay to the Class C Shareholders at the Closing, an aggregate amount of $524,542.06 pursuant to the Company Shares Redemption set forth in Section 4.2 hereof by wire transfer of immediately available federal funds to such account or accounts of the Class C Shareholders as are designated by them prior to the Closing. Each such aggregate payment shall be divided among the Class C Shareholders in proportion to the number of shares of Class C Preferred Stock owned of record by each Class C Shareholder. 4.4. Deliveries. Upon confirmation of the transmission of the wire transfers contemplated by Section 4.3 hereof, the Class C Shareholders will deliver to the Company, and the Company will accept from the Class C Shareholders, the stock certificates representing the Affiliate Class C Shares and the Company Class C Shares, duly endorsed or accompanied by appropriate stock powers. -6- 10 ARTICLE 5 REPRESENTATIONS AND WARRANTIES OF THE SHAREHOLDERS, THE MEMBERS AND THE WARRANTHOLDERS Each of the Shareholders, the Members and the Warrantholders, severally and not jointly, hereby represents, warrants, covenants, agrees and acknowledges to the Company and to each of the other Shareholders, Members, and Warrantholders the following to be true and correct in all respects as to himself of itself: 5.1. Authority. The Shareholder, Member or Warrantholder has full power and authority to execute and deliver this Agreement and the other instruments to be executed and delivered by it pursuant hereto and to consummate the transactions contemplated hereby. This Agreement has been duly executed and delivered by the Shareholder, Member or Warrantholder and constitutes the legal, valid and binding obligations of the Shareholder, Member or Warrantholder enforceable in accordance with its terms, except as enforcement may be limited by insolvency, bankruptcy, moratorium or other laws affecting creditors' rights generally and except as enforcement may be limited by principles of equity. The execution and delivery by the Shareholder, Member or Warrantholder of this Agreement and the consummation by the Shareholder, Member or Warrantholder of the transactions contemplated hereby will not violate any law or any judgment, decree, award or order of any court or other federal, state or local department, official, commission, authority, board, bureau, agency or other public body, domestic or foreign ("Governmental Entity") to which the Shareholder, Member or Warrantholder is subject. No approval, authorization, consent or other order or action of or filing with any Governmental Entity or any other individual or entity is required for the execution and delivery by the Shareholder, Member or Warrantholder of this Agreement or such other agreements and instruments or the consummation by Shareholder, Member or Warrantholder of the transactions contemplated hereby or thereby. 5.2. Title; Third-Party Options. There are no contracts, options, commitments or rights of any kind, by or through the Shareholder, Member or Warrantholder, with, to or in any third party to acquire all or any portion of the Affiliate Preferred Shares, Affiliate Common Contribution Shares, Affiliate Warrant Shares, Company Preferred Shares, or the Company Warrant Shares and the Shareholder, Member or Warrantholder has good title to such shares and owns such shares free and clear of any claim, mortgage, assignment, conditional sale, lease, easement, consignment, bailment, contingent interest, pledge, lien, option, charge, security interest, preemptive right, encumbrance or other restrictions of any kind or nature whatsoever (a "Lien"), but not a restriction imposed by the Securities Act or any other securities laws other than restrictions imposed by contracts which, by the terms thereof, will lapse upon the consummation of the IPO. 5.3. No View to Distribution or Resale. The Shareholder will acquire the Contributed New Common Shares and the Exchanged New Common Shares solely for his or its own account without a view to the distribution or resale thereof, and does not have any contract, undertaking, agreement or arrangement to sell or otherwise transfer or dispose of any of such shares in any manner to any person except as contemplated by this Agreement. -7- 11 5.4. No Transfer Without Registration or Exemption. The Shareholder or Warrantholder will not, except as contemplated by this Agreement, sell, transfer or otherwise dispose of any of its Contributed New Common Shares, Converted New Common Shares, or its Company Warrant Shares (such shares collectively, the "New Common Shares") or the Affiliate Warrant Shares, respectively, in any manner, unless at the time of any such transfer: a Registration (as hereafter defined) under the Securities Act (as hereafter defined) and under the Applicable Laws (as hereafter defined) is in effect with respect to the New Common Shares or Affiliate Warrant Shares to be sold, transferred or disposed of, and the Shareholder or Warrantholder complies with all of the requirements of the Securities Act and the Applicable Laws with respect to the proposed transaction; or the Shareholder has obtained and has provided to the Company an opinion from counsel satisfactory to the Company (as to both the counsel rendering such opinion and the substance of the opinion) that the proposed sale, transfer or disposition does not require Registration under the Securities Act or the Applicable Laws. 5.5. New Common Shares Are Not Registered. The New Common Shares issuable by the Company pursuant to this Agreement have not been sold to the Shareholders or the Warrantholders by the Company pursuant to a Registration under the Securities Act. Except as may otherwise be provided in the registration rights agreement dated as of June 12, 1996, (i) any subsequent Registration under the Applicable Laws will not authorize sales, transfers or dispositions of any New Common Shares so issued by any Shareholder, and (ii) neither the Company nor any other person has any obligation or intention to effect the Registration of the such New Common Shares for sale, transfer or disposition by the Shareholder, the Member or the Warrantholder under the Securities Act or the Applicable Laws, or to take any action or provide any information (including, without limitation, the filing of reports or the publication of information required by Rule 144 under the Securities Act) which would make available any exemption from the Registration requirements of the Securities Act or the Applicable Laws. The Shareholders and Warrantholders must therefore hold their New Common Shares indefinitely except as contemplated by this Agreement, and unless a subsequent Registration or exemption therefrom is available and is obtained. No federal or state agency has reviewed the transactions set forth in this Agreement or approved or disapproved the New Common Shares for investment or any other purpose. All of the New Common Shares have been issued and sold to the Shareholders or Warrantholders, respectively, in reliance upon a specific exemption from the Registration requirement of the Securities Act which depends, in part, upon the accuracy of the representations, warranties, covenants, acknowledgments and agreements of the Shareholders, Members and Warrantholders set forth in this Agreement. 5.6. Securities Legend. A legend will be placed on the certificates evidencing all New Common Shares and stop-transfer instructions will be issued to any transfer agent with respect to such New Common Shares, to ensure compliance with the provisions of this Agreement and of the Securities Act and the Applicable Laws. 5.7. Investment Risk. The Shareholder, the Member or Warrantholder can bear the economic risk of his or its acquisition and ownership of their New Common Shares, including the total loss of his or its investment, has no need for liquidity in this investment and, either individually or with his or its advisers, has such knowledge and experience in financial and business matters that -8- 12 he or it is capable of evaluating the merits and risks of the Company and the investment in his or its New Common Shares. 5.8. Review of Company's Business and Records. Prior to the execution of this Agreement, the Shareholder, Member or Warrantholder and his or its advisers have been provided with full and free access and opportunity to inspect, review, examine and inquire about all books, records and information (financial or otherwise) of the Company its business and affairs, and the Shareholder, Member or Warrantholder and his or its advisers have made such inspection, review, examination and inquiry as they have deemed appropriate; and the Shareholder, Member or Warrantholder and his or its advisers have been offered the opportunity to ask such questions and obtain such additional information concerning the Company and its business and affairs as each Shareholder, Member or Warrantholder and his or its advisers have requested so as to understand the nature of the investment in the New Common Shares (including the Company Warrant Shares) and to verify the accuracy of the information obtained as a result of their investigation. 5.9. Opportunity to Question; Full Satisfaction. The Shareholder, Member or Warrantholder and their advisers, if any, have had a reasonable opportunity to ask questions of and receive answers from a person or persons acting on behalf of the Company concerning the New Common Shares and all such questions have been answered to the full satisfaction of the Shareholder, Member or Warrantholder and his or its advisers, if any. 5.10. Review of Company's Registration Statement. The Shareholder, Member or Warrantholder has received a draft of the Company's Registration Statement on Form S-1 and all other documents requested by the Shareholder, Member or Warrantholder have been carefully reviewed by him or it and he or it understands the information contained therein. 5.11. Knowledge and Experience. The Shareholder, Member or Warrantholder or his or its representatives, as the case may be, together with his or its advisers, have such knowledge and experience in financial, tax, and business matters, and, in particular, investments in securities, so as to enable them to utilize the information made available to them in connection with the New Common Shares to evaluate the merits and risks of an investment in the New Common Shares and to make an informed investment decision with respect thereto; 5.12. Accredited and Institutional Investor Status. The Shareholder, Member or Warrantholder is at least one of the following: (i) an "accredited investor," as such term is defined under Regulation D under the Securities Act and as set forth on Schedule 4.12 attached hereto, or (ii) a "financial institution or institutional investor" or a "financial institution or institutional buyer" as such terms are used in the state securities law in the state of organization of such Shareholder, Member or Warrantholder. 5.13. No Reliance. The Shareholder, Member or Warrantholder is not relying on the Company or any of its employees or agents with respect to the legal, tax, economic and related considerations of an investment in the New Common Shares, and the Shareholder, Member or -9- 13 Warrantholder has relied on the advice of, or have consulted with, only his or its own advisers with respect to such matters. 5.14. Definitions. As used herein: the term "Registration" means registration under the Securities Act and, with respect to the Applicable Laws, such registration thereunder (or, with respect to any of the Applicable Laws which do not provide for registration, such compliance therewith which is similar to registration) which has then resulted in statutory or administration authorization for the proposed transaction; the term "Securities Act" means the Securities Act of 1933, as amended, and the rules and regulations thereunder; and the term "Applicable Laws" means any applicable state securities laws and, to the extent applicable to offers or sales of securities, the Securities Exchange Act of 1934, as amended, and the rules and regulations under the foregoing. ARTICLE 6 REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company represents and warrants to the Shareholders and the Members the following to be true and correct in all respects: 6.1. Organization and Standing. The Company is a corporation duly organized, validly existing and in good standing under the laws of Tennessee, with full corporate power and authority to own, lease and operate its respective properties and assets and to carry on its respective business and operations. 6.2. Authority. The Company has full corporate power and authority to execute and deliver this Agreement and to consummate the transactions contemplated hereby. All corporate acts and other proceedings required to be taken by or on the part of the Company to authorize the Company to execute, deliver and perform this Agreement have been duly and properly taken. This Agreement has been duly executed and delivered by the Company and constitutes the legal, valid and binding obligation of Company, enforceable in accordance with its terms except as enforcement may be limited by insolvency, bankruptcy, moratorium or other laws affecting creditors' rights generally and except as enforcement may be limited by principles of equity. The execution and delivery by the Company of this Agreement and the consummation by the Company of the transactions contemplated hereby will not violate any law or any judgment, decree, award or order of any court or other Governmental Entity to which the Company is subject, and will not conflict with the Charter or Bylaws of the Company, nor will it conflict with, or be prohibited, limited or restricted in any way by the documents executed and delivered by the Company in connection with the transactions contemplated hereby. No approval, authorization, consent or other order or action of or filing with any Governmental Entity or any other individual or entity is required for the execution and delivery by the Company of this Agreement or such other agreements and instruments or the consummation by the Company of the transactions contemplated hereby. -10- 14 ARTICLE 7 ORDER OF TRANSACTIONS 7.1. The parties agree that for all purposes, the transactions contemplated by this Agreement shall be deemed to occur in the following order: (1) the Stock Split in connection with the Second Step Amendments pursuant to which the Company will make all adjustments to the price per share and number of shares issuable upon the exercise of outstanding options and warrants as a result of the Stock Split; (2) the Price Determination; (3) the Affiliate Preferred Contribution as set forth in Section 2.1.1 and Section 2.1.2 hereof; (4) the Company Preferred Exchange as set forth in Section 2.1.3 hereof; (5) the Affiliate Common Contribution as set forth in Section 2.1.4 hereof; (6) the Warrant Exercise as set forth in Section 3.1 hereof; (7) the Warrant Shares Contribution as set forth in Section 3.3 hereof; (8) the Effective Time of the Registration Statement; (9) the Affiliate Shares Purchase as set forth in Section 4.1 hereof; and (10) the Company Preferred Redemption as set forth in Section 4.3 hereof. ARTICLE 8 MISCELLANEOUS 8.1. Consents. The execution of this Agreement by the Company, Shareholders, Members and Warrantholders shall constitute consent of all such parties to the Affiliate Preferred Contribution, the Company Preferred Exchange, the Affiliate Common Contribution , the Warrant Exercise, the Warrant Shares Contribution, Company Shares Redemption and Affiliate Shares Purchase, to the extent such consent is required under the terms of the Company Charter or any agreement to which the Company and/or any such Shareholder, Member or Warrantholder is a party. 8.2. Failure to Deliver Shares. If a Shareholder or Warrantholder (the "Transferring Holder") becomes obligated to transfer any Affiliate Class A Contribution Shares, Affiliate Class B Contribution Shares, Affiliate Common Contribution Shares, Company Class A -11- 15 Shares, Company Class B Shares, Warrant Shares, Company Class C Shares or Affiliate Class C Shares (any or all thereof being referred to in this Section 8.2 as the "Shares") to the Company pursuant to any part of this Agreement and fails to deliver such Shares in accordance with the terms of this Agreement, the Company may, at its option, in addition to all other remedies it may have, either (i) send to the Transferring Holder the purchase price for such Shares or the stock certificate for Contribution New Common Shares of Exchanged New Common Shares relating thereto as is herein specified, or (ii) deposit such amount or the Contribution New Common Shares or Exchanged New Common Shares relating thereto with a trustee or escrow agent for the benefit of the Transferring Holder for release upon delivery of such Shares to the trustee or escrow agent in accordance with the terms of this Agreement. Thereupon, the Company, without written notice to the Transferring Holder, shall cancel on its books the certificate or certificates representing the Shares so required to be transferred by the Transferring Holder. The Transferring Holder failing to deliver Shares in accordance with this Agreement shall reimburse the Company for any legal or other expenses reasonably incurred by the Company in connection with the enforcement of obligations under this Agreement or utilizing the remedies set forth in this Section 8.2. All of the Transferring Holder's rights in and to such Shares shall terminate as of the Closing. 8.3. Assignment and Binding Effect. This Agreement may not be assigned by any party hereto without the prior written consent of the other parties. Subject to the foregoing, all of the terms and provisions of this Agreement shall be binding upon and inure to the benefit of and be enforceable by the successors and assigns of the parties. 8.4. Waiver. Any term or provision of this Agreement may be waived at any time by the party entitled to the benefit thereof by a written instrument executed by such party. 8.5. Notices. Any notice, request, demand, waiver, consent, approval or other communication which is required or permitted hereunder shall be in writing and shall be deemed given only if delivered personally (to the attention of the person identified) to the address set forth in Schedule 7.4 attached hereto, or sent by telecopy, telegram or by certified mail, postage prepaid, or to such other address as the addressee may have specified in a notice duly given to the sender and to counsel as provided herein. Such notice, request, demand, waiver, consent, approval or other communication will be deemed to have been given as of the date so delivered or telegraphed or, if mailed, three business days after the date so mailed. 8.6. Delaware Law to Govern. This Agreement shall be governed by and interpreted and enforced in accordance with the substantive laws of the State of Delaware without regard to the conflicts of law doctrine thereof. 8.7. No Benefit to Others. The representations, warranties, covenants and agreements contained in this Agreement are for the sole benefit of the parties hereto and their heirs, executors, legal representatives, successors and assigns, and they shall not be construed as conferring and are not intended to confer any rights on any other persons. -12- 16 8.8. Contents of Agreement. This Agreement together with any documents referred to herein set forth the entire agreement of the parties hereto and supersede any prior agreement or understanding of the parties with respect to the transactions contemplated hereby. This Agreement may not be amended except by an instrument in writing signed by the parties hereto, and no claimed amendment, modification, termination or waiver shall be binding unless in writing and signed by the party against whom or which such claimed amendment, modification, termination or waiver is sought to be enforced. 8.9. Cooperation. Subject to the provisions hereof, the parties hereto shall use their best efforts to take, or cause to be taken, such action, to execute and deliver, or cause to be executed and delivered, such additional documents and instruments and to do, or cause to be done, all things necessary, proper or advisable under the provisions of this Agreement and under applicable law, both before and after the date hereof, to consummate and make effective the transactions contemplated by this Agreement. 8.10. Severability. Any provision of this Agreement which is invalid or unenforceable in any jurisdiction shall be ineffective to the extent of such invalidity or unenforceability without invalidating or rendering unenforceable the remaining provisions hereof, and any such invalidity or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. IN WITNESS WHEREOF, the parties hereto have duly executed this Contribution Agreement as of the date first written above. KIRKLAND'S, INC. By: /s/ Carl Kirkland ------------------------------------ Name: Chief Executive Officer Title: President /s/ Carl Kirkland ---------------------------------------- Carl Kirkland /s/ Robert E. Kirkland ---------------------------------------- Robert E. Kirkland -13- 17 /s/ Robert Alderson ---------------------------------- Robert Alderson AMY KATHERINE ALDERSON TRUST, by Carl Kirkland, its trustee /s/ Carl Kirkland ---------------------------------- ALLISON LEIGH ALDERSON TRUST, by Carl Kirkland, its trustee /s/ Carl Kirkland ---------------------------------- CARL T. KIRKLAND GRANTOR RETAINED ANNUITY TRUST 97-1, by Robert Alderson, its trustee /s/ Robert Alderson ---------------------------------- KIRKLAND HOLDINGS L.L.C. By: /s/ David M. Mussafer ------------------------------------ Name: David M. Mussafer Title: ADVENT DIRECT INVESTMENT PROGRAM LIMITED PARTNERSHIP, by Advent International Corporation, its General Partner By: /s/ David M. Mussafer ------------------------------------ Name: David M. Mussafer Title: -14- 18 GLOBAL PRIVATE EQUITY II LIMITED PARTNERSHIP, by Advent International Corporation, its General Partner By: /s/ David M. Mussafer ------------------------------------ Name: David M. Mussafer Title: ADVENT PARTNERS LIMITED PARTNERSHIP, by Advent International Corporation, its General Partner By: /s/ David M. Mussafer ------------------------------------ Name: David M. Mussafer Title: SSM/KIRKLAND EQUITY PARTNERS, L.P., by SSM Venture Partners, L.P., by SSM I, L.P., its general partner, by SSM Corporation, its general partner By: /s/ R. Wilson Orr, III ------------------------------------ Name: R. Wilson Orr, III Title: CT/KIRKLAND EQUITY PARTNERS, L.P., by Kirk Holdings Ltd., its general partner By: /s/ John P. Oswald ------------------------------------ Name: John P. Oswald Title: TCW/KIRKLAND EQUITY PARTNERS, L.P., by Crescent/Mach I Partners, L.P., by TCW Asset Management Company, its investment manager By: /s/ Justin Driscoll ------------------------------------ Name: Justin Driscoll Title: -15- 19 MARLBOROUGH/KIRKLAND EQUITY PARTNERS, L.P., by The Marlborough Capital Investment Fund, L.P., its general partner, by Marlborough Capital Management, L.P., its general partner By: /s/ Margaret Lanoix --------------------------------------------- Name: Margaret Lanoix Title: R-H CAPITAL PARTNERS, L.P., by R-H/Travelers, L.P., its general partner, by R-H Capital, Inc., its general partner By: /s/ Kenneth Millar --------------------------------------------- Name: Kenneth Millar Title: CAPITAL RESOURCE LENDERS II, L.P., by Capital Resource Partners II, its general partner By: /s/ Alexander McGrath --------------------------------------------- Name: Alexander McGrath Title: ALLIED CAPITAL CORPORATION By: /s/ Gaye Truscott --------------------------------------------- Name: Gaye Truscott Title: THE MARLBOROUGH CAPITAL INVESTMENT FUND, L.P., by Marlborough Capital Management L.P., its general partner By: /s/ Margaret Lanoix --------------------------------------------- Name: Margaret Lanoix Title: -16- 20 CAPITAL TRUST INVESTMENTS, LTD., By: /s/ John P. Oswald --------------------------------------------- Name: John P. Oswald Title: -17- 21 EXHIBIT A Members of Kirkland Holdings L.L.C. Advent Direct Investment Program Limited Partnership Global Private Equity II Limited Partnership Advent Partners Limited Partnership SSM/Kirkland Equity Partners, L.P. CT/Kirkland Equity Partners, L.P. TCW/Kirkland Equity Partners, L.P. Marlborough/Kirkland Equity Partners, L.P. R-H Capital Partners, L.P. A-1 22 EXHIBIT B The Warrantholders and Warrantholder Shares
Affiliate Common Stock Warrant Company Purchase Warrantholders Shares(1) Warrant Shares(2) Warrant No. - -------------- --------- ----------------- ------------ Capital Trust Investments, Ltd. 1,071 1,071 PW-1 The Marlborough Capital 2,262 2,262 PW-2 Investment Fund, L.P. Allied Capital Corporation(3) 3,810 3,810 PW-3,PW-4 Capital Resource Lenders II, L.P. 4,762 4,762 PW-5
- ------------------- (1)These number of shares will be increased and the exercise price adjusted as a result of the Stock Split. (2)These number of shares will be increased and the exercise price adjusted as a result of the Stock Split. (3)Allied Capital Corporation II ("Allied II") has merged into Allied Capital Corporation ("Allied") and the warrants originally held by Allied II are now held by Allied in addition to the warrants originally held by Allied. B-1 23 EXHIBIT C Affiliates of Kirkland's, Inc.(4) [List of the Affiliates: Attach current list of Kirkland's companies] - ------------------- (4)Any corporations formed after the date of this Agreement to own and operate a Kirkland's store the shares of which are owned by any of the Shareholders shall be deemed to be included in this list of Affiliates for all purposes of this Agreement. C-1 24 EXHIBIT D Shareholder Ownership Group A and Group B Companies
Class A Class B Class C Common Preferred Preferred Preferred Shareholders Stock(5) Stock Stock Stock - ------------ -------- --------- --------- --------- Kirkland Holdings L.L.C. 68,400 68,400 0 0 Carl Kirkland 0 0 7,900 7,917 Robert Kirkland 7,900 0 7,900 7,544 Robert Alderson 5,900 0 7,900 2,878 The Carl T. Kirkland Grantor 7,900 0 0 0 Retained Annuity Trust 97-1, Robert Alderson, Trustee The Allison Leigh Alderson Trust, 1,000 0 0 0 Carl Kirkland, Trustee The Amy Katherine Alderson Trust, 1,000 0 0 0 Carl Kirkland, Trustee
- -------------- (5)The number of shares of Common Stock will be increased as result of the Stock Split. D-1 25 Group C and Group D Companies
Class A Class B Shareholders Common Stock(6) Preferred Stock Preferred Stock - ------------ --------------- --------------- --------------- Kirkland Holdings L.L.C. 68,400 68,400 0 Carl Kirkland 0 0 7,900 Robert Kirkland 7,900 0 7,900 Robert Alderson 5,900 0 7,900 The Carl T. Kirkland Grantor 7,900 0 0 Retained Annuity Trust 97-1, Robert Alderson, Trustee The Allison Leigh Alderson Trust, 1,000 0 0 Carl Kirkland, Trustee The Amy Katherine Alderson Trust, 1,000 0 0 Carl Kirkland, Trustee
Group E Companies Shareholders Common Stock(7) - ------------ --------------- Kirkland Holdings L.L.C. 684 Robert Kirkland 79 Robert Alderson 59 The Carl T. Kirkland Grantor Retained 79 Annuity Trust 97-1, Robert Alderson, Trustee The Allison Leigh Alderson Trust, Carl 10 Kirkland, Trustee The Amy Katherine Alderson Trust, Carl 10 Kirkland, Trustee - ---------------- (6)The number of shares of Common Stock will be increased as a result of the Stock Split. (7)The number of shares of Common Stock will be increased as a result of the Stock Split. D-2 26 D-3 27 EXHIBIT E Company Charter E-1 28 Schedule 4.12 "Accredited Investor" A Shareholder which meets any one of the following definitions will constitute an accredited investor as defined in Rule 501(a) of Regulation D adopted under the Securities Act: 1. Any director or executive officer of the Company; 2. A natural person whose individual net worth, or joint net worth with that person's spouse, at the time of his purchase exceeds $1,000,000; 3. A natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year; 4. A bank as defined in Section 3(a)(2) of the Act or any savings and loan association or other institution as defined in Section 3(a)(5)(A) of the Act whether acting in its individual or fiduciary capacity; any broker dealer registered pursuant to Section 15 of the Securities Exchange Act of 1934; any insurance company as defined in Section 2(13) of the Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in Section 2(a)(48) of that act; any Small Business Investment Company licensed by the U.S. Small Business Administration under Section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974, if the investment decision is made by a plan fiduciary, as defined in Section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors; 5. A private business development company as defined in Section 202(a)(22) of the Investment Advisers Act of 1940; 6. An organization described in Section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000; 29 7. A trust with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a person who has such knowledge and experience in financial and business matters that he or it is capable of evaluating the merits and risks of an investment or prospective investment in the Company; and 8. Any entity in which all of the equity owners are accredited investors. 30 Schedule 8.4 Notices If to the Company, to: Kirkland's, Inc. 805 North Parkway, P.O. Box 7222 Jackson, TN 38305 Attention: Carl Kirkland Telecopy No.: (901) 664-9345 With a copy to: Pepper Hamilton LP 3000 Two Logan Square 18th and Arch Streets Philadelphia, PA 19103-2799 Attention: Julia D. Corelli, Esquire Telecopy No.: (215) 981-4750 If to Holdings or to the Members, to: Kirkland Holdings L.L.C. 101 Federal Street Boston, MA 02110 Attention: David M. Mussafer Telecopy No.: (617) 951-0566 If to the Warrantholders, care of: Capital Resource Lenders II, L.P. 85 Merrimac Street Suite 200 Boston, MA 02114 Attention: Alexander S. McGrath Telecopy No.: (617) 723-9819 31 With a copy to: Testa Hurwitz & Thibeault 125 High Street Boston, MA 02110 Attention: Kevin Barry, Esquire Telecopy No.: If to Carl Kirkland, Robert Alderson, the Allison Leigh Alderson Trust, the Amy Katherine Alderson Trust, and the Carl T. Kirkland Grantor Retained Annuity Trust 97-1, care of: Kirkland's Inc. 805 North Parkway, P.O. Box 7222 Jackson, TN 38305 Attention: Carl Kirkland Telecopy No.: (901) 664-9345 With a copy to: Baker, Donelson, Bearman & Caldwell 20th Floor 2000 First Tennessee Building 165 Madison Avenue Memphis, TN 38103 Attention: Robert Walker, Esquire Telecopy No.: (901) 577-2303 If to Robert Kirkland, to: CBK, Ltd. 600 East Sherwood Union City, TN 38261 Attention: Robert Kirkland Telecopy No.: (901) 885-3857 EX-3.1 4 AMENDED AND RESTATED CHARTER OF KIRKLAND'S, INC. 1 EXHIBIT 3.1 AMENDED AND RESTATED CHARTER OF KIRKLAND'S, INC. This Amended and Restated Charter of Kirkland's, Inc., (the "Corporation") shall be effective as of 12:01 A.M. on April 27, 1998 (the "Effective Time"). The undersigned corporation hereby adopts the following amended and restated charter pursuant to Section 48-20-107 of the Tennessee Business Corporation Act: 1. Name. The name of the Corporation is Kirkland's, Inc. 2. Registered Office and Agent. The Corporation's registered office is located at 805 North Parkway, Jackson, Madison County, Tennessee 38305. The Corporation's registered agent at that office is Robert E. Alderson. 3. Principal Office. The principal office of the Corporation is located at 805 North Parkway, Jackson, Madison County, Tennessee 38305. 4. Authorized Shares. The total number of shares of all classes of stock which the Corporation shall have authority to issue is Six Hundred Twenty Thousand (620,000), of which Five Hundred Thousand (500,000) shares shall constitute a separate class of shares known as Common Stock, which shall be without par value (the "Common Stock"), and the remaining One Hundred Twenty Thousand (120,000) shares shall constitute a single class of shares known as Preferred Stock (the "Preferred Stock"). The Corporation is authorized to issue (i) Five Hundred Thousand (500,000) shares designated as Common Stock, which shall be without par value (the "Common Stock"), (ii) Sixty-Eight Thousand Four Hundred (68,400) shares designated as a series of Preferred Stock referred to as Class A Preferred Stock, which shall be without par value (the "Class A Preferred Stock"), (iii) Thirty-One Thousand Six Hundred (31,600) shares designated as a series of Preferred Stock referred to as Class B Preferred Stock, which shall be without par value (the "Class B Preferred Stock"), and (iv) Twenty Thousand (20,000) shares designated as a series of Preferred Stock referred to as Class C Preferred Stock, which shall be without par value (the "Class C Preferred Stock"). 5. Common Stock. The express terms and conditions of the shares classified and designated as Common Stock are as follows: 5.1. Voting Rights of Common Stock. Each share of Common Stock shall entitle the holder thereof to one vote, in person or by proxy, upon each question or matter submitted generally to the holders of the Common Stock of the Corporation and shall have all voting rights accorded to holders of Common Stock pursuant to the Tennessee Business Corporation Act. 2 5.2. Liquidation. On dissolution, liquidation or winding up of the Corporation, voluntarily or involuntarily (a "Liquidation"), and after payment to the holders of shares of Preferred Stock as provided below, the remaining assets and funds of the Corporation, if any, shall be distributed and paid over to the holders of Common Stock, pro rata according to their respective shares. 6. Class A Preferred Stock. The express terms and conditions of the shares classified and designated as Class A Preferred Stock, no par value, of the Corporation (the "Class A Preferred Stock") are as follows: 6.1. Designation and Number of Shares of Class A Preferred Stock. The designation of the series of preferred stock in this Section 6 is Class A Preferred Stock and the number of shares of such series is 68,400 shares having a stated value per share equal to $13.58859 (the "Class A Preferred Stock Stated Value"). The Class A Preferred Stock shall rank pari passu with the Class B Preferred Stock (except as provided in Section 6.3 and Section 7.3) and senior to all other shares of capital stock of the Corporation except the Class C Preferred Stock. 6.2. Dividends with Respect to Class A Preferred Stock. 6.2.1. In each year, the holder of each share of Class A Preferred Stock shall be entitled to receive preferential, cumulative dividends in cash, which dividends shall be cumulative and shall accrue from the date upon which the Class A Preferred Stock was issued, in an amount equal to eight percent (8%) of the Class A Preferred Stock Stated Value per share per year, provided, however, that upon the later to occur of (i) the consummation of any of the following: (A) a sale of all or a majority in value of the assets of the Corporation and all corporations, which, directly or indirectly, are controlled by or under common control with any one or more of Kirkland Holdings, L.L.C., Carl Kirkland, Robert Kirkland or Robert Alderson (the "Affiliated Corporations"). The term "control" (including, with correlative meaning, the terms "controlled by" and "under common control with"), shall mean the possession, directly or indirectly, of the power to elect a majority of the Board of Directors or to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities, by contract or otherwise; (B) the acquisition of more than fifty percent (50%) of the outstanding shares of Common Stock of corporations representing a majority of the total value of the Corporation and the Affiliated Corporations as a group, by a person or group of persons acting in concert, who are not shareholders of the Corporation at the Effective Time, other than transfers to an Affiliate or to a Permitted Transferee (as such terms are defined in the Shareholders Agreement dated as of June 12, 1996, between the Corporation, the Affiliated Corporations and the shareholders thereof) if such transfers are permitted without restriction pursuant to the terms of the Shareholders Agreement; -2- 3 (C) a sale of shares of the common capital stock of the Corporation or the Affiliated Corporations (or of a successor thereto) in a registered underwritten public offering resulting in gross proceeds to the Corporation or one or more Affiliated Corporations (or successors) of at least Thirty Million Dollars ($30,000,000) in the aggregate (a "Qualified Public Offering"); or (D) a refinancing after the Effective Time of the indebtedness of the Corporation or the Affiliated Corporations for borrowed money existing as of the Effective Time, in connection with which the Corporation or Affiliated Corporations repurchase or redeem any capital stock for value (each of the events listed in subparagraphs (A) through (D) above is referred to herein as a "Liquidity Event"), (ii) June 12, 1999 or (iii) the full payment and discharge of the senior subordinated indebtedness of the Corporation and the Affiliated Corporations (in the initial principal amount of Twenty Million Dollars ($20,000,000)), dividends shall accrue in an amount equal to ten (10%) per annum of the Class A Preferred Stock Stated Value. Dividends shall accrue daily whether or not declared and whether or not funds are legally available therefor. If such dividends are not paid within ninety (90) days after the end of the Corporation's fiscal quarter, such dividends shall accrue additional dividends from the last day of such fiscal quarter at the same rate per annum. Dividends shall be paid only to the extent that (i) there shall be sufficient funds of the Corporation legally available for the payment of such dividends, (ii) the payment of such dividend would not violate any covenants of the Corporation to any lender to the Corporation or its subsidiaries and (iii) the payment of such dividend would not violate the terms of any management or shareholder agreement to which the Corporation is party. 6.2.2. If, in any dividend period or periods, full dividends (whether past or current) upon the outstanding Class A Preferred Stock at the dividend rate set forth herein shall not have been paid, then, unless and until all dividends accrued and unpaid on the Class A Preferred Stock through the payment date for such dividends are declared and paid on each share of Class A Preferred Stock, no dividends shall be declared or paid or set apart for payment upon any Common Stock or class or series of the Corporation's capital stock authorized, created or designated after June 12, 1996 nor shall the Corporation purchase, redeem or otherwise acquire for consideration any such stock. If, at any time, the Corporation shall pay less than the total amount of dividends then payable on the then outstanding Class A Preferred Stock, the aggregate payment to all holders of Class A Preferred Stock shall be distributed among all such holders so that an amount ratably in proportion to the respective dividends due thereon shall be paid with respect to each outstanding share of Class A Preferred Stock. 6.2.3. Holders of the Class A Preferred Stock shall not, solely as a result of such holders' ownership of such Class A Preferred Stock, be entitled to participate in any dividends or other distributions (cash, stock or otherwise) declared or paid on or with respect to any other class of stock or equity security of the Corporation or any series of any such class. -3- 4 6.2.4. No dividend shall be paid upon shares of Class A Preferred Stock unless like dividends are simultaneously paid on shares of Class B Preferred Stock. 6.3. Liquidation Preference with Respect to Class A Preferred Stock. 6.3.1. In the event of a Liquidation, after any distribution of any of the assets of the Corporation to holders of Class C Preferred Stock pursuant to Section 8.3, the holders of Class A Preferred Stock shall be entitled to receive out of the assets of the Corporation legally available for distributions to its stockholders, prior and in preference to any distribution of any of the assets of the Corporation to the holders of any (i) Common Stock, (ii) class or series of the Corporation's capital stock authorized, created or designated after June 12, 1996 or (iii) Class B Preferred Stock, an amount per share equal to the sum of the Class A Preferred Stock Stated Value plus all accrued and unpaid dividends, if any, to the date of payment, less the Class A Excess Dividend Amount (hereinafter defined) (the "Class A Liquidation Preference") for each share of Class A Preferred Stock held. If upon any Liquidation the assets of the Corporation available for distribution to its shareholders shall be insufficient to pay the holders of shares of Class A Preferred Stock the full amount of the Class A Liquidation Preference, the holders of shares of Class A Preferred Stock shall share ratably in any distribution of assets available for distribution to the Class A Preferred Stock holders after distributions to the holders of the Class C Preferred Stock pursuant to Section 8.3. 6.3.2. In the event of any Liquidation, after payment of the Class A Liquidation Preference and the Class B Liquidation Preference (hereinafter defined), the holders of the Class A Preferred Stock shall be entitled to receive pari passu with the amounts payable to holders of Class B Preferred Stock pursuant to Section 7.3.2, an amount equal to all accrued and unpaid dividends, if any, to the date of payment owing on the Class A Preferred Stock other than accrued and unpaid dividends that would be owing thereon if all dividends accrued on the Class A Preferred Stock at the rate of eight percent (8%) per annum (the "Class A Excess Dividend Amount"). 6.3.3. In the event of any Liquidation, after payment shall have been made to the holders of shares of Class A Preferred Stock of the amounts described in Section 6.3.1 and Section 6.3.2, the holders of shares of Class A Preferred Stock shall be entitled to no further participation in the distribution of the assets of the Corporation. 6.3.4. The sale or other disposition (other than by a contribution to or merger with another corporation of which more than eighty percent (80%) of the stock (by vote and value) is owned (directly or indirectly) by the Corporation (or its shareholders) of all or substantially all the assets of the Corporation shall be deemed to be a Liquidation. 6.4. Voting Rights with Respect to Class A Preferred Stock. The Class A Preferred Stock shall have the right to vote on all matters as to which holders of the Common Stock shall be entitled to vote (at the rate of one vote per share), in the same manner and with the same effect as such holders of the Common Stock, voting together with the holders of Common Stock and Class -4- 5 B Preferred Stock as one voting group. Without first obtaining the approval (by vote or written consent) of at least seventy-five percent (75%) of the outstanding shares of the Class A Preferred Stock as a separate class, the Corporation shall not, 6.4.1. in any manner authorize, create or issue (x) any class or series of capital stock which (A) ranks, either as to payment of dividends, distribution of assets or redemption, prior to or on parity with the Class A Preferred Stock or (B) in any manner adversely affects the holders of the Class A Preferred Stock, or (y) any additional shares of capital stock or any class or series of any bonds, debentures, notes or other obligations convertible into or exchangeable for, or having optional rights to purchase, any shares of capital stock having any priority over or parity with or otherwise adversely affecting the holders of the Class A Preferred Stock; 6.4.2. in any manner alter or change the designations or the powers, preferences or rights, or the qualifications, limitations or restrictions of the Class A Preferred Stock, including without limitation, by increasing or decreasing the number of shares of the Class A Preferred Stock authorized for issuance hereunder, or by increasing or decreasing the par value or Class A Preferred Stock Stated Value of the shares of the Class A Preferred Stock; or 6.4.3. reclassify the shares of any (a) Common Stock, (b) class or series of the Corporation's capital stock authorized, created or designated after the Effective Time or (c) Class B Preferred Stock into shares of any class or series of capital stock (A) ranking, either as to payment of dividends, distribution of assets or redemption, prior to or on a parity with the Class A Preferred Stock or (B) which in any manner adversely affects the holders of the Class A Preferred Stock. 6.5. Redemptions with Respect to Class A Preferred Stock. 6.5.1. At any time and from time to time after (or simultaneously with) the completion of the redemption of all of the outstanding Class C Preferred Stock pursuant to Section 8.5 and after the earlier to occur of (i) the closing of a Liquidity Event or (ii) June 12, 2004 (the earlier of such dates being herein the "Redemption Allowance Date"), at the option of the Corporation and upon the Corporation's delivery of thirty (30) days prior written notice of such a redemption to be effected on or after the Redemption Allowance Date, the Corporation may redeem all or any portion of the Class A Preferred Stock then outstanding; provided, however, that (x) any redemption of less than all of the shares of Class A Preferred Stock shall be divided ratably and equally among the then extant holders of Class A Preferred Stock and (y) no shares of Class A Preferred Stock shall be redeemed pursuant to this Section 6.5.1 unless a pro rata number (based on aggregate stated values) of Class B Preferred shares shall be redeemed pursuant to Section 7.5.1. For each share of Class A Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant to this Section 6.5.1, the Corporation shall be obligated to pay to the holder thereof (upon surrender by such holder at the Corporation's principal office of the certificate representing such share duly endorsed in blank or accompanied by an appropriate form of assignment) an amount for such share equal to Class A Preferred Stock Stated Value plus all accrued -5- 6 and unpaid dividends with respect to such share to the date of payment (the "Class A Preferred Stock Redemption Price"). 6.5.2. After (or simultaneously with) the completion of the redemption of all of the outstanding Class C Preferred Stock pursuant to Section 8.5, at any time and from time to time after June 12, 2004, at the option of a holder of the Class A Preferred Stock and upon thirty (30) days prior delivery of written notice by the holder to the Corporation of redemption to be effected on or after such date, such holder may require the Corporation to redeem all or any portion of the Class A Preferred Stock held by such holder. For each share of Class A Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant to this Section 6.5.2, the Corporation shall be obligated to pay to the holder thereof (upon surrender by such holder at the Corporation's principal office of the certificate representing such share duly endorsed in blank or accompanied by an appropriate form of assignment) an amount for such share equal to the Class A Preferred Stock Redemption Price. 6.5.3. If the funds of the Corporation legally available for redemption pursuant to Section 6.5.2 and Section 7.5.2 are insufficient to redeem the number of shares which the Corporation is required to redeem pursuant to Section 6.5.2 and Section 7.5.2, those funds which are available will be used to redeem the maximum possible number of shares (or fraction thereof) and such funds shall be distributed ratably among each of the holders of the Class A Preferred Stock and Class B Preferred Stock, in proportion to the amount that would have been distributed to each such holder if the funds of the Corporation would have been sufficient to permit payment of the full amount required to be paid in respect of such redemption. At any time, and from time to time thereafter, until all shares of Class A Preferred Stock and Class B Preferred Stock which the Corporation shall be obligated to redeem are so redeemed, when additional funds of the Corporation are legally available for the redemption of any of the shares of Class A Preferred Stock and Class B Preferred Stock (including fractional shares), such funds shall be used immediately to redeem shares (or fractions thereof) which the Corporation has become obligated to redeem but which it has not redeemed, such amount to be applied ratably among each of the holders of shares of Class A Preferred Stock and Class B Preferred Stock which the Corporation is then obligated to redeem in proportion to the number of shares of Class A Preferred Stock and Class B Preferred Stock which are held by them and which the Corporation shall then be obligated to redeem. Notwithstanding the foregoing, in connection with any Liquidation, any redemption payments owing to holders of Class A Preferred Stock shall be paid in full (up to the Class A Liquidation Preference) before payments shall be made to holders of Class B Preferred Stock pursuant to Section 7.5. 6.5.4. Notwithstanding the fact that a written notice of redemption is given, all rights of the redeeming holder with respect to shares of Class A Preferred Stock which are the subject of such written notice of redemption shall continue as if the written notice of redemption had not been given until the Class A Preferred Stock Redemption Price therefor is paid (such payment being a continuing obligation of the Corporation). -6- 7 6.5.5. Upon payment of the Class A Preferred Stock Redemption Price by the Corporation with respect to shares of Class A Preferred Stock being redeemed pursuant to this Section 6.5, such shares of Class A Preferred Stock shall no longer be deemed to be outstanding, shall be canceled and shall not be subject to reissuance by the Corporation. 6.6. Conversion Rights. Upon the occurrence of the closing of a Qualified Public Offering, provided that, prior to such closing: (a) at least thirty (30) days prior to the date which the Board of Directors estimates in good faith to be the likely effective date of the registration of a Qualified Public Offering (the "Anticipated Effective Date"), the Board of Directors shall have provided to all of the holders of Class A Preferred Stock and Class B Preferred Stock notice of an anticipated Qualified Public Offering, which notice shall include the Anticipated Effective Date and the anticipated offering price per share of Common Stock at which the Common Stock will be first offered to the public in the Qualified Public Offering and (b) at least twenty (20) days prior to the Anticipated Effective Date, the holders of the Class A Preferred Stock and holders of Class B Preferred Stock, together representing at least sixty percent (60%) of the aggregate outstanding shares of Class A Preferred Stock and Class B Preferred Stock shall have elected to convert all of the issued and outstanding shares of Class A Preferred Stock and Class B Preferred Stock (other than those shares being redeemed pursuant to Section 6.5.1 and Section 7.5.1, respectively) into shares of Common Stock, then in such event (an "Event of Conversion") each and every share of Class A Preferred Stock then outstanding (other than those shares being redeemed pursuant to Section 6.5.1), by virtue of, and simultaneously with the occurrence of the Event of Conversion and without any additional action on the part of the holder thereof, be deemed automatically converted into such number of fully paid and nonassessable shares of Common Stock as is equal to the quotient obtained by dividing (x) the Class A Preferred Stock Stated Value by (y) the Conversion Price (as hereinafter defined). The "Conversion Price" shall be the offering price per share at which the Common Stock of the Corporation is first offered to the public in the Qualified Public Offering. 6.6.1. The holder of any shares of Class A Preferred Stock converted into shares of Common Stock pursuant to Section 6.6 shall remain entitled to payment of all accrued but unpaid dividends, if any, payable with respect to such shares of Class A Preferred Stock up to and including the date upon which the Qualified Public Offering is closed (the "Conversion Date"). 6.6.2. Conversion shall be deemed to have been effected with respect to conversion under Section 6.6 on the Conversion Date. Simultaneous with the conversion being effected, the shares of Class A Preferred Stock so converted shall no longer be deemed outstanding, shall be canceled and shall not be subject to reissuance by the Corporation. As promptly as practicable thereafter, the Corporation shall issue and deliver to the record locations of each of the holders (or upon the written order of a holder, at the place designated by such holder), a certificate or certificates for the number of full shares of Common Stock to which each respective holder is entitled and a check or cash in respect of any fractional interest in a share of Common Stock, as provided in Section 6.6.3, payable with respect to the shares of Class A Preferred Stock so converted. The person in whose name the certificate or certificates for Common Stock are to be issued shall be deemed to have become a stockholder of record on the Conversion Date unless the transfer books -7- 8 of the Corporation are closed on that date, in which event such holder shall be deemed to have become a stockholder of record on the next succeeding date on which the transfer books are open. 6.6.3. No fractional shares of Common Stock shall be issued upon conversion of shares of Class A Preferred Stock. Instead of any fractional shares of Common Stock which would otherwise be issuable upon conversion of any shares of Class A Preferred Stock, the Corporation shall pay a cash adjustment in respect of such fractional interest in an amount equal to the Conversion Price of a share of Class A Preferred Stock multiplied by such fractional interest. Holders of fractional interests shall not be entitled to dividends in respect of such fractional interests and the holders of fractional interests shall not be entitled to any rights as stockholders of the Corporation in respect of such fractional interests. 6.6.4. The Corporation shall pay all documentary, stamp or other transaction taxes attributable to the issuance or delivery of shares of Common Stock upon conversion of any shares of Class A Preferred Stock; provided, however, that the Corporation shall not be required to pay any taxes which may be payable in respect of any transfer involved in the issuance or delivery of any certificate for such shares in a name other than that of the holder of the shares of Class A Preferred Stock in respect of which such shares are being issued. 6.6.5. The holders of the Class A Preferred Stock and the holders of the Class B Preferred Stock, by vote of sixty percent (60%) of the aggregate outstanding shares of Class A Preferred Stock and Class B Preferred Stock, voting together as a single voting group, shall have the right to amend the Corporation's Charter for the sole purpose of authorizing sufficient additional shares of Common Stock to effect the conversions under this Section 6.6 and Section 7.6. The additional shares, when so authorized, shall be reserved by the Corporation for the purpose of effecting such conversions and shall be free of preemptive rights. 6.6.6. All shares of Common Stock which may be issued in connection with the conversion provisions set forth herein will, upon issuance by the Corporation, be validly issued, fully paid and nonassessable and free from all taxes, liens or charges with respect thereto created or imposed by the Corporation. 7. Class B Preferred Stock. The express terms and conditions of the shares classified and designated as Class B Preferred Stock, no par value, of the Corporation are as follows: 7.1. Designation and Number of Shares of Class B Preferred Stock. The designation of the series of Preferred Stock set forth in this Section 7 is Class B Preferred Stock and the number of shares of such series is 31,600 shares having a stated value per share equal to $13.58859 (the "Class B Preferred Stock Stated Value"). The Class B Preferred Stock shall rank pari passu with the Class A Preferred Stock (except as provided in Section 6.3 and Section 7.3 hereof) and senior to all other shares of the capital stock of the Corporation except the Class C Preferred Stock. -8- 9 7.2. Dividends with respect to Class B Preferred Stock. 7.2.1. In each year, the holder of each share of Class B Preferred Stock shall be entitled to receive preferential, cumulative dividends in cash, which dividends shall be cumulative and shall accrue from the date upon which the Class B Preferred Stock was issued, in an amount equal to eight percent (8%) of the Class B Preferred Stock Stated Value per share per year, provided, however, that upon the later to occur of (i) the consummation of a Liquidity Event, (ii) June 12, 1999 or (iii) the full payment and discharge of the senior subordinated indebtedness of the Corporation and the Affiliated Corporations (in the initial principal amount of Twenty Million Dollars ($20,000,000)), dividends shall accrue in an amount equal to ten percent (10%) per annum of the Class B Preferred Stock Stated Value. Dividends shall accrue daily whether or not declared and whether or not funds are legally available therefor. If such dividends are not paid within ninety (90) days after the end of each of the Corporation's fiscal quarters, such dividends shall accrue additional dividends from the last day of such fiscal quarter at the same rate per annum. Dividends shall be paid only to the extent that (i) there shall be sufficient funds of the Corporation legally available for the payment of such dividends, (ii) the payment of such dividend would not violate any covenants of the Corporation to any lender to the Corporation or its subsidiaries and (iii) the payment of such dividend would not violate the terms of any management or shareholder agreement to which the Corporation is party. 7.2.2. If, in any dividend period or periods, full dividends (whether past or current) upon the outstanding Class B Preferred Stock at the dividend rate set forth herein shall not have been paid, then, unless and until all dividends accrued and unpaid on the Class B Preferred Stock through the payment date for such dividends are declared and paid on each share of Class B Preferred Stock, no dividends shall be declared or paid or set apart for payment upon any Common Stock or class or series of the Corporation's capital stock authorized, created or designated after June 12, 1996 nor shall the Corporation purchase, redeem or otherwise acquire for consideration any such stock. If, at any time, the Corporation shall pay less than the total amount of dividends then payable on the then outstanding Class B Preferred Stock, the aggregate payment to all holders of Class B Preferred Stock shall be distributed among all such holders so that an amount ratably in proportion to the respective dividends due thereon shall be paid with respect to each outstanding share of Class B Preferred Stock. 7.2.3. Holders of the Class B Preferred Stock shall not, solely as a result of such holders' ownership of such Class B Preferred Stock, be entitled to participate in any dividends or other distributions (cash, stock or otherwise) declared or paid on or with respect to any other class of stock or equity security of the Corporation or any series of any such class. 7.2.4. No dividend shall be paid upon shares of Class B Preferred Stock unless like dividends are simultaneously paid on shares of Class A Preferred Stock. -9- 10 7.3. Liquidation Preference with Respect to Class B Preferred Stock. 7.3.1. In the event of a Liquidation, after any distribution of any of the assets of the Corporation to holders of Class C Preferred Stock pursuant to Section 8.3, the holders of Class B Preferred Stock shall be entitled to receive out of the assets of the Corporation legally available for distributions to its stockholders, prior and in preference to any distribution of any of the assets of the Corporation to the holders of any Common Stock or class or series of the Corporation's capital stock authorized, created or designated after June 12, 1996, and after payments of the Class A Liquidation Preference to holders of Class A Preferred Stock under Section 6.3 hereof, an amount per share equal to the sum of the Class B Preferred Stock Stated Value plus all accrued and unpaid dividends, if any, to the date of payment, less the Class B Excess Dividend Amount (hereinafter defined) (the "Class B Liquidation Preference") for each share of Class B Preferred Stock held. If upon any Liquidation the assets of the Corporation available for distribution to its shareholders shall be insufficient to pay the holders of shares of Class B Preferred Stock. the full amount of the Class B Liquidation Preference the holders of shares of Class B Preferred Stock shall share ratably in any distribution of assets available for distribution to the Class B Preferred Stock holders after distributions to the holders of the Class C Preferred Stock pursuant to Section 8.3 and distribution of the Class A Liquidation Preference to the holders of the Class A Preferred Stock pursuant to Section 6.3. 7.3.2. In the event of any Liquidation, after payment of the Class A Liquidation Preference and the Class B Liquidation Preference, the holders of the Class B Preferred Stock shall be entitled to receive, pari passu with the amounts payable to holders of Class A Preferred Stock pursuant to Section 6.3.2, an amount equal to all accrued and unpaid dividends, if any, to the date of payment owing on the Class B Preferred Stock other than accrued and unpaid dividends that would be owing thereon if all dividends accrued on the Class B Preferred Stock at the rate of eight percent (8%) per annum (the "Class B Excess Dividend Amount"). 7.3.3. In the event of any Liquidation, after payment shall have been made to the holders of shares of Class B Preferred Stock of the amounts described in Section 7.3.1 or Section 7.3.2, the holders of shares of Class B Preferred Stock shall be entitled to no further participation in the distribution of the assets of the Corporation. 7.3.4. The sale or other disposition (other than by a contribution to or merger with another corporation of which more than eighty percent (80%) of the stock (by vote and value) is owned (directly or indirectly) by the Corporation or its shareholders) of all or substantially all the assets of the Corporation shall be deemed to be a Liquidation. 7.4. Voting Rights with Respect to Class B Preferred Stock. The Class B Preferred Stock shall have the right to vote on all matters as to which holders of the Common Stock shall be entitled to vote (at the rate of one vote per share), in the same manner and with the same effect as such holders of the Common Stock, voting together with the holders of Common Stock and Class A Preferred Stock as one voting group. Without first obtaining the approval (by vote or written -10- 11 consent) of at least seventy-five percent (75%) of the outstanding shares of the Class B Preferred Stock as a separate class, the Corporation shall not, 7.4.1. in any manner authorize, create or issue (x) any class or series of capital stock which (A) ranks, either as to payment of dividends, distribution of assets or redemption, prior to or on parity with the Class B Preferred Stock or (B) in any manner adversely affects the holders of the Class B Preferred Stock, or (y) any additional shares of Class A Preferred Stock, Class C Preferred Stock or any shares of any class or series of any bonds, debentures, notes or other obligations convertible into or exchangeable for, or having optional rights to purchase, any shares having any such priority or parity with or so adversely affecting the holders of the Class B Preferred Stock; 7.4.2. in any manner alter or change the designations or the powers, preferences or rights, or the qualifications, limitations or restrictions of the Class B Preferred Stock, including without limitation, by increasing or decreasing the number of shares of the Class B Preferred Stock authorized for issuance hereunder, or by increasing or decreasing the par value or Class B Preferred Stock Stated Value of the shares of the Class B Preferred Stock; or 7.4.3. reclassify the shares of any (a) Common Stock, (b) class or series of the Corporation's capital stock authorized, created or designated after June 12, 1996 or (c) Class A Preferred Stock into shares of any class or series of capital stock (A) ranking, either as to payment of dividends, distribution of assets or redemption, prior to or on a parity with the Class B Preferred Stock or (B) which in any manner adversely affects the holders of the Class B Preferred Stock. 7.5. Redemptions with Respect to Class B Preferred Stock. 7.5.1. At any time and from time to time after (or simultaneously with) the completion of the redemption of all of the outstanding Class C Preferred Stock pursuant to Section 8.5 and after the Redemption Allowance Date, at the option of the Corporation and upon the Corporation's delivery of thirty (30) days prior written notice of such a redemption to be effected on or after the Redemption Allowance Date, the Corporation may redeem all or any portion of the Class B Preferred Stock then outstanding; provided, however, that (x) any redemption of less than all of the shares of Class B Preferred Stock shall be divided ratably and equally among the then extant holders of Class B Preferred Stock and (y) no shares of Class B Preferred Stock shall be redeemed pursuant to this Section 7.5.1 unless a pro rata number (based on aggregate stated values) of Class A Preferred Stock shall be redeemed pursuant to Section 6.5.1. For each share of Class B Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant to this Section 7.5.1, the Corporation shall be obligated to pay to the holder thereof (upon surrender by such holder at the Corporation's principal office of the certificate representing such share duly endorsed in blank or accompanied by an appropriate form of assignment) an amount for such share equal to the Class B Preferred Stock Stated Value plus all accrued and unpaid dividends with respect to such share to the date of payment (the "Class B Preferred Stock Redemption Price"). -11- 12 7.5.2. After (or simultaneously with) the completion of the redemption of all of the outstanding Class C Preferred Stock pursuant to Section 8.5, at any time and from time to time after June 12, 2004, at the option of a holder of the Class B Preferred Stock and upon thirty (30) days prior delivery of a written notice by the holder to the Corporation of redemption to be effected on or after such date, such holder may require the Corporation to redeem all or any portion of the Class B Preferred Stock held by such holder. For each share of Class B Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant, to this Section 7.5.2, the Corporation shall be obligated to pay to the holder thereof (upon surrender by such holder at the Corporation's principal office of the certificate representing such share duly endorsed in blank or accompanied by an appropriate form of assignment) an amount for such share equal to the Class B Preferred Stock Redemption Price. 7.5.3. If the funds of the Corporation legally available for redemption pursuant to Section 7.5.2 and Section 6.5.2 are insufficient to redeem the number of shares which the Corporation is required to redeem pursuant to this Section 7.5.2 and Section 6.5.2, those funds which are available will be used to redeem the maximum possible number of shares (or fraction thereof) and such funds shall be distributed ratably among each of the holders of the Class A Preferred Stock and Class B Preferred Stock in proportion to the amount that would have been distributed to each such holder if the funds of the Corporation would have been sufficient to permit payment of the full amount required to be paid in respect of such redemption. At any time, and from time to the thereafter, until all shares the Corporation shall be obligated to redeem are so redeemed, when additional funds of the Corporation are legally available for the redemption of any of the shares of Class A Preferred Stock and Class B Preferred Stock (including fractional shares), such funds shall be used immediately to redeem shares (or fractions thereof), which the Corporation has become obligated to redeem but which it has not redeemed, such amount to be applied ratably among each of the holders of shares of Class A Preferred Stock and Class B Preferred Stock which the Corporation is then obligated to redeem in proportion to the number of shares of Class A Preferred Stock and Class B Preferred Stock which are held by them and which the Corporation shall then be obligated to redeem. Notwithstanding the foregoing, in connection with any Liquidation, any redemption payments owing to holders of Class A Preferred Stock shall be paid in full (up to the Class A Liquidation Preference) before payments shall be made to holders of Class B Preferred Stock pursuant to this Section 7.5. 7.5.4. Notwithstanding the fact that a written notice of redemption is given, all rights of the redeeming holder with respect to shares of Class B Preferred Stock which are the subject of such written notice of redemption shall continue as if the written notice of redemption had not been given until the Class B Preferred Stock Redemption Price therefor is paid (such payment being a continuing obligation of the Corporation). 7.5.5. Upon payment of the Class B Preferred Stock Redemption Price by the Corporation with respect to shares of Class B Preferred Stock being redeemed pursuant to this -12- 13 Section 7.5, such shares of Class B Preferred Stock shall no longer be deemed to be outstanding, shall be canceled and shall not be subject to reissuance by the Corporation. 7.6. Conversion Rights. Upon the occurrence of an Event of Conversion, each and every share of Class B Preferred Stock then outstanding (other than those shares being redeemed pursuant to Section 7.5.1), by virtue of, and simultaneously with the occurrence of the Event of Conversion and without any additional action on the part of the holder thereof, be deemed automatically converted into such number of fully paid and nonassessable shares of Common Stock as is equal to the quotient obtained by dividing (x) the Class B Preferred Stock Stated Value by (y) the Conversion Price. 7.6.1. The holder of any shares of Class B Preferred Stock converted into shares of Common Stock pursuant to Section 7.6 shall remain entitled to payment of all accrued but unpaid dividends, if any, payable with respect to such shares of Class B Preferred Stock up to and including the Conversion Date. 7.6.2. Conversion shall be deemed to have been effected with respect to conversion under Section 7.6 on the Conversion Date. Simultaneous with the conversion being effected, the shares of Class B Preferred Stock so converted shall no longer be deemed outstanding, shall be canceled and shall not be subject to reissuance by the Corporation. As promptly as practicable thereafter, the Corporation shall issue and deliver to the record locations of each of the holders (or upon the written order of a holder, at the place designated by such holder), a certificate or certificates for the number of full shares of Common Stock to which each respective holder is entitled and a check or cash in respect of any fractional interest in a share of Common Stock, as provided in Section 7.6.3, payable with respect to the shares of Class B Preferred Stock so converted. The person in whose name the certificate or certificates for Common Stock are to be issued shall be deemed to have become a stockholder of record on the Conversion Date unless the transfer books of the Corporation are closed on that date, in which event such holder shall be deemed to have become a stockholder of record on the next succeeding date on which the transfer books are open. 7.6.3. No fractional shares of Common Stock shall be issued upon conversion of shares of Class B Preferred Stock. Instead of any fractional shares of Common Stock which would otherwise be issuable upon conversion of any shares of Class B Preferred Stock, the Corporation shall pay a cash adjustment in respect of such fractional interest in an amount equal to the Conversion Price of a share of Class B Preferred Stock multiplied by such fractional interest. Holders of fractional interests shall not be entitled to dividends in respect of such fractional interests, and the holders of fractional interests shall not be entitled to any rights as stockholders of the Corporation in respect of such fractional interests. 7.6.4. The Corporation shall pay all documentary, stamp or other transaction taxes attributable to the issuance or delivery of shares of Common Stock upon conversion of any shares of Class B Preferred Stock; provided, however, that the Corporation shall not be required to pay any taxes which may be payable in respect of any transfer involved in the issuance or delivery -13- 14 of any certificate for such shares in a name other than that of the holder of the shares of Class B Preferred Stock in respect of which such shares are being issued. 7.6.5. The holders of the Class A Preferred Stock and the holders of the Class B Preferred Stock, by vote of sixty percent (60%) of the aggregate outstanding shares of Class A Preferred Stock and Class B Preferred Stock, voting together as a single voting group, shall have the right to amend the Corporation's Charter for the sole purpose of authorizing sufficient additional shares of Common Stock to effect the conversions under this Section 7.6 and Section 6.6. The additional shares, when so authorized, shall be reserved by the Corporation for the purpose of effecting such conversions and shall be free of preemptive rights. 7.6.6. All shares of Common Stock which may be issued in connection with the conversion provisions set forth herein will, upon issuance by the Corporation, be validly issued, fully paid and nonassessable and free from all taxes, liens or charges with respect thereto created or imposed by the Corporation. 8. Class C Preferred Stock. The express terms and conditions of the shares classified and designated as Class C Preferred Stock, no par value, of the Corporation are as follows: 8.1. Designation and Number Preferred Stock. The designation of the series of preferred stock in this Section 8 is Class C Preferred Stock (hereinafter called "Class C Preferred Stock") and the number of shares of such series is 20,000 shares having a stated value per share equal to $30.63556 (the "Class C Preferred Stock Stated Value"). The Class C Preferred Stock shall rank senior to all other shares of the capital stock of the Corporation. 8.2. Dividends with Respect Class C Preferred Stored Stock. Except as provided herein, the holders of shares of Class C Preferred Stock shall not be entitled to receive dividends with respect to their shares of Class C Preferred Stock nor shall they be entitled to participate in any dividends (cash, stock or otherwise) declared or paid on or with respect to any other class of stock or equity security of the Corporation or any series of any such class solely as a result of their ownership of such Class C Preferred Stock. 8.3. Liquidation Preference with Respect to Class C Preferred Stock. 8.3.1. In the event of any Liquidation, the holders of Class C Preferred Stock shall be entitled to receive out of the assets of the Corporation legally available for distributions to its stockholders, prior and in preference to any distribution of any of the assets of the Corporation to the holders of any other class of stock or equity security of the Corporation or any series of any such class, an amount per share equal to the sum of the Class C Preferred Stock Stated Value plus all accrued and unpaid dividends, if any, to the date of payment (the "Class C Liquidation Preference") for each share of Class C Preferred Stock held. If upon any Liquidation the assets of the Corporation available for distribution to its shareholders shall be insufficient to pay the holders of shares of Class C Preferred Stock the full amount of the Class C Liquidation Preference, the -14- 15 holders of shares of Class C Preferred Stock shall share ratably in any distribution of assets available for distribution to the Class C Preferred Stock holders. 8.3.2. In the event of any Liquidation, after payment shall have been made to the holders of shares of Class C Preferred Stock of the amounts described in Section 8.3.1, the holders of shares of Class C Preferred Stock shall be entitled to no further participation in the distribution of the assets of the Corporation. 8.3.3. The sale or other disposition (other than by a contribution to or merger with another corporation of which more than eighty percent (80%) of the stock (by vote and value) is owned (directly or indirectly) by the Corporation or its shareholders) of all or substantially all the assets of the Corporation shall be deemed to be a Liquidation. 8.4. Voting Rights with Respect to Class C Preferred Stock. The Class C Preferred shall not have any voting rights except as set forth in this Section 8.4. Without first obtaining the approval (by vote or written consent) of at least seventy-five percent (75%) of the outstanding shares of the Class C Preferred Stock as a separate class, the Corporation shall not, 8.4.1. in any manner authorize, create or issue (x) any class or series of capital stock which (A) ranks, either as to payment of dividends, distribution of assets or redemption, prior to or on parity with the Class C Preferred Stock or (B) in any manner adversely affects the holders of the Class C Preferred Stock, or (y) any shares of any class or series of any bonds, debentures, notes or other obligations convertible into or exchangeable for, or having optional rights to purchase, any shares having any such priority or parity with or so adversely affecting the holders of the Class C Preferred Stock; 8.4.2. in any manner alter or change the designations or the powers, preferences or rights, or the qualifications, limitations or restrictions of the Class C Preferred Stock, including without limitation, by increasing or decreasing the number of shares of the Class C Preferred Stock authorized for issuance hereunder, or by increasing or decreasing the par value of the shares of the Class C Preferred Stock; or 8.4.3. reclassify any shares of capital stock of the Corporation into shares of any class or series of capital stock (A) ranking, either as to payment of dividends, distribution of assets or redemption, prior to or on a parity with the Class C Preferred Stock or (B) which in any manner adversely affects the holders of the Class C Preferred Stock. 8.5. Redemption with Respect to Class C Preferred Stock. 8.5.1. At any time and from time to time after the Effective Time, at the option of the Corporation and upon the Corporation's delivery of thirty (30) days prior written notice, the Corporation may redeem all or any portion of the Class C Preferred Stock then outstanding; -15- 16 provided, however, that any redemption of less than all of the shares of Class C Preferred Stock shall be divided ratably and equally among the then extant holders of Class C Preferred Stock. 8.5.2. The Class C Preferred Stock shall be mandatorily redeemable in whole upon the Redemption Allowance Date (the "Class C Redemption Event"). In the event that the Corporation is prevented from redeeming the Class C Preferred Stock when required in accordance with the foregoing sentence, whether by contract or law, dividends will accrue and cumulate thereon at an annual rate of nine percent (9%) from the date payment is due as a result of such Class C Redemption Event pursuant to Section 8.5.3, until the redemption occurs. 8.5.3. For each share of Class C Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant to this Section 8.5, the Corporation shall be obligated to pay to the holder thereof (upon surrender by such holder at the Corporation's principal office of the certificate representing such share duly endorsed in blank or accompanied by an appropriate form of assignment) an amount for such share equal to the Class C Preferred Stock Stated Value plus all accrued and unpaid dividends, if any, with respect to such share to the date of payment (the "Class C Preferred Stock Redemption Price"), on (i) in the case of a redemption at the option of the Corporation, the last day of any fiscal quarter if, during the quarter then ending, a written notice of redemption shall have been delivered by the Corporation to the holder more than thirty (30) days prior to such last day or thirty (30) or fewer days prior to the end of the immediately preceding fiscal quarter, or (ii) for purposes of the mandatory redemption described in Section 8.5.2, the earlier to occur of (A) a date set by the Corporation in the redemption notice which is within thirty (30) days after June 12, 2004 or (B) upon the closing of a Liquidity Event. 8.5.4. If the funds of the Corporation legally available for redemption pursuant to Section 8.5.1 or Section 8.5.2 are insufficient to redeem the number of shares which the Corporation is required to redeem pursuant to Section 8.5.1 or Section 8.5.2, those funds which are available will be used to redeem the maximum possible number of shares (or fraction thereof) and such funds shall be distributed ratably among each of the holders of the Class C Preferred Stock in proportion to the amount that would have been distributed to each such holder if the funds of the Corporation would have been sufficient to permit payment of the full amount required to be paid in respect of such redemption. At any time, and from time to time there after, until all shares of Class C Preferred Stock which the Corporation shall be obligated to redeem are so redeemed, when additional funds of the Corporation are legally available for the redemption of any of the shares of Class C Preferred Stock (including fractional shares), such funds shall be used immediately to redeem shares (or fractions thereof) which the Corporation has become obligated to redeem but which it has not redeemed, such amount to be applied ratably among each of the holders of shares of Class C Preferred Stock which the Corporation is the obligated to redeem in proportion to the number of shares of Class C Preferred Stock which are held by them and which the Corporation shall be obligated to redeem. 8.5.5. Notwithstanding the fact that a written notice of redemption is given, all rights of the redeeming holder with respect to shares of Class C Preferred Stock which are the -16- 17 subject of such written notice of redemption shall continue as if the written notice of redemption had not been given until the Class C Preferred Stock Redemption Price therefor is paid (it being understood that such payment shall be a continuing obligation of the Corporation). 8.5.6. Once the Class C Preferred Stock Redemption Price has been paid by the Corporation with respect to shares of Class C Preferred Stock being redeemed pursuant to this Section 8.5, such shares of Class C Preferred Stock shall no longer be deemed to be outstanding, shall be canceled and shall not be subject to reissuance by the Corporation. 9. Limitation of Liability. Directors of the Corporation shall have no liability to the Corporation or its shareholders for monetary damages for breach of fiduciary duty as a director, provided that this Section 9 shall not eliminate liability of a director for (i) any breach of the director's duty of loyalty to the Corporation or its shareholders; (ii) acts or omissions that are not in good faith or that involve intentional misconduct or a knowing violation of law; or (iii) unlawful distributions under Section 48-18-304 of the Tennessee Business Corporation Act. If the Tennessee Business Corporation Act is amended or other Tennessee law is enacted to permit further elimination or limitation of the personal liability of directors, then the liability of directors of the Corporation shall be eliminated or limited to the fullest extent permitted by the Tennessee Business Corporation Act, as so amended, or by such other Tennessee law, as so enacted. Any repeal or modification of this Section 9 or subsequent amendment of the Tennessee Business Corporation Act or enactment of other applicable Tennessee law shall not adversely affect any right or protection of a director of the Corporation existing at the time of such repeal, modification, amendment or enactment. 10. Adoption. This amended and restated charter was adopted by unanimous written consent of the Board of Directors and Shareholders of the Corporation dated March , 1998. This charter replaces and supersedes the original charter of the Corporation filed with the Tennessee Secretary of State and all amendments thereto. 11. Corporation for Profit. The Corporation is for profit. Dated: April 22, 1998. KIRKLAND'S, INC. By: /s/ Carl Kirkland --------------------------- Title: Chief Executive Officer ------------------------- -17- EX-3.2 5 FORM OF AMENDED AND RESTATED CHARTER OF KIRKLAND'S 1 EXHIBIT 3.2 AMENDED AND RESTATED CHARTER OF KIRKLAND'S, INC. This Amended and Restated Charter of Kirkland's, Inc., (the "Corporation") shall be effective as of 12:01 A.M. on ____________, 1998 (the "Effective Time"). The undersigned corporation hereby adopts the following amended and restated charter pursuant to Section 48-20-107 of the Tennessee Business Corporation Act: 1. Name. The name of the Corporation is Kirkland's, Inc. 2. Registered Office and Agent. The Corporation's registered office is located at 805 North Parkway, Jackson, Madison County, Tennessee 38305. The Corporation's registered agent at that office is Robert E. Alderson. 3. Principal Office. The principal office of the Corporation is located at 805 North Parkway, Jackson, Madison County, Tennessee 38305. 4. Authorized Shares. The total number of shares of all classes of stock which the Corporation shall have authority to issue is Sixty Million One Hundred Twenty Thousand (60,120,000), of which Fifty Million (50,000,000) shares shall constitute a separate class of shares known as Common Stock, which shall be without par value (the "Common Stock"), and the remaining Ten Million One Hundred Twenty Thousand (10,120,000) shares shall constitute a single class of shares known as Preferred Stock (the "Preferred Stock"). Of the Preferred Stock, (i) Sixty-Eight Thousand Four Hundred (68,400) shares shall be designated as a series referred to as Class A Preferred Stock, which shall be without par value (the "Class A Preferred Stock"), (ii) Thirty-One Thousand Six Hundred (31,600) shares shall be designated as a series referred to as Class B Preferred Stock, which shall be without par value (the "Class B Preferred Stock"), and (iii) Twenty Thousand (20,000) shares shall be designated as a series of Preferred Stock referred to as Class C Preferred Stock, which shall be without par value (the "Class C Preferred Stock"). 5. Common Stock. The express terms and conditions of the shares classified and designated as Common Stock are as follows: 5.1. Voting Rights of Common Stock. Each share of Common Stock shall entitle the holder thereof to one vote, in person or by proxy, upon each question or matter submitted generally to the holders of the Common Stock of the Corporation and shall have all voting rights accorded to holders of Common Stock pursuant to the Tennessee Business Corporation Act. 5.2. Liquidation. On dissolution, liquidation or winding up of the Corporation, voluntarily or involuntarily (a "Liquidation"), and after payment to the holders of shares of Preferred Stock as provided below, the remaining assets and funds of the Corporation, if any, shall be 2 distributed and paid over to the holders of Common Stock, pro rata according to their respective shares. 6. Preferred Stock. The Board of Directors of the Corporation is authorized to amend this Charter, by adoption of amendments to the Charter effective without shareholder approval (hereinafter referred to as a "Preferred Stock Designation"), to provide for the issuance of serial preferred stock in series and to fix the preferences, limitations and relative rights of each such series, including, but not limited to, determination of any of the following: (a) the distinctive designation for each series and the number of shares constituting such series; (b) the voting rights, full, conditional or limited, of shares of such series; (c) whether the shares of such series shall be redeemable and, if so, the price or prices at which, and the terms and conditions upon which, such shares may be redeemed; (d) the dividend rate or the amount of dividends to be paid on the shares of such series, whether dividends shall be cumulative and, if so, from which date(s), the payment date(s) for dividends, and the participating or other special rights, if any, with respect to dividends; (e) the amount(s) payable upon the shares of such series in the event of voluntary or involuntary liquidation, dissolution or winding up of the Corporation; (f) whether the shares of such series shall be entitled to the benefit of a sinking or retirement fund to be applied to the purchase or redemption of such shares, and if so entitled, the amount of such fund and the manner of its application, including the price(s) at which such shares may be redeemed or purchased through the application of such fund; (g) whether the shares of such series shall be convertible into, or exchangeable for, shares of any other class or classes or of any other series of the same or any other class or classes of stock of the Corporation and, if so convertible or exchangeable, the conversion price(s) or the rate(s) of exchange, and the adjustments thereof, if any, at which such conversion or exchange may be made, and any other terms and conditions of such conversion or exchange; (h) the price or other consideration for which the shares of such series shall be issued; -2- 3 (i) whether the shares of such series that are redeemed or converted shall have the status of authorized but unissued shares of serial preferred stock and whether such shares may be reissued as shares of the same or any other series of serial preferred stock; and (j) any other designations, preferences, limitations or rights that are now or hereafter permitted by applicable law and are not inconsistent with the provisions of this Charter. Except as may be provided in this Charter or in a Preferred Stock Designation, the Common Stock shall have the exclusive right to vote for the election of directors and for all other purposes, and holders of Preferred Stock shall not be entitled to receive notice of any meeting of shareholders at which they are not entitled to vote. 7. Class A Preferred Stock. The express terms and conditions of the shares classified and designated as Class A Preferred Stock, no par value, of the Corporation (the "Class A Preferred Stock") are as follows: 7.1. Designation and Number of Shares of Class A Preferred Stock. The designation of the series of preferred stock in this Section 7 is Class A Preferred Stock and the number of shares of such series is 68,400 shares having a stated value per share equal to $13.58859 (the "Class A Preferred Stock Stated Value"). The Class A Preferred Stock shall rank pari passu with the Class B Preferred Stock (except as provided in Section 7.3 and Section 8.3) and senior to all other shares of capital stock of the Corporation except the Class C Preferred Stock. 7.2. Dividends with Respect to Class A Preferred Stock. 7.2.1. In each year, the holder of each share of Class A Preferred Stock shall be entitled to receive preferential, cumulative dividends in cash, which dividends shall be cumulative and shall accrue from the date upon which the Class A Preferred Stock was issued, in an amount equal to eight percent (8%) of the Class A Preferred Stock Stated Value per share per year, provided, however, that upon the later to occur of (i) the consummation of any of the following: (A) a sale of all or a majority in value of the assets of the Corporation and all corporations, which, directly or indirectly, are controlled by or under common control with any one or more of Kirkland Holdings, L.L.C., Carl Kirkland, Robert Kirkland or Robert Alderson (the "Affiliated Corporations"). The term "control" (including, with correlative meaning, the terms "controlled by" and "under common control with"), shall mean the possession, directly or indirectly, of the power to elect a majority of the Board of Directors or to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities, by contract or otherwise; -3- 4 (B) the acquisition of more than fifty percent (50%) of the outstanding shares of Common Stock of corporations representing a majority of the total value of the Corporation and the Affiliated Corporations as a group, by a person or group of persons acting in concert, who are not shareholders of the Corporation at March , 1998, other than transfers to an Affiliate or to a Permitted Transferee (as such terms are defined in the Shareholders Agreement dated as of June 12, 1996, between the Corporation, the Affiliated Corporations and the shareholders thereof) if such transfers are permitted without restriction pursuant to the terms of the Shareholders Agreement; (C) a sale of shares of the common capital stock of the Corporation or the Affiliated Corporations (or of a successor thereto) in a registered underwritten public offering resulting in gross proceeds to the Corporation or one or more Affiliated Corporations (or successors) of at least Thirty Million Dollars ($30,000,000) in the aggregate (a "Qualified Public Offering"); or (D) a refinancing of the indebtedness of the Corporation or the Affiliated Corporations for borrowed money existing as of March , 1998, in connection with which the Corporation or Affiliated Corporations repurchase or redeem any capital stock for value (each of the events listed in subparagraphs (A) through (D) above is referred to herein as a "Liquidity Event"), (ii) June 12, 1999 or (iii) the full payment and discharge of the senior subordinated indebtedness of the Corporation and the Affiliated Corporations (in the initial principal amount of Twenty Million Dollars ($20,000,000)), dividends shall accrue in an amount equal to ten (10%) per annum of the Class A Preferred Stock Stated Value. Dividends shall accrue daily whether or not declared and whether or not funds are legally available therefor. If such dividends are not paid within ninety (90) days after the end of the Corporation's fiscal quarter, such dividends shall accrue additional dividends from the last day of such fiscal quarter at the same rate per annum. Dividends shall be paid only to the extent that (i) there shall be sufficient funds of the Corporation legally available for the payment of such dividends, (ii) the payment of such dividend would not violate any covenants of the Corporation to any lender to the Corporation or its subsidiaries and (iii) the payment of such dividend would not violate the terms of any management or shareholder agreement to which the Corporation is party. 7.2.2. If, in any dividend period or periods, full dividends (whether past or current) upon the outstanding Class A Preferred Stock at the dividend rate set forth herein shall not have been paid, then, unless and until all dividends accrued and unpaid on the Class A Preferred Stock through the payment date for such dividends are declared and paid on each share of Class A Preferred Stock, no dividends shall be declared or paid or set apart for payment upon any Common Stock or class or series of the Corporation's capital stock authorized, created or designated after June 12, 1996 nor shall the Corporation purchase, redeem or otherwise acquire for consideration any such stock. If, at any time, the Corporation shall pay less than the total amount of dividends then payable on the then outstanding Class A Preferred Stock, the aggregate payment to all holders of Class A Preferred Stock shall be distributed among all such holders so that an amount ratably in proportion -4- 5 to the respective dividends due thereon shall be paid with respect to each outstanding share of Class A Preferred Stock. 7.2.3. Holders of the Class A Preferred Stock shall not, solely as a result of such holders' ownership of such Class A Preferred Stock, be entitled to participate in any dividends or other distributions (cash, stock or otherwise) declared or paid on or with respect to any other class of stock or equity security of the Corporation or any series of any such class. 7.2.4. No dividend shall be paid upon shares of Class A Preferred Stock unless like dividends are simultaneously paid on shares of Class B Preferred Stock. 7.3. Liquidation Preference with Respect to Class A Preferred Stock. 7.3.1. In the event of a Liquidation, after any distribution of any of the assets of the Corporation to holders of Class C Preferred Stock pursuant to Section 9.3, the holders of Class A Preferred Stock shall be entitled to receive out of the assets of the Corporation legally available for distributions to its stockholders, prior and in preference to any distribution of any of the assets of the Corporation to the holders of any (i) Common Stock, (ii) class or series of the Corporation's capital stock authorized, created or designated after June 12, 1996 or (iii) Class B Preferred Stock, an amount per share equal to the sum of the Class A Preferred Stock Stated Value plus all accrued and unpaid dividends, if any, to the date of payment, less the Class A Excess Dividend Amount (hereinafter defined) (the "Class A Liquidation Preference") for each share of Class A Preferred Stock held. If upon any Liquidation the assets of the Corporation available for distribution to its shareholders shall be insufficient to pay the holders of shares of Class A Preferred Stock the full amount of the Class A Liquidation Preference, the holders of shares of Class A Preferred Stock shall share ratably in any distribution of assets available for distribution to the Class A Preferred Stock holders after distributions to the holders of the Class C Preferred Stock pursuant to Section 9.3. 7.3.2. In the event of any Liquidation, after payment of the Class A Liquidation Preference and the Class B Liquidation Preference (hereinafter defined), the holders of the Class A Preferred Stock shall be entitled to receive pari passu with the amounts payable to holders of Class B Preferred Stock pursuant to Section 8.3.2, an amount equal to all accrued and unpaid dividends, if any, to the date of payment owing on the Class A Preferred Stock other than accrued and unpaid dividends that would be owing thereon if all dividends accrued on the Class A Preferred Stock at the rate of eight percent (8%) per annum (the "Class A Excess Dividend Amount"). 7.3.3. In the event of any Liquidation, after payment shall have been made to the holders of shares of Class A Preferred Stock of the amounts described in Section 7.3.1 and Section 7.3.2, the holders of shares of Class A Preferred Stock shall be entitled to no further participation in the distribution of the assets of the Corporation. -5- 6 7.3.4. The sale or other disposition (other than by a contribution to or merger with another corporation of which more than eighty percent (80%) of the stock (by vote and value) is owned (directly or indirectly) by the Corporation (or its shareholders) of all or substantially all the assets of the Corporation shall be deemed to be a Liquidation. 7.4. Voting Rights with Respect to Class A Preferred Stock. The Class A Preferred Stock shall have the right to vote on all matters as to which holders of the Common Stock shall be entitled to vote (at the rate of one vote per share), in the same manner and with the same effect as such holders of the Common Stock, voting together with the holders of Common Stock and Class B Preferred Stock as one voting group. Without first obtaining the approval (by vote or written consent) of at least seventy-five percent (75%) of the outstanding shares of the Class A Preferred Stock as a separate class, the Corporation shall not, 7.4.1. in any manner authorize, create or issue (x) any class or series of capital stock which (A) ranks, either as to payment of dividends, distribution of assets or redemption, prior to or on parity with the Class A Preferred Stock or (B) in any manner adversely affects the holders of the Class A Preferred Stock, or (y) any additional shares of capital stock or any class or series of any bonds, debentures, notes or other obligations convertible into or exchangeable for, or having optional rights to purchase, any shares of capital stock having any priority over or parity with or otherwise adversely affecting the holders of the Class A Preferred Stock; 7.4.2. in any manner alter or change the designations or the powers, preferences or rights, or the qualifications, limitations or restrictions of the Class A Preferred Stock, including without limitation, by increasing or decreasing the number of shares of the Class A Preferred Stock authorized for issuance hereunder, or by increasing or decreasing the par value or Class A Preferred Stock Stated Value of the shares of the Class A Preferred Stock; or 7.4.3. reclassify the shares of any (a) Common Stock, (b) class or series of the Corporation's capital stock authorized, created or designated after the Effective Time or (c) Class B Preferred Stock into shares of any class or series of capital stock (A) ranking, either as to payment of dividends, distribution of assets or redemption, prior to or on a parity with the Class A Preferred Stock or (B) which in any manner adversely affects the holders of the Class A Preferred Stock. 7.5. Redemptions with Respect to Class A Preferred Stock. 7.5.1. At any time and from time to time after (or simultaneously with) the completion of the redemption of all of the outstanding Class C Preferred Stock pursuant to Section 9.5 and after the earlier to occur of (i) the closing of a Liquidity Event or (ii) June 12, 2004 (the earlier of such dates being herein the "Redemption Allowance Date"), at the option of the Corporation and upon the Corporation's delivery of thirty (30) days prior written notice of such a redemption to be effected on or after the Redemption Allowance Date, the Corporation may redeem all or any portion of the Class A Preferred Stock then outstanding; provided, however, that (x) any redemption of less than all of the shares of Class A Preferred Stock shall be divided ratably and -6- 7 equally among the then extant holders of Class A Preferred Stock and (y) no shares of Class A Preferred Stock shall be redeemed pursuant to this Section 7.5.1 unless a pro rata number (based on aggregate stated values) of Class B Preferred shares shall be redeemed pursuant to Section 8.5.1. For each share of Class A Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant to this Section 7.5.1, the Corporation shall be obligated to pay to the holder thereof (upon surrender by such holder at the Corporation's principal office of the certificate representing such share duly endorsed in blank or accompanied by an appropriate form of assignment) an amount for such share equal to Class A Preferred Stock Stated Value plus all accrued and unpaid dividends with respect to such share to the date of payment (the "Class A Preferred Stock Redemption Price"). 7.5.2. After (or simultaneously with) the completion of the redemption of all of the outstanding Class C Preferred Stock pursuant to Section 9.5, at any time and from time to time after June 12, 2004, at the option of a holder of the Class A Preferred Stock and upon thirty (30) days prior delivery of written notice by the holder to the Corporation of redemption to be effected on or after such date, such holder may require the Corporation to redeem all or any portion of the Class A Preferred Stock held by such holder. For each share of Class A Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant to this Section 7.5.2, the Corporation shall be obligated to pay to the holder thereof (upon surrender by such holder at the Corporation's principal office of the certificate representing such share duly endorsed in blank or accompanied by an appropriate form of assignment) an amount for such share equal to the Class A Preferred Stock Redemption Price. 7.5.3. If the funds of the Corporation legally available for redemption pursuant to Section 7.5.2 and Section 8.5.2 are insufficient to redeem the number of shares which the Corporation is required to redeem pursuant to Section 7.5.2 and Section 8.5.2, those funds which are available will be used to redeem the maximum possible number of shares (or fraction thereof) and such funds shall be distributed ratably among each of the holders of the Class A Preferred Stock and Class B Preferred Stock, in proportion to the amount that would have been distributed to each such holder if the funds of the Corporation would have been sufficient to permit payment of the full amount required to be paid in respect of such redemption. At any time, and from time to time thereafter, until all shares of Class A Preferred Stock and Class B Preferred Stock which the Corporation shall be obligated to redeem are so redeemed, when additional funds of the Corporation are legally available for the redemption of any of the shares of Class A Preferred Stock and Class B Preferred Stock (including fractional shares), such funds shall be used immediately to redeem shares (or fractions thereof) which the Corporation has become obligated to redeem but which it has not redeemed, such amount to be applied ratably among each of the holders of shares of Class A Preferred Stock and Class B Preferred Stock which the Corporation is then obligated to redeem in proportion to the number of shares of Class A Preferred Stock and Class B Preferred Stock which are held by them and which the Corporation shall then be obligated to redeem. Notwithstanding the foregoing, in connection with any Liquidation, any redemption payments owing to holders of Class A Preferred Stock shall be paid in full (up to the Class A Liquidation Preference) before payments shall be made to holders of Class B Preferred Stock pursuant to Section 8.5. -7- 8 7.5.4. Notwithstanding the fact that a written notice of redemption is given, all rights of the redeeming holder with respect to shares of Class A Preferred Stock which are the subject of such written notice of redemption shall continue as if the written notice of redemption had not been given until the Class A Preferred Stock Redemption Price therefor is paid (such payment being a continuing obligation of the Corporation). 7.5.5. Upon payment of the Class A Preferred Stock Redemption Price by the Corporation with respect to shares of Class A Preferred Stock being redeemed pursuant to this Section 7.5, such shares of Class A Preferred Stock shall no longer be deemed to be outstanding, shall be canceled and shall not be subject to reissuance by the Corporation. 7.6. Conversion Rights. Upon the occurrence of the closing of a Qualified Public Offering, provided that, prior to such closing: (a) at least thirty (30) days prior to the date which the Board of Directors estimates in good faith to be the likely effective date of the registration of a Qualified Public Offering (the "Anticipated Effective Date"), the Board of Directors shall have provided to all of the holders of Class A Preferred Stock and Class B Preferred Stock notice of an anticipated Qualified Public Offering, which notice shall include the Anticipated Effective Date and the anticipated offering price per share of Common Stock at which the Common Stock will be first offered to the public in the Qualified Public Offering and (b) at least twenty (20) days prior to the Anticipated Effective Date, the holders of the Class A Preferred Stock and holders of Class B Preferred Stock, together representing at least sixty percent (60%) of the aggregate outstanding shares of Class A Preferred Stock and Class B Preferred Stock shall have elected to convert all of the issued and outstanding shares of Class A Preferred Stock and Class B Preferred Stock (other than those shares being redeemed pursuant to Section 7.5.1 and Section 8.5.1, respectively) into shares of Common Stock, then in such event (an "Event of Conversion") each and every share of Class A Preferred Stock then outstanding (other than those shares being redeemed pursuant to Section 7.5.1), by virtue of, and simultaneously with the occurrence of the Event of Conversion and without any additional action on the part of the holder thereof, be deemed automatically converted into such number of fully paid and nonassessable shares of Common Stock as is equal to the quotient obtained by dividing (x) the Class A Preferred Stock Stated Value by (y) the Conversion Price (as hereinafter defined). The "Conversion Price" shall be the offering price per share at which the Common Stock of the Corporation is first offered to the public in the Qualified Public Offering. 7.6.1. The holder of any shares of Class A Preferred Stock converted into shares of Common Stock pursuant to Section 7.6 shall remain entitled to payment of all accrued but unpaid dividends, if any, payable with respect to such shares of Class A Preferred Stock up to and including the date upon which the Qualified Public Offering is closed (the "Conversion Date"). 7.6.2. Conversion shall be deemed to have been effected with respect to conversion under Section 7.6 on the Conversion Date. Simultaneous with the conversion being effected, the shares of Class A Preferred Stock so converted shall no longer be deemed outstanding, shall be canceled and shall not be subject to reissuance by the Corporation. As promptly as -8- 9 practicable thereafter, the Corporation shall issue and deliver to the record locations of each of the holders (or upon the written order of a holder, at the place designated by such holder), a certificate or certificates for the number of full shares of Common Stock to which each respective holder is entitled and a check or cash in respect of any fractional interest in a share of Common Stock, as provided in Section 7.6.3, payable with respect to the shares of Class A Preferred Stock so converted. The person in whose name the certificate or certificates for Common Stock are to be issued shall be deemed to have become a stockholder of record on the Conversion Date unless the transfer books of the Corporation are closed on that date, in which event such holder shall be deemed to have become a stockholder of record on the next succeeding date on which the transfer books are open. 7.6.3. No fractional shares of Common Stock shall be issued upon conversion of shares of Class A Preferred Stock. Instead of any fractional shares of Common Stock which would otherwise be issuable upon conversion of any shares of Class A Preferred Stock, the Corporation shall pay a cash adjustment in respect of such fractional interest in an amount equal to the Conversion Price of a share of Class A Preferred Stock multiplied by such fractional interest. Holders of fractional interests shall not be entitled to dividends in respect of such fractional interests and the holders of fractional interests shall not be entitled to any rights as stockholders of the Corporation in respect of such fractional interests. 7.6.4. The Corporation shall pay all documentary, stamp or other transaction taxes attributable to the issuance or delivery of shares of Common Stock upon conversion of any shares of Class A Preferred Stock; provided, however, that the Corporation shall not be required to pay any taxes which may be payable in respect of any transfer involved in the issuance or delivery of any certificate for such shares in a name other than that of the holder of the shares of Class A Preferred Stock in respect of which such shares are being issued. 7.6.5. The holders of the Class A Preferred Stock and the holders of the Class B Preferred Stock, by vote of sixty percent (60%) of the aggregate outstanding shares of Class A Preferred Stock and Class B Preferred Stock, voting together as a single voting group, shall have the right to amend the Corporation's Charter for the sole purpose of authorizing sufficient additional shares of Common Stock to effect the conversions under this Section 7.6 and Section 8.6. The additional shares, when so authorized, shall be reserved by the Corporation for the purpose of effecting such conversions and shall be free of preemptive rights. 7.6.6. All shares of Common Stock which may be issued in connection with the conversion provisions set forth herein will, upon issuance by the Corporation, be validly issued, fully paid and nonassessable and free from all taxes, liens or charges with respect thereto created or imposed by the Corporation. 8. Class B Preferred Stock. The express terms and conditions of the shares classified and designated as Class B Preferred Stock, no par value, of the Corporation are as follows: -9- 10 8.1. Designation and Number of Shares of Class B Preferred Stock. The designation of the series of Preferred Stock set forth in this Section 8 is Class B Preferred Stock and the number of shares of such series is 31,600 shares having a stated value per share equal to $13.58859 (the "Class B Preferred Stock Stated Value"). The Class B Preferred Stock shall rank pari passu with the Class A Preferred Stock (except as provided in Section 7.3 and Section 8.3 hereof) and senior to all other shares of the capital stock of the Corporation except the Class C Preferred Stock. 8.2. Dividends with respect to Class B Preferred Stock. 8.2.1. In each year, the holder of each share of Class B Preferred Stock shall be entitled to receive preferential, cumulative dividends in cash, which dividends shall be cumulative and shall accrue from the date upon which the Class B Preferred Stock was issued, in an amount equal to eight percent (8%) of the Class B Preferred Stock Stated Value per share per year, provided, however, that upon the later to occur of (i) the consummation of a Liquidity Event, (ii) June 12, 1999 or (iii) the full payment and discharge of the senior subordinated indebtedness of the Corporation and the Affiliated Corporations (in the initial principal amount of Twenty Million Dollars ($20,000,000)), dividends shall accrue in an amount equal to ten percent (10%) per annum of the Class B Preferred Stock Stated Value. Dividends shall accrue daily whether or not declared and whether or not funds are legally available therefor. If such dividends are not paid within ninety (90) days after the end of each of the Corporation's fiscal quarters, such dividends shall accrue additional dividends from the last day of such fiscal quarter at the same rate per annum. Dividends shall be paid only to the extent that (i) there shall be sufficient funds of the Corporation legally available for the payment of such dividends, (ii) the payment of such dividend would not violate any covenants of the Corporation to any lender to the Corporation or its subsidiaries and (iii) the payment of such dividend would not violate the terms of any management or shareholder agreement to which the Corporation is party. 8.2.2. If, in any dividend period or periods, full dividends (whether past or current) upon the outstanding Class B Preferred Stock at the dividend rate set forth herein shall not have been paid, then, unless and until all dividends accrued and unpaid on the Class B Preferred Stock through the payment date for such dividends are declared and paid on each share of Class B Preferred Stock, no dividends shall be declared or paid or set apart for payment upon any Common Stock or class or series of the Corporation's capital stock authorized, created or designated after June 12, 1996 nor shall the Corporation purchase, redeem or otherwise acquire for consideration any such stock. If, at any time, the Corporation shall pay less than the total amount of dividends then payable on the then outstanding Class B Preferred Stock, the aggregate payment to all holders of Class B Preferred Stock shall be distributed among all such holders so that an amount ratably in proportion to the respective dividends due thereon shall be paid with respect to each outstanding share of Class B Preferred Stock. 8.2.3. Holders of the Class B Preferred Stock shall not, solely as a result of such holders' ownership of such Class B Preferred Stock, be entitled to participate in any dividends -10- 11 or other distributions (cash, stock or otherwise) declared or paid on or with respect to any other class of stock or equity security of the Corporation or any series of any such class. 8.2.4. No dividend shall be paid upon shares of Class B Preferred Stock unless like dividends are simultaneously paid on shares of Class A Preferred Stock. 8.3. Liquidation Preference with Respect to Class B Preferred Stock. 8.3.1. In the event of a Liquidation, after any distribution of any of the assets of the Corporation to holders of Class C Preferred Stock pursuant to Section 9.3, the holders of Class B Preferred Stock shall be entitled to receive out of the assets of the Corporation legally available for distributions to its stockholders, prior and in preference to any distribution of any of the assets of the Corporation to the holders of any Common Stock or class or series of the Corporation's capital stock authorized, created or designated after June 12, 1996, and after payments of the Class A Liquidation Preference to holders of Class A Preferred Stock under Section 7.3 hereof, an amount per share equal to the sum of the Class B Preferred Stock Stated Value plus all accrued and unpaid dividends, if any, to the date of payment, less the Class B Excess Dividend Amount (hereinafter defined) (the "Class B Liquidation Preference") for each share of Class B Preferred Stock held. If upon any Liquidation the assets of the Corporation available for distribution to its shareholders shall be insufficient to pay the holders of shares of Class B Preferred Stock. the full amount of the Class B Liquidation Preference the holders of shares of Class B Preferred Stock shall share ratably in any distribution of assets available for distribution to the Class B Preferred Stock holders after distributions to the holders of the Class C Preferred Stock pursuant to Section 9.3 and distribution of the Class A Liquidation Preference to the holders of the Class A Preferred Stock pursuant to Section 7.3. 8.3.2. In the event of any Liquidation, after payment of the Class A Liquidation Preference and the Class B Liquidation Preference, the holders of the Class B Preferred Stock shall be entitled to receive, pari passu with the amounts payable to holders of Class A Preferred Stock pursuant to Section 7.3.2, an amount equal to all accrued and unpaid dividends, if any, to the date of payment owing on the Class B Preferred Stock other than accrued and unpaid dividends that would be owing thereon if all dividends accrued on the Class B Preferred Stock at the rate of eight percent (8%) per annum (the "Class B Excess Dividend Amount"). 8.3.3. In the event of any Liquidation, after payment shall have been made to the holders of shares of Class B Preferred Stock of the amounts described in Section 8.3.1 or Section 8.3.2, the holders of shares of Class B Preferred Stock shall be entitled to no further participation in the distribution of the assets of the Corporation. 8.3.4. The sale or other disposition (other than by a contribution to or merger with another corporation of which more than eighty percent (80%) of the stock (by vote and value) is owned (directly or indirectly) by the Corporation or its shareholders) of all or substantially all the assets of the Corporation shall be deemed to be a Liquidation. -11- 12 8.4. Voting Rights with Respect to Class B Preferred Stock. The Class B Preferred Stock shall have the right to vote on all matters as to which holders of the Common Stock shall be entitled to vote (at the rate of one vote per share), in the same manner and with the same effect as such holders of the Common Stock, voting together with the holders of Common Stock and Class A Preferred Stock as one voting group. Without first obtaining the approval (by vote or written consent) of at least seventy-five percent (75%) of the outstanding shares of the Class B Preferred Stock as a separate class, the Corporation shall not, 8.4.1. in any manner authorize, create or issue (x) any class or series of capital stock which (A) ranks, either as to payment of dividends, distribution of assets or redemption, prior to or on parity with the Class B Preferred Stock or (B) in any manner adversely affects the holders of the Class B Preferred Stock, or (y) any additional shares of Class A Preferred Stock, Class C Preferred Stock or any shares of any class or series of any bonds, debentures, notes or other obligations convertible into or exchangeable for, or having optional rights to purchase, any shares having any such priority or parity with or so adversely affecting the holders of the Class B Preferred Stock; 8.4.2. in any manner alter or change the designations or the powers, preferences or rights, or the qualifications, limitations or restrictions of the Class B Preferred Stock, including without limitation, by increasing or decreasing the number of shares of the Class B Preferred Stock authorized for issuance hereunder, or by increasing or decreasing the par value or Class B Preferred Stock Stated Value of the shares of the Class B Preferred Stock; or 8.4.3. reclassify the shares of any (a) Common Stock, (b) class or series of the Corporation's capital stock authorized, created or designated after June 12, 1996 or (c) Class A Preferred Stock into shares of any class or series of capital stock (A) ranking, either as to payment of dividends, distribution of assets or redemption, prior to or on a parity with the Class B Preferred Stock or (B) which in any manner adversely affects the holders of the Class B Preferred Stock. 8.5. Redemptions with Respect to Class B Preferred Stock. 8.5.1. At any time and from time to time after (or simultaneously with) the completion of the redemption of all of the outstanding Class C Preferred Stock pursuant to Section 9.5 and after the Redemption Allowance Date, at the option of the Corporation and upon the Corporation's delivery of thirty (30) days prior written notice of such a redemption to be effected on or after the Redemption Allowance Date, the Corporation may redeem all or any portion of the Class B Preferred Stock then outstanding; provided, however, that (x) any redemption of less than all of the shares of Class B Preferred Stock shall be divided ratably and equally among the then extant holders of Class B Preferred Stock and (y) no shares of Class B Preferred Stock shall be redeemed pursuant to this Section 8.5.1 unless a pro rata number (based on aggregate stated values) of Class A Preferred Stock shall be redeemed pursuant to Section 7.5.1. For each share of Class B Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant to this -12- 13 Section 8.5.1, the Corporation shall be obligated to pay to the holder thereof (upon surrender by such holder at the Corporation's principal office of the certificate representing such share duly endorsed in blank or accompanied by an appropriate form of assignment) an amount for such share equal to the Class B Preferred Stock Stated Value plus all accrued and unpaid dividends with respect to such share to the date of payment (the "Class B Preferred Stock Redemption Price"). 8.5.2. After (or simultaneously with) the completion of the redemption of all of the outstanding Class C Preferred Stock pursuant to Section 9.5, at any time and from time to time after June 12, 2004, at the option of a holder of the Class B Preferred Stock and upon thirty (30) days prior delivery of a written notice by the holder to the Corporation of redemption to be effected on or after such date, such holder may require the Corporation to redeem all or any portion of the Class B Preferred Stock held by such holder. For each share of Class B Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant, to this Section 8.5.2, the Corporation shall be obligated to pay to the holder thereof (upon surrender by such holder at the Corporation's principal office of the certificate representing such share duly endorsed in blank or accompanied by an appropriate form of assignment) an amount for such share equal to the Class B Preferred Stock Redemption Price. 8.5.3. If the funds of the Corporation legally available for redemption pursuant to Section 8.5.2 and Section 7.5.2 are insufficient to redeem the number of shares which the Corporation is required to redeem pursuant to this Section 8.5.2 and Section 7.5.2, those funds which are available will be used to redeem the maximum possible number of shares (or fraction thereof) and such funds shall be distributed ratably among each of the holders of the Class A Preferred Stock and Class B Preferred Stock in proportion to the amount that would have been distributed to each such holder if the funds of the Corporation would have been sufficient to permit payment of the full amount required to be paid in respect of such redemption. At any time, and from time to the thereafter, until all shares the Corporation shall be obligated to redeem are so redeemed, when additional funds of the Corporation are legally available for the redemption of any of the shares of Class A Preferred Stock and Class B Preferred Stock (including fractional shares), such funds shall be used immediately to redeem shares (or fractions thereof), which the Corporation has become obligated to redeem but which it has not redeemed, such amount to be applied ratably among each of the holders of shares of Class A Preferred Stock and Class B Preferred Stock which the Corporation is then obligated to redeem in proportion to the number of shares of Class A Preferred Stock and Class B Preferred Stock which are held by them and which the Corporation shall then be obligated to redeem. Notwithstanding the foregoing, in connection with any Liquidation, any redemption payments owing to holders of Class A Preferred Stock shall be paid in full (up to the Class A Liquidation Preference) before payments shall be made to holders of Class B Preferred Stock pursuant to this Section 8.5. 8.5.4. Notwithstanding the fact that a written notice of redemption is given, all rights of the redeeming holder with respect to shares of Class B Preferred Stock which are the subject of such written notice of redemption shall continue as if the written notice of redemption had -13- 14 not been given until the Class B Preferred Stock Redemption Price therefor is paid (such payment being a continuing obligation of the Corporation). 8.5.5. Upon payment of the Class B Preferred Stock Redemption Price by the Corporation with respect to shares of Class B Preferred Stock being redeemed pursuant to this Section 8.5, such shares of Class B Preferred Stock shall no longer be deemed to be outstanding, shall be canceled and shall not be subject to reissuance by the Corporation. 8.6. Conversion Rights. Upon the occurrence of an Event of Conversion, each and every share of Class B Preferred Stock then outstanding (other than those shares being redeemed pursuant to Section 8.5.1), by virtue of, and simultaneously with the occurrence of the Event of Conversion and without any additional action on the part of the holder thereof, be deemed automatically converted into such number of fully paid and nonassessable shares of Common Stock as is equal to the quotient obtained by dividing (x) the Class B Preferred Stock Stated Value by (y) the Conversion Price. 8.6.1. The holder of any shares of Class B Preferred Stock converted into shares of Common Stock pursuant to Section 8.6 shall remain entitled to payment of all accrued but unpaid dividends, if any, payable with respect to such shares of Class B Preferred Stock up to and including the Conversion Date. 8.6.2. Conversion shall be deemed to have been effected with respect to conversion under Section 8.6 on the Conversion Date. Simultaneous with the conversion being effected, the shares of Class B Preferred Stock so converted shall no longer be deemed outstanding, shall be canceled and shall not be subject to reissuance by the Corporation. As promptly as practicable thereafter, the Corporation shall issue and deliver to the record locations of each of the holders (or upon the written order of a holder, at the place designated by such holder), a certificate or certificates for the number of full shares of Common Stock to which each respective holder is entitled and a check or cash in respect of any fractional interest in a share of Common Stock, as provided in Section 8.6.3, payable with respect to the shares of Class B Preferred Stock so converted. The person in whose name the certificate or certificates for Common Stock are to be issued shall be deemed to have become a stockholder of record on the Conversion Date unless the transfer books of the Corporation are closed on that date, in which event such holder shall be deemed to have become a stockholder of record on the next succeeding date on which the transfer books are open. 8.6.3. No fractional shares of Common Stock shall be issued upon conversion of shares of Class B Preferred Stock. Instead of any fractional shares of Common Stock which would otherwise be issuable upon conversion of any shares of Class B Preferred Stock, the Corporation shall pay a cash adjustment in respect of such fractional interest in an amount equal to the Conversion Price of a share of Class B Preferred Stock multiplied by such fractional interest. Holders of fractional interests shall not be entitled to dividends in respect of such fractional interests, and the holders of fractional interests shall not be entitled to any rights as stockholders of the Corporation in respect of such fractional interests. -14- 15 8.6.4. The Corporation shall pay all documentary, stamp or other transaction taxes attributable to the issuance or delivery of shares of Common Stock upon conversion of any shares of Class B Preferred Stock; provided, however, that the Corporation shall not be required to pay any taxes which may be payable in respect of any transfer involved in the issuance or delivery of any certificate for such shares in a name other than that of the holder of the shares of Class B Preferred Stock in respect of which such shares are being issued. 8.6.5. The holders of the Class A Preferred Stock and the holders of the Class B Preferred Stock, by vote of sixty percent (60%) of the aggregate outstanding shares of Class A Preferred Stock and Class B Preferred Stock, voting together as a single voting group, shall have the right to amend the Corporation's Charter for the sole purpose of authorizing sufficient additional shares of Common Stock to effect the conversions under this Section 8.6 and Section 7.6. The additional shares, when so authorized, shall be reserved by the Corporation for the purpose of effecting such conversions and shall be free of preemptive rights. 8.6.6. All shares of Common Stock which may be issued in connection with the conversion provisions set forth herein will, upon issuance by the Corporation, be validly issued, fully paid and nonassessable and free from all taxes, liens or charges with respect thereto created or imposed by the Corporation. 9. Class C Preferred Stock. The express terms and conditions of the shares classified and designated as Class C Preferred Stock, no par value, of the Corporation are as follows: 9.1. Designation and Number Preferred Stock. The designation of the series of preferred stock in this Section 9 is Class C Preferred Stock (hereinafter called "Class C Preferred Stock") and the number of shares of such series is 20,000 shares having a stated value per share equal to $30.63556 (the "Class C Preferred Stock Stated Value"). The Class C Preferred Stock shall rank senior to all other shares of the capital stock of the Corporation. 9.2. Dividends with Respect Class C Preferred Stored Stock. Except as provided herein, the holders of shares of Class C Preferred Stock shall not be entitled to receive dividends with respect to their shares of Class C Preferred Stock nor shall they be entitled to participate in any dividends (cash, stock or otherwise) declared or paid on or with respect to any other class of stock or equity security of the Corporation or any series of any such class solely as a result of their ownership of such Class C Preferred Stock. 9.3. Liquidation Preference with Respect to Class C Preferred Stock. 9.3.1. In the event of any Liquidation, the holders of Class C Preferred Stock shall be entitled to receive out of the assets of the Corporation legally available for distributions to its stockholders, prior and in preference to any distribution of any of the assets of the Corporation to the holders of any other class of stock or equity security of the Corporation or any series of any -15- 16 such class, an amount per share equal to the sum of the Class C Preferred Stock Stated Value plus all accrued and unpaid dividends, if any, to the date of payment (the "Class C Liquidation Preference") for each share of Class C Preferred Stock held. If upon any Liquidation the assets of the Corporation available for distribution to its shareholders shall be insufficient to pay the holders of shares of Class C Preferred Stock the full amount of the Class C Liquidation Preference, the holders of shares of Class C Preferred Stock shall share ratably in any distribution of assets available for distribution to the Class C Preferred Stock holders. 9.3.2. In the event of any Liquidation, after payment shall have been made to the holders of shares of Class C Preferred Stock of the amounts described in Section 9.3.1, the holders of shares of Class C Preferred Stock shall be entitled to no further participation in the distribution of the assets of the Corporation. 9.3.3. The sale or other disposition (other than by a contribution to or merger with another corporation of which more than eighty percent (80%) of the stock (by vote and value) is owned (directly or indirectly) by the Corporation or its shareholders) of all or substantially all the assets of the Corporation shall be deemed to be a Liquidation. 9.4. Voting Rights with Respect to Class C Preferred Stock. The Class C Preferred shall not have any voting rights except as set forth in this Section 9.4. Without first obtaining the approval (by vote or written consent) of at least seventy-five percent (75%) of the outstanding shares of the Class C Preferred Stock as a separate class, the Corporation shall not, 9.4.1. in any manner authorize, create or issue (x) any class or series of capital stock which (A) ranks, either as to payment of dividends, distribution of assets or redemption, prior to or on parity with the Class C Preferred Stock or (B) in any manner adversely affects the holders of the Class C Preferred Stock, or (y) any shares of any class or series of any bonds, debentures, notes or other obligations convertible into or exchangeable for, or having optional rights to purchase, any shares having any such priority or parity with or so adversely affecting the holders of the Class C Preferred Stock; 9.4.2. in any manner alter or change the designations or the powers, preferences or rights, or the qualifications, limitations or restrictions of the Class C Preferred Stock, including without limitation, by increasing or decreasing the number of shares of the Class C Preferred Stock authorized for issuance hereunder, or by increasing or decreasing the par value of the shares of the Class C Preferred Stock; or 9.4.3. reclassify any shares of capital stock of the Corporation into shares of any class or series of capital stock (A) ranking, either as to payment of dividends, distribution of assets or redemption, prior to or on a parity with the Class C Preferred Stock or (B) which in any manner adversely affects the holders of the Class C Preferred Stock. -16- 17 9.5. Redemption with Respect to Class C Preferred Stock. 9.5.1. At any time and from time to time after March , 1998, at the option of the Corporation and upon the Corporation's delivery of thirty (30) days prior written notice, the Corporation may redeem all or any portion of the Class C Preferred Stock then outstanding; provided, however, that any redemption of less than all of the shares of Class C Preferred Stock shall be divided ratably and equally among the then extant holders of Class C Preferred Stock. 9.5.2. The Class C Preferred Stock shall be mandatorily redeemable in whole upon the Redemption Allowance Date. In the event that the Corporation is prevented from redeeming the Class C Preferred Stock when required in accordance with the foregoing sentence, whether by contract or law, dividends will accrue and cumulate thereon at an annual rate of nine percent (9%) from the date payment is due as a result of such Class C Redemption Event pursuant to Section 9.5.3, until the redemption occurs. 9.5.3. For each share of Class C Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant to this Section 9.5, the Corporation shall be obligated to pay to the holder thereof (upon surrender by such holder at the Corporation's principal office of the certificate representing such share duly endorsed in blank or accompanied by an appropriate form of assignment) an amount for such share equal to the Class C Preferred Stock Stated Value plus all accrued and unpaid dividends, if any, with respect to such share to the date of payment (the "Class C Preferred Stock Redemption Price"), on (i) in the case of a redemption at the option of the Corporation, the last day of any fiscal quarter if, during the quarter then ending, a written notice of redemption shall have been delivered by the Corporation to the holder more than thirty (30) days prior to such last day or thirty (30) or fewer days prior to the end of the immediately preceding fiscal quarter or (ii) for purposes of the mandatory redemption described in Section 9.5.2, the earlier to occur of (A) a date set by the Corporation in the redemption notice which is within thirty (30) days after June 12, 2004, or (B) upon the closing of a Liquidity Event. 9.5.4. If the funds of the Corporation legally available for redemption pursuant to Section 9.5.1 or Section 9.5.2 are insufficient to redeem the number of shares which the Corporation is required to redeem pursuant to Section 9.5.1 or Section 9.5.2, those funds which are available will be used to redeem the maximum possible number of shares (or fraction thereof) and such funds shall be distributed ratably among each of the holders of the Class C Preferred Stock in proportion to the amount that would have been distributed to each such holder if the funds of the Corporation would have been sufficient to permit payment of the full amount required to be paid in respect of such redemption. At any time, and from time to time there after, until all shares of Class C Preferred Stock which the Corporation shall be obligated to redeem are so redeemed, when additional funds of the Corporation are legally available for the redemption of any of the shares of Class C Preferred Stock (including fractional shares), such funds shall be used immediately to redeem shares (or fractions thereof) which the Corporation has become obligated to redeem but which it has not redeemed, such amount to be applied ratably among each of the holders of shares of Class C Preferred Stock which the Corporation is the obligated to redeem in proportion to the -17- 18 number of shares of Class C Preferred Stock which are held by them and which the Corporation shall be obligated to redeem. 9.5.5. Notwithstanding the fact that a written notice of redemption is given, all rights of the redeeming holder with respect to shares of Class C Preferred Stock which are the subject of such written notice of redemption shall continue as if the written notice of redemption had not been given until the Class C Preferred Stock Redemption Price therefor is paid (it being understood that such payment shall be a continuing obligation of the Corporation). 9.5.6. Once the Class C Preferred Stock Redemption Price has been paid by the Corporation with respect to shares of Class C Preferred Stock being redeemed pursuant to this Section 8.5, such shares of Class C Preferred Stock shall no longer be deemed to be outstanding, shall be canceled and shall not be subject to reissuance by the Corporation. 10. Special Shareholder Meetings. Special meetings of shareholders may be called at any time, but only by the Chairman of the Board of Directors, the President of the Company, or upon a resolution adopted by or affirmative vote of a majority of the Board of Directors, and not by the shareholders. 11. Directors. 11.1. Number. The number of directors of the Corporation shall be such number, neither fewer than three nor more than fifteen (exclusive of directors, if any, to be elected by holders of preferred stock of the Corporation, voting separately as a class), as determined by a majority vote of the Board of Directors. The Board of Directors has the power to fix or change the number of directors, including an increase or decrease in the number of directors from time to time as established by a majority vote of the Board of Directors. A director need not be a shareholder or a resident of the state of Tennessee. 11.2. Classes. 11.2.1. Number of Classes. The Board of Directors of the Corporation shall be divided into three classes as nearly equal in number as the then total number of directors constituting the entire Board of Directors shall permit, which classes shall be designated Class I, Class II and Class III. 11.2.2. Term. Directors assigned to be the initial Class I directors shall be elected to hold office for a term expiring at the annual meeting of shareholders to be held in 1999; directors assigned to be the initial Class II directors shall be elected to hold office for a term expiring at the annual meeting of shareholders to be held in 2000; and, directors assigned to be the initial Class III directors shall be elected to hold office for a term expiring at the annual meeting of shareholders to be held in 2001. Thereafter, at each annual meeting of shareholders of the Corporation, directors of classes the terms of which expire at such annual meeting shall be elected -18- 19 for terms of three years by a plurality vote of all votes cast at such meeting. Notwithstanding the foregoing, a director whose term shall expire at any annual meeting shall continue to serve until such time as his successor shall have been duly elected and shall have qualified unless his position on the Board of Directors shall have been abolished by action taken to reduce the size of the Board of Directors prior to said meeting. 11.2.3. Increase or Decrease in Number. Should the number of directors of the Corporation be reduced, the directorship(s) eliminated shall be allocated among classes as appropriate so that the number of directors in each class is as specified in Section 11.2.1 herein. The Board of Directors shall designate, by the name of the incumbent(s), the position(s) to be abolished. Notwithstanding the foregoing, no decrease in the number of directors shall have the effect of shortening the term of any incumbent director. Should the number of directors of the Corporation be increased, the additional directorships shall be allocated among classes as appropriate so that the number of directors in each class is as specified in paragraph Section 11.2.1. 11.3. Removal. No director of the Corporation (including those directors, if any, elected by holders of any series of preferred stock) may be removed at any time unless for cause. Upon finding of cause as determined by a majority of the Board of Directors (excluding the director which is the subject of removal), the director may be removed only upon the affirmative vote of the holders of at least 80% of outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors (the "Voting Power"), considered for this purpose as one class, except as otherwise required by law. 11.4. Vacancies and Newly Created Directorships. Unless the Board of Directors otherwise determines, and subject to the rights of the holders of any series of preferred stock, newly created directorships resulting from any increase in the authorized number of directors or any vacancies on the Board of Directors resulting from death, resignation, retirement, disqualification, removal from office or other cause may be filled only by a majority vote of the directors then in office, though less than a quorum, and shall not be filled by the shareholders. Any director chosen to fill a vacancy (a "vacancy director") shall be a director of the same class as the director whose vacancy he or she fills. Any director chosen to fill a vacancy or a newly created directorship (collectively, a "vacancy director") shall hold office until the next annual meeting of shareholders and until his or her successor shall have been elected and qualified. The shareholders shall thereupon elect a director to fill the vacancy or newly created directorship having been temporarily filled by the vacancy director, which individual may include the incumbent vacancy director. The director so elected shall be a director of the same class as the vacancy director and shall serve until the annual meeting of shareholders at which the term of office of such class expires and until such director's successor shall have been duly elected and qualified. 12. Limitation of Liability. Directors of the Corporation shall have no liability to the Corporation or its shareholders for monetary damages for breach of fiduciary duty as a director, provided that this Section 12 shall not eliminate liability of a director for (i) any breach of the director's duty of loyalty to the Corporation or its shareholders; (ii) acts or omissions not in good -19- 20 faith or which involve intentional misconduct or a knowing violation of law; or (iii) unlawful distributions under Section 48-18-304 of the Tennessee Business Corporation Act. If the Tennessee Business Corporation Act is amended or other Tennessee law is enacted to permit further elimination or limitation of the personal liability of directors, then the liability of directors of the Corporation shall be eliminated or limited to the fullest extent permitted by the Tennessee Business Corporation Act, as so amended, or by such other Tennessee law, as so enacted. Any repeal or modification of this Section 12 or subsequent amendment of the Tennessee Business Corporation Act or enactment of other applicable Tennessee law shall not adversely affect any right or protection of a director of the Corporation existing at the time of such repeal, modification, amendment or enactment. 13. Amendment of Bylaws. To the extent permitted by the Tennessee Business Corporation Act, the Board of Directors of the Corporation is expressly authorized to repeal, alter, amend or rescind the Bylaws of the Corporation by vote of a majority of the Board of Directors at a legal meeting held in accordance with the Bylaws. The shareholders may adopt or amend a bylaw that fixes a greater quorum or voting requirement for shareholders (or voting group of shareholders) than is required by the Tennessee Business Corporation Act, to the extent such bylaw does not conflict with the provisions of this Charter. The adoption or amendment of a bylaw that adds, changes, or deletes a greater quorum or voting requirement for shareholders must meet the same quorum requirement and be adopted by the same vote and voting groups required to take action under the quorum and voting requirement then in effect or proposed to be adopted, whichever is greater. 14. Amendment of Charter. The Corporation reserves the right to repeal, alter, amend or rescind any provision contained in this Charter in the manner now or hereafter prescribed by law, and all rights conferred on shareholders herein are granted subject to this reservation. Notwithstanding the foregoing, the provisions in Sections 10, 11, 12, 13 and this Section 14 of this Charter may not be repealed, altered, amended or rescinded in any respect nor may provisions be adopted inconsistent with Sections 10, 11, 12, 13 and this Section 14 unless the same is approved by the affirmative vote of the holders at least 80% of the Voting Power, considered for this purpose as a single class; except that such repeal, alteration, amendment, rescission or adoption may be made by the affirmative vote of the holders of a majority of the outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors (considered for this purpose as a single class) if the same is first approved by a majority of the Board of Directors. 15. Adoption. This amended and restated charter was adopted by unanimous written consent of the Board of Directors and Shareholders of the Corporation dated March , 1998. This charter replaces and supersedes the original charter of the Corporation filed with the Tennessee Secretary of State and all amendments thereto. -20- 21 16. Corporation for Profit. The Corporation is for profit. Dated: ______________________, 1998. KIRKLAND'S, INC. By: ______________________________ Title: ______________________________ -21- EX-3.3 6 BYLAWS OF KIRKLAND'S, INC. 1 EXHIBIT 3.3 BYLAWS OF KIRKLAND'S INC. ARTICLE I. OFFICES Section 1. The principal office of Kirkland's, Inc. (the "Corporation"), is 805 North Parkway, Jackson, Tennessee 38305. The principal office may be changed at any time by appropriate resolution of the Board of Directors. The Corporation may have offices and places of business at such other places within or without the State of Tennessee as shall be determined by the Board of Directors. Section 2. The registered office of the Corporation for any particular state may be, but need not be, identical with the principal office of the Corporation in that state, and the address of the registered office may be changed from time to time by appropriate resolution of the Board of Directors. ARTICLE II. SHAREHOLDERS Section 1. Meetings. All meetings of shareholders shall be held either in the principal office of the Corporation or at any other place within or without the City of Jackson, Tennessee, as designated by the Board of Directors. Section 2. Annual Meeting. The annual meeting of the shareholders shall be held on the second Tuesday in May of each year or such other date, in any particular year, designated by the Board of Directors, for the purpose of electing directors and for the transaction of any other business authorized to be transacted by the shareholders. If the appointed day is a legal holiday the meeting shall be held at the same time on the next succeeding day not a holiday. In the event that the annual meeting is committed by oversight or otherwise on the date herein provided for, the directors shall cause a meeting in lieu thereof to be held as soon thereafter as conveniently may be, and any business transacted or elections held at such meeting shall be as valid as if transacted or held at the annual meeting. Such subsequent meeting shall be called in the same manner as provided for the annual shareholders meeting. Section 3. Special Meetings. (a) The holders of a majority of the Class A Preferred Stock of the Corporation shall have the right at any time to call a special meeting of the shareholders of the Corporation in order for the shareholders to vote on a proposal to engage in a business combination transaction with one or more other businesses, whether by purchase, sale of substantially all assets, merger, consolidation or otherwise. 2 (b) At any time following the earlier to occur of: (i) such time as it shall be possible for the Corporation to do so without resulting in a breach of any agreement to which the Corporation is a party or any event, which with or without the giving of notice or the passage of time, would result in such a breach, or (ii) June 5, 1997, the holders of a majority of the Class A Preferred Stock of the Corporation shall have the right to call a special meeting of the shareholders of the Corporation in order for the shareholders to vote on a proposal to amend the Corporation's Charter and Bylaws as set forth in this paragraph. Such amendment shall eliminate all special voting rights and restrictions on-the Class A Preferred Stock and Class C Preferred Stock such that the Class A Preferred Stock and Class C Preferred Stock shall have no voting rights except as provided by applicable law. Such amendment shall eliminate any reference to the special voting rights and restrictions of the common stock and shall provide for the conversion of all Non-Voting Common Stock into Voting Common Stock. Such amendment shall delete from the Bylaws the special approval provisions set forth in Article III, Section 14 hereof. Section 4. Notice Of Meetings. Notice of all shareholders' meetings stating the time, place and the objects for which such meetings are called shall be given by the President or the Vice-President or the Secretary or an Assistant Secretary to each shareholder of record entitled to vote at such meeting not less than ten (10) days or more than two (2) months prior to the date of the meeting by written notice delivered personally, mailed or delivered via overnight courier to each shareholder. If delivered personally, such notice shall be deemed to be delivered when received. If mailed or delivered via overnight courier service, such notice shall be deemed to be delivered when deposited in the United States Mail in a sealed envelope with postage thereon prepaid, or deposited with the overnight courier service, as the case may be, addressed to the shareholder at his address as it appears on the stock record books of the Corporation, unless he shall have filed with the Secretary of the Corporation a written request that notice intended for him be mailed to some other address, in which case it shall be mailed to the address designated in such request. Any meeting at which all shareholders entitled to vote have waived or at any time shall waive notice shall be a legal meeting for the transaction of business, notwithstanding that notice has not been given as herein before provided. The waiver must be in writing, signed by the shareholder entitled to the notice, and be delivered to the Corporation for inclusion in the minutes or filing with the corporate records. Section 5. Notice of Right to Dissent. If shareholders are to vote at a meeting on a corporate action which would give rise to a dissenter's right to payment for his shares in accordance with the Tennessee Business Corporation Act, notice of such meeting shall be given to every shareholder who will be entitled to dissent from such action and to receive payment for his shares whether or not entitled to vote thereon. Such notice shall be given in accordance with the provisions of Section 4 of this Article and shall also contain a statement, displayed with reasonable prominence, that upon compliance with the Tennessee Business Corporation Act, dissenting shareholders are entitled to be paid the fair value of their shares as provided in said -2- 3 Act, and shall be accompanied by a copy of chapter 23 of the Tennessee Business Corporation Act. Section 6. Closing of Transfer Books or Fixing of Record Date. For the purpose of determining the shareholders entitled to notice of or to vote at any meeting of shareholders or any adjournment thereof, or shareholders entitled to receive payment of any dividend, or in order to make a determination of shareholders for any other proper purpose, the Board of Directors of the Corporation may provide that the stock transfer book shall be closed for a stated period not to exceed in any case thirty days. If the stock transfer book shall be closed for the purpose of determining shareholders, such books shall be closed for at least ten (10) days immediately preceding such meeting. In lieu of closing the stock transfer books, the Board of Directors may fix in advance a date as the record date for any such determination of shareholders, such date in any case to be not more than thirty (30) days and in case of a meeting of shareholders, not less than ten (10) days prior to the date on which the particular action requiring such determination of shareholders is to be taken. If the stock transfer books are not closed and no record date is fixed for the determination of shareholders entitled to notice of or to vote at a meeting of shareholders, or shareholders entitled to receive payment of a dividend, the date on which notice of the meeting is mailed or the date on which the resolution of the Board of Directors declaring such dividend is adopted, as the case may be, shall be the record date for such determination of shareholders. When a determination of shareholders entitled to vote at any meeting of shareholders has been made as provided in this Section, such determination shall apply to any adjournment thereof. Section 7. Voting Lists. The officer or agent having charge of the stock transfer books for common shares of the Corporation shall make available, within two (2) business days after notice of a meeting is given, a complete list of the shareholders entitled to vote at such meeting or any adjournment thereof, arranged in alphabetical order, with the address of and the number of shares held by each shareholder, which list, for a period beginning within two (2) business days after notice of such meeting is given shall be kept on file at the registered office of the Corporation and shall be subject to inspection by any shareholder at any time during usual business hours. Such list shall be kept open at the time and place of the meeting and be subject to the inspection of any shareholder during the entire time of the meeting. In the event of any challenge to the right of any person to vote at the meeting, the presiding officer at such meeting may rely on said list as proper evidence of the right of parties to vote at such meeting. Section 8. Quorum. Except as may be otherwise provided by law, a majority of the outstanding shares of the Corporation entitled to vote, represented in person or by proxy, shall constitute a quorum at a meeting of shareholders. In the event that a majority of the outstanding shares are represented at any meeting, action on a matter is approved if the votes cast favoring the action exceed the votes cast opposing the action, unless the question is one upon which by express provision of law or of the Charter or of these bylaws a larger or different vote is required, in which case such express provision shall govern and control the decision of each question. -3- 4 Section 9. Proxies. Shareholders of record who are entitled to vote may vote at any meeting either in person or by written proxy, which shall be filed with the secretary of the meeting before being voted. Such proxy shall entitle the holders thereof to vote at any adjournment of such meeting, but shall not be valid after the final adjournment thereof. No proxy shall be valid after the expiration of eleven months from the date of its execution unless the shareholder executing it shall have specified therein the length of time it is to continue in force, which shall be for some limited period. Section 10. Voting of Shares. Except as otherwise provided in the charter or these bylaws, each share of common stock shall have all voting rights accorded to holders of common stock pursuant to the corporate law of the state of incorporation, at the rate of one vote per share, except with respect to the election of directors. With respect to the election of directors of the Corporation, the holders of the common stock, voting as a separate voting group, shall have the special and exclusive right at all times to elect four (4) directors to the Board of Directors of the Corporation. The Class A Preferred Stock shall not have any voting rights except as set forth in this Section. At any shareholders meeting called pursuant to Article II, Section 3(a) or Section 3(b) above, each share of Class A Preferred Stock shall entitle the holder thereof to one vote on the proposal being voted upon, voting together with the holders of the voting common stock and Class C Preferred Stock as one voting group. If the shareholders approve such proposal by a majority vote, the matter shall be submitted to the vote of the Board of Directors of the Corporation. If the Board of Directors of the Corporation shall not approve the proposal within five days after the date of the shareholders meeting (a "Board Expansion Event"), then the holders of the Class A Preferred Stock, voting as a separate voting group, shall thereafter have the special and exclusive right at all times to elect two (2) directors to the Board of Directors of the Corporation. The Class B Preferred Stock shall not have any voting rights. The Class C Preferred Stock shall not have any voting rights except as set forth in this Section. Except with respect to the election of directors, the holders of the Class C Preferred Stock shall have the right to vote on all matters as to which holders of the common stock shall be entitled to vote (at the rate of one vote per share), in the same market and with the same effect as such holders of common stock, voting together with the holders of common stock as one voting group. With respect to the election of directors for the Corporation, the holders of the Class C Preferred Stock, voting as a separate voting group, shall have the special and exclusive right at all times to elect five (5) directors to the Board of Directors of the Corporation. Section 11. Informal Action by Shareholders. Any action required to be taken at a meeting of the shareholders, or any other action which may be taken at a meeting of the shareholders, may be taken without a meeting if all shareholders entitled to vote on the action consent to taking such action without a meeting. If all shareholders entitled to vote on the action consent to taking such action without a meeting, then the affirmative vote of the number of shares necessary to authorize such action at a meeting is the act of the shareholders. The action must be evidenced by one or more written consents describing the action taken, signed by each shareholder entitled to vote on the action, indicating each signing -4- 5 shareholder's vote or abstention on the action, and delivered to the Corporation for inclusion in the minutes or filing with the corporate records. Section 12. Meetings by any Form of Communication. The Corporation shall have the power to permit any or all shareholders to participate in an annual or special meeting by, or conduct the meeting through the use of, any means of communication by which all shareholders participating may simultaneously hear each other during the meeting; provided, however, that the Corporation may permit such shareholder participation only so long as total number of shareholders of the Corporation is less than fifteen (15) shareholders. A shareholder who participates in a meeting by this means is deemed to be present in person at the meeting. ARTICLE III. BOARD OF DIRECTORS Section 1. Number, Tenure and Qualifications. The number of Directors of the Corporation shall be nine (9) unless and until a Board Expansion Event occurs, in which case the number of Directors shall be eleven (11). Section 2. Powers of Directors. The Board of Directors shall have the entire management of the business of the Corporation. In the management and control of the property, business and affairs of the Corporation, the Board of Directors is hereby vested with all the powers possessed by the Corporation itself, so far as this delegation of authority is not inconsistent with the laws of the State of Tennessee, with the Charter of the Corporation, or with these bylaws. The Board of Directors shall have the power to determine what constitutes net earnings, profits, and surplus, respectively, what amount shall be reserved for working capital and to establish reserves for any other proper purpose, and what amount shall be declared as dividends, and such determination by the Board of Directors shall be final and conclusive. The Board of Directors shall have the power to declare dividends for and on behalf of the Corporation, which dividends may include or consist of stock dividends. A majority of the directors elected by the holders of the common stock shall have the right to make all determinations concerning the taking of action by the Corporation to enforce its rights under the Recapitalization Agreement dated April 26, 1996. Section 3. Regular Meetings of the Board. Immediately after the annual election of directors, the newly elected directors may meet at the same place for the purpose of organization, the election of corporate officers and the transaction of other business; if a quorum of the directors be then present no prior notice of such meeting shall be required. Other regular meetings of the Board shall be held at such times and places as the Board by resolution may determine and specify, and if so determined no notice thereof need be given, provided that, unless all the directors are present at the meeting at which said resolution is passed, the first meeting held pursuant to said resolution shall not be held for at least five (5) days following the date on which the resolution is passed. -5- 6 Section 4. Special Meetings. Special meetings of the Board of Directors may be held at any time or place whenever called by the President, or the Vice-President or the Secretary, or by written request of at least two directors, notice thereof being given to each director by the Secretary or other officer calling the meeting, or they may be held at any time without formal notice provided all of the directors are present or those not present shall at any time waive or have waived notice thereof. Section 5. Notice. Notice of any special meetings shall be given at least two (2) days previously thereto by written notice delivered personally, by mail, by telegram, by overnight courier service, or by facsimile. If mailed, such notice shall be mailed to each director at his business address no less than five (5) days previously thereto, and shall be deemed to be delivered when deposited in the United States mail so addressed, with postage thereon prepaid. If notice be given by telegram, such notice shall be deemed to be delivered when the telegram is delivered to the telegraph company. If notice be delivered via overnight courier service, such notice shall be deemed to be delivered when deposited with the overnight courier service. If notice be given by facsimile, such notice shall be deemed to be delivered when information of the transmission is received. Section 6. Meetings by any Form of Communication. The Board of Directors shall have the power to permit any and all directors to participate in a regular or special meeting by, or conduct the meeting through the use of any means of communication by which all directors participating may simultaneously hear each other during the meeting. A Director participating in a meeting by this means is deemed to be present in person at the meeting. Section 7. Quorum. A majority of the members of the Board of Directors, as constituted for the time being, shall constitute a quorum for the transaction of business, but a lesser number may adjourn any meeting and the meeting may be held as adjourned without further notice. When a quorum is present at any meeting, a majority of the members present thereat shall decide any question brought before such meeting, except as otherwise provided by law or by these bylaws. The fact that a director has an interest in a matter to be voted on by the meeting shall not prevent his being counted for purposes of a quorum. Section 8. Vacancies. Any vacancy occurring in the Board of Directors, including vacancies by virtue of removal for cause, may be filled only by the vote of a majority of the voting group which elected the director. Section 9. Compensation. By resolution of the Board of Directors, the directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors, and may be paid a fixed sum for attendance at each meeting of the Board of Directors or a stated salary as a director. No such payment shall preclude any director from serving the Corporation in any other capacity and receiving compensation therefor. -6- 7 Section 10. Removal. Any director elected by the holders of the common stock shall not be subject to removal, other than for cause, unless such removal is approved by a majority of all the votes entitled to be cast by the holders of the common stock. Any director elected by the holders of the Class C Preferred Stock shall not be subject to removal, other than for cause, unless such removal is approved by a majority of all votes entitled to be cast by the holders of the Class C Preferred Stock. Following a Board Expansion Event, any director elected by the holders of the Class A Preferred Stock shall not be subject to removal, other than for cause, unless such removal is approved by a majority of all votes entitled to be cast by the holders of the Class A Preferred Stock. Cause shall be defined as the final conviction of a felony, declaration of unsound mind by court order, or nonacceptance of office. Section 11. Committees. The majority of the Board of Directors may appoint an executive committee or such other committees as it may deem advisable, composed of one (1) or more directors, and may delegate authority to such committees as is not inconsistent with the Tennessee Business Corporation Act. The members of such committee shall serve at the pleasure of the Board of Directors. Section 12. Presumption of Assent. A director of the Corporation who is present at a meeting of the Board of Directors at which action on any corporate matter is taken shall be presumed to have assented to the action taken unless his dissent shall be entered in the minutes of the meeting or unless he shall file his written dissent to such action with the person acting as the secretary of the meeting before the adjournment thereof or shall forward such dissent by registered mail to the Secretary of the Corporation immediately after the adjournment of the meeting. Such right to dissent shall not apply to a director who voted in favor of such action. Section 13. Informal Action by Directors. Any action required to be taken at a meeting of the Board of Directors, or any other action which may be taken at a meeting of the Board of Directors, may be taken without a meeting if all directors consent to taking such action without a meeting. If all directors consent to taking such action without a meeting, the affirmative vote of the majority of the directors is the act of the Board of Directors. The action must be evidenced by one or more written consents describing the action taken, signed by each director, indicating each signing directors vote or abstention on the action, and shall be included in the minutes or filed with the corporate records reflecting the action taken. Section 14. Approval Regarding Certain Actions. In order for the Corporation to take any of the following actions, the approval of at least one of the directors elected by the holders of the common stock shall be required: (i) Any sale, lease or assignment of the Corporation's interest in any assets outside the ordinary course of business. (ii) Any borrowings or incurrence of indebtedness (or series of borrowings or incurrences of indebtedness) within any 12-month period, or any commitment for -7- 8 any of the foregoing, in an amount exceeding $300,000 by the Corporation or $5 million by the Corporation and its affiliated corporations. (iii) Any capital expenditures within any 12-month period in excess of $50,000 by the Corporation or $1 million by the Corporation and its affiliated corporations, in the aggregate. (iv) Any sale or other issuance, or any purchase or redemption, of any securities of the Corporation or its affiliated corporations, as the case may be, by the Corporation. (v) Any merger or consolidation by the Corporation with any other entity or corporation or any liquidation or dissolution. (vi) Any amendment to the Corporation's Charter or Bylaws. (vii) The removal or election of any corporate officer, or the termination of employment of or hiring of any employee earning annualized compensation of more than $100,000. (viii) Any contract with Carl Kirkland, Robert Kirkland, Bruce Moore, Robert Anderson or any Affiliate of any such individuals not in the ordinary course of business. An Affiliate shall mean any sole proprietorship, corporation, partnership, joint venture, association, or any other entity or organization (a "Person"), which, directly or indirectly, is controlled by or is under common control with Carl Kirkland, Robert Kirkland, Bruce Moore or Robert Anderson. The term "control" (including, with correlative meaning, the terms "controlled by and under common control with"), shall mean the possession, directly or indirectly, of the power to elect a majority of the Board of Directors or to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities, by contract or otherwise. ARTICLE IV. WAIVER OF NOTICE Whenever any notice is required to be given by these bylaws, or the Charter of the Corporation, or any other laws of the State of Tennessee, a waiver thereof in writing signed by the person or persons entitled to such notice and filed with the minutes or corporate records, whether before or after the time stated therein, shall be deemed equivalent thereto. Where the person or persons entitled to such notice sign the minutes of any shareholder's or directors meeting, which minutes contain the statement that said person or persons have waived notice of the meeting, then such person or persons are deemed to have waived notice in writing. -8- 9 ARTICLE V. OFFICERS Section 1. Number. The officers of the Corporation shall be a President, one or more Vice Presidents (the number thereof to be determined by the Board of Directors), and a Secretary, each of whom shall be elected by the Board of Directors. Such other officers and assistant officers as may be deemed necessary may be elected or appointed by the Board of Directors. Any two or more offices may be held by the same person, except the offices of President and Secretary. Section 2. Election and Term of Office. The officers of the Corporation to be elected by the Board of Directors shall be elected annually by the Board of Directors at the first meeting of the Board of Directors held after each annual meeting of the shareholders. If the election of officers shall not be held in such meeting, such election shall be held as soon thereafter as conveniently may be. Each officer shall hold office until his successor is duly elected and is qualified or until his death or until he resigns or is removed in the manner hereinafter provided. Section 3. Removal. Any officer or agent elected or appointed by the Board of Directors may be removed by the Board of Directors whenever in its judgment the best interests of the Corporation would be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. Section 4. Vacancies. A vacancy in any office because of death, resignation, removal, disqualification or otherwise, may be filled by the Board of Directors for the unexpired portion of the term. Section 5. President. The President shall be the principal executive officer of the Corporation and, subject to the control of the Board of Directors, shall in general supervise and control all of the business and affairs of the Corporation. He shall, when present, preside at all meetings of the shareholders and of the Board of Directors. He may sign, either alone or with the Secretary, an Assistant Secretary or any other proper officer of the Corporation thereunto authorized by the Board of Directors, certificates for shares of the Corporation, any deed, mortgages, bonds, contracts, or other instruments which the Board of Directors has authorized to be executed, except in cases where the signing and execution thereof shall be expressly delegated by the Board of Directors or by these bylaws to some other officer or agent of the Corporation, or shall be required by law to be otherwise signed or executed, and in general shall perform all duties incident to the office of President and such other duties as may be prescribed by the Board of Directors from time to time. Section 6. The Vice-Presidents. In the absence of the President or in the event of his death, inability or refusal to act, the Vice-President (or in the event there be more than one Vice-President, the Vice-Presidents in the order designated at the time of their election, or in the -9- 10 absence of any designation, then in the order of their election) shall perform the duties of the President, and when so acting, shall have all the powers of and be subject to all the restrictions upon the President. Any Vice-President may sign, either alone or with the Secretary or an Assistant Secretary, certificates for shares of the Corporation any deed, mortgages, bonds, contracts or other instruments which the Board of Directors has authorized to be executed, except in cases where the signing and execution thereof shall be expressly delegated by the Board of Directors or by these bylaws to some other officer or agent of the Corporation, or shall be required by law to be otherwise signed or executed, and shall perform such other duties as from time to time may be assigned to him by the President or by the Board of Directors. Section 7. The Secretary. The Secretary shall: (a) keep the minutes of the shareholders' and of the Board of Directors' meetings in one or more books provided for that purpose; (b) see that all notices are duly given in accordance with the provisions of these bylaws or as required by law; (c) be custodian of the corporate records and of the seal (if any) of the Corporation and see that said seal is affixed to all documents, the execution of which on behalf of the Corporation under its seal is duly authorized; (d) keep a register of the post office address of each shareholder which shall be furnished to the Secretary by such shareholder; (e) sign with the President, or a Vice-President, certificates for shares of the Corporation, the issuance of which shall have been authorized by resolution of the Board of Directors; (f) have general charge of the stock transfer books of the Corporation; and (g) in general perform all duties as from time to time may be assigned to him by the President or by the Board of Directors. Section 8. Assistant Secretaries. The Assistant Secretaries, when authorized by the Board of Directors, may sign with the President or a Vice-President certificates for shares of the Corporation the issuance of which shall have been authorized by a resolution of the Board of Directors. The Assistant Secretaries, in general, shall perform such duties as shall be assigned to them by the Secretary, or by the President or the Board of Directors. Section 9. Registered Agent. The Board of Directors shall appoint a Registered Agent for the Corporation in accordance with the Tennessee Business Corporation Act and may pay the agent such compensation from time to time as it may deem appropriate. ARTICLE VI. CONTRACTS, LOANS, CHECKS AND DEPOSITS Section 1. Contracts. The Board of Directors may authorize any officer or officers, agent or agents, to enter into any contract or execute and deliver any instrument in the name of and on behalf of the Corporation, and such authority may be general or confined to specific instances. Section 2. Loans. No loans shall be contracted on behalf of the Corporation and no evidences of indebtedness shall be issued in its name unless authorized by a resolution of the Board of Directors. Such authority may be general or confined to specific instances. -10- 11 Notwithstanding the foregoing, the Corporation shall not make any loan other than a sale on credit in the ordinary course of business or a life insurance policy loan, either directly or indirectly, to any director or officer of the Corporation except with the consent of the holders of a majority of all the outstanding shares owned or controlled by shareholders other than a shareholder for whose benefit such action is being taken, or if the Board of Directors determines that the loan benefits the Corporation and approves the transaction. Section 3. Checks, Drafts, etc. All checks, drafts, or other orders for the pavement of money, notes or other evidences of indebtedness issued in the name of the Corporation, shall be signed by such officer or officers, agent or agents of the Corporation and in such manner as shall from time to time be determined by resolution of the, Board of Directors. Section 4. Deposits. All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in such banks, trust companies or other depositories as the Board of Directors may select. ARTICLE VII. SHARES OF STOCK Section 1. Certificates for Shares. Certificates representing shares of the Corporation shall be in such form as shall be determined by the Board of Directors. Such certificates shall be signed by the President or Vice-President and by the Secretary or an Assistant Secretary. The use of facsimile signatures on any stock certificate of the Corporation is authorized. All such certificates shall state the name of the Corporation, that it is organized under the laws of the State of Tennessee, the name of the person to whom issued, and the number of shares and class of shares that the certificate represents. All certificates for shares shall be consecutively numbered or otherwise identified. The name and address of the person to whom the shares represented thereby are issued, with the number of shares and date of issue, shall be entered on the stock transfer books of the Corporation. All certificates surrendered to the Corporation for transfer shall be cancelled and no new certificate shall be issued until the former certificate for a number of shares shall have been surrendered and cancelled, except that in case of a lost, destroyed or mutilated certificate a new one may be issued therefor upon such terms and indemnity to the Corporation as the Board of Directors may prescribe. Section 2. Transfer of Shares. Shares of stock may be transferred by delivery of the certificate accompanied either by an assignment in writing on the back of the certificate or by a written power of attorney to sell, assign and transfer the same on the books of the Corporation, signed by the person appearing on the certificate to be the owner of the shares represented thereby, and shall be transferable on the books of the Corporation upon surrender thereof so assigned or endorsed. The person registered on the books of the Corporation as the owner of any shares of stock shall be entitled to all the rights of ownership with respect to such shares. It shall be the duty of every shareholder to notify the Corporation of his post office address. -11- 12 ARTICLE VIII. DIVIDENDS The Board of Directors may from time to time declare, and the Corporation may pay dividends on its outstanding shares in the manner and upon the terms and conditions provided by the Tennessee Business Corporation Act and by its articles of incorporation. ARTICLE IX. FISCAL YEAR The books of the Corporation shall be on a calendar year basis and shall begin on the lst day of January and end on the 31st day of December of each year. ARTICLE X. SEAL This Corporation may or may not have a seal and in any event the failure to affix a corporate seal to any instrument executed by the Corporation shall not affect the validity thereof. If a seal is adopted, the seal of this Corporation shall include the following letters cut or engraved thereon: KIRKLAND'S INC. ARTICLE XI. INDEMNIFICATION OF DIRECTORS AND OFFICERS Section 1. Civil Proceedings. The Corporation shall indemnify an individual made a party to a proceeding because he is or was a director or officer of the Corporation against liability incurred in any civil proceeding if he conducted himself in good faith and, in the case of conduct, in his official capacity with the Corporation, he reasonably believed that his conduct was in the best interest of the Corporation, or in all other cases he reasonably believed that his conduct was at least not opposed to the best interest of the Corporation. Section 2. Criminal Proceedings. The Corporation shall indemnify any individual made a party to a criminal proceeding because he is or was a director or officer of the Corporation against any liability incurred in any criminal proceeding if he had no reasonable cause to believe his conduct was unlawful. Section 3. Employee Benefit Plan. The Corporation shall indemnify any individual made a party to any proceeding because he is or was a director or officer of the Corporation against any liability incurred in any proceeding relating to any employee benefit plan maintained by the Corporation if his conduct with respect to said employee benefit plan was for a -12- 13 purpose he reasonably believed to be in the interests of the participants and the beneficiaries of the plan and his conduct was not opposed to the best interests of the Corporation. Section 4. Limitations. The termination of any proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent is not, of itself, determinative that the director or officer did not meet the standard of conduct required in this Article. However, the Corporation will not indemnify a director or officer if in connection with a proceeding by or in the right of the Corporation in which the director was adjudged liable to the Corporation, or in connection with any other proceeding charging improper personal benefit to him, whether or not involving action in his official capacity, in which he was adjudged liable on the basis that personal benefit was improperly received by him. The Corporation will indemnify a director or officer who is wholly successful, on the merits or otherwise, in the defense of any proceeding to which he is a party because he is or was a director or officer of the Corporation against reasonable expenses incurred by him in connection with the proceeding. Section 5. Advance for Expenses. The Corporation shall pay for or reimburse the reasonable expenses incurred by a director or officer who is a party to a proceeding in advance of final disposition of the proceeding if the director or officer furnishes the Corporation a written affirmation of his good faith belief that he has met the standard of conduct required in this Article, furnishes the Corporation a written undertaking, executed personally or on his behalf, secured or unsecured, to repay the advance if it is ultimately determined that he did not meet the required standard of conduct, and a determination is made that the facts then known to those making the determination would not preclude indemnification of said director or officer. Section 6. Authorization. A majority vote of the Board of Directors shall determine whether or not indemnification of a director or officer is permissible under the circumstances because he has met the required standard of conduct. Alternatively, a majority vote of the Board of Directors may appoint an independent special legal counsel to determine whether or not indemnification of a director or officer is permissible under the circumstances because he has met the required standard of conduct. Section 7. Insurance. The Corporation may purchase and maintain insurance on behalf of an individual who is or was a director, officer, employee, or agent of the Corporation, or who, while a director, officer, employee, or agent of the Corporation, is or was serving at the request of the Corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise, against liability asserted against or incurred by him in that capacity or arising from his status as a director, officer, employee, or agent, whether or not the Corporation would have power to indemnify him against the same liability under applicable state law. Section 8. Interpretation. This Article shall be interpreted to allow indemnification of directors and officers to the fullest extent allowable under Title 48 of the Tennessee Code Annotated as amended from time to time. -13- 14 ARTICLE XII. AMENDMENTS Subject to Article III, Section 14 hereof, the bylaws of the corporation may be altered, amended or repealed and new bylaws may be adopted at any meeting of the Board of Directors of the Corporation by a majority vote of the directors present at the meeting or at any meeting of the shareholders if the votes cast favoring the amendment exceed the votes cast opposing the amendment. ATTEST: /s/ Robert Alderson ------------------- Secretary -14- EX-3.4 7 FORM OF AMENDED & RESTATED BYLAWS OF KIRKLAND'S 1 EXHIBIT 3.4 AMENDED AND RESTATED BYLAWS OF KIRKLAND'S INC. ARTICLE I OFFICES Section 1. The principal office of Kirkland's, Inc. (the "Corporation"), is 805 North Parkway, Jackson, Tennessee 38305. The principal office may be changed at any time upon a resolution adopted by the Board of Directors of the Corporation (the "Board of Directors"). The Corporation may have offices and places of business at such other places within or without the State of Tennessee as shall be determined by the Board of Directors. Section 2. The registered office of the Corporation for any particular state may be, but need not be, identical with the principal office of the Corporation in that state, and the address of the registered office may be changed from time to time by appropriate resolution of the Board of Directors. ARTICLE II SHAREHOLDERS Section 1. Meetings. All meetings of shareholders shall be held either in the principal office of the Corporation or at any other place within or without the City of Jackson, Tennessee, as designated by the Board of Directors. Section 2. Annual Meeting. The annual meeting of the shareholders shall be held on the second Tuesday in May of each year or such other date, in any particular year, designated by the Board of Directors, for the purpose of electing directors and for the transaction of any other business authorized to be transacted by the shareholders. If the appointed day is a legal holiday the meeting shall be held at the same time on the next succeeding day not a holiday. In the event that the annual meeting is committed by oversight or otherwise on the date herein provided for, the Board of Directors shall cause a meeting in lieu thereof to be held as soon thereafter as conveniently may be, and any business transacted or elections held at such meeting shall be as valid as if transacted or held at the annual meeting. Such subsequent meeting shall be called in the same manner as provided for the annual shareholders meeting. Section 3. Special Meetings. Special meetings of shareholders may be called at any time, but only by the chairman of the Board of Directors (the "Chairman of the Board"), the president of the Corporation (the "President"), or upon a resolution adopted by or affirmative vote of a majority of the Board of Directors, and not by the shareholders. Section 4. Notice Of Meetings. Notice of all shareholders' meetings stating the time, place and the objects for which such meetings are called shall be given by the Chairman of the Board, the President or any vice-president (a "Vice-President") or the Secretary (the 2 "Secretary") or any assistant secretary (an "Assistant Secretary") of the Corporation to each shareholder of record entitled to vote at such meeting not less than ten (10) days or more than two (2) months prior to the date of the meeting by written notice delivered personally, mailed or delivered via overnight courier to each shareholder. If delivered personally, such notice shall be deemed to be delivered when received. If mailed or delivered via overnight courier service, such notice shall be deemed to be delivered when deposited in the United States Mail in a sealed envelope with postage thereon prepaid, or deposited with the overnight courier service, as the case may be, addressed to the shareholder at his address as it appears on the stock record books of the Corporation, unless he shall have filed with the Secretary a written request that notice intended for him be mailed to some other address, in which case it shall be mailed to the address designated in such request. Any meeting at which all shareholders entitled to vote have waived or at any time shall waive notice shall be a legal meeting for the transaction of business, notwithstanding that notice has not been given as herein before provided. The waiver must be in writing, signed by the shareholder entitled to the notice, and be delivered to the Corporation for inclusion in the minutes or filing with the corporate records. Section 5. Notice for Nominations and Proposals. 5.1. Annual Meetings. Nominations for the election of directors and proposals for any new business to be taken up at any annual meeting of shareholders may be made by the Board of Directors or, as provided in this bylaw, by any shareholder of the Corporation entitled to vote generally in the election of directors, subject to the rights of the holders of preferred stock, if applicable. In order for a shareholder of the Corporation to make any such nominations and/or proposals, he shall give notice thereof in writing, delivered or mailed by first class United States mail, postage prepaid, to the Secretary so that it is received at least 120 calendar days in advance of the month and day the Corporation's proxy statement to shareholders was mailed to shareholders the preceding year, or, if the Corporation's common stock is not registered under the Securities Exchange Act of 1934 (the "Exchange Act"), not fewer than 90 days nor more than 120 days prior to any such meeting; provided, however, that if notice or public disclosure of the meeting is effected fewer than 40 calendar days before the meeting, such written notice from the shareholder shall be delivered or mailed, as prescribed, to the Secretary not later than the close of the 10th calendar day following the day on which notice of the meeting was mailed to shareholders. Each such notice given by a shareholder with respect to nominations for the election of directors shall set forth (i) the name, age, business address and, if known, residence address of each nominee proposed in such notice, (ii) the principal occupation or employment of each such nominee, and (iii) the number of shares of stock of the Corporation which are beneficially owned by each such nominee. As to any other business that the shareholder proposes to bring before the meeting, such notice shall set forth (i) a brief description of the business desired to be brought before the meeting, (ii) the reasons for conducting such business at the meeting and any material interest in such business of such shareholder and (iii) the beneficial owner, if any, on whose behalf the proposal is made. As to -2- 3 the shareholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made, such notice shall set forth (i) the name and address of such shareholder, as it appears on the Corporation's books, and of such beneficial owner and (ii) the class and number of shares of the Corporation which are owned beneficially and of record by such shareholder and such beneficial owner. 5.2. Special Meetings. Only such business shall be conducted at a special meeting of shareholders as shall have been brought before the meeting pursuant to the Corporation's notice of meeting. Nominations of persons for election to the Board of Directors may be made at a special meeting of shareholders at which directors are to be elected pursuant to the Corporation's notice of meeting (i) by or at the direction of the Board of Directors or (ii) provided that the Board of Directors has determined that directors shall be elected at such meeting, by any shareholder of the Corporation who is a shareholder of record at the time of giving of notice provided for in this bylaw, who shall be entitled to vote at the meeting and who complies with the notice procedures set forth in this bylaw. In the event the Corporation calls a special meeting of shareholders for the purpose of electing one or more directors to the Board of Directors, any such shareholder may nominate a person or persons (as the case may be), for election to such position(s) as specified in the Corporation's notice of meeting for inclusion in the shareholder's notice required by Section 5.1 of these Bylaws if such nomination shall be delivered to the Secretary at the principal executive offices of the Corporation not earlier than the close of business on the 90th day prior to such special meeting and not later than the close of business on the later of the 60th day prior to such special meeting or the 10th day following the day on which public announcement is first made of the date of the special meeting and of the nominees proposed by the Board of Directors to be elected at such meeting. In no event shall the public announcement of an adjournment of a special meeting commence a new time period for the giving of a shareholder's notice as described above. 5.3. General. Only such persons who are nominated by a shareholder in accordance with the procedures set forth in this bylaw shall be eligible to serve as directors and only such business shall be conducted at a meeting of shareholders as shall have been brought before the meeting in accordance with the procedures set forth in this bylaw. Except as otherwise provided by law, the charter of the Corporation (the "Charter") or these Bylaws, the Chairman of the Board shall have the power and duty to determine whether a nomination or any business proposed to be brought before the meeting was made or proposed, as the case may be, in accordance with the procedures set forth in this bylaw and, if any proposed nomination or business is not in compliance with this bylaw, to declare that such defective proposal or nomination shall be disregarded. 5.4. Public Announcement. For purposes of this bylaw, "public announcement" shall mean disclosure in a press release reported by the Dow Jones News Service, Associated Press or comparable national news service or in a document publicly filed by the Corporation with the Securities and Exchange Commission pursuant to Section 13, 14 or 15(d) of the Exchange Act. -3- 4 5.5. Non-Exclusivity. Notwithstanding the foregoing provisions of this Section 5, in the event the Common Stock of the Corporation is registered under the Exchange Act, a shareholder shall also comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this bylaw. Nothing in this Section 5 shall be deemed to affect any rights (i) of shareholders to request inclusion of proposals in the Corporation's proxy statement pursuant to Rule 14a-8 under the Exchange Act or (ii) of the holders of any series of Preferred Stock to elect directors under specified circumstances. Section 6. Quorum. Except as may be otherwise provided by law, a majority of the outstanding shares of the Corporation entitled to vote, represented in person or by proxy, shall constitute a quorum at a meeting of shareholders. In the event that a majority of the outstanding shares are represented at any meeting, action on a matter is approved if the votes cast favoring the action exceed the votes cast opposing the action, unless the question is one upon which by express provision of law or of the Charter or of these Bylaws a larger or different vote is required, in which case such express provision shall govern and control the decision of each question. If a quorum of the shares entitled to vote shall fail to be obtained at any meeting, or in the event of any other proper business purpose, the chair of the meeting or the holders of a majority of the shares present, in person or by proxy, may adjourn the meeting to another place, date or time by announcement to shareholders present in person at the meeting and no other notice of such place, date or time need be given. Section 7. Organization. At every meeting of the shareholders the Chairman of the Board, or, in his absence, the President, or in the absence of the Chairman of the Board and the President, a director or an officer of the Corporation designated by the Board shall act as chairman. The Secretary, or, in his absence, an Assistant Secretary, shall act as secretary at all meetings of the shareholders. In the absence from any such meeting of the Secretary and any Assistant Secretary, the chairman may appoint any person to act as secretary of the meeting. Section 8. Closing of Transfer Books or Fixing of Record Date. For the purpose of determining the shareholders entitled to notice of or to vote at any meeting of shareholders or any adjournment thereof, or shareholders entitled to receive payment of any dividend, or in order to make a determination of shareholders for any other proper purpose, the Board of Directors may provide that the stock transfer book shall be closed for a stated period not to exceed in any case thirty days. If the stock transfer book shall be closed for the purpose of determining shareholders, such books shall be closed for at least ten (10) days immediately preceding such meeting. In lieu of closing the stock transfer books, the Board of Directors may fix in advance a date as the record date for any such determination of shareholders, such date in any case to be not more than thirty (30) days and not less than ten (10) days prior to the date on which the particular action requiring such determination of shareholders is to be taken. If the stock transfer books are not closed and no record date is fixed for the determination of shareholders entitled to notice of or to vote at a meeting of shareholders, or shareholders entitled to receive payment of a dividend, -4- 5 the date on which notice of the meeting is mailed or the date on which the resolution of the Board of Directors declaring such dividend is adopted, as the case may be, shall be the record date for such determination of shareholders. When a determination of shareholders entitled to vote at any meeting of shareholders has been made as provided in this Section, such determination shall apply to any adjournment thereof. Section 9. Voting Lists. The officer or agent having charge of the stock transfer books for common shares of the Corporation shall make available, within two (2) business days after notice of a meeting is given, a complete list of the shareholders entitled to vote at such meeting or any adjournment thereof, arranged in alphabetical order, with the address of and the number of shares held by each shareholder, which list, for a period beginning within two (2) business days after notice of such meeting is given, shall be kept on file at the registered office of the Corporation and shall be subject to inspection by any shareholder at any time during usual business hours. Such list shall be kept open at the time and place of the meeting and be subject to the inspection of any shareholder during the entire time of the meeting. In the event of any challenge to the right of any person to vote at the meeting, the presiding officer at such meeting may rely on said list as proper evidence of the right of parties to vote at such meeting. Section 10. Proxies. Shareholders of record who are entitled to vote may vote at any meeting either in person or by written proxy, which shall be filed with the secretary of the meeting before being voted. Such proxy shall entitle the holders thereof to vote at any adjournment of such meeting, but shall not be valid after the final adjournment thereof. No proxy shall be valid after the expiration of eleven months from the date of its execution unless the shareholder executing it shall have specified therein the length of time it is to continue in force, which shall be for some limited period. A proxy is revocable by the shareholder unless it conspicuously states that it is irrevocable and the appointment of the proxy is coupled with an interest. Section 11. Voting of Shares. Except as otherwise provided in the Charter or these Bylaws, each share of Common Stock shall have all voting rights accorded to holders of Common Stock pursuant to the Tennessee Business Corporation Act, at the rate of one vote per share. Section 12. Informal Action by Shareholders. Any action required to be taken at a meeting of the shareholders, or any other action which may be taken at a meeting of the shareholders, may be taken without a meeting if all shareholders entitled to vote on the action consent to taking such action without a meeting. If all shareholders entitled to vote on the action consent to taking such action without a meeting, then the affirmative vote of the number of shares that would be necessary to authorize such action at a meeting is the act of the shareholders. The action must be evidenced by one or more written consents describing the action taken, signed by each shareholder entitled to vote on the action, indicating each signing -5- 6 shareholder's vote or abstention on the action, and delivered to the Corporation for inclusion in the minutes or filing with the corporate records. Section 13. Business and Order of Business. At each meeting of the shareholders such business may be transacted as may properly be brought before such meeting, except as otherwise provided by law or in these Bylaws. The order of business at all meetings of the shareholders shall be as determined by the Chairman, unless otherwise determined by a majority in interest of the shareholders present in person or by proxy at such meeting and entitled to vote thereat. ARTICLE III BOARD OF DIRECTORS Section 1. Number. The number of directors of the Corporation shall be such number, neither fewer than three nor more than fifteen (exclusive of directors, if any, to be elected by holders of Preferred Stock of the Corporation, voting separately as a class), as determined by a majority vote of the Board of Directors. The Board of Directors has the power to fix or change the number of directors, including an increase or decrease in the number of directors, from time to time as established by a majority vote of the Board of Directors. A director need not be a shareholder or a resident of the state of Tennessee. Section 2. Powers of Directors. The Board of Directors shall have the entire management of the business of the Corporation. In the management and control of the property, business and affairs of the Corporation, the Board of Directors is hereby vested with all the powers possessed by the Corporation itself, so far as this delegation of authority is not inconsistent with the laws of the State of Tennessee, with the Charter, or with these Bylaws. The Board of Directors shall have the power to determine what constitutes net earnings, profits, and surplus, respectively, what amount shall be reserved for working capital and to establish reserves for any other proper purpose, and what amount shall be declared as dividends, and such determination by the Board of Directors shall be final and conclusive. The Board of Directors shall have the power to declare dividends for and on behalf of the Corporation, which dividends may include or consist of stock dividends. Section 3. Regular Meetings of the Board. Immediately after the annual election of directors, the newly elected directors may meet at the same place for the purpose of organization, the election of corporate officers and the transaction of other business; if a quorum of the directors be then present no prior notice of such meeting shall be required. Other regular meetings of the Board of Directors shall be held at such times and places as the Board of Directors by resolution may determine and specify, and if so determined no notice thereof need be given, provided that, unless all the directors are present at the meeting at which said resolution is passed, the first meeting held pursuant to said resolution shall not be held for at least five (5) days following the date on which the resolution is passed. -6- 7 Section 4. Special Meetings. Special meetings of the Board of Directors may be held at any time or place whenever called by the Chairman of the Board, the President, or any Vice-President or the Secretary, or by written request of at least two directors, notice thereof being given to each director by the Secretary or other officer calling the meeting, or they may be held at any time without formal notice provided all of the directors are present or those not present shall at any time waive or have waived notice thereof. Section 5. Notice. Notice of any special meetings shall be given at least two (2) days previously thereto by written notice delivered personally, by mail, by telegram, by overnight courier service, or by facsimile. If mailed, such notice shall be mailed to each director at his business address no less than five (5) days previously thereto, and shall be deemed to be delivered when deposited in the United States mail so addressed, with postage thereon prepaid. If notice be given by telegram, such notice shall be deemed to be delivered when the telegram is delivered to the telegraph company. If notice be delivered via overnight courier service, such notice shall be deemed to be delivered when deposited with the overnight courier service. If notice be given by facsimile, such notice shall be deemed to be delivered when information of the transmission is received. Section 6. Quorum. A majority of the members of the Board of Directors, as constituted for the time being, shall constitute a quorum for the transaction of business, but a lesser number may adjourn any meeting and the meeting may be held as adjourned without further notice. If a quorum is present when a vote is taken, the affirmative vote of a majority of the directors present is the act of the Board of Directors, except as otherwise provided by law or by these Bylaws. The fact that a director has an interest in a matter to be voted on by the meeting shall not prevent his being counted for purposes of a quorum. Section 7. Presumption of Assent. A director of the Corporation who is present at a meeting of the Board of Directors at which action on any corporate matter is taken shall be presumed to have assented to the action taken unless his dissent shall be entered in the minutes of the meeting or unless he shall file his written dissent to such action with the person acting as the secretary of the meeting before the adjournment thereof or shall forward such dissent by registered mail to the Secretary immediately after the adjournment of the meeting. Such right to dissent shall not apply to a director who voted in favor of such action. Section 8. Informal Action by Directors. Any action required to be taken at a meeting of the Board of Directors, or any other action which may be taken at a meeting of the Board of Directors, may be taken without a meeting if all directors consent to taking such action without a meeting. If all directors consent to taking such action without a meeting, the affirmative vote of the [majority of the directors] [the number of directors that would be necessary to authorize or take such action at a meeting] is the act of the Board of Directors. The action must be evidenced by one or more written consents describing the action taken, signed by each director, indicating each signing director's vote or abstention on the action, and shall be included in the minutes or filed with the corporate records reflecting the action taken. -7- 8 Section 9. Meetings by any Form of Communication. The Board of Directors shall have the power to permit any and all directors to participate in a regular or special meeting by, or conduct the meeting through the use of any means of communication by which all directors participating may simultaneously hear each other during the meeting. A director participating in a meeting by this means is deemed to be present in person at the meeting. Section 10. Organization. At each meeting of the Board of Directors, the Chairman of the Board, or, in his absence, the Chief Executive Officer of the Corporation (the "Chief Executive Officer'), or, in the absence of the Chairman of the Board and the Chief Executive Officer, the President, or in the absence of the Chairman of the Board, the Chief Executive Officer and the President, a director or an officer of the Corporation designated by the Board of Directors shall act as chairman. The Secretary, or, in the Secretary's absence, any person appointed by the chairman, shall act as secretary of the meeting. Section 11. Removal. No director of the Corporation may be removed at any time unless for cause. Upon finding of cause as determined by a majority of the Board of Directors (excluding the director which is the subject of removal), the director may be removed only upon the affirmative vote of the holders of at least 80% of outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors (the "Voting Power"), considered for this purpose as one class, except as otherwise required by law. Section 12. Vacancy. Unless the Board of Directors otherwise determines, and subject to the rights of the holders of any series of Preferred Stock, newly created directorships resulting from any increase in the authorized number of directors or any vacancies on the Board of Directors resulting from death, resignation, retirement, disqualification, removal from office or other cause may be filled only by a majority vote of the directors then in office, though less than a quorum, and shall not be filled by the shareholders unless there are no directors remaining on the Board of Directors. Any director so chosen (a "vacancy director") shall be a director of the same class as the director whose vacancy he or she fills. Such vacancy director shall hold office until the next annual meeting of shareholders and until his or her successor shall have been elected and qualified. The shareholders shall thereupon elect a director to fill the vacancy having been temporarily filled by the vacancy director, which individual may include the incumbent vacancy director. The director so elected shall be a director of the same class as the vacancy director and shall serve until the annual meeting of shareholders at which the term of office of such class expires and until such director's successor shall have been duly elected and qualified. Section 13. Resignations. A director may resign at any time by delivering written notice to the Board of Directors, the Chairman of the Board or the President. Resignation is effective when the notice is delivered, unless the notice specifies a later effective date. Section 14. Compensation. By resolution of the Board of Directors, the directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors. No -8- 9 such payment shall preclude any director from serving the Corporation in any other capacity and receiving compensation therefor. ARTICLE IV COMMITTEES. Section 1. Appointment and Powers. The Board of Directors may, by resolution passed by a majority of the whole Board of Directors, create one or more committees, each committee to consist of two or more directors of the Corporation, which, to the extent provided in said resolution or in these Bylaws and not inconsistent with Section 48-18-206 of the Tennessee Business Corporation Act, shall have and may exercise the powers of the Board of Directors in the management of the business and affairs of the Corporation, and may authorize the seal of the Corporation to be affixed to all papers which may require it. Such committee or committees shall have such name or names as may be determined from time to time by resolution adopted by the Board of Directors. The Board of Directors may, by resolution passed by a majority of the whole Board of Directors, abolish any such committee. Section 2. Term of Office and Vacancies. Each member of a committee shall continue in office until a director to succeed him shall have been elected and shall have qualified, or until he ceases to be a director or until he shall have resigned or shall have been removed in the manner hereinafter provided. Any vacancy in a committee shall be filled by the vote of a majority of the whole Board of Directors at any regular or special meeting thereof. Section 3. Organization. Unless otherwise provided by the Board of Directors, each committee shall appoint a chairman. Each committee shall keep a record of its acts and proceedings and report the same from time to time to the Board of Directors as the Board of Directors may require. Section 4. Resignations. Any member of a committee may resign from the committee at any time by giving written notice to the Chairman of the Board, the President or the Secretary. Such resignation shall take effect at the time of the receipt of such notice or at any later time specified therein, and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. Section 5. Removal. Any member of a committee may be removed from the committee with or without cause at any time by resolution passed by a majority of the whole Board of Directors at any regular or special meeting. Section 6. Meetings. Regular meetings of each committee, of which no notice shall be required, shall be held on such days and at such places as the chairman of the committee shall determine or as shall be fixed by a resolution passed by a majority of all the members of such committee. Special meetings of each committee will be called by the Secretary at the request of any two members of such committee, or in such other manner as may be determined -9- 10 by the committee. Notice of each special meeting of a committee shall be mailed to each member thereof at least two days before the meeting or shall be given personally or by telephone or other electronic transmission at least one day before the meeting. Every such notice shall state the date, time and place of the meeting, but need not state the purposes of the meeting. No notice of any meeting of a committee shall be required to be given to any alternate. Section 7. Quorum and Manner of Acting. Unless otherwise provided by resolution of the Board of Directors, a majority of a committee shall constitute a quorum for the transaction of business and the act of a majority of those present at a meeting at which a quorum is present shall be the act of such committee. The members of each committee shall act only as a committee and the individual members shall have no power as such. Actions taken at a meeting of any committee shall be reported to the Board of Directors at its next meeting following such committee meeting; provided that, when the meeting of the Board of Directors is held within two (2) days after the committee meeting, such report may be made to the Board of Directors at its second meeting following such committee meeting. Section 8. Compensation. Each member of a committee shall be paid such compensation, if any, as shall be fixed by the Board of Directors. ARTICLE V WAIVER OF NOTICE Whenever any notice is required to be given by these Bylaws, or the Charter, or any other laws of the State of Tennessee, a waiver thereof in writing signed by the person or persons entitled to such notice and filed with the minutes or corporate records, whether before or after the time stated therein, shall be deemed equivalent thereto. Where the person or persons entitled to such notice sign the minutes of any shareholders' or directors' meeting, which minutes contain the statement that said person or persons have waived notice of the meeting, then such person or persons are deemed to have waived notice in writing. [A shareholder's attendance at a meeting waives objection to lack of notice or defective notice of the meeting, unless the shareholder at the beginning of the meeting (or promptly upon the shareholder's arrival) objects to holding the meeting or transacting business at the meeting, and also waives objection to consideration of a particular matter at the meeting that is not within the purpose or purposes described in the meeting notice, unless the shareholder objects to considering the matter when it is presented. A director's attendance at or participation in a meeting waives any required notice to the director of the meeting unless the director at the beginning of the meeting (or promptly upon the director's arrival) objects to holding the meeting or transacting business at the meeting and does not thereafter vote for or assent to action taken at the meeting.] -10- 11 ARTICLE VI OFFICERS Section 1. Number. The officers of the Corporation shall be a Chairman of the Board, Chief Executive Officer, President, Chief Financial Officer, Chief Operating Officer, one or more Vice Presidents (the number thereof to be determined by the Board of Directors), and a Secretary, each of whom shall be elected by the Board of Directors. Such other officers and assistant officers as may be deemed necessary may be elected or appointed by the Board of Directors. Any two or more offices may be held by the same person, except the offices of President and Secretary. Section 2. Election and Term of Office. The officers of the Corporation to be elected by the Board of Directors shall be elected annually by the Board of Directors at the first meeting of the Board of Directors held after each annual meeting of the shareholders. If the election of officers shall not be held in such meeting, such election shall be held as soon thereafter as conveniently may be. Each officer shall hold office until his successor is duly elected and is qualified or until his death or until he resigns or is removed in the manner hereinafter provided. Section 3. Removal. Any officer or agent elected or appointed by the Board of Directors may be removed by the Board of Directors whenever in its judgment the best interests of the Corporation would be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. Section 4. Vacancies. A vacancy in any office because of death, resignation, removal, disqualification or otherwise, may be filled by the Board of Directors for the unexpired portion of the term. Section 5. Chairman of the Board. The Chairman of the Board shall preside at all meetings of the shareholders and the directors. The Chairman of the Board shall represent the Corporation in all matters involving the shareholders of the Corporation. He shall also perform such other duties the Board of Directors may assign to him from time to time. Section 6. Chief Executive Officer. The Chief Executive Officer shall in general supervise and control all of the business and affairs of the Corporation. He shall, in the absence of the Chairman of the Board, preside at all meetings of the shareholders and of the Board of Directors and shall enforce the observance of the Bylaws of the Corporation and the rules of order for the meetings of the Board of Directors and the shareholders. He shall keep the Board of Directors appropriately informed on the business and affairs of the Corporation. He may sign, either alone or with the Secretary, an Assistant Secretary or any other proper officer of the Corporation thereunto authorized by the Board of Directors, certificates for shares of the Corporation, any deed, mortgages, bonds, contracts, or other instruments which the Board of Directors has authorized to be executed, except in cases where the signing and execution thereof -11- 12 shall be expressly delegated by the Board of Directors or by these Bylaws to some other officer or agent of the Corporation, or shall be required by law to be otherwise signed or executed, and in general shall perform all duties incident to the office of President and such other duties as may be prescribed by the Board of Directors from time to time. Section 7. President. The President shall have general and active management of the business of the Corporation and shall see that all orders and resolutions of the Board of Directors are carried into effect. He shall, in the absence of the Chairman of the Board and the Chief Executive Officer, preside at all meetings of the shareholders and of the Board of Directors. He may sign, either alone or with any other proper officer, as necessary, certificates for shares of the Corporation, any deed, mortgages, bonds, contracts, or other instruments which the Board of Directors has authorized to be executed, except in cases where the signing and execution thereof shall be expressly delegated by the Board of Directors or by these Bylaws to some other officer or agent of the Corporation, or shall be required by law to be otherwise signed or executed, and in general shall perform all duties incident to the office of Chief Executive Officer and such other duties as may be prescribed by the Board of Directors from time to time. Section 8. Chief Financial Officer. The Chief Financial Officer shall arrange for the keeping of adequate records of all assets, liabilities and transactions of the corporation. He shall provide for the establishment of internal controls and see that adequate audits are currently and regularly made. He shall submit to the President, the Chairman of the Board and the Board of Directors timely statements of the accounts of the corporation and the financial results of the operations thereof. Section 9. Chief Operating Officer. The Chief Operating Officer shall supervise the operation of the Corporation, subject to the policies and directions of the Board of Directors. He shall provide for the proper operation of the Corporation and oversee the internal interrelationship amongst any and all departments of the Corporation. He shall submit to the President and the Board of Directors timely reports on the operations of the Corporation. Section 10. The Vice-Presidents. In the absence of the President or in the event of his death, inability or refusal to act, the Vice-President (or in the event there be more than one Vice-President, the Vice-Presidents in the order designated at the time of their election, or in the absence of any designation, then in the order of their election) shall perform the duties of the President, and when so acting, shall have all the powers of and be subject to all the restrictions upon the President . Any Vice-President may sign, either alone or with the Secretary or an Assistant Secretary, certificates for shares of the Corporation any deed, mortgages, bonds, contracts or other instruments which the Board of Directors has authorized to be executed, except in cases where the signing and execution thereof shall be expressly delegated by the Board of Directors or by these bylaws to some other officer or agent of the Corporation, or shall be required by law to be otherwise signed or executed, and shall perform such other duties as from time to time may be assigned to him by the President or by the Board of Directors. -12- 13 Section 11. The Secretary. The Secretary shall: (a) prepare and keep the minutes of the shareholders' and of the Board of Directors' meetings in one or more books provided for that purpose; (b) see that all notices are duly given in accordance with the provisions of these bylaws or as required by law; (c) be custodian of the corporate records and of the seal (if any) of the Corporation and see that said seal is affixed to all documents, the execution of which on behalf of the Corporation under its seal is duly authorized; (d) keep a register of the post office address of each shareholder which shall be furnished to the Secretary by such shareholder; (e) sign with the President or a Vice-President certificates for shares of the Corporation, the issuance of which shall have been authorized by resolution of the Board of Directors; (f) have general charge of the stock transfer books of the Corporation; and (g) in general perform all duties as from time to time may be assigned to him by the President or by the Board of Directors. Section 12. Assistant Secretaries. The Assistant Secretaries, when authorized by the Board of Directors, may sign with the President or a Vice-President certificates for shares of the Corporation the issuance of which shall have been authorized by a resolution of the Board of Directors. The Assistant Secretaries, in general, shall perform such duties as shall be assigned to them by the Secretary, or by the President or the Board of Directors. Section 13. Registered Agent. The Board of Directors shall appoint a Registered Agent for the Corporation in accordance with the Tennessee Business Corporation Act and may pay the agent such compensation from time to time as it may deem appropriate. ARTICLE VII CONTRACTS, LOANS, CHECKS AND DEPOSITS Section 1. Contracts. The Board of Directors may authorize any officer or officers, agent or agents, to enter into any contract or execute and deliver any instrument in the name of and on behalf of the Corporation, and such authority may be general or confined to specific instances. Section 2. Loans. No loans shall be contracted on behalf of the Corporation and no evidences of indebtedness shall be issued in its name unless authorized by a resolution of the Board of Directors. Such authority may be general or confined to specific instances. Notwithstanding the foregoing, the Corporation shall not make any loan other than a sale on credit in the ordinary course of business or a life insurance policy loan, either directly or indirectly, to any director or officer of the Corporation except with the consent of the holders of a majority of all the outstanding shares owned or controlled by shareholders other than a shareholder for whose benefit such action is being taken, or if the Board of Directors determines that the loan benefits the Corporation and approves the transaction. Section 3. Checks, Drafts, etc. All checks, drafts, or other orders for the pavement of money, notes or other evidences of indebtedness issued in the name of the -13- 14 Corporation, shall be signed by such officer or officers, agent or agents of the Corporation and in such manner as shall from time to time be determined by resolution of the Board of Directors. Section 4. Deposits. All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in such banks, trust companies or other depositories as the Board of Directors may select. ARTICLE VIII SHARES OF STOCK Section 1. Certificates for Shares. Certificates representing shares of the Corporation shall be in such form as shall be determined by the Board of Directors. Such certificates shall be signed by the President or Vice-President and by the Secretary or an Assistant Secretary. The use of facsimile signatures on any stock certificate of the Corporation is authorized. All such certificates shall state the name of the Corporation, that it is organized under the laws of the State of Tennessee, the name of the person to whom issued, and the number of shares and class of shares that the certificate represents. All certificates for shares shall be consecutively numbered or otherwise identified. The name and address of the person to whom the shares represented thereby are issued, with the number of shares and date of issue, shall be entered on the stock transfer books of the Corporation. All certificates surrendered to the Corporation for transfer shall be canceled and no new certificate shall be issued until the former certificate for a number of shares shall have been surrendered and canceled, except that in case of a lost, destroyed or mutilated certificate a new one may be issued therefor upon such terms and indemnity to the Corporation as the Board of Directors may prescribe. Section 2. Registered Ownership of Shares. The Corporation shall be entitled to treat the person in whose name any share of its stock is registered as the owner thereof for all purposes and shall not be bound to recognize any equitable or other claim to, or interest in, such share on the part of any other person, whether or not the Corporation shall have notice thereof, except as expressly provided by applicable law. Section 3. Transfer of Shares. Shares of stock may be transferred by delivery of the certificate accompanied either by an assignment in writing on the back of the certificate or by a written power of attorney to sell, assign and transfer the same on the books of the Corporation, signed by the person appearing on the certificate to be the owner of the shares represented thereby, and shall be transferable on the books of the Corporation upon surrender thereof so assigned or endorsed. The person registered on the books of the Corporation as the owner of any shares of stock shall be entitled to all the rights of ownership with respect to such shares. It shall be the duty of every shareholder to notify the Corporation of his post office address. -14- 15 ARTICLE IX DIVIDENDS The Board of Directors may from time to time declare, and the Corporation may pay dividends on its outstanding shares in the manner and upon the terms and conditions provided by the Tennessee Business Corporation Act and by its Charter. ARTICLE X FISCAL YEAR The books of the Corporation shall be on a calendar year basis and shall begin on the lst day of January and end on the 31st day of December of each year. ARTICLE XI SEAL This Corporation may or may not have a seal and in any event the failure to affix a corporate seal to any instrument executed by the Corporation shall not affect the validity thereof. If a seal is adopted, the seal of this Corporation shall include the following letters cut or engraved thereon: KIRKLAND'S INC. ARTICLE XII INDEMNIFICATION Section 1. Definitions. As used in this Article XII: (a) "Director" shall mean any individual who is or was a director of the Corporation, or any individual who, [while a director of the Corporation], is or was serving at the Corporation's request as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan or other enterprise. A director is considered to be serving an employee benefit plan at the Corporation's request if the director's duties to the Corporation also impose duties on or otherwise involves services by the director to the plan or to participants in or beneficiaries of the plan. "Director" includes, unless the context requires otherwise, the estate or personal representative of the director; (b) "Employee or Agent" shall mean any individual who is or was an employee or agent of the Corporation [other than a director or officer of the Corporation], or any individual who, is or was serving at the Corporation's request as an employee or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan or other enterprise; -15- 16 (c) "Expenses" shall include reasonable costs, disbursements and counsel fees; (d) "Independent Legal Counsel" means a law firm, or a member of a law firm, that (i) is experienced in matters of corporation law; (ii) neither presently is, nor in the past five years has been, retained to represent the Corporation or the corporate agent claiming indemnification or any other party to the action, suit, or proceeding giving rise to a claim for indemnification, in any matter material to the Corporation, the claimant or any such other party; and (iii) would not, under applicable standards of professional conduct then prevailing, have a conflict of interest in representing either the Corporation or such corporate agent in an action to determine the Corporation's or such person's rights under this Article XII; (e) "Liability" shall mean any obligation to pay a judgment, settlement, penalty, fine (including an excise tax assessed with respect to an employee benefit plan), or reasonable expenses incurred with respect to a proceeding; (f) "Officer" shall mean any individual who is or was an officer of the Corporation, or any individual who is or was serving at the Corporation's request as an employee or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan or other enterprise; and (g) "Proceeding" shall mean any threatened, pending, or completed action, suit or proceeding, whether civil, criminal, administrative, or investigative and whether formal or informal. Section 2. General. Except as provided in Section 4 of this Article XII, the Corporation shall indemnify any director or officer who is made a party to any proceeding because the individual is or was a director or officer against liability incurred in the proceeding if: (a) the following standards are met: (i) the individual's conduct was in good faith; (ii) the individual reasonably believed, (A) in the case of conduct in the individual's official capacity with the Corporation, that the individual's conduct was in the best interest of the Corporation; and (B) in all other cases, that the individual's conduct was at least not opposed to the best interests of the Corporation; and -16- 17 (iii) in the case of any criminal proceeding, the individual had no reasonable cause to believe the individual's conduct was unlawful; For purposes of Section 2(a)(ii)(B) hereof, with respect to an employee benefit plan maintained by the Corporation, the individual shall be deemed to have reasonably believed that the individual's conduct was not opposed to the best interests of the Corporation if such conduct was for a purpose the individual reasonably believed was in the interests of the participants in and beneficiaries of the plan; and (b) the individual was wholly successful, on the merits or otherwise, in the defense of any proceedings to which the individual was a party because that individual is or was a director or officer of the Corporation. Section 3. Termination of Proceedings. The termination of any action or proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent shall not, of itself, create a presumption that the director or officer (i) did not act in good faith and in a manner that the individual reasonably believed to be in, or not opposed to, the best interests of the Corporation and (ii) with respect to any criminal proceeding, had reasonable cause to believe that the individual's conduct was unlawful. Section 4. Limitations. The Corporation shall not indemnify a director or officer in connection with a proceeding by or in the right of the Corporation in which such individual was adjudged liable to the Corporation or in connection with any other proceeding charging improper personal benefit to the individual, whether or not involving action in the individual's official capacity, in which the individual was adjudged liable on the basis that personal benefit was improperly received by such individual. Section 5. Expenses. The Corporation shall pay for or reimburse the reasonable expenses incurred by a director or officer who is a party to a proceeding in advance of final disposition of the proceeding if: (i) the director or officer furnishes the Corporation a written affirmation of his good faith belief that he has met the standard of conduct set forth in Section 2 of this Article XII; (ii) the director or officer furnishes the Corporation a written undertaking, executed personally or on his behalf, to repay the advance if it is ultimately determined that he is not entitled to indemnification; and (iii) a determination is made that the facts then known to those making the determination would not preclude indemnification under this Article XII. -17- 18 Section 6. Determination and Authorization of Indemnification. The Corporation may not indemnify a director or officer under Section 2 of this Article XII unless authorized in the specific case after a determination has been made that indemnification of the director or officer is permissible in the circumstances because he has met the standard set forth in Section 2 of this Article XII and is in accordance with the Procedures for Submission and Determination of Claims for Indemnification set forth in the Appendix to these Bylaws. The determination shall be made: (i) By the Board of Directors by majority vote of a quorum consisting of directors not at the time parties to the proceeding; (ii) If a quorum cannot be obtained under Section 6(i) of this Article XII, by majority vote of a committee duly designated by the Board of Directors (in which designation directors who are parties may participate), consisting solely of two or more directors not at the time parties to the proceeding; (iii) By independent legal counsel: (A) Selected by the Board of Directors or its committee in the manner prescribed in Section 6(i) or Section 6(ii) of this Article XII; or (B) If a quorum of the Board of Directors cannot be obtained under Section 6(i) and a committee cannot be designated under Section 6(ii) of this Article XII, selected by majority vote of the full Board of Directors (in which directors who are parties may participate); or (iv) By the shareholders, but shares owned by or voted under the control of directors who are at the time parties to the proceeding may not be voted on the determination. Section 7. Determination and Authorization of Expenses Authorization of indemnification and evaluation that indemnification is permissible as to reasonableness of expenses under Section 5 of this Article XII shall be made in the same manner as the determination that indemnification is permissible, except that, if the determination is made by independent legal counsel, authorization of indemnification and evaluation as to reasonableness of expenses shall be made by those entitled under Section 6(iii) of this Article XII to select counsel. Section 8. Employees and Agents. The Corporation may indemnify and advance expenses to an employee or agent of the Corporation to the same extent as a director or officer under Section 2 of this Article XII, subject to the determination and authorization of indemnification procedures set forth in Section 6 of this Article XII and in the Appendix to these Bylaws. -18- 19 Section 9. Applicability. The indemnification and advancement of expenses granted pursuant to this Article XII shall not be deemed exclusive of any other rights to which a director, officer, employee or agent seeking indemnification or advancement of expenses may be entitled, whether contained in the Charter or Bylaws of the Corporation, or authorized in a resolution of shareholders, a resolution of directors, or an agreement providing for such indemnification, to the extent permitted by applicable law. Section 10. Intent and Interpretation. It is the intention of this Article XII to provide for indemnification of directors and officers to the fullest extent permitted by the Tennessee Business Corporation Act, and this Article XII shall be interpreted accordingly. If this Article XII or any portion hereof shall be invalidated on any ground by any court of competent jurisdiction, then the Corporation shall nevertheless indemnify each director, officer, employee, and agent of the Corporation as to costs, charges, and expenses (including attorneys' fees), judgments, fines, and amounts paid in settlement with respect to any proceeding, including an action by or in the right of the Corporation, to the full extent permitted by any applicable portion of this Article XII that shall not have been invalidated and to the full extent permitted by applicable law. If the Tennessee Business Corporation Act is amended or other Tennessee law is enacted to permit further or additional indemnification of a director, officer, employee or agent of the Corporation beyond that provided in this Article XII, then the Corporation shall be permitted to indemnify such director, officer, employee or agent to the fullest extent permitted by the Tennessee Business Corporation Act, as so amended, or by such other Tennessee law. Section 11. Insurance. The Corporation may purchase and maintain insurance on behalf of an individual who is or was a director, officer, employee, or agent of the Corporation, or who, while a director, officer, employee, or agent of the Corporation, is or was serving at the request of the Corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise, against liability asserted against or incurred by the individual in that capacity or arising from the individual's status as a director, officer, employee, or agent, whether or not the Corporation would have power to indemnify him against the same liability under applicable state law. ARTICLE XIII AMENDMENTS The Board of Directors is expressly authorized to repeal, alter, amend or rescind these Bylaws of the Corporation by vote of a majority of the Board of Directors at a legal meeting held in accordance with these Bylaws. Notwithstanding any other provision of the Charter or these Bylaws (and notwithstanding some lesser percentage may be specified by law), the Bylaws shall be repealed, altered, amended or rescinded by the shareholders of the -19- 20 Corporation only by affirmative vote of at least 80 % of the outstanding shares of capital stock of the Corporation entitled to vote generally, considered for this purpose as one class. ATTEST: ------------------------------------- Name: Title: -20- 21 APPENDIX PROCEDURES FOR SUBMISSION AND DETERMINATION OF CLAIMS FOR INDEMNIFICATION PURSUANT TO ARTICLE XII OF THE BYLAWS. Section 1. Purpose. The Procedures for Submission and Determination of Claims for Indemnification Pursuant to Article XII of the Bylaws (the "Procedures") are to implement the provisions of Article XII of the Bylaws of the Corporation (the "Bylaws") in compliance with the requirements of Section 6 of Article XII. Section 2. Definitions. For purposes of these Procedures: (a) All terms that are defined in Section 1 of Article XII of the Bylaws shall have the meanings ascribed to them therein when used in these Procedures unless otherwise defined herein. (b) "Change of control" shall mean: (i) the acquisition in one or more transactions by any "Person" (as the term person is used for purposes of Sections 13(d) or 14(d) of the Securities Exchange Act of 1934 (the "Exchange Act")) of "Beneficial ownership" (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of twenty-five percent (25%) or more of the combined voting power of the Corporation's then outstanding voting securities (the "Voting Securities"), provided that for purposes of this clause (i) Voting Securities acquired directly from the Corporation by any Person shall be excluded from the determination of such Person's Beneficial ownership of Voting Securities (but such Voting Securities shall be included in the calculation of the total number of Voting Securities then outstanding); or (ii) approval by shareholders of the Corporation of: (A) a merger, reorganization or consolidation involving the Corporation if the shareholders of the Corporation immediately before such merger, reorganization or consolidation do not or will not own directly or indirectly immediately following such merger, reorganization or consolidation, more than fifty percent (50%) of the combined voting A-1 22 power of the outstanding voting securities of the Corporation resulting from or surviving such merger, reorganization or consolidation in substantially the same proportion as their ownership of the Voting Securities outstanding immediately before such merger, reorganization or consolidation; or (B) a complete liquidation or dissolution of the Corporation; or (C) an agreement for the sale or other disposition of all or substantially all of the assets of the Corporation; or (iii) acceptance by shareholders of the Corporation of shares in a share exchange if the shareholders of the Corporation immediately before such share exchange do not or will not own directly or indirectly immediately following such share exchange more than fifty percent (50%) of the combined voting power of the outstanding voting securities of the entity with which the shareholders effect such share exchange in substantially the same proportion as their ownership of the Voting Securities outstanding immediately before such share exchange. Section 3. Submission and Determination of Claims. (a) To obtain indemnification or advancement of expenses under [Section 2, Section 5 or Section 8 of] Article XII of the Bylaws, a corporate agent shall submit to the Secretary of the Corporation a written request therefor, including therein or therewith such documentation and information as is reasonably available to the corporate agent and is reasonably necessary to permit a determination as to whether and what extent the Corporate agent is entitled to indemnification or advancement of expenses, as the case may be. The Secretary shall, promptly upon receipt of a request for indemnification, advise the Board of Directors thereof in writing if a determination in accordance with Section 6 of Article XII of the Bylaws is required. (b) Upon written request by an corporate agent for indemnification pursuant to Section 3(a) hereof, a determination with respect to the corporate agent's entitlement thereto in the specific case, if required by the Bylaws, shall be made in accordance with Section 6 of Article XII of the Bylaws, and, if it is so determined that the corporate agent is entitled to A-2 23 indemnification, payment to the corporate agent shall be made within ten days after such determination. The corporate agent shall cooperate with the person, persons or entity making such determination, with respect to the corporate agent's entitlement to indemnification, including providing to such person, persons or entity upon reasonable advance request any documentation or information which is not privileged or otherwise protected from disclosure and which is reasonably available to the corporate agent and reasonably necessary to such determination. (c) If entitlement to indemnification is to be made by independent legal counsel pursuant to Section 6(iii) of Article XII of the Bylaws such counsel shall be selected as provided in this Section 3(c). If a change of control shall not have occurred, the independent legal counsel shall be selected by the Board of Directors as set forth in Section 6(iii) of Article XII of the Bylaws, and the Corporation shall give written notice to the corporate agent advising the corporate agent of the identity of the independent legal counsel so selected. If a change of control shall have occurred, the independent legal counsel shall be selected by the corporate agent (unless the corporate agent shall request that such selection be made by the Board of Directors, in which event the immediately preceding sentence shall apply), and the corporate agent shall give written notice to the Corporation advising it of the identity of the independent legal counsel so selected. In either event, the corporate agent or the Corporation, as the case may be, may, within seven days after such written notice of selection shall have been given, deliver to the Corporation or to the corporate agent, as the case may be, a written objection to such selection. Such objection may be asserted only on the ground that the independent legal counsel so selected does not meet the requirements of "independent legal counsel" as defined in Section 1 of Article XII of the Bylaws, and the objection shall set forth with particularity the factual basis of such assertion. If such written objection is made, the independent legal counsel so selected may not serve as independent legal counsel unless and until a court has determined that such objection is without merit. If, within twenty days after the next regularly scheduled Board of Directors meeting following submission by the corporate agent of a written request for indemnification pursuant to Section 3(a) hereof, no independent legal counsel shall have been selected and not objected to, either the Corporation or the corporate agent may petition the [SPECIFY COURT] Court of the State of Tennessee or other court of competent jurisdiction for resolution of any objection which shall have been made by the Corporation or the corporate agent to the other's selection of independent legal counsel and/or for the appointment as independent legal counsel of a person selected by the Court or by such other person as the Court shall designate, and the person with respect to whom an objection is favorably resolved or the person so appointed shall act as independent legal counsel under Section 6(iii) of Article XII of the Bylaws. The Corporation shall pay any and all reasonable fees and expenses (including without limitation any advance retainers reasonably required by counsel) of independent legal counsel incurred by such independent legal counsel in connection with acting pursuant to Section 6(iii) of Article XII of the Bylaws, and the Corporation shall pay all reasonable fees and expenses (including without limitation any advance retainers reasonably required by counsel) incident to the procedures of Section 6(iii) of Article XII of the Bylaws and this Section 3(c), regardless of the manner in which independent legal counsel was selected or appointed. Upon the delivery of A-3 24 its opinion pursuant to Section 6(iii) of Article XII of the Bylaws or, if earlier, the due commencement of any judicial proceeding or arbitration pursuant to Section 4(a)(3) of these Procedures, independent legal counsel shall be discharged and relieved of any further responsibility in such capacity (subject to the applicable standards of professional conduct then prevailing). (d) If a change of control shall have occurred, in making a determination with respect to entitlement to indemnification under the Bylaws, the person, persons or entity making such determination shall presume that an corporate agent is entitled to indemnification under the Bylaws if the corporate agent has submitted a request for indemnification in accordance with Section 3(a) hereof, and the Corporation shall have the burden of proof to overcome that presumption in connection with the making by any person, persons or entity of any determination contrary to that presumption. Section 4. Review and Enforcement of Determination. (a) In the event that (1) advancement of expenses is not timely made pursuant to Section 5 of Article XII of the Bylaws, (2) payment of indemnification is not made pursuant to Section 2 of Article XII of the Bylaws within ten days after receipt by the Corporation of written request therefor, (3) a determination is made pursuant to Section 6 of Article XII of the Bylaws that a corporate agent is not entitled to indemnification under the Bylaws, (4) the determination of entitlement to indemnification is to be made by independent legal counsel pursuant to Section 6(iii) of Article XII of the Bylaws and such determination shall not have been made and delivered in a written opinion within ninety days after receipt by the Corporation of the written request for indemnification, or (5) payment of indemnification is not made within ten days after a determination has been made pursuant to Section 6 of Article XII of the Bylaws that a corporate agent is entitled to indemnification, the corporate agent shall be entitled to an adjudication in an appropriate court of the State of Tennessee, or in any other court of competent jurisdiction, of the corporate agent's entitlement to such indemnification or advancement of expenses. Alternatively, the corporate agent, at his or her option, may seek an award in arbitration to be conducted by a single arbitrator pursuant to the rules of the American Arbitration Association. The corporate agent shall commence such proceeding seeking an adjudication or an award in arbitration within one year following the date on which the corporate agent first has the right to commence such proceeding pursuant to this Section 4(a). The Corporation shall not oppose the corporate agent's right to seek any such adjudication or award in arbitration. (b) In the event that a determination shall have been made pursuant to Section 6 of Article XII of the Bylaws that a corporate agent is not entitled to indemnification, any judicial proceeding or arbitration commenced pursuant to this Section 4 shall be conducted in all respects as a de novo trial, or arbitration, on the merits and the corporate agent shall not be prejudiced by reason of that adverse determination. If a change of control shall have occurred, the Corporation shall have the burden of proving in any judicial proceeding or arbitration A-4 25 commenced pursuant to this Section 4 that the corporate agent is not entitled to indemnification or advancement of expenses, as the case may be. (c) If a determination shall have been made or deemed to have been made pursuant to Section 6 of Article XII of the Bylaws that a corporate agent is entitled to indemnification, the Corporation shall be bound by such determination in any judicial proceeding or arbitration commenced pursuant to this Section 4, absent (1) a misstatement or omission of a material fact in connection with the corporate agent's request for indemnification, or (2) a prohibition of such indemnification under applicable law. (d) The Corporation shall be precluded from asserting in any judicial proceeding or arbitration commenced pursuant to this Section 4 that the procedures and presumptions of these Procedures are not valid, binding and enforceable, and shall stipulate in any such judicial proceeding or arbitration that the Corporation is bound by all the provisions of these Procedures. (e) In the event that a corporate agent, pursuant to this Section 4, seeks to enforce the corporate agent's rights under, or to recover damages for breach of, Article XII of the Bylaws or these Procedures in a judicial proceeding or arbitration, the Corporate agent shall be entitled to recover from the Corporation, and shall be indemnified by the Corporation against, any and all expenses [(of the types described in the definition of expenses in Section 1 of Article XII of the Bylaws)] actually and reasonably incurred in such judicial proceeding or arbitration, but only if the corporate agent prevails therein. If it shall be determined in such judicial proceeding or arbitration that the corporate agent is entitled to receive part but not all of the indemnification or advancement of expenses sought, the expenses incurred by the corporate agent in connection with such judicial proceeding or arbitration shall be appropriately prorated. Section 5. AMENDMENTS. These Procedures may be amended at any time and from time to time in the same manner as any bylaw of the Corporation in accordance with the Amended and Restated Charter of the Corporation and the Bylaws; provided, however, that notwithstanding any amendment, alteration or repeal of these Procedures or any provision hereof, any corporate agent shall be entitled to utilize these Procedures with respect to any claim for indemnification arising out of any action taken or omitted prior to such amendment, alteration or repeal except to the extent otherwise required by law. A-5 EX-4.1 8 SPECIMEN STOCK CERTIFICATE 1 Exhibit 4.1 KIRKLAND'S INC. NUMBER SHARES SC INCORPORATED UNDER THE LAWS SEE REVERSE FOR CERTAIN DEFINITIONS OF THE STATE OF TENNESSEE CUSIP_____________________________ THIS CERTIFIES THAT is the owner of FULLY PAID AND NON-ASSESSABLE SHARES OF THE COMMON STOCK, NO PAR VALUE, OF KIRKLAND'S INC. transferable on the books of the Corporation by the holder hereof in person or by duly authorized attorney upon surrender of this certificate properly endorsed or assigned. This certificate and the shares represented hereby are issued and shall be held subject to all of the provisions of the Charter and all amendments thereto, to all of which the holder by acceptance hereof assents. This certificate is not valid until countersigned by the Transfer Agent and registered by the Registrar. WITNESS the facsimile seal of the Corporation and the facsimile signatures of its duly authorized officers. Dated: Kirkland's, Inc. Corporate Seal 1981 Tennessee /s/ Carl Kirkland /s/ Robert E. Alderson Chief Executive Officer Secretary COUNTERSIGNED AND REGISTERED BANKBOSTON, N.A. TRANSFER AGENT AND REGISTRAR BY AUTHORIZED SIGNATURE 2 The Corporation will furnish without charge to each stockholder who so requests the powers, designations, preferences and relative, participating, optional, or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights. The following abbreviations, when used in the inscription on the face of this certificate, shall be construed as though they were written out in full according to applicable laws or regulations: TEN COM -- as tenants in common TEN ENT -- as tenants by the entireties JT TEN -- as joint tenants with right of survivorship and not as tenants in common UNIF GIFT MIN ACT -- _______________ Custodian _______________ (Cust) (Minor) under Uniform Gifts to Minors Act _____________________________________ (State) Additional abbreviations may also be used though not in the above list. For value received, __________________ hereby sell, assign and transfer unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE ______________________________________ ________________________________________________________________________________ (PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE) ________________________________________________________________________________ ________________________________________________________________________________ _________________________________________________________________________ Shares of the common stock represented by the within Certificate, and do hereby irrevocably constitute and appoint _______________________________________________________________________ Attorney to transfer the said stock on the books of the within named Corporation with full power of substitution in the premises. Dated _________________________ SIGNATURE(S) GUARANTEED: _________________________________________________ NOTICE: The signature to this assignment must correspond with the name as written upon the face of the certificate in every particular without alteration or enlargement or any change whatever. The signature of the person executing this power must be guaranteed by an Eligible Guarantor Institution such as a Commercial Bank, Trust Company, Securities Broker/Dealer, Credit Union, or a Savings Association participating in a Medallion program approved by the Securities Transfer Association, Inc. EX-10.1 9 CREDIT AGREEMENT DATED AS OF JUNE 12, 1996 1 EXHIBIT 10.1 CREDIT AGREEMENT AMONG KIRKLAND HOLDINGS L.L.C. THE BORROWERS SPECIFIED HEREIN, THE SEVERAL LENDERS FROM TIME TO TIME PARTIES HERETO, THE FIRST NATIONAL BANK OF BOSTON, AS ADMINISTRATIVE AGENT AND LEHMAN COMMERCIAL PAPER INC., AS ADVISOR AND ARRANGER DATED AS OF JUNE 12, 1996 2 TABLE OF CONTENTS Page SECTION 1. DEFINITIONS..................................................... 2 1.1 Defined Terms.................................................. 2 1.2 Other Definitional Provisions.................................. 22 SECTION 2. AMOUNT AND TERMS OF COMMITMENTS................................. 22 2.1 Tranche A Term Loans........................................... 22 2.2 Procedure for Tranche A Term Loan Borrowing.................... 22 2.3 Tranche B Term Loans........................................... 23 2.4 Procedure for Tranche B Term Loan Borrowing.................... 23 2.5 Revolving Credit Commitments................................... 23 2.6 Procedure for Revolving Credit Borrowing....................... 24 2.7 Clean-Up....................................................... 24 2.8 Commitment Fees, etc. ......................................... 25 2.9 Repayment of Loans; Evidence of Debt........................... 25 2.10 Termination or Reduction of Revolving Credit Commitments...... 26 2.11 Optional Prepayments.......................................... 26 2.12 Mandatory Prepayments and Commitment Reductions............... 27 2.13 Conversion and Continuation Options........................... 28 2.14 Minimum Amounts and Maximum Number of Eurodollar Tranches..... 29 2.15 Interest Rates and Payment Dates.............................. 29 2.16 Computation of Interest and Fees.............................. 30 2.17 Inability to Determine Interest Rate.......................... 30 2.18 Pro Rata Treatment and Payments; Use of Proceeds.............. 31 2.19 Illegality.................................................... 32 2.20 Requirements of Law........................................... 32 2.21 Taxes ........................................................ 33 2.22 Indemnity..................................................... 35 2.23 Change of Lending Office...................................... 35 2.24 Right of Contribution......................................... 35 2.25 Swing Line Commitment......................................... 36 2.26 Procedure for Swing Line Borrowing............................ 36 2.27 Refunded Swing Line Loans; Swing Line Loan Participations..... 37 SECTION 3. LETTERS OF CREDIT............................................... 38 3.1 L/C Commitment................................................. 38 3.2 Procedure for Issuance of Letter of Credit..................... 39 3.3 Fees, Commissions and Other Charges............................ 39 3.4 L/C Participations............................................. 40 3.5 Reimbursement Obligation of the Borrowers...................... 41 3.6 Obligations Absolute........................................... 41 3.7 Letter of Credit Payments...................................... 41 3.8 Applications................................................... 42 -i- 3 Page SECTION 4. REPRESENTATIONS AND WARRANTIES.................................. 42 4.1 Financial Condition............................................ 42 4.2 No Change...................................................... 43 4.3 Corporate Existence; Compliance with Law....................... 43 4.4 Corporate Power; Authorization; Enforceable Obligations........ 43 4.5 No Legal Bar................................................... 44 4.6 No Material Litigation......................................... 44 4.7 No Default..................................................... 44 4.8 Ownership of Property; Liens................................... 44 4.9 Intellectual Property.......................................... 44 4.10 No Burdensome Restrictions.................................... 45 4.11 Taxes ........................................................ 45 4.12 Federal Regulations........................................... 45 4.13 ERISA ........................................................ 45 4.14 Investment Company Act; Other Regulations..................... 46 4.15 Subsidiaries.................................................. 46 4.16 Purpose of Loans; Limitations on Use.......................... 46 4.17 Environmental Matters......................................... 46 4.18 Accuracy of Information....................................... 47 4.19 Security Documents............................................ 48 4.20 Solvency...................................................... 48 4.21 Purchase Agreement Representations and Warranties............. 48 SECTION 5. CONDITIONS PRECEDENT............................................ 48 5.1 Conditions to Initial Extension of Credit...................... 48 5.2 Conditions to Each Extension of Credit......................... 53 SECTION 6. AFFIRMATIVE COVENANTS........................................... 54 6.1 Financial Statements........................................... 54 6.2 Certificates; Other Information................................ 55 6.3 Payment of Obligations......................................... 56 6.4 Conduct of Business and Maintenance of Existence, etc. ........ 56 6.5 Maintenance of Property; Insurance............................. 56 6.6 Inspection of Property; Books and Records; Discussions......... 57 6.7 Notices........................................................ 57 6.8 Environmental Laws............................................. 58 6.9 Interest Rate Protection....................................... 58 6.10 Further Assurances............................................ 58 6.11 Additional Collateral......................................... 58 6.12 Key Man Life Insurance........................................ 59 6.13 Store Locations............................................... 59 6.14 Landlord Waivers.............................................. 59 6.15 Purchase Agreement Affirmative Covenants...................... 59 6.16 Termination of Series C Preferred Voting Rights............... 60 SECTION 7. NEGATIVE COVENANTS.............................................. 60 -ii- 4 Page 7.2 Limitation on Indebtedness..................................... 63 7.3 Limitation on Liens............................................ 64 7.4 Limitation on Guarantee Obligations............................ 65 7.5 Limitation on Fundamental Changes.............................. 65 7.6 Limitation on Sale of Assets................................... 66 7.7 Limitation on Restricted Payments.............................. 66 7.8 Limitation on Capital Expenditures............................. 67 7.9 Limitation on Investments, Loans and Advances.................. 67 7.10 Limitation on Optional Payments and Modifications of Debt Instruments and Preferred Stock, etc................. 68 7.11 Limitation on Transactions with Affiliates.................... 68 7.12 Limitation on Sales and Leasebacks............................ 68 7.13 Limitation on Changes in Fiscal Year.......................... 69 7.14 Limitation on Negative Pledge Clauses......................... 69 7.15 Limitation on Lines of Business............................... 69 7.16 Limitation on Activities of the Parent........................ 69 7.17 Purchase Agreement Negative Covenants......................... 69 SECTION 8. EVENTS OF DEFAULT............................................... 70 SECTION 9. THE ADMINISTRATIVE AGENT........................................ 73 9.1 Appointment.................................................... 73 9.2 Delegation of Duties........................................... 74 9.3 Exculpatory Provisions......................................... 74 9.4 Reliance by Administrative Agent............................... 74 9.5 Notice of Default.............................................. 75 9.6 Non-Reliance on Administrative Agent and Other Lenders......... 75 9.7 Indemnification................................................ 75 9.8 Administrative Agent in Its Individual Capacity................ 76 9.9 Successor Administrative Agent................................. 76 9.10 The Arranger.................................................. 76 SECTION 10. GUARANTEE...................................................... 77 10.1 Guarantee..................................................... 77 10.2 No Subrogation, Contribution, Reimbursement or Indemnity...... 77 10.3 Amendments, etc. with respect to the Obligations.............. 77 10.4 Guarantee Absolute and Unconditional.......................... 78 10.5 Reinstatement................................................. 79 10.6 Payments...................................................... 79 SECTION 11. MISCELLANEOUS.................................................. 79 11.1 Amendments and Waivers........................................ 79 11.2 Notices....................................................... 80 11.3 No Waiver; Cumulative Remedies................................ 82 11.4 Survival...................................................... 82 11.5 Payment of Expenses and Taxes................................. 82 -iii- 5 Page 11.6 Successors and Assigns; Participations and Assignments........ 83 11.7 Adjustments; Set-off.......................................... 86 11.8 Counterparts.................................................. 87 11.9 Severability.................................................. 87 11.10 Integration.................................................. 87 11.11 GOVERNING LAW................................................ 87 11.12 Submission To Jurisdiction; Waivers.......................... 87 11.13 Acknowledgements............................................. 88 11.14 WAIVERS OF JURY TRIAL........................................ 88 11.15 Confidentiality.............................................. 89 11.16 Reliance on Representations and Actions of Designated Borrower.................................................... 89 -iv- 6 SCHEDULES: 1.1A Schedule of Borrowers 1.1B Commitments and Addresses of Lenders 1.1C Mortgaged Property 1.1D Tranche A Term Loan Amortization Schedule 1.1E Tranche B Term Loan Amortization Schedule 4.4 Consents, Authorizations, Filings and Notices 4.19(b) UCC Filing Jurisdictions 4.19(c) Mortgage Filing Jurisdiction 5.1(y) Prior Credit Facilities 7.2(d) Existing Indebtedness 7.3(f) Existing Liens 7.4(a) Existing Guarantee Obligations 7.11 Transactions with Affiliates EXHIBITS: A-1 Form of Revolving Credit Note A-2 Form of Tranche A Term Note A-3 Form of Tranche B Term Note A-4 Form of Swing Line Note B Form of Borrowers Security Agreement C Form of Mortgage D Form of Assignment and Acceptance E-1 Form of Parent Pledge Agreement E-2 Form of Management Pledge Agreement F Form of Assignment of Insurance G Form of Closing Certificate H-1 Legal Opinion of Pepper, Hamilton & Scheetz H-2 Legal Opinion of Baker, Donelson, Bearman & Caldwell I-1 Form of Alternative Revolving Credit Note I-2 Form of Alternative Tranche A Term Note I-3 Form of Alternative Tranche B Term Note J Form of Swing Line Loan Participation Certificate -v- 7 CREDIT AGREEMENT, dated as of June 12, 1996, among Kirkland's Holdings L.L.C., a Delaware limited liability company (the "Parent"), the entities listed on Schedule 1.1A hereto, as joint and several borrowers hereunder (the "Borrowers"), the several banks and other financial institutions or entities from time to time parties to this Agreement (the "Lenders"), The First National Bank of Boston, as Administrative Agent (as hereinafter defined) for the Lenders hereunder, and Lehman Commercial Paper Inc., as advisor and arranger with respect to the credit facilities contained herein (the "Arranger"). W I T N E S S E T H WHEREAS, funds (the "Advent Funds") affiliated with Advent International Corporation ("Advent") own 64.26% of the membership interests of the Parent; WHEREAS, the Parent has agreed to acquire all of the Class A Preferred Stock and common stock from each of the Borrowers which after the transactions contemplated by the Recapitalization Agreement (as defined herein) will comprise approximately 68.4% of the common stock of each of the Borrowers; WHEREAS, immediately following the Parent's investment in the Borrowers, a portion of the capital stock of the Borrowers owned by Carl Kirkland, Bruce Moore, Robert Alderson (collectively, the "Management Shareholders") and Robert Kirkland (together with the Management Shareholders, the "Individual Shareholders") will be redeemed (the "Redemptions"); WHEREAS, the Redemptions will be financed by (a) the issuance by the Borrowers of: (i) $20,000,000 of 12.25% to 12.50% senior subordinated notes (the "Subordinated Debt") to Capital Resource Lenders II, L.P., Allied Capital Corporation, Allied Capital Corporation II and The Marlboro Capital Investment Fund, L.P., and Capital Trust Investments, Ltd. (collectively, the "Subordinated Debt Holders"); (ii) at least $30,749,220 of Series A Redeemable Preferred Stock (the "Series A Preferred") to the Parent; and (iii) at least $14,205,780 of Series B Redeemable Preferred Stock (the "Series B Preferred") to the Individual Shareholders and (b) borrowings under the credit facilities provided for herein in an amount not to exceed $52,000,000; WHEREAS, following the Redemptions, certain Individual Shareholders will purchase common stock of the Borrowers and the Borrowers will recapitalize so that each of the Individual Shareholders owns 25% of the outstanding Class B Preferred Stock and 7.9% of the outstanding common stock of the Borrowers; WHEREAS, in connection with the issuance of the Subordinated Debt, the Borrowers have issued to the Subordinated Debt Holders the Warrants (as defined below); WHEREAS, the Borrowers have requested that the Lenders make the Loans and issue and participate in the Letters of Credit (as defined herein) to provide for a portion of the financing required for the Redemptions and the ongoing working capital needs of the Borrowers; 8 2 WHEREAS, all the obligations of the Borrowers under the Loan Documents (as defined herein) will be secured by, among other things, (i) a security interest in and perfected lien on certain assets and property of the Borrowers and (ii) a pledge of all the issued and outstanding capital stock of each Borrower, and all such obligations will be unconditionally guaranteed by the Parent; NOW, THEREFORE, the parties hereto hereby agree as follows: SECTION 1. DEFINITIONS 1.1 Defined Terms. As used in this Agreement, the following terms shall have the following meanings: "Affiliate": as to any Person, any other Person which, directly or indirectly, is in control of, is controlled by, or is under common control with, such Person. For purposes of this definition, "control" of a Person means the power, directly or indirectly, either to (a) vote 10% or more of the securities having ordinary voting power for the election of directors of such Person or (b) direct or cause the direction of the management and policies of such Person, whether by contract or otherwise. "Administrative Agent": The First National Bank of Boston, together with its affiliates, as the administrative agent for the Lenders under this Agreement and the other Loan Documents, and together with any of their respective successors. "Advent": as defined in the recitals hereto. "Advent Funds": as defined in the recitals hereto. "Aggregate Outstanding Revolving Extensions of Credit": as to any Revolving Credit Lender at any time, an amount equal to the sum of (a) the aggregate principal amount of all Revolving Credit Loans made by such Lender then outstanding, (b) such Lender's Revolving Credit Percentage of the L/C Obligations then outstanding and (c) such Lender's Revolving Credit Percentage of the aggregate principal amount of Swing Line Loans then outstanding. "Agreement": this Credit Agreement, as amended, supplemented or otherwise modified from time to time. "Alternative Note": as defined in Section 11.6(d). "Alternative Noteholder": as defined in Section 11.6(e). 9 3 "Applicable Margin": for each Type of Loan, the rate per annum set forth under the relevant column heading below:
Eurodollar Base Rate Loans Loans --------------- ---------- Revolving Credit Loans 2-1/4% 3-1/4% Tranche A Loans 2-1/4% 3-1/4% Tranche B Term Loans 2-3/4% 3-3/4%
"Application": an application, in such form as the Issuing Lender may specify from time to time, requesting the Issuing Lender to open a Letter of Credit. "Arranger": as defined in the preamble hereto. "Asset Sale": any sale or other disposition by the Parent, any Borrower or any of their Subsidiaries of any asset or assets of the Parent, such Borrower or such Subsidiary (including any sale and leaseback of assets and any mortgage of real property other than pursuant to a Mortgage); provided, that any sale of assets expressly permitted by clauses (a), (b), (c) or (d) of Section 7.6 shall not constitute an "Asset Sale" hereunder. "Assignee": as defined in Section 11.6(c). "Assignment of Insurance": the Assignments of Insurance, each executed and delivered by [the appropriate Borrower], substantially in the form of Exhibit F, as the same may be amended, supplemented or otherwise modified from time to time. "Available Revolving Credit Commitment": as to any Lender at any time, an amount equal to the excess, if any, of (a) such Lender's Revolving Credit Commitment over (b) such Lender's Aggregate Outstanding Revolving Extensions of Credit; provided, that in calculating any Lender's Aggregate Outstanding Revolving Extensions of Credit for the purpose of determining such Lender's Available Revolving Credit Commitment pursuant to Section 2.8(a), the aggregate unpaid principal amount of Swing Line Loans then outstanding shall be deemed to be zero. "Base Rate": for any day, a rate per annum (rounded upwards, if necessary, to the next 1/16 of 1%) equal to the greater of (a) the Prime Rate in effect on such day, and (b) the Federal Funds Effective Rate in effect on such day plus 1/2 of 1%. For purposes hereof: "Prime Rate" shall mean the rate of interest per annum publicly announced from time to time by the Administrative Agent as its prime or base rate in effect at its principal office in Boston, Massachusetts; and "Federal Funds Effective Rate" shall mean, for any day, the weighted average of the rates on overnight federal funds transactions with members of the Federal Reserve System arranged by federal funds brokers, as published on the next succeeding Business Day by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations for the day of such transactions received 10 4 by the Administrative Agent from three federal funds brokers of recognized standing selected by it. Any change in the Base Rate due to a change in the Prime Rate or the Federal Funds Effective Rate shall be effective as of the opening of business on the effective day of such change in the Prime Rate or the Federal Funds Effective Rate, respectively. "Base Rate Loans": Loans the rate of interest applicable to which is based upon the Base Rate. "Board": the Board of Governors of the Federal Reserve System of the United States (or any successor). "Borrowers Security Agreement": the Borrowers Security Agreement to be executed and delivered by each Borrower, substantially in the form of Exhibit B, as the same may be amended, supplemented or otherwise modified from time to time. "Borrowing Date": any Business Day specified in a notice pursuant to Section 2.2, 2.4, 2.6 or 2.26 as a date on which the Designated Borrower requests the Lenders to make Loans hereunder. "Business": as defined in Section 4.17. "Business Day": a day other than a Saturday, Sunday or other day on which commercial banks in Boston, Massachusetts are authorized or required by law to close. "Capital Expenditures": for any period, with respect to any Person, the aggregate of all expenditures by such Person and its Subsidiaries for the acquisition or leasing (pursuant to a capital lease) of fixed or capital assets or additions to equipment (including replacements, capitalized repairs and improvements during such period) which should be capitalized under GAAP on a combined balance sheet of such Person and its Subsidiaries. "Capital Lease Obligations": as to any Person, the obligations of such Person to pay rent or other amounts under any lease of (or other arrangement conveying the right to use) real or personal property, or a combination thereof, which obligations are required to be classified and accounted for as capital leases on a balance sheet of such Person under GAAP and, for the purposes of this Agreement, the amount of such obligations at any time shall be the capitalized amount thereof at such time determined in accordance with GAAP. "Capital Stock": any and all shares, interests, participations or other equivalents (however designated) of capital stock of a corporation, any and all equivalent ownership interests in a Person (other than a corporation) and any and all warrants, rights or options to purchase any of the foregoing. 11 5 "Cash Equivalents": (a) marketable direct obligations issued by, or unconditionally guaranteed by, the United States Government or issued by any agency thereof and backed by the full faith and credit of the United States, in each case maturing within one year from the date of acquisition; (b) certificates of deposit, time deposits, eurodollar time deposits or overnight bank deposits having maturities of six months or less from the date of acquisition issued by any Lender or by any commercial bank organized under the laws of the United States or any state thereof having combined capital and surplus of not less than $250,000,000; and (c) commercial paper of (i) an issuer rated at least A-1 by Standard & Poor's Ratings Services or P-1 by Moody's Investors Service, Inc., or carrying an equivalent rating by a nationally recognized rating agency, if both of the two named rating agencies cease publishing ratings of commercial paper issuers generally or (ii) the holding company of any Lender, and, in either case, maturing within six months from the date of acquisition. "C/D Assessment Rate": for any day as applied to any Base Rate Loan, the annual assessment rate in effect on such day which is payable by a member of the Bank Insurance Fund maintained by the Federal Deposit Insurance Corporation (the "FDIC") classified as well-capitalized and within supervisory subgroup "B" (or a comparable successor assessment risk classification) within the meaning of 12 C.F.R. Section 327.3(d) (or any successor provision) to the FDIC (or any successor) for the FDIC's (or such successor's) insuring time deposits at offices of such institution in the United States. "C/D Reserve Percentage": for any day as applied to any Base Rate Loan, that percentage (expressed as a decimal) which is in effect on such day, as prescribed by the Board, for determining the maximum reserve requirement for a Depositary Institution (as defined in Regulation D of the Board as in effect from time to time) in respect of new non-personal time deposits in Dollars having a maturity of 30 days or more. "Certificate of Designations": the Certificate of Designations, dated June 7, 1996 and effective as of June 12, 1996 at 12:01 a.m., of each Borrower. "Closing Date": the date on which the conditions precedent set forth in Section 5.1 shall be satisfied. "Code": the Internal Revenue Code of 1986, as amended from time to time. "Collateral": all assets of the Loan Parties or the Individual Shareholders, now owned or hereafter acquired, upon which a Lien is purported to be created by any Security Document. "Combined Current Assets": at a particular date, all amounts (other than cash and Cash Equivalents) which would, in conformity with GAAP, be set forth opposite 12 6 the caption "total current assets" (or any like caption) on a combined balance sheet of the Borrowers and their Subsidiaries at such date. "Combined Current Liabilities": at a particular date, all amounts which would, in conformity with GAAP, be set forth opposite the caption "total current liabilities" (or any like caption) on a combined balance sheet of the Borrowers and their Subsidiaries at such date, but excluding (a) the current portion of any Funded Debt of the Borrowers and their Subsidiaries and (b) without duplication of clause (a) above, all Indebtedness consisting of Revolving Credit Loans or Swing Line Loans to the extent otherwise included therein. "Combined EBITDA": for any period, Combined Net Income for such period plus, without duplication and to the extent reflected as a charge in the statement of such Combined Net Income for such period, the sum of (a) total income tax expense, (b) interest expense, amortization or writeoff of debt discount and debt issuance costs and commissions, discounts and other fees and charges associated with Indebtedness (including the Loans), (c) depreciation and amortization expense, (d) amortization of intangibles (including, but not limited to, goodwill) and organization costs, (e) any extraordinary expenses or losses (including, whether or not otherwise includable as a separate item in the statement of such Combined Net Income for such period, losses on sales of assets outside of the ordinary course of business), (f) any other noncash charges (excluding inventory writedowns and LIFO charges) and (g) if applicable, restructuring charges, write-off of goodwill and licensing agreements and minus, to the extent included in the statement of such Combined Net Income for such period, the sum of (a) non-cash interest income, (b) any extraordinary income or gains (including, whether or not otherwise includable as a separate item in the statement of such Combined Net Income for such period, gains on the sales of assets outside of the ordinary course of business) and (c) any other noncash income, all as determined on a combined basis. "Combined Fixed Charge Coverage Ratio": for any period, the ratio of (a) (i) the sum of (without duplication) (A) Combined EBITDA for such period, (B) any Management Fee accrued during such period and (C) Combined Lease Expense minus (ii) the sum of (without duplication) (A) any provision for cash income taxes made by the Borrowers or any of their Subsidiaries on a combined basis in respect of such period, and (B) Capital Expenditures actually paid in cash for such period to (b) the sum (without duplication) of (I) Combined Interest Expense for such period, (II) any Management Fee accrued during such period, (III) scheduled payments required to have been made during such period on account of principal of Indebtedness of the Borrowers or any of their Subsidiaries (including the Loans but excluding optional principal prepayments in respect of Revolving Credit Loans) and (IV) Combined Lease Expense, determined without duplication of items included in Combined Interest Expense. 13 7 "Combined Interest Coverage Ratio": for any period, the ratio of (a) Combined EBITDA plus the Management Fee for such period to (b) Combined Interest Expense for such period. "Combined Interest Expense": for any period, total interest expense (including that attributable to Capital Lease Obligations), both expensed and capitalized, of the Borrowers and their Subsidiaries for such period with respect to all outstanding Indebtedness of the Borrowers and their Subsidiaries (including, without limitation, all commissions, discounts and other fees and charges owed with respect to letters of credit and bankers' acceptance financing and net costs under Interest Rate Protection Agreements to the extent such net costs are allocable to such period in accordance with GAAP), determined on a combined basis in accordance with GAAP. "Combined Lease Expense": for any period, the aggregate amount of fixed and contingent rentals payable by the Borrowers and their Subsidiaries, determined on a combined basis in accordance with GAAP, for such period with respect to leases of real and personal property; provided that amounts included in Capital Lease Obligations shall be excluded from Combined Lease Expense. "Combined Management Fee Ratio": for any fiscal year, the ratio of (a) Combined EBITDA plus the Management Fee for such fiscal year to (b) the sum of (I) Combined Interest Expense for such fiscal year plus (II) any Management Fee accrued during such fiscal year. "Combined Net Income": for any period, the combined net income (or loss) of the Borrowers and their Subsidiaries, determined on a combined basis in accordance with GAAP; provided that there shall be excluded (a) the income (or deficit) of any Person accrued prior to the date it becomes a Subsidiary of the Borrowers or is merged into or combined with the Borrowers or any of their Subsidiaries, (b) the income (or deficit) of any Person (other than a Subsidiary of the Borrowers) in which the Borrowers or any of their Subsidiaries has an ownership interest, except to the extent that any such income is actually received by the Borrowers or such Subsidiary in the form of dividends or similar distributions and (c) the undistributed earnings of any Subsidiary of the Borrowers to the extent that the declaration or payment of dividends or similar distributions by such Subsidiary is not at the time permitted by the terms of any Contractual Obligation (other than under any Loan Document) or Requirement of Law applicable to such Subsidiary. "Combined Net Worth": at a particular date, all amounts which would, in conformity with GAAP, be included on a combined balance sheet of the Borrowers and their Subsidiaries as at such date for Preferred Stock plus any increase or decrease in retained earnings between the Closing Date and such date. "Combined Total Debt": at any date, the aggregate principal amount of all Funded Debt (other than Revolving Credit Loans, Swing Line Loans and 14 8 Reimbursement Obligations) of the Borrowers and their Subsidiaries at such date, determined on a combined basis in accordance with GAAP. "Combined Total Debt Ratio": as of the last day of any period, the ratio of (a) Combined Total Debt as of such day to (b) Combined EBITDA plus the Management Fee for such period. "Combined Working Capital": the excess of Combined Current Assets over Combined Current Liabilities. "Commercial Letter of Credit": as defined in Section 3.1(a). "Commitment": as to any Lender, the sum of the Tranche A Term Loan Commitment, the Tranche B Term Loan Commitment and the Revolving Credit Commitment of such Lender. "Commonly Controlled Entity": an entity, whether or not incorporated, which is under common control with any Borrower within the meaning of Section 4001 of ERISA or is part of a group which includes any Borrower and which is treated as a single employer under Section 414 of the Code. "Confidential Information Memorandum": the Confidential Information Memorandum dated as of May, 1996 with respect to the Borrowers and the credit facilities provided for herein. "Consulting Agreement": the consulting agreement dated June 12, 1996, between Kirkland's Inc. and Robert Kirkland. "Contractual Obligation": as to any Person, any provision of any security issued by such Person or of any agreement, instrument or other undertaking to which such Person is a party or by which it or any of its property is bound. "Default": any of the events specified in Section 8, whether or not any requirement for the giving of notice, the lapse of time, or both, has been satisfied. "Designated Borrower": Kirkland's Inc., a Tennessee corporation, on behalf of itself or any of the other Borrowers in accordance with the terms hereof. "Dollars" and "$": dollars in lawful currency of the United States. "Environmental Laws": any and all foreign, Federal, state, local or municipal laws, rules, orders, regulations, statutes, ordinances, codes, decrees, requirements of any Governmental Authority or other Requirements of Law (including common law) regulating, relating to or imposing liability or standards of conduct concerning the protection of human health or the environment, as now or may at any time hereafter be in effect. 15 9 "ERISA": the Employee Retirement Income Security Act of 1974, as amended from time to time. "Eurocurrency Reserve Requirements": for any day as applied to a Eurodollar Loan, the aggregate (without duplication) of the rates (expressed as a decimal fraction) of reserve requirements in effect on such day (including, without limitation, basic, supplemental, marginal and emergency reserves under any regulations of the Board or other Governmental Authority having jurisdiction with respect thereto) dealing with reserve requirements prescribed for eurocurrency funding (currently referred to as "Eurocurrency Liabilities" in Regulation D of the Board) maintained by a member bank of the Federal Reserve System. "Eurodollar Base Rate": with respect to each day during each Interest Period pertaining to a Eurodollar Loan, the rate of interest determined on the basis of the rate for deposits in dollars for a period equal to such Interest Period commencing on the first day of such Interest Period appearing on Page 3750 of the Telerate Service as of 11:00 A.M., London time, two Business Days prior to the beginning of such Interest Period. In the event that such rate does not appear on Page 3750 of the Telerate Service (or otherwise on such service), the "Eurodollar Base Rate" shall be determined by reference to such other publicly available service for displaying eurodollar rates as may be agreed upon by the Administrative Agent and the Designated Borrower or, in the absence of such agreement, the "Eurodollar Base Rate" shall instead be the rate per annum equal to the rate at which the Administrative Agent is offered Dollar deposits at or about 10:00 A.M., New York City time, two Business Days prior to the beginning of such Interest Period in the interbank eurodollar market where the eurodollar and foreign currency and exchange operations in respect of its Eurodollar Loans are then being conducted for delivery on the first day of such Interest Period for the number of days comprised therein and in an amount comparable to the amount of its Eurodollar Loans to be outstanding during such Interest Period. "Eurodollar Loans": Loans the rate of interest applicable to which is based upon the Eurodollar Rate. "Eurodollar Rate": with respect to each day during each Interest Period pertaining to a Eurodollar Loan, a rate per annum determined for such day in accordance with the following formula (rounded upward to the nearest 1/100th of 1%): Eurodollar Base Rate ---------------------------------------- 1.00 - Eurocurrency Reserve Requirements "Eurodollar Tranche": the collective reference to Eurodollar Loans that are Tranche A Term Loans, Tranche B Term Loans or Revolving Credit Loans, as the case may be, the then current Interest Periods with respect to all of which begin on the same date and end on the same later date (whether or not such Loans shall originally have been made on the same day). 16 10 "Event of Default": any of the events specified in Section 8, provided that any requirement for the giving of notice, the lapse of time, or both, has been satisfied. "Excess Cash Flow": for any period, Combined Net Income for such period, plus the sum of (i) depreciation expense and amortization expense deducted from earnings in determining such Combined Net Income, (ii) the net increase during such period (if any) in deferred tax accounts, (iii) any proceeds received by the Borrowers during such period in respect of the key man life insurance policies required hereunder and (iv) the decrease during such period (if any) in Combined Working Capital minus the sum of (i) the net decrease during such period (if any) in deferred tax accounts, (ii) the aggregate amount actually paid in cash during such period on account of Capital Expenditures permitted hereunder (but only to the extent not financed by Indebtedness or capital contributions), in each case, determined on a consolidated basis in accordance with GAAP, (iii) the increase during such period (if any) in Combined Working Capital and (iv) scheduled principal payments on Indebtedness of the Borrowers and their Subsidiaries not prohibited hereunder during such period (not including optional principal prepayments in respect of Revolving Credit Loans or Swing Line Loans). For purposes of calculating Excess Cash Flow for the fiscal year ending December 31, 1996, (i) any change in Combined Working Capital shall be calculated for the entire fiscal year ending December 31, 1996, and (ii) all other amounts shall be calculated based on the period from the Closing Date through December 31, 1996. "Excess Cash Flow Application Date": as defined in Section 2.12(c). "Financing Lease": any lease of property, real or personal, the obligations of the lessee in respect of which are required in accordance with GAAP to be capitalized on a balance sheet of the lessee. "Funded Debt": as to any Person, all Indebtedness of such Person that matures more than one year from the date of its creation or matures within one year from such date but is renewable or extendible, at the option of such Person, to a date more than one year from such date or arises under a revolving credit or similar agreement that obligates the lender or lenders to extend credit during a period of more than one year from such date, including, without limitation, all current maturities and current sinking fund payments in respect of such Indebtedness whether or not required to be paid within one year from the date of its creation and, in the case of the Borrowers, all current maturities in respect of the Loans. "GAAP": generally accepted accounting principles in the United States in effect from time to time. "Governmental Authority": any nation or government, any state or other political subdivision thereof and any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government. 17 11 "Guarantee Obligation": as to any Person (the "guaranteeing person"), any obligation of (a) the guaranteeing person or (b) another Person (including, without limitation, any bank under any letter of credit) to induce the creation of which the guaranteeing person has issued a reimbursement, counterindemnity or similar obligation, in either case guaranteeing or in effect guaranteeing any Indebtedness, leases, dividends or other obligations (the "primary obligations") of any other third Person (the "primary obligor") in any manner, whether directly or indirectly, including, without limitation, any obligation of the guaranteeing person, whether or not contingent, (i) to purchase any such primary obligation or any property constituting direct or indirect security therefor, (ii) to advance or supply funds (1) for the purchase or payment of any such primary obligation or (2) to maintain working capital or equity capital of the primary obligor or otherwise to maintain the net worth or solvency of the primary obligor, (iii) to purchase property, securities or services primarily for the purpose of assuring the owner of any such primary obligation of the ability of the primary obligor to make payment of such primary obligation or (iv) otherwise to assure or hold harmless the owner of any such primary obligation against loss in respect thereof; provided, however, that the term Guarantee Obligation shall not include endorsements of instruments for deposit or collection in the ordinary course of business. The amount of any Guarantee Obligation of any guaranteeing person shall be deemed to be the lower of (a) an amount equal to the stated or determinable amount of the primary obligation in respect of which such Guarantee Obligation is made and (b) the maximum amount for which such guaranteeing person may be liable pursuant to the terms of the instrument embodying such Guarantee Obligation, unless such primary obligation and the maximum amount for which such guaranteeing person may be liable are not stated or determinable, in which case the amount of such Guarantee Obligation shall be such guaranteeing person's maximum reasonably anticipated liability in respect thereof as determined by the Borrowers in good faith. "Incur": as defined in Section 7.2. "Indebtedness": of any Person at any date, without duplication, (a) all indebtedness of such Person for borrowed money, (b) all obligations of such Person for the deferred purchase price of property or services (other than current trade payables incurred in the ordinary course of such Person's business), (c) all obligations of such Person evidenced by notes, bonds, debentures or other similar instruments, (d) all indebtedness created or arising under any conditional sale or other title retention agreement with respect to property acquired by such Person (even though the rights and remedies of the seller or lender under such agreement in the event of default are limited to repossession or sale of such property), (e) all Capital Lease Obligations (and not operating lease obligations) of such Person, (f) all obligations, contingent or otherwise, of such Person as an account party under acceptance, letter of credit or similar facilities, (g) all obligations of such Person to purchase, redeem, retire or otherwise acquire for value any Capital Stock of such Person, (h) all Guarantee Obligations of such Person and (i) all obligations of the kind referred to in clauses (a) through (h) above secured by any Lien on property (including, without limitation, 18 12 accounts and contract rights) owned by such Person, whether or not such Person has assumed or become liable for the payment of such obligation. "Individual Shareholders": as defined in the recitals hereto. "Insolvency": with respect to any Multiemployer Plan, the condition that such Plan is insolvent within the meaning of Section 4245 of ERISA. "Insolvent": pertaining to a condition of Insolvency. "Insurance Policies": (i) key man life insurance policies on each of the three Management Shareholders in the amount of $3,000,000 per person, on terms satisfactory to the Arranger, (ii) the insurance policies the Borrowers are required to maintain pursuant to Sections 6.5 and 6.12 and (iii) the insurance policies the Borrowers are required to maintain pursuant to Section 4.2 of the Borrowers Security Agreement. "Interest Payment Date": (a) as to any Base Rate Loan, the last day of each March, June, September and December to occur while such Loan is outstanding, (b) as to any Eurodollar Loan having an Interest Period of three months or less, the last day of such Interest Period, (c) as to any Eurodollar Loan having an Interest Period longer than three months, each day which is three months, or a whole multiple thereof, after the first day of such Interest Period and the last day of such Interest Period. "Interest Period": as to any Eurodollar Loan, (a) initially, the period commencing on the borrowing or conversion date, as the case may be, with respect to such Eurodollar Loan and ending one, two, three or six months thereafter, as selected by the Borrowers in their notice of borrowing or notice of conversion, as the case may be, given with respect thereto; and (b) thereafter, each period commencing on the last day of the next preceding Interest Period applicable to such Eurodollar Loan and ending one, two, three or six months thereafter, as selected by the Borrowers by irrevocable notice to the Administrative Agent not less than three Business Days prior to the last day of the then current Interest Period with respect thereto; provided that, all of the foregoing provisions relating to Interest Periods are subject to the following: (i) if any Interest Period would otherwise end on a day that is not a Business Day, such Interest Period shall be extended to the next succeeding Business Day unless the result of such extension would be to carry such Interest Period into another calendar month in which event such Interest Period shall end on the immediately preceding Business Day; (ii) any Interest Period that would otherwise extend beyond the Revolving Credit Termination Date (in the case of Revolving Credit Loans) or beyond the date final payment is due on the Tranche A Term Loans or the Tranche B Term Loans (in the case of the Term Loans) shall end on the Revolving Credit Termination Date or such date of final payment, as applicable; 19 13 (iii) any Interest Period that begins on the last 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 Business Day of a calendar month; and (iv) the Borrowers shall select Interest Periods so as not to require a payment or prepayment of any Eurodollar Loan during an Interest Period for such Loan. "Interest Rate Protection Agreement": any interest rate protection agreement, interest rate futures contract, interest rate option, interest rate cap or other interest rate hedge arrangement, to or under which the Borrowers or any Subsidiary is a party or a beneficiary on the date hereof or becomes a party or a beneficiary after the date hereof. "Issuing Lender": The First National Bank of Boston, in its capacity as issuer of any Letter of Credit and any other Lender designated as "Issuing Lender" hereunder by the Designated Borrower with the consent of the Arranger, the Administrative Agent and such Lender. "L/C Commitment": $5,000,000. "L/C Fee Payment Date": the last day of each March, June, September and December and the last day of the Revolving Credit Commitment Period. "L/C Obligations": at any time, an amount equal to the sum of (a) the aggregate then undrawn and unexpired amount of the then outstanding Letters of Credit and (b) the aggregate amount of drawings under Letters of Credit which have not then been reimbursed pursuant to Section 3.5. "L/C Participants": the collective reference to all the Revolving Credit Lenders other than the Issuing Lender. "Letters of Credit": as defined in Section 3.1(a). "Lien": any mortgage, pledge, hypothecation, assignment, deposit arrangement, encumbrance, lien (statutory or other), charge or other security interest or any preference, priority or other security agreement or preferential arrangement of any kind or nature whatsoever (including, without limitation, any conditional sale or other title retention agreement and any capital lease having substantially the same economic effect as any of the foregoing). "Loan": any loan made by any Lender pursuant to this Agreement. "Loan Documents": this Agreement, the Notes, the Applications and the Security Documents. 20 14 "Loan Parties": the Parent, the Borrowers and each other Subsidiary of the Parent or the Borrowers which is a party to a Loan Document. "Management Contracts": the collective reference to the letter agreements, each dated June 12, 1996, between Kirkland's, Inc. and each of the Management Shareholders. "Management Fee": the amount payable to (a) the Management Shareholders pursuant to clause (b) of the third sentence of Section 2 of the Management Contracts and (b) to Robert Kirkland pursuant to Section 3 of the Consulting Agreement. "Management Pledge Agreement": the Pledge Agreement to be executed and delivered by the Management Shareholders substantially in the form of Exhibit E-2, as the same may be amended, supplemented or otherwise modified from time to time. "Management Shareholders": as defined in the recitals hereto. "Material Adverse Effect": a material adverse effect on (a) the consummation of the Recapitalization in accordance with the Recapitalization Documents, (b) the business, assets, results of operations, financial condition or prospects of the Parent, the Borrowers and their Subsidiaries taken as a whole or (c) the validity or enforceability of this Agreement or any of the other Loan Documents or the rights or remedies of the Administrative Agent or the Lenders hereunder or thereunder. "Material Environmental Amount": an amount payable by the Borrowers and/or their Subsidiaries in excess of $250,000 for remedial costs, compliance costs, compensatory damages, punitive damages, fines, penalties or any combination thereof. "Materials of Environmental Concern": any gasoline or petroleum (including crude oil or any fraction thereof) or petroleum products or any hazardous or toxic substances, materials or wastes, defined or regulated as such in or under any Environmental Law, including, without limitation, asbestos, polychlorinated biphenyls and urea-formaldehyde insulation. "Mortgage": the mortgage or deed of trust made by the appropriate Loan Party in favor of, or for the benefit of, the Administrative Agent for the benefit of the Lenders, substantially in the form of Exhibit C (with such changes thereto as shall be advisable under the law of the jurisdiction in which such mortgage or deed of trust is to be recorded), as the same may be amended, supplemented or otherwise modified from time to time. "Mortgaged Property": the real property listed on Schedule 1.1C, as to which the Administrative Agent for the benefit of the Lenders shall be granted a Lien pursuant to each Mortgage. 21 15 "Multiemployer Plan": a Plan which is a multiemployer plan as defined in Section 4001(a)(3) of ERISA. "Net Cash Proceeds": (a) in connection with any Asset Sale or any Recovery Event, the proceeds thereof in the form of cash and Cash Equivalents (including any such proceeds received by way of deferred payment of principal pursuant to a note or installment receivable or purchase price adjustment receivable or otherwise, but only as and when received) of such Asset Sale or Recovery Event, net of attorneys' fees, accountants' fees, investment banking fees, amounts required to be applied to the repayment of Indebtedness secured by a Lien expressly permitted hereunder on any asset which is the subject of such Asset Sale or Recovery Event (other than any Lien in favor of the Administrative Agent for the benefit of the Lenders) and other customary fees and expenses actually incurred in connection therewith and net of taxes paid or reasonably estimated to be payable as a result thereof (after taking into account any available tax credits or deductions and any tax sharing arrangements) and (b) in connection with any issuance or sale of equity securities or debt securities or instruments or the incurrence of loans, the cash proceeds received from such issuance or incurrence, net of attorneys' fees, investment banking fees, accountants' fees, underwriting discounts and commissions and other customary fees and expenses actually incurred in connection therewith. "Non-Excluded Taxes": as defined in Section 2.21(a). "Non-U.S. Lender": as defined in Section 2.21(b). "Notes": the collective reference to the Tranche A Term Notes, the Tranche B Term Notes, the Revolving Credit Notes and the Swing Line Notes. "Obligations": the unpaid principal of and interest on (including, without limitation, interest accruing after the maturity of the Loans and Reimbursement Obligations and interest accruing after the filing of any petition in bankruptcy, or the commencement of any insolvency, reorganization or like proceeding, relating to the Borrowers, whether or not a claim for post-filing or post-petition interest is allowed in such proceeding) the Notes and all other obligations and liabilities of the Borrowers to the Administrative Agent or to any Lender, whether direct or indirect, absolute or contingent, due or to become due, or now existing or hereafter incurred, which may arise under, out of, or in connection with, this Agreement, any other Loan Document, the Letters of Credit, any Interest Rate Protection Agreement entered into with any Lender or any other document made, delivered or given in connection herewith or therewith, whether on account of principal, interest, reimbursement obligations, fees, indemnities, costs, expenses (including, without limitation, all fees, charges and disbursements of counsel to the Administrative Agent or to any Lender that are required to be paid by the Borrowers pursuant hereto). 22 16 "Parent Pledge Agreement": the Parent Pledge Agreement to be executed and delivered by the Parent, substantially in the form of Exhibit E, as the same may be amended, supplemented or otherwise modified from time to time. "Participant": as defined in Section 11.6(b). "PBGC": the Pension Benefit Guaranty Corporation established pursuant to Subtitle A of Title IV of ERISA (or any successor). "Person": an individual, partnership, corporation, business trust, joint stock company, trust, unincorporated association, joint venture, Governmental Authority or other entity of whatever nature. "Plan": at a particular time, any employee benefit plan which is covered by ERISA and in respect of which the Borrowers or a Commonly Controlled Entity is (or, if such plan were terminated at such time, would under Section 4069 of ERISA be deemed to be) an "employer" as defined in Section 3(5) of ERISA. "Pledge Agreements": the collective reference to the Management Pledge Agreement and the Parent Pledge Agreement. "Preferred Stock": the collective reference to the Series A Preferred, the Series B Preferred and the Series C Preferred, in each case, as defined in the recitals hereto. "Prior Credit Facilities": the debt obligations referred to on Schedule 5.1(y). "Pro Forma Balance Sheet": as defined in Section 4.1(a). "Projections": as defined in Section 6.2(c). "Properties": the collective reference to the real property owned, leased or operated by the Parent, the Borrowers or any of their Subsidiaries. "Purchase Agreement": the Senior Subordinated Note and Warrant Purchase Agreement dated as of June 12, 1996 among the Subordinated Debt Holders and the Borrowers. "Recapitalization": as defined in the Recapitalization Agreement. "Recapitalization Agreement": the Recapitalization Agreement dated April 26, 1996 among the Parent, the Borrowers and the Individual Shareholders, together with such amendments, waivers, supplements and other modifications thereto as shall be reasonably satisfactory to the Administrative Agent and the Lenders (the consent of the Administrative Agent and the Lenders shall only be required with respect to material amendments, waivers, supplements and other modifications). 23 17 "Recapitalization Documents": the Recapitalization Agreement and any agreement or other document entered into or executed by any Loan Party in connection with the Recapitalization Agreement. "Recovery Event": any settlement of or payment in respect of a property or casualty insurance claim relating to any asset of the Parent, the Borrowers or any of their Subsidiaries. "Refunded Swing Line Loans": as defined in Section 2.27(a). "Register": as defined in Section 11.6(g). "Registration Rights Agreement" the Registration Rights Agreement dated as of June 12, 1996 among the Parent, Kirkland's Inc., the other corporations listed on the signature pages thereto, the Subordinated Debt Holders and the Individual Shareholders, as amended, supplemented or otherwise modified from time to time. "Reimbursement Obligation": the obligation of the Borrowers to reimburse the Issuing Lender pursuant to Section 3.5 for amounts drawn under Letters of Credit. "Reinvestment Deferred Amount": with respect to any Reinvestment Event, the aggregate Net Cash Proceeds received by the Parent, the Borrowers or any of their Subsidiaries in connection therewith which are not applied to prepay the Term Loans or reduce the Revolving Credit Commitments pursuant to Section 2.12(b) as a result of the delivery of a Reinvestment Notice. "Reinvestment Event": any Recovery Event in respect of which the Designated Borrower has delivered a Reinvestment Notice. "Reinvestment Notice": a written notice executed by a Responsible Officer of the Designated Borrower to the Administrative Agent within 30 days of the Reinvestment Event to which it relates stating that no Event of Default has occurred and is continuing and that the Borrowers (directly or indirectly through another Subsidiary), in good faith, intend and expect to use all or a specified portion of the Net Cash Proceeds of a Recovery Event to restore or replace the assets in respect of which such Recovery Event occurred within twelve months from the date of receipt of such Net Cash Proceeds (provided that if the affected assets constituted Collateral, such restored or replacement assets shall also constitute Collateral). "Reinvestment Prepayment Amount": with respect to any Reinvestment Event, the Reinvestment Deferred Amount relating thereto less any amount expended prior to the relevant Reinvestment Prepayment Date to restore or replace the assets in respect of which a Recovery Event has occurred. "Reinvestment Prepayment Date": with respect to any Reinvestment Event, the earliest of (a) the first date occurring after such Reinvestment Event on which an 24 18 Event of Default shall have occurred, (b) the date occurring twelve months after such Reinvestment Event and (c) the date on which the applicable Borrower shall have determined not to, or shall have otherwise ceased to, restore or replace the assets in respect of which a Recovery Event has occurred. "Reorganization": with respect to any Multiemployer Plan, the condition that such plan is in reorganization within the meaning of Section 4241 of ERISA. "Reportable Event": any of the events set forth in Section 4043(b) of ERISA, other than those events as to which the thirty day notice period is waived under subsection .13, .14, .16, .18, .19 or .20 of PBGC Reg. Section 2615. "Required Lenders": at any date shall mean the holders of 66-2/3% or more of (a) until the Closing Date, the Commitments and (b) thereafter, the sum of (i) the aggregate unpaid principal amount of the Term Loans and (ii) the aggregate Revolving Credit Commitments, or, if the Revolving Credit Commitments have been terminated, the Aggregate Outstanding Revolving Extensions of Credit of the Revolving Credit Lenders. "Requirement of Law": as to any Person, the Certificate of Incorporation and By-Laws or other organizational or governing documents of such Person, and any law, treaty, rule or regulation or determination of an arbitrator or a court or other Governmental Authority, in each case applicable to or binding upon such Person or any of its property or to which such Person or any of its property is subject. "Responsible Officer": the chief executive officer, president or chief financial officer of the Parent, the Designated Borrower or any other Borrower, as the case may be, but in any event, with respect to financial matters, the chief financial officer of the Parent, the Designated Borrower or any other Borrower, as the case may be. "Revolving Credit Commitment": as to any Lender, the obligation of such Lender, if any, to make Revolving Credit Loans to and/or issue or participate in Letters of Credit issued on behalf of a Borrower hereunder in an aggregate principal and/or face amount not to exceed the amount set forth under the heading "Revolving Credit Commitment" opposite such Lender's name on Schedule 1.1B, as the same may be changed from time to time pursuant to the terms hereof. "Revolving Credit Commitment Period": the period from and including the Closing Date to but not including the Revolving Credit Termination Date, or such earlier date on which the Revolving Credit Commitments shall have been terminated. "Revolving Credit Lender": each Lender which has a Revolving Credit Commitment or which has made Revolving Credit Loans. "Revolving Credit Loans": as defined in Section 2.5(a). 25 19 "Revolving Credit Note": as defined in Section 2.9(e). "Revolving Credit Percentage": as to Revolving Credit Lender at any time, the percentage which such Lender's Revolving Credit Commitment then constitutes of the aggregate Revolving Credit Commitments (or, at any time after the Revolving Credit Commitments shall have expired or terminated, the percentage which the aggregate principal amount of such Lender's Revolving Credit Loans then outstanding constitutes of the aggregate principal amount of the Revolving Credit Loans then outstanding). "Revolving Credit Termination Date": June 30, 2001. "Security Documents": the collective reference to each Mortgage, the Borrowers Security Agreement, the Pledge Agreements, the Assignments of Insurance and all other security documents hereafter delivered to the Administrative Agent granting a Lien on any asset or assets of any Person to secure the obligations and liabilities of the Borrowers hereunder and/or under any of the other Loan Documents or to secure any guarantee of any such obligations and liabilities. "Series C Preferred": the $20,000,000 of Series C Redeemable Preferred Stock issued by the Borrowers pursuant to the Recapitalization Agreement. "Shareholders Agreement": the Shareholders Agreement dated as of June 12, 1996 among the Parent, the Borrowers, the Individual Shareholders and the Subordinated Debt Holders, as amended, supplemented or otherwise modified from time to time. "Single Employer Plan": any Plan which is covered by Title IV of ERISA, but which is not a Multiemployer Plan. "Solvent": when used with respect to any Person, means that, as of any date of determination, (a) the amount of the "present fair saleable value" of the assets of such Person will, as of such date, exceed the amount of all "liabilities of such Person, contingent or otherwise", as of such date, as such quoted terms are determined in accordance with applicable federal and state laws governing determinations of the insolvency of debtors, (b) the present fair saleable value of the assets of such Person will, as of such date, be greater than the amount that will be required to pay the liability of such Person on its debts as such debts become absolute and matured, (c) such Person will not have, as of such date, an unreasonably small amount of capital with which to conduct its business, and (d) such Person will be able to pay its debts as they mature. For purposes of this definition, (i) "debt" means liability on a "claim", and (ii) "claim" means any (x) right to payment, whether or not such a right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured or (y) right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured or unmatured, disputed, undisputed, secured or unsecured. 26 20 "Standby Letter of Credit": as defined in Section 3.1(a). "Subordinated Debt": as defined in the recitals hereto. "Subordinated Debt Holders": as defined in the recitals hereto. "Subordination Agreement": the Subordination and Intercreditor Agreement dated as of June 12, 1996 by and among the Administrative Agent, on behalf of the Lenders, and the Subordinated Debt Holders. "Subsidiary": as to any Person, a corporation, partnership or other entity of which shares of stock or other ownership interests having ordinary voting power (other than stock or such other ownership interests having such power only by reason of the happening of a contingency) to elect a majority of the board of directors or other managers of such corporation, partnership or other entity are at the time owned, or the management of which is otherwise controlled, directly or indirectly through one or more intermediaries, or both, by such Person. Unless otherwise qualified, all references to a "Subsidiary" or to "Subsidiaries" in this Agreement shall refer to a Subsidiary or Subsidiaries of a Borrower. "Swing Line Commitment": the obligation of the Swing Line Lender to make Swing Line Loans pursuant to Section 2.25 in an aggregate principal amount at any one time outstanding not to exceed $2,500,000. "Swing Line Lender": as defined in Section 2.25. "Swing Line Loan Participation Certificate": a certificate substantially in the form of Exhibit J. "Swing Line Loans": as defined in Section 2.25. "Swing Line Note": as defined in Section 2.9(e). "Swing Line Participation Amount": as defined in Section 2.27(c). "Term Loan Lenders": the collective reference to the Tranche A Term Loan Lenders and the Tranche B Term Loan Lenders. "Term Loans": the collective reference to the Tranche A Term Loans and Tranche B Term Loans. "Tranche A Loans": the collective reference to the Tranche A Term Loans, the Revolving Credit Loans and Swing Line Loans. "Tranche A Term Loan": as defined in Section 2.1. 27 21 "Tranche A Term Loan Commitment": as to any Lender, the obligation of such Lender, if any, to make a Tranche A Term Loan to the Borrowers hereunder in a principal amount not to exceed the amount set forth under the heading "Tranche A Term Loan Commitment" opposite such Lender's name on Schedule 1.1B. "Tranche A Term Loan Lender": each Lender which has a Tranche A Term Loan Commitment or which has made a Tranche A Term Loan. "Tranche A Term Loan Percentage": as to any Tranche A Term Loan Lender at any time, the percentage which such Lender's Tranche A Term Loan Commitment then constitutes of the aggregate Tranche A Term Loan Commitments (or, at any time after the Closing Date, the percentage which the aggregate principal amount of such Lender's Tranche A Term Loans then outstanding constitutes of the aggregate principal amount of the Tranche A Term Loans then outstanding). "Tranche A Term Note": as defined in Section 2.9(e). "Tranche B Term Loan": as defined in Section 2.3. "Tranche B Term Loan Commitment": as to any Tranche B Term Loan Lender, the obligation of such Lender, if any, to make a Tranche B Term Loan to the Borrowers hereunder in a principal amount not to exceed the amount set forth under the heading "Tranche B Term Loan Commitment" opposite such Lender's name on Schedule 1.1B. "Tranche B Term Loan Lender": each Lender which has a Tranche B Term Loan Commitment or which has made a Tranche B Term Loan. "Tranche B Term Loan Percentage": as to any Lender at any time, the percentage which such Lender's Tranche B Term Loan Commitment then constitutes of the aggregate Tranche B Term Loan Commitments (or, at any time after the Closing Date, the percentage which the aggregate principal amount of such Lender's Tranche B Term Loans then outstanding constitutes of the aggregate principal amount of the Tranche B Term Loans then outstanding). "Tranche B Term Note": as defined in Section 2.9(e). "Transferee": as defined in Section 11.6(i). "Type": as to any Loan, its nature as a Base Rate Loan or a Eurodollar Loan. "Uniform Customs": the Uniform Customs and Practice for Documentary Credits (1993 Revision), International Chamber of Commerce Publication No. 500, as the same may be amended from time to time. "United States": the United States of America. 28 22 "U.S. Taxes": as defined in Section 11.6(d). "Warrants": collectively, (a) the warrants to purchase up to 10% of the common stock of each of the Borrowers and (b) the Contingent Warrants (as defined in the Purchase Agreement) to purchase up to 3.5% of the common stock of each of the Borrowers, in each case, pursuant to the Purchase Agreement. "Wholly Owned Subsidiary": as to any Person, any other Person all of the Capital Stock of which (other than directors' qualifying shares required by law) is owned by such Person directly and/or through other Wholly Owned Subsidiaries. 1.2 Other Definitional Provisions. (a) Unless otherwise specified therein, all terms defined in this Agreement shall have the defined meanings when used in the other Loan Documents or any certificate or other document made or delivered pursuant hereto or thereto. (b) As used herein and in the other Loan Documents, and any certificate or other document made or delivered pursuant hereto or thereto, accounting terms relating to the Parent, the Borrowers and their Subsidiaries not defined in Section 1.1 and accounting terms partly defined in Section 1.1, to the extent not defined, shall have the respective meanings given to them under GAAP. (c) The words "hereof", "herein" and "hereunder" and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement, and Section, Schedule and Exhibit references are to this Agreement unless otherwise specified. (d) The meanings given to terms defined herein shall be equally applicable to both the singular and plural forms of such terms. SECTION 2. AMOUNT AND TERMS OF COMMITMENTS 2.1 Tranche A Term Loans. Subject to the terms and conditions hereof, each Tranche A Term Loan Lender severally agrees to make term loans (a "Tranche A Term Loan") to the Borrowers, jointly and severally, on the Closing Date in an amount not to exceed the amount of the Tranche A Term Loan Commitment of such Lender. The Tranche A Term Loans may from time to time be (a) Eurodollar Loans, (b) Base Rate Loans or (c) a combination thereof, as determined by the Designated Borrower and notified to the Administrative Agent in accordance with Sections 2.2 and 2.13. 2.2 Procedure for Tranche A Term Loan Borrowing. The Designated Borrower, as agent for the Borrowers, shall give the Administrative Agent irrevocable notice (which notice must be received by the Administrative Agent prior to 10:00 A.M., New York City time, one Business Day prior to the anticipated Closing Date) requesting that the Tranche A Term Loan Lenders make Tranche A Term Loan(s) on the Closing Date and specifying (a) 29 23 the amount to be borrowed, (b) the account to which the proceeds of such Loans should be deposited and (c) the Closing Date. The Tranche A Term Loans made on the Closing Date shall initially be Base Rate Loans and no Tranche A Term Loan may be converted into or continued as a Eurodollar Loan having an Interest Period in excess of one month prior to the date which is 60 days after the Closing Date. Upon receipt of such notice, the Administrative Agent shall promptly notify each Tranche A Term Loan Lender thereof. Not later than 12:00 Noon, New York City time, on the Closing Date, each Tranche A Term Loan Lender shall make available to the Administrative Agent at its office specified in Section 11.2 an amount in immediately available funds equal to the Tranche A Term Loan to be made by such Lender. The Administrative Agent shall on such date by 2:00 P.M., New York City time, deposit to the designated account, in accordance with the instructions of the Designated Borrower, the aggregate of the amounts made available to the Administrative Agent by the Tranche A Term Loan Lenders in immediately available funds. 2.3 Tranche B Term Loans. Subject to the terms and conditions hereof, each Tranche B Term Loan Lender severally agrees to make term loans (a "Tranche B Term Loan") to the Borrowers, jointly and severally, on the Closing Date in an amount not to exceed the amount of the Tranche B Term Loan Commitment of such Lender then in effect. The Tranche B Term Loans may from time to time be (a) Eurodollar Loans, (b) Base Rate Loans or (c) a combination thereof, as determined by the Designated Borrower and notified to the Administrative Agent in accordance with Sections 2.4 and 2.13. 2.4 Procedure for Tranche B Term Loan Borrowing. The Designated Borrower, as agent for the Borrowers, shall give the Administrative Agent irrevocable notice (which notice must be received by the Administrative Agent prior to 10:00 A.M., New York City time, one Business Day prior to the anticipated Closing Date) requesting that the Tranche B Term Loan Lenders make the Tranche B Term Loan(s) on the Closing Date and specifying (a) the amount to be borrowed, (b) the account to which the proceeds of such Loans shall be deposited and (c) the Closing Date. The Tranche B Term Loans made on the Closing Date shall initially be Base Rate Loans and no Tranche B Term Loan may be converted into or continued as a Eurodollar Loan having an Interest Period in excess of one month prior to the date which is 60 days after the Closing Date. Upon receipt of such notice, the Administrative Agent shall promptly notify each Tranche B Term Loan Lender thereof. Not later than 12:00 Noon, New York City time, on the Closing Date, each Tranche B Term Loan Lender shall make available to the Administrative Agent at its office specified in Section 11.2 an amount in immediately available funds equal to the Tranche B Term Loan to be made by such Lender. The Administrative Agent shall on such date by 2:00 P.M., New York City time, deposit to the designated account, in accordance with the instructions of the Designated Borrower, the aggregate of the amounts made available to the Administrative Agent by the Tranche B Term Loan Lenders in immediately available funds. 2.5 Revolving Credit Commitments. (a) Subject to the terms and conditions hereof, each Revolving Credit Lender severally agrees to make revolving credit loans ("Revolving Credit Loans") to the Borrowers, jointly and severally, from time to time during the Revolving Credit Commitment Period in an aggregate principal amount at any one time outstanding which, when added to such Lender's Revolving Credit Percentage of the sum of 30 24 (i) the L/C Obligations then outstanding and (ii) the aggregate principal amount of the Swing Line Loans then outstanding, does not exceed the amount of such Lender's Revolving Credit Commitment. During the Revolving Credit Commitment Period, the Borrowers may use the Revolving Credit Commitments by borrowing, prepaying the Revolving Credit Loans in whole or in part, and reborrowing, all in accordance with the terms and conditions hereof. (b) The Revolving Credit Loans may from time to time be (i) Eurodollar Loans, (ii) Base Rate Loans or (iii) a combination thereof, as determined by the Designated Borrower and notified to the Administrative Agent in accordance with Sections 2.6 and 2.13, provided that no Revolving Credit Loan shall be made as a Eurodollar Loan after the day that is one month prior to the Revolving Credit Termination Date. 2.6 Procedure for Revolving Credit Borrowing. The Borrowers may borrow under the Revolving Credit Commitments during the Revolving Credit Commitment Period on any Business Day, provided that the Designated Borrower shall give the Administrative Agent irrevocable notice (which notice must be received by the Administrative Agent prior to 12:00 Noon, New York City time, (a) three Business Days prior to the requested Borrowing Date, if all or any part of the requested Revolving Credit Loans are to be Eurodollar Loans or (b) one Business Day prior to the requested Borrowing Date, otherwise), specifying (i) the amount to be borrowed, (ii) the requested Borrowing Date, (iii) whether the borrowing is to be of Eurodollar Loans, Base Rate Loans, or a combination thereof, (iv) the identity of the Borrower or Borrowers to which the proceeds of the Revolving Credit Loan should be made available and (v) if the borrowing is to be entirely or partly of Eurodollar Loans, the respective amounts of each such Type of Loan and the respective lengths of the initial Interest Periods therefor; provided that prior to the date which is 60 days after the Closing Date no Revolving Credit Loan may be made, converted or continued as a Eurodollar Loan having an Interest Period in excess of one month. Each borrowing under the Revolving Credit Commitments shall be in an amount equal to (x) in the case of Base Rate Loans, $1,000,000 or a whole multiple thereof (or, if the then Available Revolving Credit Commitments are less than $1,000,000, such lesser amount) and (y) in the case of Eurodollar Loans, $2,500,000 or a whole multiple of $1,000,000 in excess thereof; provided, that the Swing Line Lender may request, on behalf of the Borrowers, borrowings under the Revolving Credit Commitments which are Base Rate Loans in other amounts pursuant to Section 2.27(a). Upon receipt of any such notice from the Designated Borrower, the Administrative Agent shall promptly notify each Revolving Credit Lender thereof. Each Revolving Credit Lender will make the amount of its pro rata share of each borrowing available to the Administrative Agent for the account of the appropriate Borrower at the office of the Administrative Agent specified in Section 11.2 prior to 11:00 A.M., New York City time, on the Borrowing Date requested by the Designated Borrower in funds immediately available to the Administrative Agent. The aggregate of the amounts made available to the Administrative Agent by the Revolving Credit Lenders will then be made available to the appropriate Borrower by the Administrative Agent in accordance with the instructions of the Designated Borrower in like funds as received by the Administrative Agent. 2.7 Clean-Up. Notwithstanding the foregoing provisions of this Section 2 for a period of not less than 30 consecutive days during each period from December 1 to 31 25 March 1 during the term of this Agreement the aggregate outstanding principal amount of the Revolving Credit Loans and Swing Line Loans shall be reduced to zero. 2.8 Commitment Fees, etc. (a) The Borrowers jointly and severally agree to pay to the Administrative Agent for the account of each Revolving Credit Lender a commitment fee for the period from and including the Closing Date to the last day of the Revolving Credit Commitment Period, computed at the rate of 1/2 of 1% per annum on the average daily amount of the Available Revolving Credit Commitment of such Lender during the period for which payment is made, payable quarterly in arrears on the last day of each March, June, September and December and on the last day of the Revolving Credit Commitment Period, commencing on the first of such dates to occur after the date hereof. (b) The Borrowers jointly and severally agree to pay to the Arranger the fees in the amounts and on the dates previously agreed to in writing by Advent and the Arranger. (c) The Borrowers jointly and severally agree to pay to the Administrative Agent the fees in the amounts and on the dates previously agreed to in writing by the Administrative Agent and the Borrowers. 2.9 Repayment of Loans; Evidence of Debt. (a) The Borrowers jointly and severally hereby unconditionally promise to pay to the Administrative Agent for the account of the appropriate Lender (i) the then unpaid principal amount of each Revolving Credit Loan of such Revolving Credit Lender on the last day of the Revolving Credit Commitment Period (or such earlier date on which the Revolving Credit Loans become due and payable pursuant to Section 8), (ii) the principal amount of the Tranche A Term Loans of such Tranche A Term Loan Lender, in 20 consecutive quarterly installments, according to the amortization schedule set forth on Schedule 1.1D, commencing on September 30, 1996 (or on such earlier date on which the then unpaid principal amount of the Tranche A Term Loans become due and payable pursuant to Section 8) and (iii) the principal amount of the Tranche B Term Loans of such Tranche B Term Loan Lender, in 24 consecutive quarterly installments, according to the amortization schedule set forth on Schedule 1.1E, commencing on September 30, 1996 (or on such earlier date on which the then unpaid principal amount of such Tranche B Term Loans become due and payable pursuant to Section 8). The Borrowers jointly and severally hereby further agree to pay interest on the unpaid principal amount of the Loans from time to time outstanding from the date hereof until payment in full thereof at the rates per annum, and on the dates, set forth in Section 2.15. (b) Each Lender shall maintain in accordance with its usual practice an account or accounts evidencing indebtedness of the Borrowers to such Lender resulting from each Loan of such Lender from time to time, including the amounts of principal and interest payable and paid to such Lender from time to time under this Agreement. (c) The Administrative Agent, on behalf of the Borrowers, shall maintain the Register pursuant to Section 11.6(g), and a subaccount therein for each Lender, in which shall be recorded (i) the amount of each Revolving Credit Loan, Tranche A Term Loan and Tranche B Term Loan made hereunder, the Type thereof and each Interest Period applicable 32 26 thereto, (ii) the amount of any principal or interest due and payable or to become due and payable from the Borrowers to each Lender hereunder and (iii) both the amount of any sum received by the Administrative Agent hereunder from the Borrowers and each Lender's share thereof. (d) The entries made in the Register and the accounts of each Lender maintained pursuant to Section 2.9(b) shall, to the extent permitted by applicable law, be prima facie evidence of the existence and amounts of the obligations of the Borrowers therein recorded; provided, however, that the failure of any Lender or the Administrative Agent to maintain the Register or any such account, or any error therein, shall not in any manner affect the obligation of the Borrowers to repay (with applicable interest) the Loans made to such Borrowers by such Lender in accordance with the terms of this Agreement. (e) Each of the Borrowers agrees that, upon the request to the Administrative Agent by any Lender, the Borrowers will execute and deliver to such Lender (i) a promissory note of the Borrowers evidencing any Revolving Credit Loans of such Lender, substantially in the form of Exhibit A-1 with appropriate insertions as to date and principal amount (together with any alternative note substantially in the form of Exhibit I-1 issued in lieu thereof or in exchange therefor, a "Revolving Credit Note"), and/or (ii) a promissory note of the Borrowers evidencing any Tranche A Term Loan of such Lender, substantially in the form of Exhibit A-2with appropriate insertions as to date and principal amount (together with any alternative note substantially in the form of Exhibit I-2 issued in lieu thereof or in exchange therefor, a "Tranche A Term Note") and/or (iii) a promissory note of the Borrowers evidencing any Tranche B Term Loans of such Lender, substantially in the form of Exhibit A-3 with appropriate insertions as to date and principal amount (together with any alternative note substantially in the form of Exhibit I-3 issued in lieu thereof or in exchange therefor, a "Tranche B Term Note") and/or (iv) in the case of a request by the Swing Line Lender, a promissory note of the Borrowers evidencing any Swing Line Loans of the Swing Line Lender, substantially in the form of Exhibit A-4 with appropriate insertions as to the date and principal amount (a "Swing Line Note"). 2.10 Termination or Reduction of Revolving Credit Commitments. The Designated Borrower shall have the right, upon not less than three Business Days' notice to the Administrative Agent, to terminate the Revolving Credit Commitments or, from time to time, to reduce the amount of the Revolving Credit Commitments; provided that no such termination or reduction of Revolving Credit Commitments shall be permitted if, after giving effect thereto and to any prepayments of the Revolving Credit Loans and Swing Line Loans made on the effective date thereof, the sum of the Aggregate Outstanding Revolving Extensions of Credit of all Revolving Credit Lenders would exceed the Revolving Credit Commitments then in effect. Any such reduction shall be in an amount equal to $500,000, or a whole multiple thereof, and shall reduce permanently the Revolving Credit Commitments then in effect. 2.11 Optional Prepayments. The Borrowers may at any time and from time to time prepay the Loans, in whole or in part, without premium or penalty, upon at least three Business Days' irrevocable notice to the Administrative Agent by the Designated Borrower, 33 27 specifying the date and amount of prepayment and whether the prepayment is of Eurodollar Loans, Base Rate Loans or a combination thereof, and, if of a combination thereof, the amount allocable to each, provided, that if a Eurodollar Loan is prepaid on any day other than the last day of the Interest Period applicable thereto, the Borrowers shall also pay any amounts owing pursuant to Section 2.22. Upon receipt of any such notice, the Administrative Agent shall promptly notify each Lender thereof. If any such notice is given, the amount specified in such notice shall be due and payable on the date specified therein, together with accrued interest to such date on the amount prepaid. Partial prepayments of the Term Loans shall be applied pro rata to the Tranche A Term Loans and the Tranche B Term Loans, and to the remaining installments of principal thereof pro rata in accordance with the remaining outstanding principal amounts thereof. Notwithstanding the foregoing, so long as any Tranche A Term Loans are outstanding, each Tranche B Term Loan Lender shall have the right to refuse all or any portion of any prepayment pursuant to this Section 2.11 allocable to such Lender's Tranche B Term Loans, and the amount so refused shall be applied to prepay the Tranche A Term Loans in accordance with the preceding sentence. Amounts prepaid on account of the Term Loans may not be reborrowed. Partial prepayments of Term Loans and Revolving Credit Loans shall be in an aggregate principal amount of $500,000 or a whole multiple thereof. Partial prepayments of Swing Line Loans shall be in an aggregate principal amount of $100,000 or a whole multiple thereof. 2.12 Mandatory Prepayments and Commitment Reductions. (a) If any class of equity or debt securities or instruments of the Parent, the Borrowers or any of their Subsidiaries shall be issued or sold or the Parent, the Borrowers or any of their Subsidiaries shall incur or permit the incurrence of loans (except (i) any Capital Stock issued pursuant to the Recapitalization or to an employee of a Borrower in connection with a Guarantee Obligation or a loan or advance permitted by Sections 7.4(e) or 7.9(c)(ii), respectively, (ii) any debt securities or instruments issued or loans incurred in accordance with Section 7.2 and (iii) so long as such equity investment is not for the purpose of and does not have the effect of curing a Default or Event of Default, any Person who owns Capital Stock in the Parent, the Borrowers or any of their Subsidiaries on the date hereof (subsequent to the Recapitalization) may make a one-time equity investment in the Parent, which the Parent shall invest in the equity of the Borrowers, in the aggregate amount of up to $5,000,000), an amount equal to 100% of the Net Cash Proceeds thereof shall be applied on the date of such issuance or incurrence toward the prepayment of the Term Loans and the reduction of the Revolving Credit Commitments as set forth in paragraph (d) of this Section 2.12. (b) If on any date the Parent, the Borrowers or any of their Subsidiaries shall receive Net Cash Proceeds from any Asset Sale or from any Recovery Event (other than, if no Event of Default shall have occurred and be continuing, to the extent that such Net Cash Proceeds are to be used to restore or replace the assets in respect of which such Recovery Event occurred within twelve months from the date of such Recovery Event, as certified by a Responsible Officer of the Designated Borrower pursuant to a Reinvestment Notice), such Net Cash Proceeds shall be applied on such date toward the prepayment of the Term Loans and the reduction of the Revolving Credit Commitments as set forth in paragraph (d) of this Section 2.12; provided, that, notwithstanding the foregoing, on each Reinvestment Prepayment Date, an amount equal to the Reinvestment Prepayment Amount with respect to the relevant 34 28 Reinvestment Event shall be applied toward the prepayment of the Term Loans and the reduction of the Revolving Credit Commitments as set forth in paragraph (d) of this Section 2.12. (c) If, for any fiscal year of the Borrowers ending after the Closing Date, there shall be Excess Cash Flow, the Borrowers shall, on the relevant Excess Cash Flow Application Date, apply toward the prepayment of the Term Loans and the reduction of the Revolving Credit Commitments as set forth in paragraph (d) of this Section 2.12 a percentage of such Excess Cash Flow equal to 75%. Each such prepayment and commitment reduction shall be made on a date (an "Excess Cash Flow Application Date") no later than five days after the earlier of (i) the date on which the financial statements of the Borrowers referred to in Section 6.1(a), for the fiscal year with respect to which such prepayment is made, are required to be delivered to the Lenders and (ii) the date such financial statements are actually delivered. (d) Amounts to be applied in connection with prepayments and Commitment reductions made pursuant to this Section 2.12 shall be applied, first, to the prepayment of the Term Loans and, second, to reduce permanently the Revolving Credit Commitments. Any such reduction of the Revolving Credit Commitments shall be accompanied by prepayment of the Revolving Credit Loans and/or Swing Line Loans to the extent, if any, that the sum of the Aggregate Outstanding Revolving Extensions of Credit of all Revolving Credit Lenders exceeds the amount of the aggregate Revolving Credit Commitments as so reduced, provided that if the aggregate principal amount of Revolving Credit Loans and Swing Line Loans then outstanding is less than the amount of such excess (because L/C Obligations constitute a portion thereof), the Borrowers shall, to the extent of the balance of such excess, replace outstanding Letters of Credit and/or deposit an amount in cash in a cash collateral account established with the Administrative Agent for the benefit of the Lenders on terms and conditions satisfactory to the Administrative Agent. The application of any prepayment pursuant to this Section 2.12 shall be made, within each category of Loans to be prepaid as provided above, first to Base Rate Loans and second to Eurodollar Loans. Each prepayment of the Loans under this Section 2.12 shall be accompanied by accrued interest to the date of such prepayment on the amount prepaid. All prepayments of the Term Loans pursuant to this Section 2.12 shall be applied pro rata to the Tranche A Term Loans and the Tranche B Term Loans and to the remaining installments of principal thereof in the inverse order of scheduled maturity. Notwithstanding the foregoing, so long as any Tranche A Term Loans are outstanding, each Tranche B Term Loan Lender shall have the right to refuse all or any portion of any prepayment pursuant to this Section 2.12 allocable to such Lender's Tranche B Term Loans and the amount so refused shall be applied first pro rata to prepay the Tranche A Term Loans and second to reduce permanently the Revolving Credit Commitments as provided above. Amounts prepaid on account of the Term Loans may not be reborrowed. 2.13 Conversion and Continuation Options. (a) The Borrowers may elect from time to time to convert Eurodollar Loans to Base Rate Loans by the Designated Borrower giving the Administrative Agent at least two Business Days' prior irrevocable notice of such election, provided that any such conversion of Eurodollar Loans may only be made on the last day of an Interest Period with respect thereto. The Borrowers may elect from time to time to 35 29 convert Base Rate Loans to Eurodollar Loans by the Designated Borrower giving the Administrative Agent at least three Business Days' prior irrevocable notice of such election. Any such notice of conversion to Eurodollar Loans shall specify the length of the initial Interest Period therefor. Upon receipt of any such notice, the Administrative Agent shall promptly notify each Lender thereof. All or any part of outstanding Eurodollar Loans and Base Rate Loans may be converted as provided herein, provided that (i) no Loan may be converted into a Eurodollar Loan when any Event of Default has occurred and is continuing and the Administrative Agent has or the Required Lenders have determined in its or their sole discretion not to permit such a conversion and (ii) no Loan may be converted into a Eurodollar Loan after the date that is one month prior to (i) the Revolving Credit Termination Date, with respect to the Tranche A Loans and (ii) the Tranche B Termination Date, with respect to the Tranche B Term Loans. (b) Any Eurodollar Loans may be continued as such upon the expiration of the then current Interest Period with respect thereto by the Designated Borrower giving irrevocable notice to the Administrative Agent, in accordance with the applicable provisions of the term "Interest Period" set forth in Section 1.1, of the length of the next Interest Period to be applicable to such Loans, provided that no Eurodollar Loan may be continued as such (i) when any Event of Default has occurred and is continuing and the Administrative Agent has or the Required Lenders have determined in its or their sole discretion not to permit such a continuation or (ii) after the date that is one month prior to (A) the Revolving Credit Termination Date, with respect to the Tranche A Loans or (B) the Tranche B Termination Date, with respect to the Tranche B Term Loans, and provided, further, that if the Designated Borrower shall fail to give any required notice as described above in this paragraph or if such continuation is not permitted pursuant to the preceding proviso such Loans shall be automatically converted to Base Rate Loans on the last day of such then expiring Interest Period. 2.14 Minimum Amounts and Maximum Number of Eurodollar Tranches. Notwithstanding anything to the contrary in this Agreement, all borrowings, conversions, continuations and optional prepayments of Loans hereunder and all selections of Interest Periods hereunder shall be in such amounts and be made pursuant to such elections so that, (a) after giving effect thereto, the aggregate principal amount of the Loans comprising each Eurodollar Tranche shall be equal to $2,500,000 or a whole multiple of $1,000,000 in excess thereof, (b) no more than two Eurodollar Tranches in respect of the Revolving Credit Loans shall be outstanding at any one time and (c) no more than seven Eurodollar Tranches in respect of all Loans (including the Revolving Credit Loans) shall be outstanding at any one time. 2.15 Interest Rates and Payment Dates. (a) Each Eurodollar Loan shall bear interest for each day during each Interest Period with respect thereto at a rate per annum equal to the Eurodollar Rate determined for such day plus the Applicable Margin. (b) Each Base Rate Loan shall bear interest at a rate per annum equal to the Base Rate plus the Applicable Margin. 36 30 (c) If all or a portion of (i) any principal of any Loan or Reimbursement Obligations, (ii) any interest payable thereon, (iii) any commitment fee or (iv) any other amount payable hereunder shall not be paid when due (whether at the stated maturity, by acceleration or otherwise), the principal of the Loans and Reimbursement Obligations and any such overdue interest, commitment fee or other amount shall bear interest at a rate per annum which is (x) in the case of principal of the Loans, the rate that would otherwise be applicable thereto pursuant to the foregoing provisions of this Section plus 2% and (y) in the case of Reimbursement Obligations, and any overdue interest, commitment fee or other amount, the rate applicable to Tranche A Loans which are Base Rate Loans plus 2%, in each case from the date of such non-payment until such overdue principal, interest, commitment fee or other amount is paid in full (as well after as before judgment). (d) Interest shall be payable in arrears on each Interest Payment Date, provided that interest accruing pursuant to paragraph (c) of this Section 2.15 shall be payable from time to time on demand. 2.16 Computation of Interest and Fees. (a) Interest on Loans and Reimbursement Obligations, commitment fees, letter of credit commissions and interest on overdue interest, commitment fees and other amounts payable hereunder shall be calculated on the basis of a 360-day year for the actual days elapsed, except that, with respect to Base Rate Loans the rate of interest on which is calculated on the basis of the Prime Rate, the interest thereon shall be calculated on the basis of a 365- (or 366-, as the case may be) day year for the actual days elapsed. The Administrative Agent shall as soon as practicable notify the Designated Borrower and the Lenders of each determination of a Eurodollar Rate. Any change in the interest rate on a Loan resulting from a change in the Base Rate or the Eurocurrency Reserve Requirements shall become effective as of the opening of business on the day on which such change becomes effective. The Administrative Agent shall as soon as practicable notify the Designated Borrower and the Lenders of the effective date and the amount of each such change in interest rate. (b) Each determination of an interest rate by the Administrative Agent pursuant to any provision of this Agreement shall be conclusive and binding on the Borrowers and the Lenders in the absence of manifest error. The Administrative Agent shall, at the request of the Designated Borrower, deliver to the Designated Borrower a statement showing the quotations used by the Administrative Agent in determining any interest rate pursuant to Section 2.15(a). 2.17 Inability to Determine Interest Rate. If prior to the first day of any Interest Period: (a) the Administrative Agent shall have determined (which determination shall be conclusive and binding upon the Borrowers) that, by reason of circumstances affecting the relevant market, adequate and reasonable means do not exist for ascertaining the Eurodollar Rate for such Interest Period, or 37 31 (b) the Administrative Agent shall have received notice from the Required Lenders that the Eurodollar Rate determined or to be determined for such Interest Period will not adequately and fairly reflect the cost to such Lenders (as conclusively certified by such Lenders) of making or maintaining their affected Loans during such Interest Period, the Administrative Agent shall give telecopy or telephonic notice thereof to the Designated Borrower and the Lenders as soon as practicable thereafter. If such notice is given (x) any Eurodollar Loans requested to be made on the first day of such Interest Period shall be made as Base Rate Loans, (y) any Loans that were to have been converted on the first day of such Interest Period to Eurodollar Loans shall be continued as Base Rate Loans and (z) any outstanding Eurodollar Loans shall be converted, on the first day of such Interest Period, to Base Rate Loans. Until such notice has been withdrawn by the Administrative Agent, no further Eurodollar Loans shall be made or continued as such, nor shall the Borrowers have the right to convert Loans to Eurodollar Loans. 2.18 Pro Rata Treatment and Payments; Use of Proceeds. (a) Each borrowing by the Borrowers from the Lenders hereunder, each payment by the Borrowers on account of any commitment fee and any reduction of the Commitments of the Lenders shall be made pro rata according to the respective Tranche A Term Loan Percentages, Tranche B Term Loan Percentages or Revolving Credit Percentages, as the case may be, of the relevant Lenders. Except as provided in Section 2.11 and 2.12, each payment (including each prepayment) by the Borrowers on account of principal of and interest on the Term Loans shall be made pro rata according to the respective outstanding principal amounts of the Term Loans then held by the Term Loan Lenders (or, in the case of installment payments made pursuant to Section 2.9 or payments of accrued interest in respect thereof, the affected Term Loans then held by the relevant Term Loan Lenders). Each payment (including each prepayment) by the Borrowers on account of principal of and interest on the Revolving Credit Loans shall be made pro rata according to the respective outstanding principal amounts of the Revolving Credit Loans then held by the Revolving Credit Lenders. All payments (including prepayments) to be made by the Borrowers hereunder and under the Notes, whether on account of principal, interest, fees or otherwise, shall be made without setoff or counterclaim and shall be made prior to 12:00 Noon, New York City time, on the due date thereof to the Administrative Agent, for the account of the Lenders, at the Administrative Agent's office specified in Section 11.2, in Dollars and in immediately available funds. The Administrative Agent shall distribute such payments to the Lenders promptly upon receipt in like funds as received. If any payment hereunder (other than payments on the Eurodollar Loans) becomes due and payable on a day other than a Business Day, such payment shall be extended to the next succeeding Business Day. If any payment on a Eurodollar Loan becomes due and payable on a day other than a Business Day, the maturity thereof shall be extended to the next succeeding Business Day unless the result of such extension would be to extend such payment into another calendar month, in which event such payment shall be made on the immediately preceding Business Day. In the case of any extension of any payment of principal pursuant to the preceding two sentences, interest thereon shall be payable at the then applicable rate during such extension. 38 32 (b) Unless the Administrative Agent shall have been notified in writing by any Lender prior to a borrowing that such Lender will not make the amount that would constitute its share of such borrowing available to the Administrative Agent, the Administrative Agent may assume that such Lender is making such amount available to the Administrative Agent, and the Administrative Agent may, in reliance upon such assumption, make available to the Borrower a corresponding amount. If such amount is not made available to the Administrative Agent by the required time on the Borrowing Date therefor, such Lender shall pay to the Administrative Agent, on demand, such amount with interest thereon at a rate equal to the daily average Federal Funds Effective Rate for the period until such Lender makes such amount immediately available to the Administrative Agent. A certificate of the Administrative Agent submitted to any Lender with respect to any amounts owing under this Section 2.18(b) shall be conclusive in the absence of manifest error. If such Lender's share of such borrowing is not made available to the Administrative Agent by such Lender within three Business Days of such Borrowing Date, the Administrative Agent shall also be entitled to recover such amount with interest thereon at the rate per annum applicable to Base Rate Loans hereunder, on demand, from the Borrowers. (c) The Borrowers shall use the proceeds of the Loans only in the manner expressly contemplated by Section 4.16. 2.19 Illegality. Notwithstanding any other provision herein, if the adoption of or any change in any Requirement of Law or in the interpretation or application thereof shall make it unlawful for any Lender to make or maintain Eurodollar Loans as contemplated by this Agreement, (a) the commitment of such Lender hereunder to make Eurodollar Loans, continue Eurodollar Loans as such and convert Base Rate Loans to Eurodollar Loans shall forthwith be cancelled and (b) such Lender's Loans then outstanding as Eurodollar Loans, if any, shall be converted automatically to Base Rate Loans on the respective last days of the then current Interest Periods with respect to such Loans or within such earlier period as required by law. If any such conversion of a Eurodollar Loan occurs on a day which is not the last day of the then current Interest Period with respect thereto, the Borrowers shall pay to such Lender such amounts, if any, as may be required pursuant to Section 2.22. 2.20 Requirements of Law. (a) If the adoption of or any change in any Requirement of Law or in the interpretation or application thereof or compliance by any Lender with any request or directive (whether or not having the force of law) from any central bank or other Governmental Authority made subsequent to the date hereof: (i) shall subject any Lender to any tax of any kind whatsoever with respect to this Agreement, any Note, any Letter of Credit, any Application or any Eurodollar Loan made by it, or change the basis of taxation of payments to such Lender in respect thereof (except for Non-Excluded Taxes covered by Section 2.21 and changes in the rate of tax on the overall net income of such Lender); (ii) shall impose, modify or hold applicable any reserve, special deposit, compulsory loan or similar requirement against assets held by, deposits or other liabilities in or for the account of, advances, loans or other extensions of credit by, or 39 33 any other acquisition of funds by, any office of such Lender which is not otherwise included in the determination of the Eurodollar Rate hereunder; or (iii) shall impose on such Lender any other condition; and the result of any of the foregoing is to increase the cost to such Lender, by an amount which such Lender deems to be material, of making, converting into, continuing or maintaining Eurodollar Loans or issuing or participating in Letters of Credit, or to reduce any amount receivable hereunder in respect thereof, then, in any such case, the Borrowers shall promptly pay such Lender, upon its demand, any additional amounts necessary to compensate such Lender for such increased cost or reduced amount receivable. If any Lender becomes entitled to claim any additional amounts pursuant to this Section 2.20, it shall promptly notify the Designated Borrower (with a copy to the Administrative Agent) of the event by reason of which it has become so entitled. (b) If any Lender shall have determined that the adoption of or any change in any Requirement of Law regarding capital adequacy or in the interpretation or application thereof or compliance by such Lender or any corporation controlling such Lender with any request or directive regarding capital adequacy (whether or not having the force of law) from any Governmental Authority made subsequent to the date hereof shall have the effect of reducing the rate of return on such Lender's or such corporation's capital as a consequence of its obligations hereunder or under or in respect of any Letter of Credit to a level below that which such Lender or such corporation could have achieved but for such adoption, change or compliance (taking into consideration such Lender's or such corporation's policies with respect to capital adequacy) by an amount deemed by such Lender to be material, then from time to time, after submission by such Lender to the Designated Borrower (with a copy to the Administrative Agent) of a written request therefor, the Designated Borrower shall pay to such Lender such additional amount or amounts as will compensate such Lender for such reduction. (c) If any Lender becomes entitled to claim any additional amounts pursuant to this subsection, it shall promptly notify the Designated Borrower (with a copy to the Administrative Agent) of the event by reason of which it has become so entitled. A certificate as to any additional amounts payable pursuant to this Section 2.20 submitted by any Lender to the Designated Borrower (with a copy to the Administrative Agent) shall be conclusive in the absence of manifest error. The obligations of the Borrowers pursuant to this Section 2.20 shall survive the termination of this Agreement and the payment of the Notes and all other amounts payable hereunder. 2.21 Taxes. (a) All payments made by the Borrowers under this Agreement and the Notes shall be made free and clear of, and without deduction or withholding for or on account of, any present or future income, stamp or other taxes, levies, imposts, duties, charges, fees, deductions or withholdings, now or hereafter imposed, levied, collected, withheld or assessed by any Governmental Authority, excluding net income taxes and franchise taxes (imposed in lieu of net income taxes) imposed on the Administrative Agent or any Lender as a result of a present or former connection between the Administrative Agent or 40 34 such Lender and the jurisdiction of the Governmental Authority imposing such tax or any political subdivision or taxing authority thereof or therein (other than any such connection arising solely from the Administrative Agent or such Lender having executed, delivered or performed its obligations or received a payment under, or enforced, this Agreement or any other Loan Document). If any such non-excluded taxes, levies, imposts, duties, charges, fees, deductions or withholdings ("Non-Excluded Taxes") are required to be withheld from any amounts payable to the Administrative Agent or any Lender hereunder or under the Notes, the amounts so payable to the Administrative Agent or such Lender shall be increased to the extent necessary to yield to the Administrative Agent or such Lender (after payment of all Non-Excluded Taxes) interest or any such other amounts payable hereunder at the rates or in the amounts specified in this Agreement and the Notes, provided, however, that the Borrowers shall make payments net of and after deduction for Non-Excluded Taxes and shall not be required to increase any such amounts payable to any Lender if, (i) at the time such Lender becomes a party to this Agreement such Lender fails to establish a complete exemption from such withholding, or (ii) such Lender fails to comply with its obligations under subsection 2.21(b) on an ongoing basis. Whenever any Non-Excluded Taxes are payable by the Borrowers, as promptly as possible thereafter the Designated Borrower shall send to the Administrative Agent for its own account or for the account of such Lender, as the case may be, a certified copy of an original official receipt received by the Borrowers showing payment thereof. If the Borrowers fail to pay any Non-Excluded Taxes when due to the appropriate taxing authority or fails to remit to the Administrative Agent the required receipts or other required documentary evidence, the Borrowers shall indemnify the Administrative Agent and the Lenders for any incremental Non-Excluded Taxes and related interest or penalties that may become payable by the Administrative Agent or any Lender as a result of any such failure. The agreements in this Section 2.21 shall survive the termination of this Agreement and the payment of the Notes and all other amounts payable hereunder. (b) Each Lender (or Transferee) that is not a citizen or resident of the United States, a corporation, partnership or other entity created or organized in or under the laws of the United States, or any estate or trust that is subject to federal income taxation regardless of the source of its income (a "Non-U.S. Lender") shall deliver to the Designated Borrower and the Administrative Agent (or, in the case of a Participant, to the Lender from which the related participation shall have been purchased) two copies of either U.S. Internal Revenue Service Form 1001 or Form 4224, or any subsequent versions thereof or successors thereto or, in the case of a Non-U.S. Lender claiming exemption from U.S. federal withholding tax under Section 871(h) or 881(c) of the Code with respect to payments of "portfolio interest", a Form W-8, or any subsequent versions thereof or successors thereto (and, if such Non-U.S. Lender delivers a Form W-8 claiming the payments constitute "portfolio interest", an annual certificate representing that such Non-U.S. Lender is not a "bank" (or other prohibited recipient, as may be defined in the Code or regulations promulgated under the Code for purposes of Section 881(c) of the Code, is not a 10-percent shareholder (within the meaning of Section 871(h)(3)(B) of the Code) of any Borrower and is not a controlled foreign corporation related to the Borrowers (within the meaning of Section 864(d)(4) of the Code) (such Sections to include any successor Sections covering similar items)), properly completed and duly executed by such Non-U.S. Lender claiming complete exemption from, or a reduced rate of, U.S. federal withholding tax on all payments by the Borrowers under this Agreement 41 35 and the other Loan Documents. Such forms shall be delivered by each Non-U.S. Lender on or before the date it becomes a party to this Agreement (or, in the case of any Participant, on or before the date such Participant purchases the related participation). In addition, each Non-U.S. Lender shall deliver such forms promptly upon the obsolescence or invalidity of any form previously delivered by such Non-U.S. Lender. Each Non-U.S. Lender shall promptly notify the Designated Borrower at any time it determines that it is no longer in a position to provide any previously delivered certificate to the Borrowers (or any other form of certification adopted by the U.S. taxing authorities for such purpose). Notwithstanding any other provision of this Section 2.21(b), a Non-U.S. Lender shall not be required to deliver any form pursuant to this Section 2.21(b) that such Non-U.S. Lender is not legally able to deliver. 2.22 Indemnity. The Borrowers agree to indemnify each Lender and to hold each Lender harmless from any loss or expense which such Lender may sustain or incur as a consequence of (a) default by the Borrowers in making a borrowing of, conversion into or continuation of Eurodollar Loans after the Designated Borrower has given a notice requesting the same in accordance with the provisions of this Agreement, (b) default by the Borrowers in making any prepayment after the Designated Borrower has given a notice thereof in accordance with the provisions of this Agreement or (c) the making of a prepayment of Eurodollar Loans on a day which is not the last day of an Interest Period with respect thereto. Such indemnification may include an amount equal to the excess, if any, of (i) the amount of interest which would have accrued on the amount so prepaid, or not so borrowed, converted or continued, for the period from the date of such prepayment or of such failure to borrow, convert or continue to the last day of such Interest Period (or, in the case of a failure to borrow, convert or continue, the Interest Period that would have commenced on the date of such failure) in each case at the applicable rate of interest for such Loans provided for herein (excluding, however, the Applicable Margin included therein, if any) over (ii) the amount of interest (as reasonably determined by such Lender) which would have accrued to such Lender on such amount by placing such amount on deposit for a comparable period with leading banks in the interbank eurodollar market. A certificate as to any amounts payable pursuant to this Section 2.22 submitted to the Designated Borrower by any Lender shall be conclusive in the absence of manifest error. This covenant shall survive the termination of this Agreement and the payment of the Notes and all other amounts payable hereunder. 2.23 Change of Lending Office. Each Lender (or Transferee) agrees that, upon the occurrence of any event giving rise to the operation of Section 2.19, 2.20(a) or 2.21 with respect to such Lender (or Transferee), it will, if requested by the Designated Borrower, use reasonable efforts (subject to overall policy considerations of such Lender (or Transferee)) to designate another lending office for any Loans affected by such event with the object of avoiding the consequences of such event; provided, that such designation is made on terms that, in the sole judgment of such Lender, cause such Lender and its lending office(s) to suffer no material economic, legal or regulatory disadvantage, and provided, further, that nothing in this Section 2.23 shall affect or postpone any of the obligations of any Borrowers or the rights of any Lender (or Transferee) pursuant to Section 2.19, 2.20(a) or 2.21. 2.24 Right of Contribution. Each Borrower hereby agrees that to the extent a Borrower shall have paid more than its proportionate share of any payment made hereunder, 42 36 such Borrower shall be entitled to seek and receive contribution from and against any other Borrower hereunder who has not paid its proportionate share of such payment; provided however such Borrower shall not seek any such contribution from any other Borrower until all Obligations have been paid in full and all Commitments of the Lenders hereunder have been terminated. The provisions of this Section 2.24 shall in no respect limit the obligations and liabilities of any Borrower to the Administrative Agent and the Lenders, and each Borrower shall remain liable to the Administrative Agent and the Lenders for the full amount of its obligations hereunder. 2.25 Swing Line Commitment. Subject to the terms and conditions hereof, The First National Bank of Boston (in such capacity, the "Swing Line Lender") agrees to make a portion of the credit otherwise available to the Borrowers under the Revolving Credit Lenders' Revolving Credit Commitments from time to time during the Revolving Credit Commitment Period by making swing line loans ("Swing Line Loans") to the Borrowers in an aggregate principal amount not to exceed at any one time outstanding the Swing Line Commitment; provided that (a) the aggregate principal amount of Swing Line Loans outstanding at any time shall not exceed the Swing Line Commitment then in effect (notwithstanding that the Swing Line Loans outstanding at any time, when aggregated with the Swing Line Lender's other outstanding Loans hereunder, may exceed the Swing Line Commitment then in effect) and (b) the Designated Borrower shall not request, and the Swing Line Lender shall not make, any Swing Line Loan if, after giving effect to the making of such Swing Line Loan, the aggregate amount of the Available Revolving Credit Commitments would be less than zero. During the Revolving Credit Commitment Period, the Borrowers may use the Swing Line Commitment by borrowing, repaying and reborrowing, all in accordance with the terms and conditions hereof. Swing Line Loans shall be Base Rate Loans only. The Borrower shall repay all outstanding Swing Line Loans on the last day of the Revolving Credit Commitment Period. 2.26 Procedure for Swing Line Borrowing. Whenever the Designated Borrower desires that the Swing Line Lender make Swing Line Loans under Section 2.25 it shall give the Swing Line Lender irrevocable telephonic notice confirmed promptly in writing (which telephonic notice must be received by the Swing Line Lender not later than 1:00 P.M., New York City time, on the proposed Borrowing Date), specifying (a) the amount to be borrowed, (b) the requested Borrowing Date (which shall be a Business Day during the Revolving Credit Commitment Period) and (c) the identity of the Borrower or Borrowers to which the proceeds of the Swing Line Loans should be made available. Each borrowing under the Swing Line Commitment shall be in an amount equal to $100,000 or a whole multiple thereof. Not later than 3:00 P.M., New York City time, on the Borrowing Date specified in the notice in respect of Swing Line Loans, the Swing Line Lender shall make available to the Administrative Agent at its office specified in Section 11.2 an amount in immediately available funds equal to the amount of the Swing Line Loan to be made by the Swing Line Lender. The Administrative Agent shall make the proceeds of such Swing Line Loan available to the appropriate Borrower on such Borrowing Date in accordance with the instructions of the Designated Borrower in like funds as received by the Administrative Agent. 43 37 2.27 Refunded Swing Line Loans; Swing Line Loan Participations. (a) The Swing Line Lender, at any time and from time to time in its sole and absolute discretion may, on behalf of the Borrowers (which hereby irrevocably direct the Swing Line Lender to act on their behalf), on one Business Day's notice given by the Swing Line Lender no later than 10:00 A.M., New York City time, request each Revolving Credit Lender to make, and each Revolving Credit Lender hereby agrees to make, a Revolving Credit Loan, in an amount equal to such Revolving Credit Lender's Revolving Credit Percentage of the aggregate amount of the Swing Line Loans (the "Refunded Swing Line Loans") outstanding on the date of such notice, to repay the Swing Line Lender. Unless any of the events described in Section 8(f) shall have occurred and be continuing (in which case the procedures of Section 2.27(c) shall apply), each Revolving Credit Lender shall make the amount of such Revolving Credit Loan available to the Administrative Agent at its office set forth in Section 11.2 in immediately available funds, not later than 10:00 A.M., New York City time, one Business Day after the date of such notice. The proceeds of such Revolving Credit Loans shall be immediately applied by the Swing Line Lender to repay the Refunded Swing Line Loans. Effective on the day such Revolving Credit Loans are made, the portion of the Swing Line Loans so paid shall no longer be outstanding as Swing Line Loans and shall be due as Revolving Credit Loans in accordance with their respective Revolving Credit Percentages. The Borrowers irrevocably authorize the Swing Line Lender to charge the Borrowers' accounts with the Administrative Agent (up to the amount available in each such account) to immediately pay the amount of such Refunded Swing Line Loans to the extent amounts received from the Revolving Credit Lenders are not sufficient to repay in full such Refunded Swing Line Loans. (b) The making of any Swing Line Loan hereunder shall be subject to the satisfaction of the applicable conditions precedent thereto set forth in Section 5 (unless otherwise waived in accordance with Section 11.1). The Swing Line Lender shall notify the Designated Borrower of its election not to make Swing Line Loans hereunder as a result of the failure to satisfy such conditions precedent, unless an Event of Default of the type specified in Section 8(f) shall have occurred and be continuing. (c) If prior to the time a Revolving Credit Loan would have otherwise been made pursuant to Section 2.27(a), one of the events described in Section 8(f) shall have occurred and be continuing, each Revolving Credit Lender shall, on the date such Revolving Credit Loan was to have been made pursuant to the notice referred to in Section 2.27(a) (the "Refunding Date"), purchase an undivided participating interest in an amount equal to (i) its Revolving Credit Percentage times (ii) the aggregate principal amount of Swing Line Loans then outstanding which were to have been repaid with such Revolving Credit Loans (the "Swing Line Participation Amount"). On the Refunding Date, each Revolving Credit Lender shall transfer to the Swing Line Lender, in immediately available funds, such Lender's Swing Line Participation Amount and upon receipt thereof the Swing Line Lender shall deliver to such Lender a Swing Line Loan Participation Certificate dated the date of the Swing Line Lender's receipt of such funds and in such Swing Line Participation Amount. (d) Whenever, at any time after the Swing Line Lender has received from any Revolving Credit Lender such Lender's Swing Line Participation Amount, the Swing Line 44 38 Lender receives any payment on account of the Swing Line Loans, the Swing Line Lender will distribute to such Lender its Swing Line Participation Amount (appropriately adjusted, in the case of interest payments, to reflect the period of time during which such Lender's participating interest was outstanding and funded and, in the case of principal and interest payments, to reflect such Lender's pro rata portion of such payment if such payment is not sufficient to pay the principal of and interest on all Swing Line Loans then due); provided, however, that in the event that such payment received by the Swing Line Lender is required to be returned, such Revolving Credit Lender will return to the Swing Line Lender any portion thereof previously distributed to it by the Swing Line Lender. (e) Each Revolving Credit Lender's obligation to make the Loans referred to in Section 2.27(a) and to purchase participating interests pursuant to Section 2.27(c) shall be absolute and unconditional and shall not be affected by any circumstance, including, without limitation, (i) any setoff, counterclaim, recoupment, defense or other right which such Revolving Credit Lender or the Borrowers may have against the Swing Line Lender, the Borrowers or any other Person for any reason whatsoever; (ii) the occurrence or continuance of a Default or an Event of Default or the failure to satisfy any of the other conditions specified in Section 5; (iii) any adverse change in the condition (financial or otherwise) of the Borrowers; (iv) any breach of this Agreement or any other Loan Document by the Borrowers, any other Loan Party or any other Revolving Credit Lender; or (v) any other circumstance, happening or event whatsoever, whether or not similar to any of the foregoing. SECTION 3. LETTERS OF CREDIT 3.1 L/C Commitment. (a) Subject to the terms and conditions hereof, the Issuing Lender, in reliance on the agreements of the other Revolving Credit Lenders set forth in Section 3.4(a), agrees to issue letters of credit ("Letters of Credit") for the account of the Borrowers on any Business Day during the Revolving Credit Commitment Period in such form as may be approved from time to time by the Issuing Lender; provided that the Issuing Lender shall have no obligation to issue any Letter of Credit if, after giving effect to such issuance, (i) the L/C Obligations would exceed the L/C Commitment or (ii) the aggregate amount of the aggregate Available Revolving Credit Commitments would be less than zero. Each Letter of Credit shall (i) be denominated in Dollars, (ii) be either (x) a standby letter of credit issued to support (I) obligations of the Borrowers or any of their Subsidiaries, contingent or otherwise, which finance the working capital and business needs of the Borrowers or their Subsidiaries or (II) performance obligations of the Borrowers and their Subsidiaries, in each case, incurred in the ordinary course of business (a "Standby Letter of Credit"), or (y) a commercial letter of credit in respect of the purchase of goods or services by the Borrowers or any of their Subsidiaries in the ordinary course of business (a "Commercial Letter of Credit"), (iii) expire no later than five Business Days prior to the Revolving Credit Termination Date and (iv) expire no later than 365 days after its date of issuance, provided that any Letter of Credit with a 365-day duration may provide for the renewal thereof at the election of the Designated Borrower (in accordance with procedures to be established by the Issuing Lender) for additional 365-day periods (which shall not expire later than the Revolving Credit Termination Date). 45 39 (b) Each Letter of Credit shall be subject to the Uniform Customs and, to the extent not inconsistent therewith, the laws of the State of New York. (c) The Issuing Lender shall not at any time be obligated to issue any Letter of Credit hereunder if such issuance would conflict with, or cause the Issuing Lender or any L/C Participant to exceed any limits imposed by, any applicable Requirement of Law. 3.2 Procedure for Issuance of Letter of Credit. The Designated Borrower may from time to time request that the Issuing Lender issue a Letter of Credit by delivering to the Issuing Lender at its address for notices specified herein an Application therefor, completed to the satisfaction of the Issuing Lender, and such other certificates, documents and other papers and information as the Issuing Lender may request. Upon receipt of any Application, the Issuing Lender will process such Application and the certificates, documents and other papers and information delivered to it in connection therewith in accordance with its customary procedures and shall promptly issue the Letter of Credit requested thereby (but in no event shall the Issuing Lender be required to issue any Letter of Credit earlier than three Business Days after its receipt of the Application therefor and all such other certificates, documents and other papers and information relating thereto) by issuing the original of such Letter of Credit to the beneficiary thereof or as otherwise may be agreed to by the Issuing Lender and the Designated Borrower. The Issuing Lender shall furnish a copy of such Letter of Credit to the Designated Borrower promptly following the issuance thereof. The Issuing Lender shall promptly furnish to the Administrative Agent, which shall in turn promptly furnish to the Lenders, notice of the issuance of each Standby Letter of Credit (including the amount thereof). On each L/C Fee Payment Date, the Issuing Lender shall promptly furnish to the Administrative Agent, which shall in turn promptly furnish to the Lenders, notice of the aggregate face amount of the Commercial Letters of Credit outstanding on such date. 3.3 Fees, Commissions and Other Charges. (a) The Borrowers jointly and severally agree that they will pay a commission on all outstanding Standby Letters of Credit at the rate of 3-1/2% per annum of the face amount of each such Letter of Credit, of which 1/4 of 1% per annum will be a fronting fee for the account of the Issuing Lender, and the remainder will be shared ratably among the Revolving Credit Lenders in accordance with their Revolving Credit Percentage, payable quarterly in arrears on each L/C Fee Payment Date after the issuance date. The Borrowers jointly and severally agree that they will pay a commission on all outstanding Commercial Letters of Credit at the rate of 3-1/2% per annum of the average daily face amount of such Letters of Credit during the period for which such payment is made, of which 1/4 of 1% per annum will be a fronting fee for the account of the Issuing Lender, and the remainder will be shared ratably among the Revolving Credit Lenders in accordance with the Revolving Credit Percentage, payable quarterly in arrears on each L/C Fee Payment Date. (b) In addition to the foregoing fees and commissions, the Borrowers jointly and severally agree that they shall pay or reimburse the Issuing Lender for such normal and customary costs and expenses as are incurred or charged by the Issuing Lender in issuing, negotiating, effecting payment under, amending or otherwise administering any Letter of Credit. 46 40 (c) The Administrative Agent shall, promptly following its receipt thereof, distribute to the Issuing Lender and the L/C Participants all fees and commissions received by the Administrative Agent for their respective accounts pursuant to this Section. 3.4 L/C Participations. (a) The Issuing Lender irrevocably agrees to grant and hereby grants to each L/C Participant, and, to induce the Issuing Lender to issue Letters of Credit hereunder, each L/C Participant irrevocably agrees to accept and purchase and hereby accepts and purchases from the Issuing Lender, on the terms and conditions hereinafter stated, for such L/C Participant's own account and risk an undivided interest equal to such L/C Participant's Revolving Credit Percentage in the Issuing Lender's obligations and rights under each Letter of Credit issued hereunder and the amount of each draft paid by the Issuing Lender thereunder. Each L/C Participant unconditionally and irrevocably agrees with the Issuing Lender that, if a draft is paid under any Letter of Credit for which the Issuing Lender is not reimbursed in full by the Borrowers in accordance with the terms of this Agreement, such L/C Participant shall pay to the Issuing Lender upon demand at the Issuing Lender's address for notices specified herein an amount equal to such L/C Participant's Revolving Credit Percentage of the amount of such draft, or any part thereof, which is not so reimbursed. (b) If any amount required to be paid by any L/C Participant to the Issuing Lender pursuant to Section 3.4(a) in respect of any unreimbursed portion of any payment made by the Issuing Lender under any Letter of Credit is paid to the Issuing Lender within three Business Days after the date such payment is due, such L/C Participant shall pay to the Issuing Lender on demand an amount equal to the product of (i) such amount, times (ii) the daily average Federal Funds Effective Rate during the period from and including the date such payment is required to the date on which such payment is immediately available to the Issuing Lender, times (iii) a fraction the numerator of which is the number of days that elapse during such period and the denominator of which is 360. If any such amount required to be paid by any L/C Participant pursuant to Section 3.4(a) is not made available to the Issuing Lender by such L/C Participant within three Business Days after the date such payment is due, the Issuing Lender shall be entitled to recover from such L/C Participant, on demand, such amount with interest thereon calculated from such due date at the rate per annum applicable to Base Rate Loans hereunder. A certificate of the Issuing Lender submitted to any L/C Participant with respect to any amounts owing under this Section shall be conclusive in the absence of manifest error. (c) Whenever, at any time after the Issuing Lender has made payment under any Letter of Credit and has received from any L/C Participant its pro rata share of such payment in accordance with Section 3.4(a), the Issuing Lender receives any payment related to such Letter of Credit (whether directly from the Designated Borrower or otherwise, including proceeds of collateral applied thereto by the Issuing Lender), or any payment of interest on account thereof, the Issuing Lender will distribute to such L/C Participant its pro rata share thereof; provided, however, that in the event that any such payment received by the Issuing Lender shall be required to be returned by the Issuing Lender, such L/C Participant shall return to the Issuing Lender the portion thereof previously distributed by the Issuing Lender to it. 47 41 3.5 Reimbursement Obligation of the Borrowers. The Borrowers jointly and severally agree to reimburse the Issuing Lender on each date on which the Issuing Lender notifies the Designated Borrower of the date and amount of a draft presented under any Letter of Credit and paid by the Issuing Lender for the amount of (a) such draft so paid and (b) any taxes, fees, charges or other costs or expenses incurred by the Issuing Lender in connection with such payment. Each such payment shall be made to the Issuing Lender at its address for notices specified herein in lawful money of the United States and in immediately available funds. Interest shall be payable on any and all amounts remaining unpaid by the Borrowers under this Section from the date such amounts become payable (whether at stated maturity, by acceleration or otherwise) until payment in full at the rate set forth in Section 2.15(c). Each drawing under any Letter of Credit shall constitute a request by the Designated Borrower to the Administrative Agent for a borrowing pursuant to Section 2.6 of Base Rate Loans (or, at the option of the Administrative Agent and the Swing Line Lender in their sole discretion, a borrowing pursuant to Section 2.25 of Swing Line Loans) in the amount of such drawing, the proceeds of such Loans to be applied to reimburse such drawing. The Borrowing Date with respect to such borrowing shall be the date of such drawing. 3.6 Obligations Absolute. The Borrowers' obligations under this Section 3 shall be absolute and unconditional under any and all circumstances and irrespective of any setoff, counterclaim or defense to payment which the Borrowers may have or have had against the Issuing Lender, any beneficiary of a Letter of Credit or any other Person. The Borrowers jointly and severally also agree with the Issuing Lender that the Issuing Lender shall not be responsible for, and the Borrowers' Reimbursement Obligations under Section 3.5 shall not be affected by, among other things, the validity or genuineness of documents or of any endorsements thereon, even though such documents shall in fact prove to be invalid, fraudulent or forged, or any dispute between or among any Borrower and any beneficiary of any Letter of Credit or any other party to which such Letter of Credit may be transferred or any claims whatsoever of any Borrower against any beneficiary of such Letter of Credit or any such transferee. The Issuing Lender shall not be liable for any error, omission, interruption or delay in transmission, dispatch or delivery of any message or advice, however transmitted, in connection with any Letter of Credit, except for errors or omissions found by a final and nonappealable decision of a court of competent jurisdiction to have resulted from the gross negligence or willful misconduct of the Issuing Lender. The Borrowers jointly and severally agree that any action taken or omitted by the Issuing Lender under or in connection with any Letter of Credit or the related drafts or documents, if done in the absence of gross negligence or willful misconduct and in accordance with the standards or care specified in the Uniform Commercial Code of the State of New York, shall be binding on the Borrowers jointly and severally and shall not result in any liability of the Issuing Lender to the Borrowers. 3.7 Letter of Credit Payments. If any draft shall be presented for payment under any Letter of Credit, the Issuing Lender shall promptly notify the Designated Borrower of the date and amount thereof. The responsibility of the Issuing Lender to the Borrowers in connection with any draft presented for payment under any Letter of Credit shall, in addition to any payment obligation expressly provided for in such Letter of Credit, be limited to 48 42 determining that the documents (including each draft) delivered under such Letter of Credit in connection with such presentment are substantially in conformity with such Letter of Credit. 3.8 Applications. To the extent that any provision of any Application related to any Letter of Credit is inconsistent with the provisions of this Section 3, the provisions of this Section 3 shall apply. SECTION 4. REPRESENTATIONS AND WARRANTIES To induce the Administrative Agent and the Lenders to enter into this Agreement and to make the Loans and issue or participate in the Letters of Credit, the Parent and the Borrowers hereby jointly and severally represent and warrant to the Administrative Agent and each Lender that: 4.1 Financial Condition. (a) The unaudited pro forma combined balance sheet of the Borrowers as at April 30, 1996 (including the notes thereto) (the "Pro Forma Balance Sheet"), copies of which have heretofore been furnished to each Lender, has been prepared giving effect (as if such events had occurred on such date) to (i) the Recapitalization, (ii) the borrowings under this Agreement contemplated to be made on the Closing Date and the use of proceeds thereof, (iii) the incurrence of the Subordinated Debt, (iv) the issuance of the Preferred Stock, (v) the other transactions contemplated by the Recapitalization Agreement and (vi) the payment of fees and expenses in connection with the foregoing. The Pro Forma Balance Sheet has been prepared based on the best information available to the Borrowers as of the date of delivery thereof, and presents fairly on a pro forma basis the estimated combined financial position of the Borrowers as of April 30, 1996, assuming that the events specified in the preceding sentence had actually occurred at such date. (b) The combined balance sheet of the Borrowers as at December 31, 1995 and December 31, 1994 and the related combined statements of income and of cash flows for the fiscal years ended on such dates, reported on by KPMG Peat Marwick LLP, copies of which have heretofore been furnished to each Lender, are complete and correct and present fairly the combined financial condition of the Borrowers as at such dates, and the combined results of their operations and their combined cash flows for the fiscal years then ended. The unaudited combined balance sheet of the Borrowers as at April 30, 1996 and the related unaudited combined statements of income and of cash flows for the four-month period ended on such date, certified by a Responsible Officer of the Designated Borrower, copies of which have heretofore been furnished to each Lender, are complete and correct and present fairly the combined financial condition of the Borrowers as at such date, and the combined results of their operations and their combined cash flows for the four-month period then ended (subject to normal year-end audit adjustments (including adjustments for inventory capitalization and depreciation). All such financial statements, including the related schedules and notes thereto, have been prepared in accordance with GAAP applied consistently throughout the periods involved (except as approved by such accountants or Responsible Officer of the Designated Borrower, as the case may be, and as disclosed therein and except for the absence of 49 43 adjustments for inventory capitalization and depreciation in the case of the April 30, 1996 financial statements). None of the Borrowers had, at the date of the most recent balance sheet referred to above, any undisclosed liabilities, any material Guarantee Obligation, contingent liability or liability for taxes, or any long-term lease or unusual forward or long-term commitment, including, without limitation, any interest rate or foreign currency swap or exchange transaction, which is not reflected in the foregoing statements or in the notes thereto and not required to be disclosed by GAAP. During the period from December 31, 1995 to and including the date hereof there has been no sale, transfer or other disposition by the Borrowers or any of their combined Subsidiaries of any material part of their business or property and no purchase or other acquisition of any business or property (including any Capital Stock of any other Person) material in relation to the combined financial condition of the Borrowers at December 31, 1995, other than pursuant to the Recapitalization Agreement. 4.2 No Change. (a) Since December 31, 1995, there has been no development or event which has had or could reasonably be expected to have a Material Adverse Effect, and (b) during the period from December 31, 1995 to and including the date hereof no dividends or other distributions have been declared, paid or made upon the Capital Stock of the Parent, the Borrowers or any Subsidiary nor has any of the Capital Stock of the Parent, the Borrowers or any Subsidiary been redeemed, retired, purchased or otherwise acquired for value by the Parent, the Borrowers any or any of their Subsidiaries, other than pursuant to the Recapitalization Agreement. 4.3 Corporate Existence; Compliance with Law. Each of the Parent, the Borrowers and their Subsidiaries (a) is duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization, (b) has the power and authority, and the legal right, to own and operate its property, to lease the property it operates as lessee and to conduct the business in which it is currently engaged, (c) is duly qualified and in good standing under the laws of each jurisdiction where its ownership, lease or operation of property or the conduct of its business requires such qualification and (d) is in compliance with all Requirements of Law except to the extent that the failure to comply therewith could not, in the aggregate, reasonably be expected to have a Material Adverse Effect. 4.4 Corporate Power; Authorization; Enforceable Obligations. Each Loan Party has the power and authority, and the legal right, to make, deliver and perform each Loan Document to which it is a party and, in the case of the Borrowers, to borrow hereunder. Each Loan Party has taken all necessary action to authorize the execution, delivery and performance of the Loan Documents to which it is a party and, in the case of the Borrowers, to authorize the borrowings on the terms and conditions of this Agreement and the Notes. No material consent or authorization of, filing with, notice to or other act by or in respect of, any Governmental Authority or any other Person is required in connection with the Recapitalization, the borrowings hereunder or with the execution, delivery, performance, validity or enforceability of this Agreement or any of the Loan Documents, except (i) consents, authorizations, filings and notices described in Schedule 4.4, which consents, authorizations, filings and notices have been obtained or made and are in full force and effect and (ii) the filings referred to in Section 4.19(b). Each Loan Document has been duly 50 44 executed and delivered on behalf of each Loan Party thereto. This Agreement constitutes, and each other Loan Document upon execution will constitute, a legal, valid and binding obligation of each Loan Party thereto, enforceable against each such Loan Party in accordance with its terms, except as enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the enforcement of creditors' rights generally and by general equitable principles (whether enforcement is sought by proceedings in equity or at law). 4.5 No Legal Bar. The execution, delivery and performance of this Agreement and the other Loan Documents, the issuance of Letters of Credit, the borrowings hereunder and the use of the proceeds thereof will not violate any Requirement of Law or Contractual Obligation of the Parent, the Borrowers or of any of their Subsidiaries and will not result in, or require, the creation or imposition of any Lien on any of their respective properties or revenues pursuant to any such Requirement of Law or Contractual Obligation (other than the Liens created by the Security Documents). 4.6 No Material Litigation. No litigation, investigation or proceeding of or before any arbitrator or Governmental Authority is pending or, to the knowledge of the Parent or the Borrowers, threatened by or against the Parent, the Borrowers or any of their Subsidiaries or against any of its or their respective properties or revenues (a) with respect to any of the Loan Documents or any of the transactions contemplated hereby or thereby, or (b) which could reasonably be expected to have a Material Adverse Effect. 4.7 No Default. Neither the Parent, the Borrowers nor any of their Subsidiaries is in default under or with respect to any of its Contractual Obligations in any respect which could reasonably be expected to have a Material Adverse Effect. No Default or Event of Default has occurred and is continuing. 4.8 Ownership of Property; Liens. Each of the Parent, the Borrowers and their Subsidiaries has title in fee simple to, or a valid leasehold interest in, all its real property, and good title to, or a valid leasehold interest in, all its other property, and none of such property is subject to any Lien except as permitted by Section 7.3. The Parent, the Borrowers and their Subsidiaries have title in fee simple to no real property other than the Mortgaged Property. 4.9 Intellectual Property. The Parent, the Borrowers and each of their Subsidiaries owns, or is licensed to use, all trademarks, tradenames, copyrights, technology, know-how and processes necessary for the conduct of its business as currently conducted, except for those the failure to own or license which could not reasonably be expected to have a Material Adverse Effect ("Intellectual Property"). No material claim has been asserted and is pending by any Person challenging or questioning the use of any Intellectual Property or the validity or effectiveness of any Intellectual Property, nor does the Parent or any of the Borrowers know of any valid basis for any such claim. The use of Intellectual Property by the Parent, the Borrowers and their Subsidiaries does not infringe on the rights of any Person in any material respect. 51 45 4.10 No Burdensome Restrictions. No Requirement of Law or Contractual Obligation of the Parent, the Borrowers or any of their Subsidiaries could reasonably be expected to have a Material Adverse Effect. 4.11 Taxes. Each of the Parent, the Borrowers and their Subsidiaries has filed or caused to be filed all Federal, state and other material tax returns which are required to be filed and has paid all taxes shown to be due and payable on said returns or on any assessments made against it or any of its property and all other taxes, fees or other charges imposed on it or any of its property by any Governmental Authority (other than any the amount or validity of which are currently being contested in good faith by appropriate proceedings and with respect to which reserves in conformity with GAAP have been provided on the books of the Borrowers); no tax Lien has been filed, and, to the knowledge of the Parent and the Borrowers, no claim is being asserted, with respect to any such tax, fee or other charge. 4.12 Federal Regulations. No part of the proceeds of any Loans will be used for "purchasing" or "carrying" any "margin stock" within the respective meanings of each of the quoted terms under Regulation G or Regulation U of the Board as now and from time to time hereafter in effect or for any purpose which violates the provisions of the Regulations of the Board. If requested by any Lender or the Administrative Agent, the Borrowers will furnish to the Administrative Agent and each Lender a statement to the foregoing effect in conformity with the requirements of FR Form G-1 or FR Form U-1 referred to in said Regulation G or Regulation U, as the case may be. 4.13 ERISA. Neither a Reportable Event nor an "accumulated funding deficiency" (within the meaning of Section 412 of the Code or Section 302 of ERISA) has occurred during the five-year period prior to the date on which this representation is made or deemed made with respect to any Plan, and each Plan has complied in all material respects with the applicable provisions of ERISA and the Code. No termination of a Single Employer Plan has occurred, and no Lien in favor of the PBGC or a Plan has arisen, during such five-year period. The present value of all accrued benefits under each Single Employer Plan (based on those assumptions used to fund such Plans) did not, as of the last annual valuation date prior to the date on which this representation is made or deemed made, exceed the value of the assets of such Plan allocable to such accrued benefits by a material amount. Neither any Borrower nor any Commonly Controlled Entity has had a complete or partial withdrawal from any Multiemployer Plan which has resulted or could reasonably be expected to result in a material liability under ERISA, and neither any Borrower nor any Commonly Controlled Entity would become subject to any material liability under ERISA if any Borrower or any such Commonly Controlled Entity were to withdraw completely from all Multiemployer Plans as of the valuation date most closely preceding the date on which this representation is made or deemed made. No such Multiemployer Plan is in Reorganization or Insolvent. The present value (determined using actuarial and other assumptions which are reasonable in respect of the benefits provided and the employees participating) of the liability of the Borrowers and each Commonly Controlled Entity for post retirement benefits to be provided to their current and former employees under Plans which are welfare benefit plans (as defined 52 46 in Section 3(1) of ERISA) does not, in the aggregate, exceed the assets under all such Plans allocable to such benefits by an amount in excess of $50,000. 4.14 Investment Company Act; Other Regulations. No Loan Party is an "investment company", or a company "controlled" by an "investment company", within the meaning of the Investment Company Act of 1940, as amended. No Loan Party is subject to regulation under any Federal or State statute or regulation (other than Regulation X of the Board) which limits its ability to incur Indebtedness. 4.15 Subsidiaries. The Borrowers listed on Schedule 1.1A constitute all the direct or indirect Subsidiaries of the Parent. 4.16 Purpose of Loans; Limitations on Use. The proceeds of the Term Loans shall be used to finance the Recapitalization and to pay related fees and expenses. The Revolving Credit Loans shall be used to finance the working capital needs of the Borrowers and their Subsidiaries. 4.17 Environmental Matters. (a) The Properties do not contain, and have not previously contained, any Materials of Environmental Concern in amounts or concentrations or under circumstances which (i) constitute or constituted a violation of, or (ii) could give rise to liability under, any Environmental Law, except in either case insofar as such violation or liability, or any aggregation thereof, could not reasonably be expected to result in the payment of a Material Environmental Amount. (b) The Properties and all operations at the Properties are in material compliance, and have in the last five years been in material compliance, with all applicable Environmental Laws, and there is no contamination at, under or about the Properties or violation of any Environmental Law with respect to the Properties or the business operated by the Parent, the Borrowers or any of their Subsidiaries (the "Business") which could reasonably be expected to materially interfere with the continued operation of the Properties or materially impair the fair saleable value thereof. Neither the Parent, the Borrowers nor any of their Subsidiaries has assumed any liability of any other Person under Environmental Laws. (c) Neither the Parent, the Borrowers nor any of their Subsidiaries has received or is aware of any notice of violation, alleged violation, non-compliance, liability or potential liability regarding environmental matters or compliance with Environmental Laws with regard to any of the Properties or the Business, nor does the Parent, the Borrowers or any of their Subsidiaries have knowledge or reason to believe that any such notice will be received or is being threatened, except insofar as such notice or threatened notice, or any aggregation thereof, does not involve a matter or matters that could reasonably be expected to result in the payment of a Material Environmental Amount. 53 47 (d) Materials of Environmental Concern have not been transported or disposed of from the Properties in violation of, or in a manner or to a location which could reasonably be expected to give rise to liability under, any Environmental Law, nor have any Materials of Environmental Concern been generated, treated, stored or disposed of at, on or under any of the Properties in violation of, or in a manner that could give rise to liability under, any applicable Environmental Law, except insofar as any such violation or liability referred to in this paragraph, or any aggregation thereof, could not reasonably be expected to result in the payment of a Material Environmental Amount. (e) No judicial proceeding or governmental or administrative action is pending or, to the knowledge of the Parent, the Borrowers or any of their Subsidiaries, threatened, under any Environmental Law to which the Parent, the Borrowers or any of their Subsidiaries is or will be named as a party with respect to the Properties or the Business, nor are there any consent decrees or other decrees, consent orders, administrative orders or other orders, or other administrative or judicial requirements outstanding under any Environmental Law with respect to the Properties or the Business, except insofar as such proceeding, action, decree, order or other requirement, or any aggregation thereof, could not reasonably be expected to result in the payment of a Material Adverse Amount. (f) There has been no release or threat of release of Materials of Environmental Concern at or from the Properties, or arising from or related to the operations of the Parent, the Borrowers or any of their Subsidiaries in connection with the Properties or otherwise in connection with the Business, in violation of or in amounts or in a manner that could give rise to liability under Environmental Laws, except insofar as any such violation or liability referred to in this paragraph, or any aggregation thereof, could not reasonably be expected to result in the payment of a Material Environmental Amount. 4.18 Accuracy of Information. No statement or information contained in this Agreement, any other Loan Document, the Confidential Information Memorandum or any other document, certificate or statement furnished to the Administrative Agent or the Lenders, by or on behalf of any Loan Party for use in connection with the transactions contemplated by this Agreement or the other Loan Documents, contained as of the date such statement, information, document or certificate was so furnished any untrue statement of a material fact or omitted to state a material fact necessary in order to make the statements contained herein or therein not misleading. The projections and pro forma financial information contained in the materials referenced above are based upon good faith estimates and assumptions believed by management of the Parent, the Borrowers and their Subsidiaries to be reasonable at the time made, it being recognized by the Lenders that such financial information as it relates to future events is not to be viewed as fact and that actual results during the period or periods covered by such financial information may differ from the projected results set forth therein by a material amount. There is no fact known to the Parent, the Borrowers or any of their Subsidiaries that could reasonably be expected to have a Material Adverse Effect that has not been expressly disclosed herein, in the other Loan Documents, or in such other documents, 54 48 certificates and statements furnished to the Administrative Agent and the Lenders for use in connection with the transactions contemplated hereby and by the other Loan Documents. 4.19 Security Documents. (a) Each of the Pledge Agreements is effective to create in favor of the Administrative Agent, for the benefit of the Lenders, a legal, valid and enforceable security interest in the Pledged Stock described therein and proceeds thereof and, when the stock certificates representing the Pledged Stock described therein are delivered to the Administrative Agent, each such Pledge Agreement shall constitute a fully perfected first priority Lien on, and security interest in, all right, title and interest of the relevant pledgor in such Pledged Stock and the proceeds thereof, as security for the Obligations (as defined in the relevant Pledge Agreement), in each case prior and superior in right to any other Person. (b) The Borrowers Security Agreement is effective to create in favor of the Administrative Agent, for the benefit of the Lenders, a legal, valid and enforceable security interest in the Collateral described therein and proceeds thereof, and when financing statements in appropriate form are filed in the offices specified on Schedule 4.19(b), the Borrowers Security Agreement shall constitute a fully perfected Lien on, and security interest in, all right, title and interest of the Loan Parties in such Collateral and the proceeds thereof, as security for the Obligations (as defined in the Borrowers Security Agreement), in each case prior and superior in right to any other Person, other than with respect to Liens expressly permitted by Section 7.3. (c) Each Mortgage, when executed and delivered by the relevant Loan Party, shall be effective to create in favor of the Administrative Agent, for the benefit of the Lenders, a legal, valid and enforceable Lien on the Mortgaged Property described therein and proceeds thereof, and when each Mortgage is filed in the office(s) specified on Schedule 4.19(c), each Mortgage shall constitute a fully perfected Lien on, and security interest in, all right, title and interest of the Loan Parties in the Mortgaged Property and the proceeds thereof, as security for the Obligations (as defined in the relevant Mortgage), in each case prior and superior in right to any other Person, other than with respect to Liens expressly permitted by Section 7.3. 4.20 Solvency. Each Loan Party is, and after giving effect to the consummation of the Recapitalization and to the incurrence of all Indebtedness and obligations being incurred in connection herewith and therewith will be and will continue to be, taking into account the provisions of Section 2.24, Solvent. 4.21 Purchase Agreement Representations and Warranties. On the Closing Date, each of the representatives and warranties of the Borrowers set forth in Article VI of the Purchase Agreement are true and correct in all material respects. SECTION 5. CONDITIONS PRECEDENT 5.1 Conditions to Initial Extension of Credit. The agreement of each Lender to make the initial extension of credit requested to be made by it is subject to the satisfaction, 55 49 prior to or concurrently with the making of such extension of credit on the Closing Date, of the following conditions precedent: (a) Loan Documents. The Arranger shall have received (i) this Agreement, executed and delivered by a duly authorized officer of the Parent and each of the Borrowers, with a counterpart for each Lender, (ii) for the account of any Lender requesting Notes in accordance with Section 2.9(e), Notes conforming to the requirements hereof and executed and delivered by a duly authorized officer of the Borrowers, (iii) each of the Pledge Agreements, each executed and delivered by a duly authorized officer of each party thereto, with a counterpart or a conformed copy for each Lender, (iv) the Borrowers Security Agreement, executed and delivered by a duly authorized officer of each Borrower, with a counterpart or a conformed copy for each Lender, (v) (except as provided in subsection 6.12) each of the Assignments of Insurance, each executed and delivered by a duly authorized officer of each party thereto, with a counterpart or a conformed copy for each Lender, and (vi) each Mortgage, executed and delivered by a duly authorized officer of each party thereto, with a counterpart for each Lender. (b) Related Agreements. The Arranger shall have received, in form and substance satisfactory to it, with a copy for each Lender, true and correct copies, certified as to authenticity by the Designated Borrower, of (i) the Recapitalization Agreement and any of the other Recapitalization Documents reasonably requested by the Arranger (ii) the Management Contracts, (iii) the Shareholders Agreement, (iv) the Certificate of Designations for each series of the Preferred Stock, (v) the Registration Rights Agreement (vi) the Purchase Agreement, (vii) the limited liability company agreement for the Parent, and (viii) the Subordination Agreement. Except as provided in subsection 6.12, the Arranger shall have received (in a form reasonably satisfactory to the Arranger), with a copy for each Lender, true and correct copies, certified as to authenticity by the Designated Borrower, of the Insurance Policies (or certificates evidencing the effectiveness of such Insurance Policies and the material terms thereof) and such other documents or instruments as may be reasonably requested by the Arranger, including, without limitation, a copy of any other debt instrument, security agreement or other material contract to which any Borrower may be a party. (c) Recapitalization. On or prior to the Closing Date, the Recapitalization shall have been consummated for an aggregate purchase price not exceeding $125,000,000 (which amount may be increased or decreased in accordance with certain purchase price adjustments described in section 4.3 of the Recapitalization Agreement, including all fees, costs, and expenses incurred in connection therewith, pursuant to the Recapitalization Documents, any conditions precedent set forth in the Recapitalization Agreement shall have been satisfied or waived, and no material provision of the Recapitalization Documents shall have been amended, supplemented, waived or otherwise modified without the prior written consent of the Arranger. (d) Capitalization; Capital Structure. The Borrowers shall have received (i) at least $30,780,000 from the issuance of the Series A Preferred, (ii) at least $20,000,000 56 50 from the issuance of the Subordinated Debt pursuant to the Purchase Agreement and (iii) at least $14,200,000 and at least $20,000,000 from the issuance of the Series B Preferred and the Series C Preferred, respectively, to the Individual Shareholders. The capital structure of the Parent, the Borrowers and each of their Subsidiaries after the Recapitalization shall be satisfactory to the Arranger and the Lenders in all respects. (e) Pro Forma Balance Sheet; Financial Statements. The Lenders shall have received (i) the Pro Forma Balance Sheet, which Pro Forma Balance Sheet shall be in form and substance satisfactory to the Lenders and (ii) satisfactory unaudited interim combined financial statements of the Borrowers for each fiscal month of the Borrowers ended in the 1996 fiscal year of the Borrowers as to which such financial statements are available prior to the Closing Date and such financial statements shall not reflect any material adverse change in the combined financial condition of the Borrowers as reflected in the financial statements previously delivered to the Lenders. (f) Approvals. All governmental and third party approvals (including landlords' and other consents) necessary or advisable in connection with the Recapitalization, the transactions contemplated hereby and the continuing operations of the Borrowers shall have been obtained and be in full force and effect, and all applicable waiting periods shall have expired without any action being taken or threatened by any competent authority which would restrain, prevent or otherwise impose adverse conditions on the Recapitalization, the financing thereof, the financing contemplated hereby or the continuing operations of the Borrowers. Notwithstanding the foregoing requirement with respect to third party approvals, the Borrowers shall not be required to have obtained landlords' waivers in form and substance satisfactory to the Arranger relating to the Lender's security interest in the Borrower's assets for more than 20% of the Borrowers' leases on the Closing Date. (g) Business Plan. The Lenders shall have received a satisfactory detailed business plan of the Borrowers for fiscal years 1996 - 2002 and a satisfactory written analysis of the business and prospects of the Borrowers for the period from the Closing Date through the final maturity of the Term Loans. (h) Lien Searches. The Arranger shall have received the results of a recent lien search in each of the relevant jurisdictions where assets of the Borrowers are located, and such search shall reveal no liens on any of the assets of the Borrowers except for liens permitted by Section 7.3 or liens to be discharged on or prior to the Closing Date pursuant to documentation satisfactory to the Arranger. (i) Expenses. The expenses incurred in connection with the Recapitalization and the financing thereof shall not exceed $7,000,000 in the aggregate. (j) Valuation of Inventory. The Lenders shall have received copies of a valuation, prepared by a firm satisfactory to the Arranger and in form and substance satisfactory to the Arranger, of the inventory of the Borrowers. 57 51 (k) Management. The Lenders shall be satisfied that senior managers acceptable to them shall be available to manage the Borrowers. (l) Working Capital. The Lenders shall be satisfied with the sufficiency of amounts available to the Borrowers pursuant to the aggregate Revolving Credit Commitments to meet the ongoing working capital needs of the Borrowers following the Recapitalization and the consummation of the other transactions contemplated hereby. (m) Officers. The Lenders shall be satisfied with the results of an independent background investigation concerning certain key officers, directors and managers of the Borrowers. (n) Closing Certificate. The Arranger shall have received, with a counterpart for each Lender, a certificate of each Loan Party (other than the Individual Shareholders), dated the Closing Date, substantially in the form of Exhibit G, with appropriate insertions and attachments, executed by the President or any Vice President and the Secretary or any Assistant Secretary of such Loan Party. (o) Corporate Proceedings of Loan Parties. The Arranger shall have received, with a counterpart for each Lender, a copy of the resolutions of the Board of Directors of each Loan Party authorizing (i) the execution, delivery and performance of the Loan Documents to which it is a party, and (ii) in the case of the Borrowers, the borrowings contemplated hereunder. (p) Fees. The Arranger shall have received all fees, expenses and other consideration required to be paid on or before the Closing Date. (q) Legal Opinions. The Arranger shall have received, with a counterpart for each Lender, the following executed legal opinions: (i) the executed legal opinion of Pepper, Hamilton & Scheetz, counsel to the Parent, substantially in the form of Exhibit H-1; (ii) the executed legal opinion of Baker, Donelson, Bearman & Caldwell, counsel of the Borrowers and the other Loan Parties, substantially in the form of Exhibit H-2; and (iii) the executed legal opinion of Simpson Thacher & Bartlett, in form and substance satisfactory to the Arranger; Each such legal opinion shall be in form and substance satisfactory to the Lenders and shall cover such matters incident to the transactions contemplated by this Agreement as the Arranger may reasonably require. 58 52 (r) Pledged Stock; Stock Powers. The Arranger shall have received the certificates representing the shares pledged pursuant to each of the Pledge Agreements, together with an undated stock power for each such certificate executed in blank by a duly authorized officer of the pledgor thereof. (s) Filings, Registrations and Recordings. Each document (including, without limitation, any Uniform Commercial Code financing statement) required by the Security Documents or under law or reasonably requested by the Arranger to be filed, registered or recorded in order to create in favor of the Arranger, for the benefit of the Lenders, a perfected Lien on the Collateral described therein, prior and superior in right to any other Person (other than with respect to Liens expressly permitted by Section 7.3), shall be in proper form for filing, registration or recordation in each jurisdiction in which the filing, registration or recordation thereof is so required or requested. (t) Surveys. The Arranger shall have received, and the title insurance company issuing the policy referred to in Section 5.1(u) (the "Title Insurance Company") shall have received, maps or plats of an as-built survey of the sites of the property covered by each Mortgage certified to the Administrative Agent and the Title Insurance Company in a manner satisfactory to them, dated a date satisfactory to the Arranger and the Title Insurance Company by an independent professional licensed land surveyor satisfactory to the Arranger and the Title Insurance Company, which maps or plats and the surveys on which they are based shall be made in accordance with the Minimum Standard Detail Requirements for Land Title Surveys jointly established and adopted by the American Land Title Association and the American Congress on Surveying and Mapping in 1992, and, without limiting the generality of the foregoing, there shall be surveyed and shown on such maps, plats or surveys the following: (i) the locations on such sites of all the buildings, structures and other improvements and the established building setback lines; (ii) the lines of streets abutting the sites and width thereof; (iii) all access and other easements appurtenant to the sites or necessary or desirable to use the sites; (iv) all roadways, paths, driveways, easements, encroachments and overhanging projections and similar encumbrances affecting the site, whether recorded, apparent from a physical inspection of the sites or otherwise known to the surveyor; (v) any encroachments on any adjoining property by the building structures and improvements on the sites; and (vi) if the site is described as being on a filed map, a legend relating the survey to said map. (u) Title Insurance Policy. The Arranger shall have received in respect of each parcel covered by each Mortgage a mortgagee's title policy (or policies) or marked up unconditional binder for such insurance dated the Closing Date. Each such policy shall (i) be in an amount satisfactory to the Arranger; (ii) be issued at ordinary rates; (iii) insure that the Mortgage insured thereby creates a valid first Lien on such parcel free and clear of all defects and encumbrances, except such as may be approved by the Arranger; (iv) name the Administrative Agent for the benefit of the Lenders as the insured thereunder; (v) be in the form of ALTA Loan Policy - 1992; (vi) contain such endorsements and affirmative coverage as the Arranger may request and (vii) be 59 53 issued by title companies satisfactory to the Arranger (including any such title companies acting as co-insurers or reinsurers, at the option of the Arranger). The Arranger shall have received evidence satisfactory to it that all premiums in respect of each such policy, and all charges for mortgage recording tax, if any, have been paid. (v) Flood Insurance. If requested by the Arranger, the Arranger shall have received (i) a policy of flood insurance which (A) covers any parcel of improved real property which is encumbered by any Mortgage, (B) is written in an amount not less than the outstanding principal amount of the indebtedness secured by such Mortgage which is reasonably allocable to such real property or the maximum limit of coverage made available with respect to the particular type of property under the National Flood Insurance Act of 1968, whichever is less, and (C) has a term ending not earlier than the maturity of the indebtedness secured by such Mortgage and (ii) confirmation that the Company has received the notice requirement pursuant to Section 208(e)(3) of Regulation H of the Board. (w) Copies of Documents. The Arranger shall have received a copy of all recorded documents referred to, or listed as exceptions to title in, the title policy or policies referred to in Section 5.1(u) and a copy, certified by such parties as the Arranger may deem appropriate, of all other documents affecting the property covered by each Mortgage. (x) Solvency Opinion. The Arranger shall have received, with a copy for each Lender, an opinion from an independent valuation firm satisfactory to the Arranger documenting the solvency of the Borrowers after giving effect to the Recapitalization (including the fair market value of the Borrower's assets) and the other transactions contemplated hereby. (y) Termination of Prior Credit Facilities. The Arranger shall have received evidence satisfactory to it that the Prior Credit Facilities shall have been terminated and all amounts payable thereunder shall have been paid in full. 5.2 Conditions to Each Extension of Credit. The agreement of each Lender to make any extension of credit requested to be made by it on any date (including, without limitation, its initial extension of credit) is subject to the satisfaction of the following conditions precedent: (a) Representations and Warranties. Each of the representations and warranties made by any Loan Party in or pursuant to the Loan Documents shall be true and correct in all material respects on and as of such date as if made on and as of such date. (b) No Default. No Default or Event of Default shall have occurred and be continuing on such date or after giving effect to the extensions of credit requested to be made on such date. 60 54 (c) Additional Matters. All proceedings, and all documents, instruments and other legal matters in connection with the transactions contemplated by this Agreement, the other Loan Documents and the Recapitalization shall be reasonably satisfactory in form and substance to the Administrative Agent, and the Administrative Agent shall have received such other documents and legal opinions in respect of any aspect or consequence of the transactions contemplated hereby or thereby as it shall reasonably request. Each borrowing by and issuance of a Letter of Credit on behalf of the Borrowers hereunder shall constitute a representation and warranty by the Borrowers as of the date of such extension of credit that the conditions contained in this Section 5.2 have been satisfied. SECTION 6. AFFIRMATIVE COVENANTS The Parent and the Borrowers hereby jointly and severally agree that, so long as the Commitments remain in effect, any Note or Letter of Credit remains outstanding and unpaid or any other amount is owing to any Lender or the Administrative Agent hereunder, the Parent and the Borrowers shall and shall cause each of their respective Subsidiaries to: 6.1 Financial Statements. Furnish to each Lender: (a) as soon as available, but in any event within 120 days after the end of each fiscal year of the Borrowers, a copy of the combined balance sheet of the Borrowers and their Subsidiaries as at the end of such year and the related combined statements of income and retained earnings and of cash flows for such year, setting forth in each case in comparative form the figures for the previous year, reported on without a "going concern" or like qualification or exception, or qualification arising out of the scope of the audit, by KPMG Peat Marwick LLP or other independent certified public accountants of nationally recognized standing; (b) as soon as available, but in any event not later than 45 days after the end of each of the first three quarterly periods of each fiscal year of the Borrowers, the unaudited combined balance sheet of the Borrowers and their Subsidiaries as at the end of such quarter and the related unaudited combined statements of income and retained earnings and of cash flows of the Borrowers and their Subsidiaries for such quarter and the portion of the fiscal year through the end of such quarter, setting forth in each case in comparative form the figures for the previous year, certified by a Responsible Officer of the Parent and of the Designated Borrower as being fairly stated in all material respects (subject to normal year-end audit adjustments); and (c) as soon as available, but in any event not later than 45 days after the end of each month occurring during each fiscal year of the Borrowers (other than the third, sixth, ninth and twelfth such month), the unaudited combined balance sheets of the Borrowers and their Subsidiaries as at the end of such month and the related unaudited combined statements of income and retained earnings and of cash flows of the 61 55 Borrowers and their Subsidiaries for such month and the portion of the fiscal year through the end of such month, setting forth in each case in comparative form the figures for the previous year; all such financial statements shall be complete and correct in all material respects and shall be prepared in reasonable detail and in accordance with GAAP applied consistently throughout the periods reflected therein and with prior periods (except for any change in accounting principle in accordance with GAAP (A) as approved (i) by such accountants (in the case of audited financial statements) or (ii) by a Responsible Officer of the Designated Borrower (in the case of unaudited financial statements), (B) as disclosed therein, (C) as approved in writing by the Required Lenders if such change results in a significant increase in Combined EBITDA for the periods reflected therein and, (D) in the case of interim financial statements, subject to normal year-end adjustments, including adjustments for inventory capitalization and depreciation). 6.2 Certificates; Other Information. Furnish to each Lender: (a) concurrently with the delivery of the financial statements referred to in Section 6.1(a), (i) a certificate of the independent certified public accountants reporting on such financial statements stating that in making the examination necessary therefor no knowledge was obtained of any Default or Event of Default, except as specified in such certificate and (ii) copies of all reports or written communications providing advice, recommendations or analysis to the management of the Borrowers from such independent certified public accountants with regard to their audit of the financial statements referred to in Section 6.1 or the internal financial controls and systems of the Borrowers; (b) concurrently with the delivery of any financial statement pursuant to Section 6.1, (y) a certificate of a Responsible Officer of each of the Parent and the Designated Borrower stating that, to the best of each such Responsible Officer's knowledge, during such period (i) no Subsidiary has been formed or acquired (or, if any such Subsidiary has been formed or acquired, the Borrowers have complied with the requirements of Section 6.11 with respect thereto), (ii) neither the Parent, the Borrowers nor any of their Subsidiaries has changed its name, its principal place of business, its chief executive office or the location of any material item of tangible Collateral without complying with the requirements of this Agreement and the Security Documents with respect thereto and (iii) each Loan Party has observed or performed all of its covenants and other agreements, and satisfied every condition, contained in this Agreement and the other Loan Documents to which it is a party to be observed, performed or satisfied by it, and that such Responsible Officer has obtained no knowledge of any Default or Event of Default except as specified in such certificate and (z) in the case of quarterly or annual financial statements, a certificate containing all information reasonably necessary for determining compliance by the Parent, the Borrowers and their Subsidiaries with the provisions of this Agreement (including but not limited to Sections 2.12 and 7.1) as of the last day of such fiscal quarter or fiscal year of the Borrowers as the case may be; 62 56 (c) as soon as available, and in any event no later than 30 days after the end of each fiscal year of the Borrowers, a projected combined balance sheet of the Borrowers as of the end of the following fiscal year, and the related combined statements of projected cash flow, projected changes in financial position and projected income for the following fiscal year, together with an operating budget with respect to the following fiscal year, and, as soon as available, significant revisions, if any, of such projections with respect to such fiscal year (the "Projections"), which Projections shall in each case be accompanied by a certificate of a Responsible Officer of the Parent stating that such Projections are based on reasonable estimates, information and assumptions and that such Responsible Officer has no reason to believe that such Projections are incorrect or misleading in any material respect; (d) within 45 days after the end of each month of each fiscal year of the Parent, a narrative discussion and analysis of the financial condition and results of operations of the Borrowers for such month and for the period from the beginning of the then current fiscal year to the end of such month, as compared to the portion of the Projections covering such periods and to the comparable periods of the previous year; (e) within five days after the same are filed, copies of all financial statements and reports which the Parent or the Borrowers may make to, or file with, the Securities and Exchange Commission or any successor or analogous Governmental Authority; and (f) promptly, such additional financial and other information as any Lender may from time to time reasonably request. 6.3 Payment of Obligations. Pay, discharge or otherwise satisfy at or before maturity or before they become delinquent, as the case may be, all its material obligations of whatever nature, except where the amount or validity thereof is currently being contested in good faith by appropriate proceedings and reserves in conformity with GAAP with respect thereto have been provided on the books of the Parent, the Borrowers or their Subsidiaries, as the case may be. 6.4 Conduct of Business and Maintenance of Existence, etc. (a) Continue to engage in business of the same general type as now conducted by it, (b) preserve, renew and keep in full force and effect its existence and (c) take all reasonable action to maintain all rights, privileges and franchises necessary or desirable in the normal conduct of its business, except, in each case, as otherwise permitted pursuant to Section 7.5 and except, in the case of clause (c) above, to the extent that failure to do so could not reasonably be expected to have a Material Adverse Effect; and comply with all Contractual Obligations and Requirements of Law except to the extent that failure to comply therewith could not, in the aggregate, reasonably be expected to have a Material Adverse Effect. 6.5 Maintenance of Property; Insurance. (a) Keep all material property useful and necessary in its business in good working order and condition, ordinary wear and tear 63 57 excepted; (b) maintain with financially sound and reputable insurance companies insurance on all its property in at least such amounts and against at least such risks (but including in any event public liability, product liability and business interruption) as are usually insured against in the same general area by companies engaged in the same or a similar business; and (c) furnish to each Lender, upon written request, full information as to the insurance carried. 6.6 Inspection of Property; Books and Records; Discussions. Keep proper books of records and account in which full, true and correct entries in conformity with GAAP and all Requirements of Law shall be made of all dealings and transactions in relation to its business and activities; and upon reasonable notice permit representatives of any Lender to visit and inspect any of its properties and examine and make abstracts from any of its books and records at any reasonable time and as often as may reasonably be desired and to discuss the business, operations, properties and financial and other condition of the Parent, the Borrowers and their Subsidiaries with senior officers of the Parent, the Borrowers and their Subsidiaries and with its independent certified public accountants. 6.7 Notices. Promptly give notice to the Administrative Agent of: (a) the occurrence of any Default or Event of Default; (b) any (i) default or event of default under any Contractual Obligation of the Parent, the Borrowers or any of their Subsidiaries or (ii) litigation, investigation or proceeding which may exist at any time between the Parent, the Borrowers or any of their Subsidiaries and any Governmental Authority, which in either case, if not cured or if adversely determined, as the case may be, could reasonably be expected to have a Material Adverse Effect; (c) any litigation or proceeding affecting the Parent, the Borrowers or any of their Subsidiaries in which the amount involved is $250,000 or more and not covered by insurance or in which injunctive or similar relief is sought; (d) the following events, as soon as possible and in any event within 30 days after the Parent, the Borrowers or any of their Subsidiaries knows or has reason to know thereof: (i) the occurrence or expected occurrence of any Reportable Event with respect to any Plan, a failure to make any required contribution to a Plan, the creation of any Lien in favor of the PBGC or a Plan or any withdrawal from, or the termination, Reorganization or Insolvency of, any Multiemployer Plan or (ii) the institution of proceedings or the taking of any other action by the PBGC or the Borrowers or any Commonly Controlled Entity or any Multiemployer Plan with respect to the withdrawal from, or the terminating, Reorganization or Insolvency of, any Plan; and (e) any development or event which could reasonably be expected to have a Material Adverse Effect. 64 58 Each notice pursuant to this Section 6.7 shall be accompanied by a statement of a Responsible Officer of the Designated Borrower setting forth details of the occurrence referred to therein and stating what action the Parent, the relevant Borrower or the relevant Subsidiary proposes to take with respect thereto. 6.8 Environmental Laws. (a) Comply in all material respects with, and ensure compliance in all material respects by all tenants and subtenants, if any, with, all applicable Environmental Laws, and obtain and comply in all material respects with and maintain, and ensure that all tenants and subtenants obtain and comply in all material respects with and maintain, any and all licenses, approvals, notifications, registrations or permits required by applicable Environmental Laws. (b) Conduct and complete all investigations, studies, sampling and testing, and all remedial, removal and other actions required under Environmental Laws and promptly comply in all material respects with all lawful orders and directives of all Governmental Authorities regarding Environmental Laws. 6.9 Interest Rate Protection. In the case of the Borrowers, within 90 days after the Closing Date, enter into Interest Rate Protection Agreements with one or more of the Lenders providing interest rate protection with respect to at least $25,000,000 of the Term Loans for a period of at least 24 months at an interest rate not higher than 3% above the Eurodollar Rate that would be applicable to a six-month Interest Period commencing on the Closing Date. 6.10 Further Assurances. Upon the request of the Administrative Agent, promptly perform or cause to be performed any and all acts and execute or cause to be executed any and all documents (including, without limitation, financing statements and continuation statements) for filing under the provisions of the Uniform Commercial Code or any other Requirement of Law which are necessary or advisable to maintain in favor of the Administrative Agent, for the benefit of the Lenders, Liens on the Collateral that are duly perfected in accordance with all applicable Requirements of Law. 6.11 Additional Collateral. (a) With respect to any assets acquired after the Closing Date by the Parent, the Borrowers or any of their Subsidiaries that are intended to be subject to the Lien created by any of the Security Documents but which are not so subject (other than (y) any assets described in paragraph (b) of this Section and (z) immaterial assets a Lien on which cannot be perfected by filing UCC-1 financing statements), promptly (and in any event within 30 days after the acquisition thereof): (i) execute and deliver to the Administrative Agent such amendments to the relevant Security Documents or such other documents as the Administrative Agent shall deem necessary or advisable to grant to the Administrative Agent, for the benefit of the Lenders, a Lien on such assets, (ii) take all actions necessary or advisable to cause such Lien to be duly perfected in accordance with all applicable Requirements of Law, including, without limitation, the filing of financing statements in such jurisdictions as may be requested by the Administrative Agent, and (iii) if requested by the Administrative Agent, with respect to any material fee real property acquired by the Parent, the Borrowers or their Subsidiaries after the Closing Date, deliver to the 65 59 Administrative Agent legal opinions relating to the matters described in clauses (i) and (ii) immediately preceding, which opinions shall be in form and substance and from counsel reasonably satisfactory to the Administrative Agent. (b) With respect to any Person that, subsequent to the Closing Date, becomes a Subsidiary, promptly upon the request of the Administrative Agent: (i) execute and deliver to the Administrative Agent, for the benefit of the Lenders, a new pledge agreement or such amendments to the relevant Pledge Agreement as the Administrative Agent shall deem necessary or advisable to grant to the Administrative Agent, for the benefit of the Lenders, a Lien on the Capital Stock of such Subsidiary which is owned by the Parent, the Individual Shareholders, the Borrowers or any of their Subsidiaries, (ii) deliver to the Administrative Agent the certificates representing such Capital Stock, together with undated stock powers duly executed and delivered in blank, (iii) cause such new Subsidiary (A) to become a Borrower party hereto (in the case of a Subsidiary of the Parent) or a party to a guarantee and a security agreement (in the case of a Subsidiary of the Borrowers), in each case pursuant to documentation which is in form and substance satisfactory to the Administrative Agent, and (B) to take all actions necessary or advisable to cause the Lien created by such security agreement to be duly perfected in accordance with all applicable Requirements of Law, including, without limitation, the filing of financing statements in such jurisdictions as may be requested by the Administrative Agent and (iv) if requested by the Administrative Agent, deliver to the Administrative Agent legal opinions relating to the matters described in clauses (i), (ii) and (iii) immediately preceding, which opinions shall be in form and substance, and from counsel, reasonably satisfactory to the Administrative Agent. 6.12 Key Man Life Insurance. Obtain within 30 days after the Closing Date and maintain at all times thereafter key man life insurance policies in the amount of $3,000,000 on each of the Management Shareholders; and upon obtaining such policies, execute and deliver all documents and take all actions in respect thereof that would be required by subsection 5.1(b) if such policies were in effect on the Closing Date. 6.13 Store Locations. Maintain leases in accordance with past practices with respect to all store locations for the Borrowers and their Subsidiaries. 6.14 Landlord Waivers. Obtain landlords' waivers in form and substance satisfactory to the Arranger and/or the Administrative Agent relating to the Lender's security interest in the Borrower's assets for at least 20% of the leases on the Closing Date, 40% of the leases within 60 days after the Closing Date, 60% of the leases within 120 days after the Closing Date, 80% of the leases within 180 days after the Closing Date and 90% of the leases within one year after the Closing Date and thereafter. 6.15 Purchase Agreement Affirmative Covenants. Comply with Sections 7.01(a) - (o) and 7.03 of the Purchase Agreement, which Sections, together with all definitions of defined terms used in such Sections, are hereby incorporated by reference herein (without giving effect to any subsequent amendment or other modification thereof not consented to by the Required Lenders) as if such provisions were set forth in full herein. 66 60 6.16 Termination of Series C Preferred Voting Rights. Within five Business Days of the Closing Date, cause the Certificate of Designations of each Borrower to be amended to provide that (i) all voting rights of the Series C Preferred may be terminated by the Parent at any time during the continuance of an Event of Default if the Parent has been directed to do so by the Administrative Agent and (ii) all voting rights of the Series C Preferred will terminate automatically upon the occurrence of an Event of Default pursuant to Section 8(f). Upon receipt of a demand by the Administrative Agent to such effect at any time during the continuance of an Event of Default, the Parent shall immediately take all actions necessary to terminate all voting rights of the Series C Preferred. SECTION 7. NEGATIVE COVENANTS The Parent and the Borrowers hereby jointly and severally agree that, so long as the Commitments remain in effect, any Note or Letter of Credit remains outstanding and unpaid or any other amount is owing to any Lender or the Administrative Agent hereunder, the Parent and the Borrowers shall not, and shall not permit any of their respective Subsidiaries to, directly or indirectly: 7.1 Financial Condition Covenants. (a) Combined Total Debt Ratio. Permit the Combined Total Debt Ratio of the Borrowers and their Subsidiaries for any period of four consecutive fiscal quarters of the Borrowers ending with any fiscal quarter set forth below to exceed the ratio set forth below opposite such fiscal quarter:
Combined Fiscal Quarter Total Debt Ratio ---------------------- ---------------------- Third Quarter 1996 N.A. Fourth Quarter 1996 4.50 to 1.0 First Quarter 1997 4.50 to 1.0 Second Quarter 1997 4.50 to 1.0 Third Quarter 1997 4.25 to 1.0 Fourth Quarter 1997 3.50 to 1.0 First Quarter 1998 3.50 to 1.0 Second Quarter 1998 3.50 to 1.0 Third Quarter 1998 3.50 to 1.0 Fourth Quarter 1998 2.75 to 1.0 First Quarter 1999 2.75 to 1.0 Second Quarter 1999 2.75 to 1.0 Third Quarter 1999 2.50 to 1.0 Fourth Quarter 1999 2.15 to 1.0 First Quarter 2000 2.15 to 1.0
67 61
Combined Fiscal Quarter Total Debt Ratio ---------------------- ---------------------- Second Quarter 2000 2.15 to 1.0 Third Quarter 2000 1.90 to 1.0 Fourth Quarter 2000 1.60 to 1.0 First Quarter 2001 1.60 to 1.0 Second Quarter 2001 1.60 to 1.0 Third Quarter 2001 1.35 to 1.0 Fourth Quarter 2001 1.00 to 1.0 First Quarter 2002 1.00 to 1.0 Second Quarter 2002 .75 to 1.0
(b) Maintenance of Net Worth. Permit Combined Net Worth of the Borrowers and their Subsidiaries at any time during any fiscal quarter of the Borrowers set forth below to be less than the amount set forth below opposite such fiscal quarter:
Fiscal Quarter Net Worth -------------- ------------ Third Quarter 1996 $ 63,000,000 Fourth Quarter 1996 65,000,000 First Quarter 1997 65,000,000 Second Quarter 1997 65,000,000 Third Quarter 1997 65,000,000 Fourth Quarter 1997 72,000,000 First Quarter 1998 70,000,000 Second Quarter 1998 70,000,000 Third Quarter 1998 70,000,000 Fourth Quarter 1998 77,000,000 First Quarter 1999 75,000,000 Second Quarter 1999 75,000,000 Third Quarter 1999 75,000,000 Fourth Quarter 1999 85,000,000 First Quarter 2000 83,000,000 Second Quarter 2000 83,000,000 Third Quarter 2000 83,000,000 Fourth Quarter 2000 95,000,000 First Quarter 2001 93,000,000 Second Quarter 2001 93,000,000 Third Quarter 2001 93,000,000 Fourth Quarter 2001 105,000,000 First Quarter 2002 105,000,000
68 62
Fiscal Quarter Net Worth -------------- ------------ Second Quarter 2002 105,000,000
(c) Combined Interest Coverage Ratio. Permit the Combined Interest Coverage Ratio of the Borrowers and their Subsidiaries for any period of four consecutive fiscal quarters of the Borrowers ending with any fiscal quarter set forth below to be less than the ratio set forth below opposite such fiscal quarter:
Combined Interest Fiscal Quarter Coverage Ratio ---------------------- -------------- Third Quarter 1996 N.A. Fourth Quarter 1996 3.75 to 1.0 First Quarter 1997 2.50 to 1.0 Second Quarter 1997 2.20 to 1.0 Third Quarter 1997 2.20 to 1.0 Fourth Quarter 1997 2.40 to 1.0 First Quarter 1998 2.40 to 1.0 Second Quarter 1998 2.40 to 1.0 Third Quarter 1998 2.65 to 1.0 Fourth Quarter 1998 3.00 to 1.0 First Quarter 1999 3.00 to 1.0 Second Quarter 1999 3.00 to 1.0 Third Quarter 1999 3.25 to 1.0 Fourth Quarter 1999 3.75 to 1.0 First Quarter 2000 3.75 to 1.0 Second Quarter 2000 3.75 to 1.0 Third Quarter 2000 4.00 to 1.0 Fourth Quarter 2000 4.75 to 1.0 First Quarter 2001 4.75 to 1.0 Second Quarter 2001 4.75 to 1.0 Third Quarter 2001 5.00 to 1.0 Fourth Quarter 2001 5.75 to 1.0 First Quarter 2002 5.75 to 1.0 Second Quarter 2002 6.00 to 1.0
(d) Combined Fixed Charge Coverage Ratio. Permit the Combined Fixed Charge Coverage Ratio of the Borrowers and their Subsidiaries for any period of four consecutive fiscal quarters of the Borrowers ending with any fiscal quarter set forth below to be less than the ratio set forth below opposite such fiscal quarter: 69 63
Fiscal Quarter Combined Fixed Charge -------------- Coverage Ratio --------------------- Third Quarter 1996 N.A. Fourth Quarter 1996 1.35 to 1.00 First Quarter 1997 1.00 to 1.00 Second Quarter 1997 1.00 to 1.00 Third Quarter 1997 1.00 to 1.00 Fourth Quarter 1997 1.05 to 1.00 First Quarter 1998 1.00 to 1.00 Second Quarter 1998 1.00 to 1.00 Third Quarter 1998 1.00 to 1.00 Fourth Quarter 1998 1.05 to 1.00 First Quarter 1999 1.00 to 1.00 Second Quarter 1999 1.00 to 1.00 Third Quarter 1999 1.00 to 1.00 Fourth Quarter 1999 1.05 to 1.00 First Quarter 2000 1.00 to 1.00 Second Quarter 2000 1.00 to 1.00 Third Quarter 2000 1.00 to 1.00 Fourth Quarter 2000 1.10 to 1.00 First Quarter 2001 1.00 to 1.00 Second Quarter 2001 1.00 to 1.00 Third Quarter 2001 1.00 to 1.00 Fourth Quarter 2001 0.85 to 1.00 First Quarter 2002 0.85 to 1.00 Second Quarter 2002 0.75 to 1.00
7.2 Limitation on Indebtedness. Create, incur, assume or suffer to exist (in each case, to "Incur") any Indebtedness, except: (a) Indebtedness of the Borrowers under the Loan Documents and the Subordinated Debt; (b) Indebtedness of a Borrower to a Borrower or a Wholly Owned Subsidiary and of a Wholly Owned Subsidiary to a Borrower or any other Wholly Owned Subsidiary; (c) Indebtedness of a Borrower or any Subsidiary incurred to finance the acquisition of fixed or capital assets (whether pursuant to a loan, a Financing Lease or otherwise) in an aggregate principal amount not exceeding as to the Borrowers and their Subsidiaries $2,500,000 at any time outstanding; and 70 64 (d) Indebtedness outstanding on the date hereof and listed on Schedule 7.2(d). 7.3 Limitation on Liens. Create, incur, assume or suffer to exist any Lien upon any of its property, assets or revenues, whether now owned or hereafter acquired, except for: (a) Liens for taxes not yet due or which are being contested in good faith by appropriate proceedings, provided that adequate reserves with respect thereto are maintained on the books of the Parent, the Borrowers or their Subsidiaries, as the case may be, in conformity with GAAP; (b) carriers', warehousemen's, mechanics', materialmen's, repairmen's or other like Liens arising in the ordinary course of business which are not overdue for a period of more than 60 days or which are being contested in good faith by appropriate proceedings; (c) pledges or deposits in connection with workers' compensation, unemployment insurance and other social security legislation; (d) deposits to secure the performance of bids, trade contracts (other than for borrowed money), leases, statutory obligations, surety and appeal bonds, performance bonds and other obligations of a like nature incurred in the ordinary course of business; (e) easements, rights-of-way, restrictions and other similar encumbrances incurred in the ordinary course of business which, in the aggregate, are not substantial in amount and which do not in any case materially detract from the value of the property subject thereto or materially interfere with the ordinary conduct of the business of the Parent, the Borrowers or any Subsidiary; (f) Liens in existence on the date hereof listed on Schedule 7.3(f), securing Indebtedness permitted by Section 7.2(d), provided that no such Lien is spread to cover any additional property after the Closing Date and that the amount of Indebtedness secured thereby is not increased; (g) Liens securing Indebtedness of a Borrower or any Subsidiary incurred to finance the acquisition of fixed or capital assets, provided that (i) such Liens shall be created substantially simultaneously with the acquisition of such fixed or capital assets, (ii) such Liens do not at any time encumber any property other than the property financed by such Indebtedness, (iii) the amount of Indebtedness secured thereby is not increased and (iv) the proceeds of the Indebtedness secured by any such Lien shall at no time exceed 100% of the original purchase price of such property; (h) Liens created pursuant to the Security Documents; and 71 65 (i) Liens of landlords arising by operation of law, and Liens of a lessor under any lease entered into by a Borrower or any Subsidiary in the ordinary course of its business, to the extent the provisions of such leases relating to such Liens are standard and customary in the relevant market. 7.4 Limitation on Guarantee Obligations. Create, incur, assume or suffer to exist any Guarantee Obligation except: (a) Guarantee Obligations in existence on the date hereof and listed on Schedule 7.4(a); (b) guarantees made in the ordinary course of its business by the Parent or any Borrower of obligations of any of their respective Subsidiaries or a Borrower, as the case may be, which obligations are otherwise permitted under this Agreement; (c) Guarantee Obligations in respect of Standby Letters of Credit; and (d) the Guarantee Obligation of the Parent pursuant to Section 10; and (e) Guarantee Obligations in respect of loans by a third party to an employee of a Borrower or Subsidiary for the purchase of the Capital Stock of the Parent in an aggregate amount not to exceed at any one time outstanding (i) $1,000,000 minus (ii) the aggregate principal amount of any loans or advances made by the Parent or the Borrowers pursuant to Section 7.9(c)(ii). 7.5 Limitation on Fundamental Changes. Enter into any merger, consolidation or amalgamation, or liquidate, wind up or dissolve itself (or suffer any liquidation or dissolution), or convey, sell, lease, assign, transfer or otherwise dispose of, all or substantially all of its property, business or assets, or make any material change in its present method of conducting business, except: (a) any Wholly Owned Subsidiary of the Parent or Borrower may be merged or combined with or into any Borrower (provided that such Borrower shall be the continuing or surviving corporation); (b) any Wholly Owned Subsidiary or Borrower may sell, lease, transfer or otherwise dispose of any or all of its assets (upon voluntary liquidation or otherwise) to any Borrower or any other Wholly Owned Subsidiary of a Borrower; and (c) the Recapitalization, and (d) the Parent may liquidate, wind-up or dissolve itself so long as (i) at such time no Default or Event of Default shall have occurred and be continuing, (ii) the Parent has no material assets at the time of such transaction other than assets subject to the Lien of a Security Document and (iii) the distribution of such assets in such transaction is made subject to the Liens of the Security Documents and at the time of 72 66 such transaction the Borrowers and such recipients enter into such instruments and take such actions (including delivery to the Administrative Agent of appropriate legal opinions) as shall be reasonably requested by the Administrative Agent to ensure and evidence that the Liens of the Security Documents on such assets are unaffected by such transaction. 7.6 Limitation on Sale of Assets. Convey, sell, lease, assign, transfer or otherwise dispose of any of its property, business or assets (including, without limitation, receivables and leasehold interests), whether now owned or hereafter acquired, or, in the case of any Subsidiary of the Parent or any Borrower, issue or sell any shares of such Subsidiary's Capital Stock to any Person, except: (a) the sale or other disposition of obsolete or worn out property in the ordinary course of business having a fair market value not to exceed, in the aggregate, $500,000 in any period of twelve consecutive months; (b) the sale or other disposition of any property in the ordinary course of business, provided that (other than inventory) the aggregate book value of all assets so sold or disposed of in any period of twelve consecutive months shall not exceed $500,000; (c) the sale of inventory in the ordinary course of business; and (d) as permitted by Section 7.5(b). 7.7 Limitation on Restricted Payments. Declare or pay any dividend (other than dividends payable solely in common stock of the Person making such dividend) on, or make any payment on account of, or set apart assets for a sinking or other analogous fund for, the purchase, redemption, defeasance, retirement or other acquisition of, any shares of any class of Capital Stock of the Parent, the Borrowers or any Subsidiary or any warrants or options to purchase any such Capital Stock, whether now or hereafter outstanding, or make any other distribution in respect thereof, either directly or indirectly, whether in cash or property or in obligations of the Parent, the Borrowers or any Subsidiary (collectively, "Restricted Payments"), except: (a) payments of interest on the Subordinated Debt in accordance with the Subordination Agreement and the Purchase Agreement; (b) so long as (i) no Default or Event of Default shall have occurred and be continuing, (ii) there is Excess Cash Flow for the most recently ended fiscal year of the Borrowers and (iii) the Combined Management Fee Ratio for such fiscal year is greater than 3.25 to 1.00 in the case of the 1996 fiscal year, 2.25 to 1.00 in the case of the 1997 fiscal year, 2.75 to 1.00 in the case of the 1998 fiscal year, 3.50 to 1.00 in the case of the 1999 fiscal year, 4.50 to 1.00 in the case of the 2000 fiscal year, and 5.50 to 1.00 in the case of the 2001 and 2002 fiscal years, then the Borrowers may pay Management Fees to the Individual Shareholders in an amount not to exceed 73 67 $1,000,000 per year in the case of the 1996 fiscal year and $1,800,000 per year otherwise in the aggregate during the thirty-day period after the date on which the financial statements of the Borrowers referred to in Section 6.1(a) with respect to the fiscal year ending with such fourth fiscal quarter are delivered to the Lenders; and (c) so long as no Default or Event of Default shall have occurred and be continuing, purchases or redemptions of the Capital Stock of the Parent, the Borrowers or their Subsidiaries held by employees of the Borrowers, other than the Individual Shareholders, in an aggregate amount not to exceed $500,000 per year and $1,000,000 in total. 7.8 Limitation on Capital Expenditures. Make or commit to make (by way of the acquisition of securities of a Person or otherwise) any Capital Expenditure (excluding any such asset acquired in connection with normal replacement and maintenance programs properly charged to current operations) except for expenditures in the ordinary course of business not exceeding, in the aggregate for the Borrowers and their Subsidiaries during any of the fiscal years of the Borrowers set forth below, the amount set forth opposite such fiscal year below:
Fiscal Year Amount ----------- ----------- Closing Date-FYE 1996 $3,500,000 1997 $5,000,000 1998 $5,500,000 1999 $5,500,000 2000 $6,000,000 2001 $6,500,000 2002 $6,500,000
provided that not more than 20 new retail store locations on premises owned by the Borrowers in fee or subject to a long-term lease shall be opened in fiscal year 1996; not more than 22 new retail store locations on premises owned by the Borrowers in fee or subject to a long-term lease shall be opened in fiscal year 1997; and not more than 25 new retail store locations on premises owned by the Borrowers in fee or subject to a long-term lease may be opened in any fiscal year after 1997. 7.9 Limitation on Investments, Loans and Advances. Make any advance, loan, extension of credit or capital contribution to, or purchase any stock, bonds, notes, debentures or other securities of or any assets constituting a business unit of, or make any other investment in, any Person, except: (a) extensions of trade credit in the ordinary course of business; (b) investments in Cash Equivalents; 74 68 (c) loans and advances to employees of a Borrower or Subsidiary for (i) travel, entertainment and relocation expenses in the ordinary course of business in an aggregate amount for the Borrowers and their Subsidiaries not to exceed $250,000 at any one time outstanding and (ii) the purchase of the Capital Stock of the Parent in an aggregate principal amount not to exceed at any one time outstanding (A) $1,000,000 minus (B) the aggregate principal amount of any loans guaranteed by the Parent or the Borrowers pursuant to Section 7.4(e); and (d) investments by any Borrower in any Borrower or a Wholly Owned Subsidiary and investments by any Wholly Owned Subsidiary in any Borrower and in other Wholly Owned Subsidiaries. 7.10 Limitation on Optional Payments and Modifications of Debt Instruments and Preferred Stock, etc. (a) Make any optional payment or prepayment on or redemption or purchase of any material Indebtedness (other than the Loans) or preferred stock, including, without limitation, the Subordinated Debt and the Preferred Stock, (b) amend, modify or change, or consent or agree to any amendment, modification or change to any of the terms of any such Indebtedness, including but not limited to the Subordinated Debt (other than any such amendment, modification or change which would extend the maturity or reduce the amount of any payment of principal thereof or which would reduce the rate or extend the date for payment of interest or dividends thereon), (c) amend the Subordination Agreement, (d) amend, modify or change in any material respect, or consent or agree to any amendment, modification, or change in any material respect to the terms of the Preferred Stock or any other capitalization or organizational documents, except as contemplated by Section 6.4.2 of the amended and restated charter of the Borrowers as in effect on the Closing Date; (e) amend, modify or change, the Shareholders Agreement or the Registration Rights Agreement in a manner that would adversely affect the rights or interests of the Borrowers, the Administrative Agent or the Lenders or (f) amend, modify, renew or extend the Management Contracts in a manner which (i) would have the effect of increasing the compensation due the Management Shareholders in the aggregate to an amount in excess of $750,000 in any fiscal year or (ii) otherwise would adversely affect the rights or interests of the Administrative Agent or the Lenders. 7.11 Limitation on Transactions with Affiliates. Except as set forth on Schedule 7.11, enter into any transaction, including, without limitation, any purchase, sale, lease or exchange of property or the rendering of any service, with any Affiliate (other than the Parent or the Borrowers) unless such transaction (a) is otherwise permitted under this Agreement, (b) is in the ordinary course of the Parent's, the Borrowers or such Subsidiary's business, (c) is upon fair and reasonable terms no less favorable to the Parent, the Borrowers or such Subsidiary, as the case may be, than it would obtain in a comparable arm's length transaction with a Person which is not an Affiliate and (d) is (unless immaterial) disclosed in writing to the Administrative Agent. 7.12 Limitation on Sales and Leasebacks. Enter into any arrangement with any Person providing for the leasing by the Parent, the Borrowers or any Subsidiary of real or personal property which has been or is to be sold or transferred by the Parent, the Borrowers 75 69 or such Subsidiary to such Person or to any other Person to whom funds have been or are to be advanced by such Person on the security of such property or rental obligations of the Parent, the Borrowers or such Subsidiary. 7.13 Limitation on Changes in Fiscal Year. Permit the fiscal year of the Parent, the Borrowers or any of their respective Subsidiaries to end on a day other than December 31. 7.14 Limitation on Negative Pledge Clauses. Enter into with any Person, or suffer to exist, any agreement, other than (a) this Agreement and the other Loan Documents and the Purchase Agreement or (b) any industrial revenue bonds, purchase money mortgages or Financing Leases permitted by this Agreement (in which cases, any prohibition or limitation shall only be effective against the assets financed thereby) which prohibits or limits the ability of the Parent, the Borrowers or any of their Subsidiaries to create, incur, assume or suffer to exist any Lien upon any of its property, assets or revenues, whether now owned or hereafter acquired. 7.15 Limitation on Lines of Business. Enter into any business, either directly or through any Subsidiary, except for those businesses in which the Borrowers and their Subsidiaries are engaged on the date of this Agreement or which are reasonably related thereto. 7.16 Limitation on Activities of the Parent. In the case of the Parent, notwithstanding anything to the contrary in this Agreement or any other Loan Document, (a) conduct, transact or otherwise engage in, or commit to conduct, transact or otherwise engage in, any business or operations other than those incidental to its ownership of the Capital Stock of the Borrowers, (b) incur, create, assume or suffer to exist any Indebtedness or other liabilities or financial obligations, except (i) nonconsensual obligations imposed by operation of law, (ii) pursuant to the Loan Documents to which it is a party and (iii) obligations with respect to its Capital Stock (other than any such obligations constituting Indebtedness), (c) own, lease, manage or otherwise operate any properties or assets (including cash (other than cash received in connection with dividends made by the Borrowers in accordance with Section 7.7 pending application in the manner contemplated by said Section) and cash equivalents) other than the ownership of shares of Capital Stock of the Borrowers or (d) create or permit to exist any Subsidiary of the Parent or any Borrower other than a wholly owned Subsidiary. 7.17 Purchase Agreement Negative Covenants. Fail to comply with Section 7.02 of the Purchase Agreement, which Section, together with all definitions of defined terms used in such Section, are hereby incorporated by reference herein (without giving effect to any subsequent amendment or other modification thereof not consented to by the Required Lenders) as if such provisions were set forth in full herein. 76 70 SECTION 8. EVENTS OF DEFAULT If any of the following events shall occur and be continuing: (a) The Borrowers shall fail to pay any principal of any Loan or Reimbursement Obligation when due in accordance with the terms hereof; or the Borrowers shall fail to pay any interest on any Loan or Reimbursement Obligation, or any other amount payable hereunder or under any other Loan Document, within five days after any such interest or other amount becomes due in accordance with the terms hereof; or (b) Any representation or warranty made or deemed made by the Parent, a Borrower or any other Loan Party herein or in any other Loan Document or which is contained in any certificate, document or financial or other statement furnished by it at any time under or in connection with this Agreement or any such other Loan Document shall prove to have been incorrect in any material respect on or as of the date made or deemed made; or (c) (i) The Parent, a Borrower or any other Loan Party shall default in the observance or performance of any agreement contained in Section 2.7, 6.1(a), 6.7, 6.9, or 7, Section 5(b) of the Parent Pledge Agreement, Section 5(b) of the Management Pledge Agreement or Section 4.4 of the Borrowers Security Agreement or (ii) an Event of Default (as defined in the Mortgage) shall occur under any Mortgage; or (d) The Parent, a Borrower or any other Loan Party shall default in the observance or performance of any other agreement contained in this Agreement or any other Loan Document (other than as provided in paragraphs (a) through (c) of this Section), and such default shall continue unremedied for a period of 30 days after notice to the Parent, Borrower or other Loan Party, as applicable, from the Administrative Agent or the Required Lenders; or (e) The Parent, a Borrower or any Subsidiary shall (i) default in making any payment of any principal of any Indebtedness (including, without limitation, any Guarantee Obligation) on the scheduled or original due date with respect thereto; or (ii) default in making any payment of any interest on any such Indebtedness beyond the period of grace, if any, provided in the instrument or agreement under which such Indebtedness was created; or (iii) default in the observance or performance of any other agreement or condition relating to any such Indebtedness or contained in any instrument or agreement evidencing, securing or relating thereto, or any other event shall occur or condition exist, the effect of which default or other event or condition is to cause, or to permit the holder or beneficiary of such Indebtedness (or a trustee or agent on behalf of such holder or beneficiary) to cause, with the giving of notice if required, such Indebtedness to become due prior to its stated maturity or (in the case of any such Indebtedness constituting a Guarantee Obligation) to become payable; provided, that a default, event or condition described in clause (i), (ii) or (iii) of this paragraph (e) shall not at any time constitute an Event of Default under this 77 71 Agreement unless, at such time, one or more defaults, events or conditions of the type described in clauses (i), (ii) and (iii) of this paragraph (e) shall have occurred and be continuing with respect to Indebtedness and/or Guarantee Obligations of the Parent, the Borrowers and all Subsidiaries the outstanding principal amount of which exceeds in the aggregate $250,000; or (f) (i) The Parent, a Borrower or any Subsidiary shall commence any case, proceeding or other action (A) under any existing or future law of any jurisdiction, domestic or foreign, relating to bankruptcy, insolvency, reorganization or relief of debtors, seeking to have an order for relief entered with respect to it, or seeking to adjudicate it a bankrupt or insolvent, or seeking reorganization, arrangement, adjustment, winding-up, liquidation, dissolution, composition or other relief with respect to it or its debts, or (B) seeking appointment of a receiver, trustee, custodian, conservator or other similar official for it or for all or any substantial part of its assets, or the Parent, a Borrower or any Subsidiary shall make a general assignment for the benefit of its creditors; or (ii) there shall be commenced against the Parent, a Borrower or any Subsidiary any case, proceeding or other action of a nature referred to in clause (i) above which (A) results in the entry of an order for relief or any such adjudication or appointment or (B) remains undismissed, undischarged or unbonded for a period of 60 days; or (iii) there shall be commenced against the Parent, a Borrower or any Subsidiary any case, proceeding or other action seeking issuance of a warrant of attachment, execution, distraint or similar process against all or any substantial part of its assets which results in the entry of an order for any such relief which shall not have been vacated, discharged, or stayed or bonded pending appeal within 60 days from the entry thereof; or (iv) the Parent, a Borrower or any Subsidiary shall take any action in furtherance of, or indicating its consent to, approval of, or acquiescence in, any of the acts set forth in clause (i), (ii), or (iii) above; or (v) the Parent, a Borrower or any Subsidiary shall generally not, or shall be unable to, or shall admit in writing its inability to, pay its debts as they become due; or (g) (i) Any Person shall engage in any "prohibited transaction" (as defined in Section 406 of ERISA or Section 4975 of the Code) involving any Plan, (ii) any "accumulated funding deficiency" (as defined in Section 302 of ERISA), whether or not waived, shall exist with respect to any Plan or any Lien in favor of the PBGC or a Plan shall arise on the assets of a Borrower, a Subsidiary or any Commonly Controlled Entity, (iii) a Reportable Event shall occur with respect to, or proceedings shall commence to have a trustee appointed, or a trustee shall be appointed, to administer or to terminate, any Single Employer Plan, which Reportable Event or commencement of proceedings or appointment of a trustee is, in the reasonable opinion of the Required Lenders, likely to result in the termination of such Plan for purposes of Title IV of ERISA, (iv) any Single Employer Plan shall terminate for purposes of Title IV of ERISA, (v) a Borrower, a Subsidiary or any Commonly Controlled Entity shall, or in the reasonable opinion of the Required Lenders is likely to, incur any liability in connection with a withdrawal from, or the Insolvency or Reorganization of, a Multiemployer Plan or (vi) any other event or condition shall occur or exist with respect to a Plan; and in each case in clauses (i) through (vi) above, such event or 78 72 condition, together with all other such events or conditions, if any, could, in the sole judgment of the Required Lenders, reasonably be expected to have a Material Adverse Effect; or (h) One or more judgments or decrees shall be entered against the Parent, the Borrowers or any of their Subsidiaries involving in the aggregate a liability (not paid or fully covered by insurance) of $250,000 or more, and all such judgments or decrees shall not have been vacated, discharged, stayed or bonded pending appeal within 60 days from the entry thereof; or (i) Any of the Security Documents shall cease, for any reason, to be in full force and effect, or any Loan Party or any Affiliate of any Loan Party shall so assert, or any Lien created by any of the Security Documents shall cease to be enforceable and of the same effect and priority purported to be created thereby; or (j) Section 10 shall cease, for any reason, to be in full force and effect or the Parent shall so assert; or (k) (i) The Parent and the Management Shareholders shall cease to have the power (whether or not exercised) to elect a majority of the directors of any of the Borrowers, (ii) the Parent shall cease to own and control, of record and beneficially, directly, 60% of the outstanding Capital Stock of each Borrower, (iii) the Advent Funds and the Management Shareholders shall cease to own and control, directly or indirectly, 60% of the outstanding Capital Stock of each Borrower, (iv) the Advent Funds shall cease to own and control, of record and beneficially, directly, 55% of the member interests of the Parent, (v) the Advent Funds shall cease to own and control, directly or indirectly, 35% of the outstanding Capital Stock of each Borrower; provided, that (A) each of the foregoing ownership percentages in respect of the Borrower will be reduced to give effect to the dilution resulting from the exercise of the Warrants and (B) each of the foregoing shall be amended by the Administrative Agent and the Borrowers at the time of any transaction permitted by Section 7.5(d) to provide for such transaction or (vi) a "Change of Control" as defined in the Purchase Agreement shall occur and be continuing; or (l) (i) There shall have occurred any amendment, supplement or other modification of the Purchase Agreement or the Subordination Agreement, which in any such case shall not have been consented to in advance in writing by the Administrative Agent and the Required Lenders, except to the extent such amendment, supplement or modification is expressly permitted by Section 7.10 or (ii) the Subordination Agreement shall cease, for any reason, to be valid or any Loan Party or any of its Subsidiaries shall so assert in writing; or (m) There shall have occurred an "Event of Default" as defined in the Purchase Agreement; 79 73 then, and in any such event, (A) if such event is an Event of Default specified in clause (i) or (ii) of paragraph (f) above with respect to the Parent, a Borrower or any Subsidiary, automatically the Commitments shall immediately terminate and the Loans hereunder (with accrued interest thereon) and all other amounts owing under this Agreement and the other Loan Documents (including, without limitation, all amounts of L/C Obligations, whether or not the beneficiaries of the then outstanding Letters of Credit shall have presented the documents required thereunder) shall immediately become due and payable, and (B) if such event is any other Event of Default, either or both of the following actions may be taken: (i) with the consent of the Required Lenders, the Administrative Agent may, or upon the request of the Required Lenders, the Administrative Agent shall, by notice to the Designated Borrower declare the Commitments to be terminated forthwith, whereupon the Commitments shall immediately terminate; and (ii) with the consent of the Required Lenders, the Administrative Agent may, or upon the request of the Required Lenders, the Administrative Agent shall, by notice to the Designated Borrower, declare the Loans hereunder (with accrued interest thereon) and all other amounts owing under this Agreement and the other Loan Documents (including, without limitation, all amounts of L/C Obligations, whether or not the beneficiaries of the then outstanding Letters of Credit shall have presented the documents required thereunder) to be due and payable forthwith, whereupon the same shall immediately become due and payable. With respect to all Letters of Credit with respect to which presentment for honor shall not have occurred at the time of an acceleration pursuant to this paragraph, the Borrowers shall at such time deposit in a cash collateral account opened by the Administrative Agent an amount equal to the aggregate then undrawn and unexpired amount of such Letters of Credit. Amounts held in such cash collateral account shall be applied by the Administrative Agent to the payment of drafts drawn under such Letters of Credit, and the unused portion thereof after all such Letters of Credit shall have expired or been fully drawn upon, if any, shall be applied to repay other obligations of the Borrowers hereunder and under the other Loan Documents. After all such Letters of Credit shall have expired or been fully drawn upon, all Reimbursement Obligations shall have been satisfied and all other obligations of the Borrowers hereunder and under the other Loan Documents shall have been paid in full, the balance, if any, in such cash collateral account shall be returned to the Borrowers (or such other Person as may be lawfully entitled thereto). Except as expressly provided above in this Section, presentment, demand, protest and all other notices of any kind are hereby expressly waived. SECTION 9. THE ADMINISTRATIVE AGENT 9.1 Appointment. Each Lender hereby irrevocably designates and appoints the Administrative Agent as the agent of such Lender under this Agreement and the other Loan Documents, and each Lender irrevocably authorizes the Administrative Agent, in such capacity, to take such action on its behalf under the provisions of this Agreement and the other Loan Documents and to exercise such powers and perform such duties as are expressly delegated to the Administrative Agent by the terms of this Agreement and the other Loan Documents, together with such other powers as are reasonably incidental thereto. Notwithstanding any provision to the contrary elsewhere in this Agreement, the Administrative Agent shall not have any duties or responsibilities, except those expressly set 80 74 forth herein, or any fiduciary relationship with any Lender, and no implied covenants, functions, responsibilities, duties, obligations or liabilities shall be read into this Agreement or any other Loan Document or otherwise exist against the Administrative Agent. 9.2 Delegation of Duties. The Administrative Agent may execute any of its duties under this Agreement and the other Loan Documents by or through agents or attorneys-in-fact and shall be entitled to advice of counsel concerning all matters pertaining to such duties. The Administrative Agent shall not be responsible for the negligence or misconduct of any agents or attorneys in-fact selected by it with reasonable care. 9.3 Exculpatory Provisions. Neither the Administrative Agent nor any of its officers, directors, employees, agents, attorneys-in-fact or Affiliates shall be (i) liable for any action lawfully taken or omitted to be taken by it or such Person under or in connection with this Agreement or any other Loan Document (except to the extent that any of the foregoing are found by a final and nonappealable decision of a court of competent jurisdiction to have resulted from its or such Person's own gross negligence or willful misconduct) or (ii) responsible in any manner to any of the Lenders for any recitals, statements, representations or warranties made by any Loan Party or any officer thereof contained in this Agreement or any other Loan Document or in any certificate, report, statement or other document referred to or provided for in, or received by the Administrative Agent under or in connection with, this Agreement or any other Loan Document or for the value, validity, effectiveness, genuineness, enforceability or sufficiency of this Agreement or the Notes or any other Loan Document or for any failure of any Loan Party a party thereto to perform its obligations hereunder or thereunder. The Administrative Agent shall not be under any obligation to any Lender to ascertain or to inquire as to the observance or performance of any of the agreements contained in, or conditions of, this Agreement or any other Loan Document, or to inspect the properties, books or records of any Loan Party. The Administrative Agent shall not be responsible for any actions or approvals taken or granted by the Arranger. 9.4 Reliance by Administrative Agent. The Administrative Agent shall be entitled to rely, and shall be fully protected in relying, upon any Note, writing, resolution, notice, consent, certificate, affidavit, letter, telecopy, telex or teletype message, statement, order or other document or conversation believed by it to be genuine and correct and to have been signed, sent or made by the proper Person or Persons and upon advice and statements of legal counsel (including, without limitation, counsel to the Parent or the Borrowers), independent accountants and other experts selected by the Administrative Agent. The Administrative Agent may deem and treat the payee of any Note as the owner thereof for all purposes unless a written notice of assignment, negotiation or transfer thereof shall have been filed with the Administrative Agent. The Administrative Agent shall be fully justified in failing or refusing to take any action under this Agreement or any other Loan Document unless it shall first receive such advice or concurrence of the Required Lenders (or, if so specified by this Agreement, all Lenders) as it deems appropriate or it shall first be indemnified to its satisfaction by the Lenders against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action. The Administrative Agent shall in all cases be fully protected in acting, or in refraining from acting, under this Agreement and the other Loan Documents in accordance with a request of 81 75 the Required Lenders (or, if so specified by this Agreement, all Lenders), and such request and any action taken or failure to act pursuant thereto shall be binding upon all the Lenders and all future holders of the Notes. 9.5 Notice of Default. The Administrative Agent shall not be deemed to have knowledge or notice of the occurrence of any Default or Event of Default hereunder unless the Administrative Agent has received written notice from a Lender, the Parent or the Borrowers referring to this Agreement, describing such Default or Event of Default and stating that such notice is a "notice of default". In the event that the Administrative Agent receives such a notice, the Administrative Agent shall give notice thereof to the Lenders. The Administrative Agent shall take such action with respect to such Default or Event of Default as shall be reasonably directed by the Required Lenders (or, if so specified by this Agreement, all Lenders); provided that unless and until the Administrative Agent shall have received such directions, the Administrative Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Default or Event of Default as it shall deem advisable in the best interests of the Lenders. 9.6 Non-Reliance on Administrative Agent and Other Lenders. Each Lender expressly acknowledges that neither the Administrative Agent nor any of its officers, directors, employees, agents, attorneys-in-fact or Affiliates has made any representations or warranties to it and that no act by the Administrative Agent hereinafter taken, including any review of the affairs of a Loan Party or any Affiliate of a Loan Party, shall be deemed to constitute any representation or warranty by the Administrative Agent to any Lender. Each Lender represents to the Administrative Agent that it has, independently and without reliance upon the Administrative Agent or any other Lender, and based on such documents and information as it has deemed appropriate, made its own appraisal of and investigation into the business, operations, property, financial and other condition and creditworthiness of the Loan Parties and their Affiliates and made its own decision to make its Loans hereunder and enter into this Agreement. Each Lender also represents that it will, independently and without reliance upon the Administrative Agent or any other Lender, and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit analysis, appraisals and decisions in taking or not taking action under this Agreement and the other Loan Documents, and to make such investigation as it deems necessary to inform itself as to the business, operations, property, financial and other condition and creditworthiness of the Loan Parties and their Affiliates. Except for notices, reports and other documents expressly required to be furnished to the Lenders by the Administrative Agent hereunder, the Administrative Agent shall not have any duty or responsibility to provide any Lender with any credit or other information concerning the business, operations, property, condition (financial or otherwise), prospects or creditworthiness of any Loan Party or any Affiliate of a Loan Party which may come into the possession of the Administrative Agent or any of its officers, directors, employees, agents, attorneys-in-fact or Affiliates. 9.7 Indemnification. The Lenders agree to indemnify the Administrative Agent in its capacity as such (to the extent not reimbursed by the Parent or the Borrowers and without limiting the obligation of the Parent or the Borrowers to do so), ratably according to their respective Revolving Credit Percentages, Tranche A Term Loan Percentages and 82 76 Tranche B Term Loan Percentages in effect on the date on which indemnification is sought under this Section 9.7, from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind whatsoever which may at any time (including, without limitation, at any time following the payment of the Notes) be imposed on, incurred by or asserted against the Administrative Agent in any way relating to or arising out of, the Commitments, this Agreement, any of the other Loan Documents or any documents contemplated by or referred to herein or therein or the transactions contemplated hereby or thereby or any action taken or omitted by the Administrative Agent under or in connection with any of the foregoing; provided that no Lender shall be liable for the payment of any portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements which are found by a final and nonappealable decision of a court of competent jurisdiction to have resulted from the Administrative Agent's gross negligence or willful misconduct. The agreements in this Section 9.7 shall survive the payment of the Notes and all other amounts payable hereunder. 9.8 Administrative Agent in Its Individual Capacity. The Administrative Agent and its Affiliates may make loans to, accept deposits from and generally engage in any kind of business with any Loan Party as though the Administrative Agent were not the Administrative Agent hereunder and under the other Loan Documents. With respect to its Loans made or renewed by it and any Note issued to it and with respect to any Letter of Credit issued or participated in by it, the Administrative Agent shall have the same rights and powers under this Agreement and the other Loan Documents as any Lender and may exercise the same as though it were not the Administrative Agent, and the terms "Lender" and "Lenders" shall include the Administrative Agent in its individual capacity. 9.9 Successor Administrative Agent. The Administrative Agent may resign as Administrative Agent upon 10 days' notice to the Lenders. If the Administrative Agent shall resign as Administrative Agent under this Agreement and the other Loan Documents, then the Required Lenders shall appoint from among the Lenders a successor agent for the Lenders, which successor agent shall have been approved by the Parent and the Borrowers (which approval shall not be unreasonably withheld or delayed), whereupon such successor agent shall succeed to the rights, powers and duties of the Administrative Agent hereunder. Effective upon such apportionment and approval, the term "Administrative Agent" shall mean such successor agent and the former Administrative Agent's rights, powers and duties as Administrative Agent shall be terminated, without any other or further act or deed on the part of such former Administrative Agent or any of the parties to this Agreement or any holders of the Notes. After any retiring Administrative Agent's resignation as Administrative Agent, the provisions of this Section 9 shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Administrative Agent under this Agreement and the other Loan Documents. The Required Lenders, with the consent of the Designated Borrower, may replace the Administrative Agent, provided, however, that if a Default or an Event of Default shall occur and be continuing the consent of the Designated Borrower shall not be required. 9.10 The Arranger. The Arranger, in its capacity as such, shall not have any duties or responsibilities hereunder or under any Loan Document nor any fiduciary 83 77 relationship with any Lender, and no implied covenants, functions, responsibilities duties, obligations or liabilities shall be read into this Agreement or otherwise exist against the Arranger in its capacity as such. SECTION 10. GUARANTEE 10.1 Guarantee. To induce the Administrative Agent and the Lenders to execute and deliver this Agreement and to make or maintain the Loans hereunder, and in consideration thereof, the Parent hereby unconditionally and irrevocably guarantees to the Administrative Agent, for the ratable benefit of the Lenders, the prompt and complete payment and performance by the Borrowers when due (whether at stated maturity, by acceleration or otherwise) of the Obligations, and the Parent further agrees to pay any and all expenses (including, without limitation, all reasonable fees, charges and disbursements of counsel) which may be paid or incurred by the Administrative Agent or by the Lenders in enforcing, or obtaining advice of counsel in respect of, any of their rights under the guarantee contained in this Section 10. The guarantee contained in this Section 10, subject to Section 10.5, shall remain in full force and effect until the Obligations are paid in full, the Revolving Credit Commitments are terminated and no Letters of Credit are outstanding, notwithstanding that from time to time prior thereto the Borrowers may be free from any Obligations. 10.2 No Subrogation, Contribution, Reimbursement or Indemnity. Notwithstanding any payment or payments made by the Parent hereunder or any set-off or application of funds of the Parent by any Lender, the Parent shall not be entitled to be subrogated to any of the rights of the Administrative Agent or any Lender against the Borrowers or any collateral security or guarantee or right of offset held by any Lender for the payment of the Obligations, nor shall the Parent seek or be entitled to seek any contribution or reimbursement from the Borrowers in respect of payments made by the Parent hereunder, until all amounts owing to the Administrative Agent and the Lenders by the Borrowers on account of the Obligations are paid in full, no Letters of Credit are outstanding and the Revolving Credit Commitments are terminated. If any amount shall be paid to the Parent on account of such subrogation rights at any time when all of the Obligations shall not have been paid in full, any Letter of Credit shall be outstanding or the Revolving Credit Commitments shall not have been terminated, such amount shall be held by the Parent in trust for the Administrative Agent and the Lenders, segregated from other funds of the Parent, and shall, forthwith upon receipt by the Parent, be turned over to the Administrative Agent in the exact form received by the Parent (duly indorsed by the Parent to the Administrative Agent, if required), to be applied against the Obligations, whether matured or unmatured, in such order as the Administrative Agent may determine. The Parent hereby further irrevocably waives all contractual, common law, statutory and other rights of reimbursement, contribution, exoneration or indemnity (or any similar right) from or against the Borrowers or any other Person which may have arisen in connection with the guarantee contained in this Section 10. 10.3 Amendments, etc. with respect to the Obligations. The Parent shall remain obligated under this Section 10 notwithstanding that, without any reservation of rights against the Parent, and without notice to or further assent by the Parent, any demand for 84 78 payment of or reduction in the principal amount of any of the Obligations made by the Administrative Agent or any Lender may be rescinded by the Administrative Agent or such Lender, and any of the Obligations continued, and the Obligations, or the liability of any other party upon or for any part thereof, or any collateral security or guarantee therefor or right of offset with respect thereto, may, from time to time, in whole or in part, be renewed, extended, amended, modified, accelerated, compromised, waived, surrendered or released by the Administrative Agent or any Lender, and this Agreement, any other Loan Document, and any other documents executed and delivered in connection therewith may be amended, modified, supplemented or terminated, in whole or in part, as the Lenders (or the Required Lenders, as the case may be) may deem advisable from time to time, and any collateral security, guarantee or right of offset at any time held by the Administrative Agent or any Lender for the payment of the Obligations may be sold, exchanged, waived, surrendered or released. Neither the Administrative Agent nor any Lender shall have any obligation to protect, secure, perfect or insure any Lien at any time held by it as security for the Obligations or for the guarantee contained in this Section 10 or any property subject thereto. 10.4 Guarantee Absolute and Unconditional. The Parent waives any and all notice of the creation, renewal, extension or accrual of any of the Obligations and notice of or proof of reliance by the Administrative Agent or any Lender upon the guarantee contained in this Section 10 or acceptance of the guarantee contained in this Section 10; the Obligations, and any of them, shall conclusively be deemed to have been created, contracted or incurred, or renewed, extended, amended or waived, in reliance upon the guarantee contained in this Section 10; and all dealings between any Borrower or the Parent, on the one hand, and the Administrative Agent and the Lenders, on the other, shall likewise be conclusively presumed to have been had or consummated in reliance upon the guarantee contained in this Section 10. The Parent waives diligence, presentment, protest, demand for payment and notice of default or nonpayment to or upon the Borrowers or the Parent with respect to the Obligations. The guarantee contained in this Section 10 shall be construed as a continuing, absolute and unconditional guarantee of payment without regard to (a) the validity or enforceability of this Agreement or any other Loan Document, any of the Obligations or any collateral security therefor or guarantee or right of offset with respect thereto at any time or from time to time held by the Administrative Agent or any Lender, (b) any defense, setoff or counterclaim (other than a defense of payment or performance) which may at any time be available to or be asserted by any Borrower against the Administrative Agent or any Lender, or (c) any other circumstance whatsoever (with or without notice to or knowledge of any Borrower or the Parent) which constitutes, or might be construed to constitute, an equitable or legal discharge of any Borrower for the Obligations, or of the Parent under the guarantee contained in this Section 10, in bankruptcy or in any other instance. When the Administrative Agent or any Lender is pursuing its rights and remedies under this Section 10 against the Parent, the Administrative Agent or any Lender may, but shall be under no obligation to, pursue such rights and remedies as it may have against any Borrower or any other Person or against any collateral security or guarantee for the Obligations or any right of offset with respect thereto, and any failure by the Administrative Agent or any Lender to pursue such other rights or remedies or to collect any payments from any Borrower or any such other Person or to realize upon any such collateral security or guarantee or to exercise any such right of offset, or any release of the Borrowers or any such other Person or of any such collateral security, guarantee 85 79 or right of offset, shall not relieve the Parent of any liability under this Section 10, and shall not impair or affect the rights and remedies, whether express, implied or available as a matter of law, of the Administrative Agent and the Lenders against the Parent. 10.5 Reinstatement. The guarantee contained in this Section 10 shall continue to be effective, or be reinstated, as the case may be, if at any time payment, or any part thereof, of any of the Obligations is rescinded or must otherwise be restored or returned by the Administrative Agent or any Lender upon the insolvency, bankruptcy, dissolution, liquidation or reorganization of any Borrower or upon or as a result of the appointment of a receiver, intervenor or conservator of, or trustee or similar officer for, any Borrower or any substantial part of its property, or otherwise, all as though such payments had not been made. 10.6 Payments. The Parent hereby agrees that any payments in respect of the Obligations pursuant to this Section 10 will be paid to the Administrative Agent without setoff or counterclaim in Dollars at the office of the Administrative Agent specified in Section 11.2. SECTION 11. MISCELLANEOUS 11.1 Amendments and Waivers. Neither this Agreement, any other Loan Document, nor any terms hereof or thereof may be amended, supplemented or modified except in accordance with the provisions of this Section 11.1. The Required Lenders and each Loan Party to the relevant Loan Documents may, or, with the written consent of the Required Lenders, the Administrative Agent and each Loan Party to the relevant Loan Document may, from time to time, (a) enter into written amendments, supplements or modifications hereto and to the other Loan Documents for the purpose of adding any provisions to this Agreement or the other Loan Documents or changing in any manner the rights of the Lenders or of the Loan Parties hereunder or thereunder or (b) waive, on such terms and conditions as the Required Lenders or the Administrative Agent, as the case may be, may specify in such instrument, any of the requirements of this Agreement or the other Loan Documents or any Default or Event of Default and its consequences; provided, however, that no such waiver and no such amendment, supplement or modification shall (i) forgive the principal amount or extend the final scheduled date of maturity of any Note, or reduce the stated rate of any interest, fee or letter of credit commission payable hereunder or extend the scheduled date of any payment thereof or increase the amount or extend the expiration date of any Lender's Revolving Credit Commitment, or make any change in the application of any prepayment of the Loans specified in the first sentence of Section 2.12(d) or in Section 2.18(a), in each case without the consent of each Lender directly affected thereby, (ii) extend the scheduled date of any amortization payment in respect of the Tranche A Term Loans referred to in Section 2.9 without the consent of each Lender affected thereby or extend the scheduled date of any amortization payment in respect of the Tranche B Term Loans referred to in Section 2.9 without the consent of each Lender affected thereby, (iii) amend, modify or waive any provision of this Section 11.1 or reduce any percentage specified in the definition of Required Lenders, or consent to the assignment or transfer by any Loan Party of any of its rights and obligations under this Agreement and the other Loan Documents or release all or a 86 80 substantial portion of the Collateral (other than in connection with any sale or other disposition of assets permitted by Section 7.6) or any guarantee of the Obligations, in each case without the written consent of all the Lenders, (iv) amend, modify or waive any provision of Section 9 without the written consent of the Administrative Agent, (v) amend, modify or waive any provision of Section 3 without the written consent of the Issuing Lender, (vi) amend, modify or waive any provision of Section 2.25, 2.26, or 2.27 without the written consent of the Swing Line Lender or (vii) amend, modify or waive any provision of Section 2.7 without the written consent of (A) the holders of 85% or more of the aggregate Revolving Credit Commitments, or, if the Revolving Credit Commitments have been terminated, the aggregate outstanding Revolving Extensions of Credit and (B) the Required Lenders. Any such waiver and any such amendment, supplement or modification shall apply equally to each of the Lenders and shall be binding upon the Loan Parties, the Lenders, the Administrative Agent and all future holders of the Notes. In the case of any waiver, the Loan Parties, the Lenders and the Administrative Agent shall be restored to their former position and rights hereunder and under the other Loan Documents, and any Default or Event of Default waived shall be deemed to be cured and not continuing; but no such waiver shall extend to any subsequent or other Default or Event of Default, or impair any right consequent thereon. 11.2 Notices. All notices, requests and demands to or upon the respective parties hereto to be effective shall be in writing (including by telecopy), and, unless otherwise expressly provided herein, shall be deemed to have been duly given or made when delivered, or three Business Days after being deposited in the mail, postage prepaid, or, in the case of telecopy notice, when received, addressed as follows in the case of the Parent, the Designated Borrower and the Administrative Agent, and as set forth in Schedule 1.1B in the case of the other parties hereto, or to such other address as may be hereafter notified by the respective parties hereto and any future holders of the Notes: The Parent: Kirklands Holdings L.L.C. Advent International Corporation 101 Federal Street Boston, Massachusetts 02110 Attention: David M. Mussafer Telecopy: (617) 951-0566 Telephone: (617) 951-9469 87 81 The Designated Borrower: Kirkland's, Inc. 805 North Parkway Jackson, Tennessee 38305 Attention: Carl Kirkland Telecopy: (901) 664-9345 Telephone: (901) 668-2444 with a copy to: Baker, Donelson, Bearman & Caldwell Tennessee Building 165 Madison Avenue, 20th Floor Memphis, TN 38103 Attention: Robert Walker, Esq. Telecopy: (901) 577-2303 Telephone: (901) 577-2719 and Pepper, Hamelton & Scheetz 3000 Two Logan Square 18th and Arch Streets Philadelphia, PA 19103 Attention: Cary S. Levinson, Esq. Telecopy: (215) 981-4750 Telephone: (215) 981-4000 The Administrative Agent: The First National Bank of Boston 100 Federal Street Boston, Massachusetts 02110 Attention: Dan Corcoran Telecopy: (617) 434 8102 Telephone: (617) 434-2251 provided that any notice, request or demand to or upon the Administrative Agent or the Lenders pursuant to Section 2.2, 2.4, 2.6, 2.10, 2.11, 2.13 or 2.26 shall not be effective until received. Any notice or delivery to or from or consent required of the Borrowers hereunder or pursuant to any other Loan Document may be made to or by the Designated Borrower on behalf of the Borrowers. 88 82 11.3 No Waiver; Cumulative Remedies. No failure to exercise and no delay in exercising, on the part of the Administrative Agent or any Lender, any right, remedy, power or privilege hereunder or under the other Loan Documents shall operate as a waiver thereof; nor shall any single or partial exercise of any right, remedy, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, remedy, power or privilege. The rights, remedies, powers and privileges herein provided are cumulative and not exclusive of any rights, remedies, powers and privileges provided by law. 11.4 Survival. All representations and warranties made hereunder, in the other Loan Documents and in any document, certificate or statement delivered pursuant hereto or in connection herewith shall survive the execution and delivery of this Agreement and the Notes and the making of the Loans hereunder. 11.5 Payment of Expenses and Taxes. The Borrowers jointly and severally agree (a) to pay or reimburse the Administrative Agent for all its reasonable out-of-pocket costs and expenses incurred in connection with the development, preparation and execution of, and any amendment, supplement or modification to, this Agreement and the other Loan Documents and any other documents prepared in connection herewith or therewith, and the consummation and administration of the transactions contemplated hereby and thereby, including, without limitation, the reasonable fees and disbursements of counsel to the Administrative Agent, (b) to pay or reimburse each Lender and the Administrative Agent for all its costs and expenses incurred in connection with the enforcement or preservation of any rights under this Agreement, the other Loan Documents and any such other documents, including, without limitation, the fees and disbursements of counsel (including the allocated fees and expenses of in-house counsel) to each Lender and counsel to the Administrative Agent, (c) to pay, indemnify, and hold each Lender and the Administrative Agent harmless from, any and all recording and filing fees and any and all liabilities with respect to, or resulting from any delay in paying, stamp, excise and other taxes, if any, which may be payable or determined to be payable in connection with the execution and delivery of, or consummation or administration of any of the transactions contemplated by, or any amendment, supplement or modification of, or any waiver or consent under or in respect of, this Agreement, the other Loan Documents and any such other documents, and (d) to pay, indemnify, and hold each Lender and the Administrative Agent and their respective officers, directors, trustees, employees, affiliates, agents and controlling persons (each, an "indemnitee") harmless from and against any and all other liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever with respect to the execution, delivery, enforcement, performance and administration of this Agreement, the other Loan Documents and any such other documents, including, without limitation, any of the foregoing relating to the use of proceeds of the Loans or the violation of, noncompliance with or liability under, any Environmental Law applicable to the operations of the Parent, the Borrowers any of their Subsidiaries or any of the Properties (all the foregoing in this clause (d), collectively, the "indemnified liabilities"), provided, that the Borrowers shall have no obligation hereunder to any indemnitee with respect to indemnified liabilities to the extent such indemnified liabilities are found by a final and nonappealable decision of a court of competent jurisdiction to have resulted from the gross negligence or willful misconduct of such indemnitee. The agreements in this Section 89 83 11.5 shall survive repayment of the Notes and all other amounts payable hereunder and the termination of the Commitments and, in the case of any Lender that may assign any interest in its Commitments, Loans or Letter of Credit Interest hereunder, shall survive the making of such assignment, notwithstanding that such assigning Lender may cease to be a "Lender" hereunder. 11.6 Successors and Assigns; Participations and Assignments. (a) This Agreement shall be binding upon and inure to the benefit of the Parent, the Borrowers, the Lenders, the Administrative Agent, all future holders of the Notes and their respective successors and assigns, except that neither the Parent nor the Borrowers may assign or transfer any of its rights or obligations under this Agreement without the prior written consent of each Lender. (b) Any Lender may, without the consent of the Borrowers, in the ordinary course of its business and in accordance with applicable law, at any time sell to one or more banks, financial institutions or funds that regularly invest in loans and/or loan participations or, with the consent of the Borrowers and the Administrative Agent (which, in each case, shall not be unreasonably withheld or delayed), any other entities (each, a "Participant") participating interests in any Loan owing to such Lender, any Note held by such Lender, any Commitment of such Lender or any other interest of such Lender hereunder and under the other Loan Documents. In the event of any such sale by a Lender of a participating interest to a Participant, such Lender's obligations under this Agreement to the other parties to this Agreement shall remain unchanged, such Lender shall remain solely responsible for the performance thereof, such Lender shall remain the holder of any such Note for all purposes under this Agreement and the other Loan Documents, and the Borrowers and the Administrative Agent shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations under this Agreement and the other Loan Documents. In no event shall any Participant under any such participation have any right to approve any amendment or waiver of any provision of any Loan Document, or any consent to any departure by any Loan Party therefrom, except to the extent that such amendment, waiver or consent would reduce the principal of, or interest on, the Notes or any fees payable hereunder, postpone the date of the final maturity of the Notes, consent to the assignment or transfer by any Borrower of any of its rights and obligations under this Agreement and the other Loan Documents, release all or a substantial portion of the Collateral (other than in connection with any sale or other disposition of assets permitted by Section 7.6) or any guarantee of the Obligations, in each case to the extent subject to such participation. The Borrowers agree that if amounts outstanding under this Agreement and the Notes are due or unpaid, or shall have been declared or shall have become due and payable upon the occurrence of an Event of Default, each Participant shall, to the maximum extent permitted by applicable law, be deemed to have the right of setoff in respect of its participating interest in amounts owing under this Agreement and any Note to the same extent as if the amount of its participating interest were owing directly to it as a Lender under this Agreement or any Note, provided that, in purchasing such participating interest, such Participant shall be deemed to have agreed to share with the Lenders the proceeds thereof as provided in Section 11.7(a) as fully as if it were a Lender hereunder. The Borrowers also agree that each Participant shall be entitled to the benefits of Sections 2.20, 2.21 and 2.22 90 84 with respect to its participation in the Commitments and the Loans outstanding from time to time as if it was a Lender; provided that, in the case of Section 2.21, such Participant shall have complied with the requirements of said Section and provided, further, that no Participant shall be entitled to receive any greater amount pursuant to any such Section than the transferor Lender would have been entitled to receive in respect of the amount of the participation transferred by such transferor Lender to such Participant had no such transfer occurred. (c) Any Lender may, in the ordinary course of its business and in accordance with applicable law, at any time and from time to time assign to any Lender or any affiliate thereof or, with the consent of the Designated Borrower and the Administrative Agent (which, in each case, shall not be unreasonably withheld or delayed) (provided that no such consent need be obtained by Lehman Commercial Paper Inc. for a period of 120 days following the Closing Date), to an additional bank, financial institution or other entity (an "Assignee") all or any part of its rights and obligations under this Agreement, the Letters of Credit and the Notes pursuant to an Assignment and Acceptance, substantially in the form of Exhibit D, executed by such Assignee, such assigning Lender (and, in the case of an Assignee that is not then a Lender or an affiliate thereof, by the Designated Borrower and the Administrative Agent) and delivered to the Administrative Agent for its acceptance and recording in the Register; provided that no such assignment to an Assignee (other than any Lender or any affiliate thereof) shall be in an aggregate principal amount of less than $2,000,000 (other than in the case of an assignment of all of a Lender's interests under this Agreement and the Notes). Such assignment need not be ratable as among any Tranche A Term Loan Commitments and/or Tranche A Term Loans, Tranche B Term Loan Commitments and/or Tranche B Term Loans and Revolving Credit Commitments and/or Revolving Credit Loans of the assigning Lender. Upon such execution, delivery, acceptance and recording, from and after the effective date determined pursuant to such Assignment and Acceptance, (x) the Assignee thereunder shall be a party hereto and, to the extent provided in such Assignment and Acceptance, have the rights and obligations of a Lender hereunder with a Commitment as set forth therein, and (y) the assigning Lender thereunder shall, to the extent provided in such Assignment and Acceptance, be released from its obligations under this Agreement (and, in the case of an Assignment and Acceptance covering all or the remaining portion of an assigning Lender's rights and obligations under this Agreement, such assigning Lender shall cease to be a party hereto). Notwithstanding any provision of this paragraph (c) and paragraph (g) of this Section 11.6, the consent of the Designated Borrower shall not be required, and, unless requested by the Assignee and/or the assigning Lender, new Notes shall not be required to be executed and delivered by the Borrowers, for any assignment which occurs at any time when any of the events described in Section 8(f) shall have occurred and be continuing. (d) Any Non-U.S. Lender that could become completely exempt from withholding of any tax, assessment or other charge or levy imposed by or on behalf of the United States or any taxing authority thereof ("U.S. Taxes") in respect of payment of any Obligations due to such Non-U.S. Lender under this Agreement if the Obligations were in registered form for U.S. federal income tax purposes may request the Borrowers (through the Administrative Agent), and the Borrowers agree thereupon, to exchange any promissory 91 85 note(s) evidencing such Obligations for promissory note(s) registered as provided in paragraph (f) below and substantially in the form of Exhibit I-1 (in the case of Obligations in respect of Tranche A Term Loans), Exhibit I-2 (in the case of Obligations in respect of Tranche B Term Loans), or Exhibit I-3 (in the case of Obligations in respect of Revolving Credit Loans) (each, an "Alternative Note"). Alternative Notes may not be exchanged for promissory notes that are not Alternative Notes. (e) Each Non-U.S. Lender that holds Alternative Note(s) (an "Alternative Noteholder") (or, if such Alternative Noteholder is not the beneficial owner thereof, such beneficial owner) shall deliver to the Borrowers prior to or at the time such Non-U.S. Lender becomes an Alternative Noteholder each of the forms and certifications required by Section 2.21(b). (f) An Alternative Note and the Obligation(s) evidenced thereby may be assigned or otherwise transferred in whole or in part only by registration of such assignment or transfer of such Alternative Note and the Obligation(s) evidenced thereby on the Register (and each Alternative Note shall expressly so provide). Any assignment or transfer of all or part of such Obligation(s) and the Alternative Note(s) evidencing the same shall be registered on the Register only upon surrender for registration of assignment or transfer of the Alternative Note(s) evidencing such Obligation(s), duly endorsed by (or accompanied by a written instrument of assignment or transfer duly executed by) the Alternative Noteholder thereof, and thereupon one or more new Alternative Note(s) in the same aggregate principal amount shall be issued to the designated Assignee(s). No assignment of an Alternative Note and the Obligation(s) evidenced thereby shall be effective unless it has been recorded in the Register as provided in this Section 11.6(f). (g) The Administrative Agent shall maintain at its address referred to in Section 11.2 a copy of each Assignment and Acceptance delivered to it and a register (the "Register") for the recordation of the names and addresses of the Lenders (including Alternative Noteholders) and the Commitment of, and principal amount of the Loans owing to, each Lender from time to time. The entries in the Register shall be conclusive, in the absence of manifest error, and the Borrowers, the Administrative Agent and the Lenders shall treat each Person whose name is recorded in the Register as the owner of the Loan recorded therein for all purposes of this Agreement. The Register shall be available for inspection by the Borrowers or any Lender at any reasonable time and from time to time upon reasonable prior notice. (h) Upon its receipt of an Assignment and Acceptance executed by an assigning Lender and an Assignee (and, in the case of an Assignee that is not then a Lender or an affiliate thereof, by the Designated Borrower and the Administrative Agent) together with payment to the Administrative Agent of a registration and processing fee of $2,000 (except that no such registration and processing fee shall be payable (y) by Lehman Commercial Paper Inc. for a period of 120 days following the Closing Date or (z) in the case of an Assignee which is already a Lender or is an affiliate of a Lender), the Administrative Agent shall (i) promptly accept such Assignment and Acceptance and (ii) on the effective date determined pursuant thereto record the information contained therein in the Register and 92 86 give notice of such acceptance and recordation to the Lenders and the Designated Borrower. On or prior to such effective date, the Borrowers, at their own expense, shall execute and deliver to the Administrative Agent (in exchange for the Revolving Credit Note, Tranche A Term Note and/or Tranche B Term Note, as the case may be, of the assigning Lender) a new Revolving Credit Note, Tranche A Term Note and/or Tranche B Term Note, as the case may be, to the order of such Assignee (or, in the case of any Alternative Note, payable to such Assignee or its registered assigns) in an amount equal to the Revolving Credit Commitment, Tranche A Loan and/or Tranche B Loan, as the case may be, assumed by it pursuant to such Assignment and Acceptance and, if the assigning Lender has retained a Revolving Credit Commitment, Tranche A Loan and/or Tranche B Loan, as the case may be, a new Revolving Credit Note, Tranche A Term Note and/or Tranche B Term Note, as the case may be, to the order of the assigning Lender (or, in the case of any Alternative Note, payable to such assigning Lender or its registered assigns) in an amount equal to the Revolving Credit Commitment, Tranche A Loan and/or Tranche B Loan, as the case may be, retained by it hereunder. Such new Notes shall be dated the Closing Date and shall otherwise be in the form of the Note replaced thereby. (i) Each of the Parent and the Borrowers authorizes each Lender to disclose to any Participant or Assignee (each, a "Transferee") and any prospective Transferee any and all financial information in such Lender's possession concerning the Parent, the Borrowers and their respective Affiliates which has been delivered to such Lender by or on behalf of the Parent or the Borrowers pursuant to this Agreement or which has been delivered to such Lender by or on behalf of the Parent or the Borrowers in connection with such Lender's credit evaluation of the Parent, the Borrowers and their respective Affiliates prior to becoming a party to this Agreement. (j) Nothing herein shall prohibit or restrict any Lender from (i) pledging or assigning any Note to any Federal Reserve Bank in accordance with applicable law or (ii) with the prior consent of the Administrative Agent and the Borrowers (which, in each case, shall not be unreasonably withheld or delayed), pledging its rights in connection with any Loan or Note to any other Person. 11.7 Adjustments; Set-off. (a) If any Lender (a "Benefitted Lender") shall at any time receive any payment of all or part of its Loans or the Reimbursement Obligations owing to it, or interest thereon, or receive any collateral in respect thereof (whether voluntarily or involuntarily, by set-off, pursuant to events or proceedings of the nature referred to in Section 8(f), or otherwise), in a greater proportion than any such payment to or collateral received by any other Lender, if any, in respect of such other Lender's Loans or the Reimbursement Obligations owing to such other Lender, or interest thereon, such Benefitted Lender shall purchase for cash from the other Lenders a participating (or, at the option of such Lender, a direct) interest in such portion of each such other Lender's Loan and/or of the Reimbursement Obligations owing to each such other Lender, or shall provide such other Lenders with the benefits of any such collateral, or the proceeds thereof, as shall be necessary to cause such Benefitted Lender to share the excess payment or benefits of such collateral or proceeds ratably with each of the Lenders; provided, however, that if all or any portion of such excess payment or benefits is thereafter recovered from such Benefitted Lender, such 93 87 purchase shall be rescinded, and the purchase price and benefits returned, to the extent of such recovery, but without interest. (b) In addition to any rights and remedies of the Lenders provided by law, each Lender shall have the right, without prior notice to the Parent or the Borrowers, any such notice being expressly waived by the Parent and the Borrowers to the extent permitted by applicable law, upon any amount becoming due and payable by the Parent or the Borrowers hereunder or under the Notes (whether at the stated maturity, by acceleration or otherwise) to set off and appropriate and apply against such amount any and all deposits (general or special, time or demand, provisional or final), in any currency, and any other credits, indebtedness or claims, in any currency, in each case whether direct or indirect, absolute or contingent, matured or unmatured, at any time held or owing by such Lender or any branch or agency thereof to or for the credit or the account of the Parent or the Borrowers. Each Lender agrees promptly to notify the Parent, the Designated Borrower and the Administrative Agent after any such setoff and application made by such Lender, provided that the failure to give such notice shall not affect the validity of such setoff and application. 11.8 Counterparts. This Agreement may be executed by one or more of the parties to this Agreement on any number of separate counterparts (including by telecopy), and all of said counterparts taken together shall be deemed to constitute one and the same instrument. A set of the copies of this Agreement signed by all the parties shall be lodged with the Borrowers and the Administrative Agent. 11.9 Severability. Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. 11.10 Integration. This Agreement and the other Loan Documents represent the agreement of the Parent, the Borrowers, the Administrative Agent and the Lenders with respect to the subject matter hereof, and there are no promises, undertakings, representations or warranties by the Administrative Agent or any Lender relative to subject matter hereof not expressly set forth or referred to herein or in the other Loan Documents. 11.11 GOVERNING LAW. THIS AGREEMENT AND THE NOTES AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES UNDER THIS AGREEMENT AND THE NOTES SHALL BE GOVERNED BY, AND CONSTRUED AND INTERPRETED IN ACCORDANCE WITH, THE LAW OF THE STATE OF NEW YORK. 11.12 Submission To Jurisdiction; Waivers. Each of the Parent and the Borrowers hereby irrevocably and unconditionally: (a) submits for itself and its property in any legal action or proceeding relating to this Agreement and the other Loan Documents to which it is a party, or for 94 88 recognition and enforcement of any judgment in respect thereof, to the non-exclusive general jurisdiction of the Courts of the State of New York, the courts of the United States for the Southern District of New York and the courts of the Commonwealth of Massachusetts and the courts of the United States for the District of Massachusetts, and appellate courts from any thereof; (b) consents that any such action or proceeding may be brought in such courts and waives any objection that it may now or hereafter have to the venue of any such action or proceeding in any such court or that such action or proceeding was brought in an inconvenient court and agrees not to plead or claim the same; (c) agrees that service of process in any such action or proceeding may be effected by mailing a copy thereof by registered or certified mail (or any substantially similar form of mail), postage prepaid, to the Parent or the Borrowers, as the case may be at its address set forth in Section 11.2 or at such other address of which the Administrative Agent shall have been notified pursuant thereto; (d) agrees that nothing herein shall affect the right to effect service of process in any other manner permitted by law or shall limit the right to sue in any other jurisdiction; and (e) waives, to the maximum extent not prohibited by law, any right it may have to claim or recover in any legal action or proceeding referred to in this Section 11.12 any special, exemplary, punitive or consequential damages. 11.13 Acknowledgements. Each of the Parent and the Borrowers hereby acknowledges that: (a) it has been advised by counsel in the negotiation, execution and delivery of this Agreement and the other Loan Documents; (b) neither the Administrative Agent nor any Lender has any fiduciary relationship with or duty to the Parent or any Borrower arising out of or in connection with this Agreement or any of the other Loan Documents, and the relationship between Administrative Agent and Lenders, on one hand, and the Parent and the Borrowers, on the other hand, in connection herewith or therewith is solely that of debtor and creditor; and (c) no joint venture is created hereby or by the other Loan Documents or otherwise exists by virtue of the transactions contemplated hereby among the Lenders or among the Parent, the Borrowers and the Lenders. 11.14 WAIVERS OF JURY TRIAL. THE PARENT, THE BORROWERS, THE ADMINISTRATIVE AGENT AND THE LENDERS HEREBY IRREVOCABLY AND UNCONDITIONALLY WAIVE TRIAL BY JURY IN ANY 95 89 LEGAL ACTION OR PROCEEDING RELATING TO THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT AND FOR ANY COUNTERCLAIM THEREIN. 11.15 Confidentiality. Each of the Administrative Agent and each Lender agrees to keep confidential all non-public information provided to it by any Loan Party pursuant to this Agreement that is designated by such Loan Party as confidential; provided that nothing herein shall prevent the Administrative Agent or any Lender from disclosing any such information (a) to the Administrative Agent, any other Lender or any affiliate of any Lender, (b) to any Transferee or prospective Transferee which agrees to comply with the provisions of this Section 11.15, (c) to the employees, directors, agents, attorneys, accountants and other professional advisors of such Lender or its affiliates, (d) upon the request or demand of any Governmental Authority having jurisdiction over the Administrative Agent or such Lender, (e) in response to any order of any court or other Governmental Authority or as may otherwise be required pursuant to any Requirement of Law, (f) if requested or required to do so in connection with any litigation or similar proceeding, (g) which has been publicly disclosed other than in breach of this Section 11.15, or (h) in connection with the exercise of any remedy hereunder or under any other Loan Document. 11.16 Reliance on Representations and Actions of Designated Borrower. The Borrowers hereby appoint the Designated Borrower as the Borrowers' agent to execute, deliver and perform, on behalf of the Borrowers, any and all notices, certificates, documents and actions to be executed, delivered or performed hereunder or under any of the other Loan Documents, and the Borrowers hereby agree that the Administrative Agent and the Lenders may rely upon any representation, warranty, certificate, notice, document or telephone request which purports to be executed or made or which the Administrative Agent or the Lenders in good faith believe to have been executed or made by the Designated Borrower or any of its executive officers, and the Borrowers hereby further, jointly and severally, agree to indemnify and hold the Administrative Agent and the Lenders harmless for any action, including the making of Loans hereunder, and any loss or expense, taken or incurred by any of them as a result of their good faith reliance upon any such representation, warranty, certificate, notice, document or telephone request. 96 90 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered by their proper and duly authorized officers as of the day and year first above written. KIRKLANDS HOLDINGS L.L.C. By: /s/ David M. Mussafer ------------------------------------ Title: President KIRKLAND'S, INC. KIRKLAND'S OF CAROLINA, INC. KIRKLAND'S OF CHARLOTTE, EASTLAND MALL, INC. KIRKLAND'S OF TENNESSEE, INC. K. C. CORP. INC. KIRKLAND'S OF GREENSBORO, FOUR SEASONS MALL, INC. KIRKLAND'S OF FAYETTEVILLE, CROSS CREEK MALL, INC. KIRKLAND'S OF WILMINGTON, INDEPENDENCE MALL, INC. KIRKLAND'S III, JACKSON-METRO CENTER, INC. KIRKLAND'S OF MEMPHIS, TENNESSEE, LAURELWOOD SHOPPING CENTER, INC. KIRKLAND'S OF RIDGELAND, MISSISSIPPI, NORTHPARK MALL, INC. KIRKLAND'S OF KNOXVILLE, EAST TOWNE MALL, INC. KIRKLAND'S OF HUNTSVILLE, MADISON SQUARE MALL, INC. KIRKLAND'S OF VALLEY VIEW MALL, ROANOKE, VA, INC. KIRKLAND'S OF NASHVILLE, HICKORY HOLLOW MALL, INC. KIRKLAND'S OF BIRMINGHAM, RIVERCHASE GALLERIA, INC. KIRKLAND'S OF BRIARCLIFFE MALL, MYRTLE BEACH, SOUTH CAROLINA, INC. KIRKLAND'S OF PECANLAND MALL, MONROE, LA, INC. KIRKLAND'S OF TOWNE CENTER AT COBB, ATLANTA, GA, INC. KIRKLAND'S OF GWINNETT PLACE, ATLANTA, GA, INC. KIRKLAND'S OF RIVERGATE MALL, NASHVILLE, TN, INC. KIRKLAND'S OF PEACHTREE MALL, COLUMBUS, GA, INC. KIRKLAND'S OF CUMBERLAND MALL, ATLANTA, GA, INC. KIRKLAND'S OF HAMILTON PLACE MALL, CHATTANOOGA, TN, INC. KIRKLAND'S OF HOUSTON GALLERIA, HOUSTON, TX, INC. KIRKLAND'S OF MALL OF MEMPHIS, MEMPHIS, TN, INC. KIRKLAND'S OF WOODLAND HILLS MALL, TULSA, OK, INC. KIRKLAND'S OF DAYTON MALL, DAYTON, OH, INC. KIRKLAND'S OF OXMOOR CENTER, LOUISVILLE, KY, INC. 97 91 KIRKLAND'S OF SOUTH SQUARE MALL, DURHAM, NC, INC. KIRKLAND'S OF VALLEY VIEW CENTER, DALLAS, TX, INC. KIRKLAND'S OF CHESTERFIELD TOWNE CENTER, RICHMOND, VA, INC. KIRKLAND'S OF PARK PLAZA, LITTLE ROCK, AR, INC. KIRKLAND'S OF MONTGOMERY MALL, MONTGOMERY, AL, INC. KIRKLAND'S OF SOUTHLAKE MALL, ATLANTA, GA, INC. KIRKLAND'S OF SOUTHPARK MALL, RICHMOND, VA, INC. KIRKLAND'S OF EASTLAND MALL, EVANSVILLE, IN, INC. KIRKLAND'S OF FAYETTE MALL, LEXINGTON, KY, INC. KIRKLAND'S OF HICKORY RIDGE MALL, MEMPHIS, TN, INC. KIRKLAND'S OF REGENCY SQUARE MALL, JACKSONVILLE, FL, INC. KIRKLAND'S OF MCCAIN MALL, LITTLE ROCK, AR, INC. KIRKLAND'S OF RIVER RIDGE MALL, LYNCHBURG, VA, INC. KIRKLAND'S OF BEL AIR MALL, MOBILE, AL, INC. KIRKLAND'S OF THE MALL AT BARNES CROSSING, TUPELO, MS, INC. KIRKLAND'S OF CORTANA MALL, BATON ROUGE, LA, INC. KIRKLAND'S OF BELLEVUE CENTER, NASHVILLE, TN, INC. KIRKLAND'S OF TRI-COUNTY MALL, CINCINNATI, OH, INC. KIRKLAND'S OF THE MALL OF THE AVENUES, JACKSONVILLE, FL, INC. KIRKLAND'S OF EASTWOOD MALL, BIRMINGHAM, AL, INC. KIRKLAND'S OF LAKESIDE MALL, NEW ORLEANS, LA, INC. KIRKLAND'S OF CAROLINA PLACE, CHARLOTTE, N.C., INC. KIRKLAND'S OF CARY VILLAGE MALL, RALEIGH, N.C., INC. KIRKLAND'S OF COOL SPRINGS GALLERIA, NASHVILLE, TN, INC. KIRKLAND'S OF KENWOOD TOWNE CENTRE, CINCINNATI, OH, INC. KIRKLAND'S OF ST. LOUIS GALLERIA, ST. LOUIS, MO, INC. KIRKLAND'S OF WIREGRASS COMMONS MALL, DOTHAN, AL, INC. KIRKLAND'S OF REGENCY MALL, RICHMOND, VA, INC. KIRKLAND'S OF FLORENCE, FLORENCE, KY, INC. KIRKLAND'S OF ACADIANA MALL, LAFAYETTE, LA, INC. KIRKLAND'S OF PADRE STAPLES MALL, CORPUS CHRISTI, TX, INC. KIRKLAND'S OF BELDEN VILLAGE, CANTON, OH, INC. KIRKLAND'S OF WEST OAKS MALL, HOUSTON, TX, INC. KIRKLAND'S OF CHARLESTON TOWN CENTER, CHARLESTON, W. VA, INC. KIRKLAND'S OF CRESTWOOD PLAZA, ST. LOUIS, MO, INC. KIRKLAND'S OF WHITE MARSH MALL, BALTIMORE, MD, INC. 98 92 KIRKLAND'S OF COLLIN CREEK MALL, DALLAS, TX, INC. KIRKLAND'S OF BAYBROOK MALL, HOUSTON, TX, INC. KIRKLAND'S OF GOVERNOR'S SQUARE MALL, TALLAHASSEE, FL, INC. KIRKLAND'S OF BARTON CREEK MALL, AUSTIN, TX, INC. KIRKLAND'S OF HIGHLAND MALL, AUSTIN, TX, INC. KIRKLAND'S OF BATTLEFIELD MALL, SPRINGFIELD, MO, INC. KIRKLAND'S OF PENN SQUARE MALL, OKLAHOMA CITY, OK, INC. KIRKLAND'S OF OAK PARK MALL, KANSAS CITY, KS, INC. KIRKLAND'S OF MALL ST. VINCENT, SHREVEPORT, LA, INC. KIRKLAND'S OF OWINGS MILLS MALL, BALTIMORE, MD, INC. KIRKLAND'S OF OAKWOOD CENTER, NEW ORLEANS, LA, INC. KIRKLAND'S OF THE MALL AT JOHNSON CITY, JOHNSON CITY, TN, INC. KIRKLAND'S OF GLENBROOK MALL, FT. WAYNE, IN, INC. KIRKLAND'S OF NORTH POINTE MALL, ATLANTA, GA, INC. KIRKLAND'S OF NORTHPARK MALL, JOPLIN, MO, INC. KIRKLAND'S OF ORLANDO FASHION SQUARE, ORLANDO, FL, INC. KIRKLAND'S OF THE MALL AT FAIRFIELD COMMONS, DAYTON, OH, INC. KIRKLAND'S OF ST. CHARLES TOWNE CENTER, WALDORF, MD INC. KIRKLAND'S OF REGENCY MALL, FLORENCE, AL, INC. KIRKLAND'S OF SOUTH PLAINS MALL, LUBBOCK, TX, INC. KIRKLAND'S OF THE PARKS AT ARLINGTON, FT. WORTH, TX, INC. KIRKLAND'S OF PARMA TOWN MALL, CLEVELAND, OH, INC. KIRKLAND'S OF ST. CLAIR SQUARE, ST. LOUIS, MO, INC. KIRKLAND'S OF TURTLE CREEK MALL, HATTIESBURG, MS, INC. KIRKLAND'S OF THE WOODLANDS, HOUSTON, TX, INC. KIRKLAND'S OF BRANDON TOWN CENTER, TAMPA, FL, INC. KIRKLAND'S OF MEMORIAL CITY MALL, HOUSTON, TX, INC. KIRKLAND'S OF UNIVERSITY MALL, TUSCALOOSA, AL, INC. KIRKLAND'S OF SANTA ROSA MALL, FORT WALTON, FL, INC. KIRKLAND'S OF PANAMA CITY MALL, PANAMA CITY, FL, INC. KIRKLAND'S OF TOWN EAST MALL, MESQUITE, TX, INC. KIRKLAND'S OF KENTUCKY OAKS MALL, PADUCAH, KY, INC. KIRKLAND'S OF CRABTREE VALLEY MALL, RALEIGH, N.C., INC. KIRKLAND'S OF OAK HOLLOW MALL, HIGH POINT, N.C., INC. KIRKLAND'S OF FOX VALLEY MALL, CHICAGO, IL, INC. KIRKLAND'S OF HAWTHORNE MALL, CHICAGO, IL, INC. 99 93 KIRKLAND'S OF STRATFORD SQUARE, CHICAGO, IL, INC. KIRKLAND'S OF ORLAND SQUARE, CHICAGO, IL, INC. KIRKLAND'S OF COASTLAND MALL, NAPLES, FL, INC. KIRKLAND'S OF EDGEWATER MALL, BILOXI, MS, INC. KIRKLAND'S OF TOWN CENTER PLAZA, KANSAS CITY, KS, INC. KIRKLAND'S OF CASTLETON SQUARE, INDIANAPOLIS, IN., INC. KIRKLAND'S OF CORDOVA MALL, PENSACOLA, FL, INC. KIRKLAND'S OF UNIVERSITY PARK, SOUTH BEND, IN, INC. KIRKLAND'S OF WESTGATE MALL, AMARILLO, TX, INC. KIRKLAND'S OF WESTGATE MALL, SPARTANBURG, SC, INC. KIRKLAND'S OF MERIDIAN MALL, LANSING, MI, INC. KIRKLAND'S OF COTTONWOOD MALL, ALBUQUERQUE, NM, INC. KIRKLAND'S OF UNIVERSITY MALL, TAMPA, FL, INC. ATTEST: By: /s/ Robert Alderson By: /s/ Carl Kirkland --------------------- --------------------- Title: Vice President Title: President and Secretary 100 94 LEHMAN COMMERCIAL PAPER INC., as Arranger and as a Lender By: /s/ Dennis J. Dee ------------------------------------------ Title: Authorized Signatory THE FIRST NATIONAL BANK OF BOSTON, as Administrative Agent and as a Lender By: /s/ Daniel P. Corcoran ------------------------------------------ Title: Vice President FIRST AMERICAN NATIONAL BANK By: /s/ Mariah G. Lundberg ------------------------------------------ Title: Assistant Vice President HIBERNIA NATIONAL BANK By: /s/ Troy J. Villafarra ------------------------------------------ Title: Vice President 101 95 MITSUI LEASING (U.S.A.) INC. By: /s/ R. Wayne Hutton ------------------------------------------ Title: Vice President PRIME INCOME TRUST By: /s/ Rafael Scolari ------------------------------------------ Title: V.P. Portfolio Manager CRESCENT/MACH I PARTNERS, L.P. by: TCW Asset Management Company Its Investment Manager By: /s/ Justin L. Driscoll ------------------------------------------ Title: Vice President UNION PLANTERS BANK OF JACKSON, N.A. By: /s/ Frank Hudacek ------------------------------------------ Title: Vice President VOLUNTEER BANK OF JACKSON, TENNESSEE By: /s/ James N. Craft ------------------------------------------ Title: Executive Vice President 102 SCHEDULE 1.1A TO CREDIT AGREEMENT --------------------------------- SCHEDULE OF BORROWERS
Kirkland's, Inc. 101 Kirkland's of Carolina, Inc. 102 Kirkland's of Charlotte, Eastland Mall, Inc. 103 Kirkland's of Tennessee, Inc. 104 K. C. Corp. Inc. 107 Kirkland's of Greensboro, Four Seasons Mall, Inc. 109 Kirkland's of Fayetteville, Cross Creek Mall, Inc. 110 Kirkland's of Wilmington, Independence Mall, Inc. 111 Kirkland's III, Jackson-Metro Center, Inc. 114 Kirkland's of Memphis, Tennessee, Laurelwood Shopping Center, Inc. 115 Kirkland's of Ridgeland, Mississippi, Northpark Mall, Inc. 116 Kirkland's of Knoxville, East Towne Mall, Inc. 117 Kirkland's of Huntsville, Madison Square Mall, Inc. 118 Kirkland's of Valley View Mall, Roanoke, VA, Inc. 119 Kirkland's of Nashville, Hickory Hollow Mall, Inc. 120 Kirkland's of Birmingham, Riverchase Galleria, Inc. 122 Kirkland's of BriarCliffe Mall, Myrtle Beach, South Carolina, Inc. 123 Kirkland's of Pecanland Mall, Monroe, LA, Inc. 125 Kirkland's of Towne Center at Cobb, Atlanta, GA, Inc. 126 Kirkland's of Gwinnett Place, Atlanta, GA, Inc. 127 Kirkland's of Rivergate Mall, Nashville, TN, Inc. 128 Kirkland's of Peachtree Mall, Columbus, GA, Inc. 129 Kirkland's of Cumberland Mall, Atlanta, GA, Inc. 130 Kirkland's of Hamilton Place Mall, Chattanooga, TN, Inc. 131 Kirkland's of Houston Galleria, Houston, TX, Inc. 132 Kirkland's of Mall of Memphis, Memphis, TN, Inc. 134 Kirkland's of Woodland Hills Mall, Tulsa, OK, Inc. 135 Kirkland's of Dayton Mall, Dayton, OH, Inc. 136 Kirkland's of Oxmoor Center, Louisville, KY, Inc. 137 Kirkland's of South Square Mall, Durham, NC, Inc. 138 Kirkland's of Valley View Center, Dallas, TX, Inc. 139 Kirkland's of Chesterfield Towne Center, Richmond, VA, Inc. 140 Kirkland's of Park Plaza, Little Rock, AR, Inc. 141 Kirkland's of Montgomery Mall, Montgomery, AL, Inc. 142 Kirkland's of Southlake Mall, Atlanta, GA, Inc. 143 Kirkland's of Southpark Mall, Richmond, VA, Inc. 144 Kirkland's of Eastland Mall, Evansville, IN, Inc. 145 Kirkland's of Fayette Mall, Lexington, KY, Inc. 146 Kirkland's of Hickory Ridge Mall, Memphis, TN, Inc. 148 Kirkland's of Regency Square Mall, Jacksonville, FL, Inc. 149 Kirkland's of McCain Mall, Little Rock, AR, Inc. 150 Kirkland's of River Ridge Mall, Lynchburg, VA, Inc.
103
151 Kirkland's of Bel Air Mall, Mobile, AL, Inc. 152 Kirkland's of The Mall at Barnes Crossing, Tupelo, MS, Inc. 153 Kirkland's of Cortana Mall, Baton Rouge, LA, Inc. 154 Kirkland's of Bellevue Center, Nashville, TN, Inc. 155 Kirkland's of Tri-County Mall, Cincinnati, OH, Inc. 156 Kirkland's of The Mall of the Avenues, Jacksonville, FL, Inc. 157 Kirkland's of Eastwood Mall, Birmingham, AL, Inc. 158 Kirkland's of Lakeside Mall, New Orleans, LA, Inc. 159 Kirkland's of Carolina Place, Charlotte, N.C., Inc. 160 Kirkland's of Cary Village Mall, Raleigh, N.C., Inc. 161 Kirkland's of Cool Springs Galleria, Nashville, TN, Inc. 162 Kirkland's of Kenwood Towne Centre, Cincinnati, OH, Inc. 163 Kirkland's of St. Louis Galleria, St. Louis, MO, Inc. 164 Kirkland's of Wiregrass Commons Mall, Dothan, AL, Inc. 165 Kirkland's of Regency Mall, Richmond, VA, Inc. 166 Kirkland's of Florence, Florence, KY, Inc. 167 Kirkland's of Acadiana Mall, Lafayette, LA, Inc. 168 Kirkland's of Padre Staples Mall, Corpus Christi, TX, Inc. 169 Kirkland's of Belden Village, Canton, OH, Inc. 170 Kirkland's of West Oaks Mall, Houston, TX, Inc. 171 Kirkland's of Charleston Town Center, Charleston, W. VA, Inc. 172 Kirkland's of Crestwood Plaza, St. Louis, MO, Inc. 173 Kirkland's of White Marsh Mall, Baltimore, MD, Inc. 174 Kirkland's of Collin Creek Mall, Dallas, TX, Inc. 175 Kirkland's of Baybrook Mall, Houston, TX, Inc. 176 Kirkland's of Governor's Square Mall, Tallahassee, FL, Inc. 178 Kirkland's of Barton Creek Mall, Austin, TX, Inc. 179 Kirkland's of Highland Mall, Austin, TX, Inc. 180 Kirkland's of Battlefield Mall, Springfield, MO, Inc. 181 Kirkland's of Penn Square Mall, Oklahoma City, OK, Inc. 182 Kirkland's of Oak Park Mall, Kansas City, KS, Inc. 183 Kirkland's of Mall St. Vincent, Shreveport, LA, Inc. 184 Kirkland's of Owings Mills Mall, Baltimore, MD, Inc. 185 Kirkland's of Oakwood Center, New Orleans, LA, Inc. 186 Kirkland's of The Mall at Johnson City, Johnson City, TN, Inc. 187 Kirkland's of Glenbrook Mall, Ft. Wayne, IN, Inc. 188 Kirkland's of North Pointe Mall, Atlanta, GA, Inc. 189 Kirkland's of Northpark Mall, Joplin, MO, Inc. 190 Kirkland's of Orlando Fashion Square, Orlando, FL, Inc. 191 Kirkland's of The Mall at Fairfield Commons, Dayton, OH, Inc. 192 Kirkland's of St. Charles Towne Center, Waldorf, MD Inc. 193 Kirkland's of Regency Mall, Florence, AL, Inc. 194 Kirkland's of South Plains Mall, Lubbock, TX, Inc. 195 Kirkland's of The Parks at Arlington, Ft. Worth, TX, Inc. 196 Kirkland's of Parma Town Mall, Cleveland, OH, Inc. 197 Kirkland's of St. Clair Square, St. Louis, MO, Inc. 198 Kirkland's of Turtle Creek Mall, Hattiesburg, MS, Inc.
104 199 Kirkland's of The Woodlands, Houston, TX, Inc. 200 Kirkland's of Brandon Town Center, Tampa, FL, Inc. 201 Kirkland's of Memorial City Mall, Houston, TX, Inc. 202 Kirkland's of University Mall, Tuscaloosa, AL, Inc. 203 Kirkland's of Santa Rosa Mall, Fort Walton, FL, Inc. 204 Kirkland's of Panama City Mall, Panama City, FL, Inc. 205 Kirkland's of Town East Mall, Mesquite, TX, Inc. 206 Kirkland's of Kentucky Oaks Mall, Paducah, KY, Inc. 207 Kirkland's of Crabtree Valley Mall, Raleigh, N.C., Inc. 208 Kirkland's of Oak Hollow Mall, High Point, N.C., Inc. 209 Kirkland's of Fox Valley Mall, Chicago, IL, Inc. 210 Kirkland's of Hawthorne Mall, Chicago, IL, Inc. 211 Kirkland's of Stratford Square, Chicago, IL, Inc. 212 Kirkland's of Orland Square, Chicago, IL, Inc. 214 Kirkland's of Coastland Mall, Naples, FL, Inc. 215 Kirkland's of Edgewater Mall, Biloxi, MS, Inc. 216 Kirkland's of Town Center Plaza, Kansas City, KS, Inc. 217 Kirkland's of Castleton Square, Indianapolis, IN., Inc. 218 Kirkland's of Cordova Mall, Pensacola, FL, Inc. 219 Kirkland's of University Park, South Bend, IN, Inc. 220 Kirkland's of Westgate Mall, Amarillo, TX, Inc. 221 Kirkland's of Westgate Mall, Spartanburg, SC, Inc. 222 Kirkland's of Meridian Mall, Lansing, MI, Inc. 223 Kirkland's of Cottonwood Mall, Albuquerque, NM, Inc. 224 Kirkland's of University Mall, Tampa, FL, Inc. 105 - -------------------------------------------------------------------------- FIRST AMENDMENT TO CREDIT AGREEMENT Among KIRKLAND HOLDINGS L.L.C., THE BORROWERS SPECIFIED HEREIN, THE LENDERS PARTY HERETO, THE FIRST NATIONAL BANK OF BOSTON, AS ADMINISTRATIVE AGENT and LEHMAN COMMERCIAL PAPER, INC., AS ARRANGER Dated as of December 5, 1996 - -------------------------------------------------------------------------- 106 FIRST AMENDMENT TO CREDIT AGREEMENT This FIRST AMENDMENT TO CREDIT AGREEMENT is dated as of December 5, 1996 by and among KIRKLAND'S HOLDINGS L.L.C., a Delaware limited liability company (the "Parent"), the entities listed on Schedule 1.1A of that certain Credit Agreement referred to below (the "Borrowers"), THE FIRST NATIONAL BANK OF BOSTON (the "Administrative Agent"), LEHMAN COMMERCIAL PAPER, INC., (the "Arranger") and the several banks and financial institutions which are Lenders under the Credit Agreement (the "Lenders"). Recitals The Parent, the Borrowers, the Administrative Agent, the Arranger and the Lenders are party to a Credit Agreement dated as of June 12, 1996 (the "Credit Agreement"). Capitalized terms used herein and not otherwise defined shall have the meanings set forth in the Credit Agreement. The Parent and the Borrowers desire to amend the Credit Agreement in certain respects to be relieved of certain obligations to obtain landlord consents, to postpone the time for delivery of key-man life insurance required thereunder and to provide for the joinder of all Subsidiaries to the Credit Agreement as borrowers. The Administrative Agent, the Arranger and the Lenders are willing to agree to such amendments on the terms set forth herein. NOW, THEREFORE, in consideration of the premises contained herein and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: Section 1. Release of Requirement of Landlord Waivers. Section 6 of the Credit Agreement is hereby amended by deleting Section 6.14 thereof in its entirety. Section 2. Key Man Life Insurance. Section 6 of the Credit Agreement is hereby further amended by deleting Section 6.12 thereof in its entirety and substituting therefor the following: "6.12 Key Man Life Insurance. Obtain by December 31, 1996 and maintain at all times thereafter key man life insurance policies in the amount of $3,000,000 on each of the Management Shareholders; and upon obtaining such policies, execute and deliver all documents and take all actions in respect thereof that would be required by subsection 5.1(b) if such policies were in effect on the Closing Date." 107 Section 3. Subsidiaries. Section 4 of the Credit Agreement is hereby amended by deleting Section 4.15 in its entirety and substituting therefor the following: "4.15 Subsidiaries. The Borrowers listed on Schedule 1.1A, as the same may be amended from time to time with consent of the Administrative Agent, constitute all of the direct and indirect Subsidiaries of the Parent." Section 4. Joinder of Subsidiaries. Section 6.11(b) of the Credit Agreement is hereby amended by deleting clause (iii)(A) thereof in its entirety and substituting therefor the following: "(A) to become a Borrower party hereto or, with consent of the Administrative Agent, a party to a guaranty and a security agreement, in each case pursuant to documentation which is in form and substance satisfactory to the Administrative Agent, and" Section 5. Change of Control. Section 8(k) of the Credit Agreement is hereby amended by deleting clause (i) thereof and substituting therefor the following: "(i) The Parent and the Management Shareholders shall cease to have the power (whether or not exercised) to elect a majority of the directors of any of the Borrowers which is a direct Subsidiary of the Parent, or the Designated Borrower shall cease to have the power (whether or not exercised) to elect all of the directors of any of the Borrowers which is an indirect Subsidiary of the Parent," Section 6. Representations and Warranties: No Default. The Parent and the Borrowers hereby confirm to the Bank the representations and warranties of the Parent and the Borrowers set forth in Section 4 of the Credit Agreement (as amended hereby) as of the date hereof, as if set forth herein in full. The Parent and the Borrowers hereby certify that, after giving effect to this First Amendment to Credit Agreement, no Default exists under the Credit Agreement. Section 7. Miscellaneous The Parent and the Borrowers agree, jointly and severally, to pay on demand all the Administrative Agent's reasonable expenses in preparing, executing and delivering this First Amendment to Credit Agreement, and all related instruments and documents, including, without limitation, the reasonable fees and out-of-pocket expenses of the Administrative Agent's special counsel, Goodwin, Procter & 2 108 Hoar LLP. This First Amendment to Credit Agreement shall be considered a Loan Document and shall be governed by and construed and enforced under the laws of the State of New York. IN WITNESS WHEREOF, the parties hereto have caused this First Amendment to Credit Agreement to be duly executed as an instrument under seal as of the date first written above. KIRKLANDS HOLDINGS LLC By: /s/ David Mussafer ------------------------------ Name: David Mussafer Title: KIRKLAND'S INC. KIRKLAND'S OF CAROLINA, INC. KIRKLAND'S OF CHARLOTTE, EASTLAND MALL, INC. KIRKLAND'S OF TENNESSEE, INC. K.C. CORP. INC. KIRKLAND'S OF GREENSBORO, FOUR SEASONS MALL, INC. KIRKLAND'S OF FAYETTEVILLE, CROSS CREEK MALL, INC. KIRKLAND'S OF WILMINGTON, INDEPENDENCE MALL, INC. KIRKLAND'S III, JACKSON-METRO CENTER, INC. KIRKLAND'S OF MEMPHIS, TENNESSEE, LAURELWOOD SHOPPING CENTER, INC. KIRKLAND'S OF RIDGELAND, MISSISSIPPI, NORTHPARK MALL, INC. KIRKLAND'S KNOXVILLE, EAST TOWNE MALL, INC. KIRKLAND'S HUNTSVILLE, MADISON SQUARE MALL, INC. KIRKLAND'S OF VALLEY VIEW MALL, ROANOKE, VA, INC. KIRKLAND'S OF BIRMINGHAM, RIVERCHASE GALLERIA, INC. KIRKLAND'S NASHVILLE, HICKORY HOLLOW MALL, INC. KIRKLAND'S OF BRIARCLIFFE MALL, MYRTLE BEACH, SOUTH CAROLINA, INC. KIRKLAND'S OF PECANLAND MALL, MONROE, LA, INC. KIRKLAND'S OF TOWNE CENTER AT COBB, ATLANTA GA, INC. KIRKLAND'S OF GWINNETT PLACE, MONROE, LA, INC. KIRKLAND'S OF RIVERGATE MALL, NASHVILLE, TN, INC. KIRKLAND'S OF PEACHTREE MALL, COLUMBUS, GA, INC. KIRKLAND'S OF CUMBERLAND MALL, ATLANTA, GA, INC. 3 109 KIRKLAND'S OF HAMILTON PLACE MALL, CHATTANOOGA, TN, INC. KIRKLAND'S OF HOUSTON GALLERIA, HOUSTON, TX, INC. KIRKLAND'S OF MALL OF MEMPHIS, MEMPHIS, TN, INC. KIRKLAND'S OF WOODLAND HILLS MALL, TULSA, OK, INC. KIRKLAND'S OF DAYTON MALL, DAYTON, OH, INC. KIRKLAND'S OF OXMOOR CENTER, LOUISVILLE, KY, INC. KIRKLAND'S OF SOUTH SQUARE MALL, DURHAM, NC, INC. KIRKLAND'S OF VALLEY VIEW CENTER, DALLAS, TX, INC. KIRKLAND'S OF CHESTERFIELD TOWNE CENTER, RICHMOND, VA, INC. KIRKLAND'S OF PARK PLAZA, LITTLE ROCK, AR, INC. KIRKLAND'S OF MONTGOMERY MALL, MONTGOMERY, AL, INC. KIRKLAND'S OF SOUTHLAKE MALL, ATLANTA, GA, INC. KIRKLAND'S OF SOUTHPARK MALL, RICHMOND, VA, INC. KIRKLAND'S OF EASTLAND MALL, EVANSVILLE, INC, INC. KIRKLAND'S OF FAYETTE MALL, LEXINGTON, KY, INC. KIRKLAND'S OF HICKORY RIDGE MALL, MEMPHIS, TN, INC. KIRKLAND'S OF REGENCY SQUARE MALL, JACKSONVILLE, FL, INC. KIRKLAND'S OF MCCAIN MALL, LITTLE ROCK, AR, INC. KIRKLAND'S OF RIVER RIDGE MALL, LYNCHBURG, VA, INC. KIRKLAND'S OF BEL AIR MALL, MOBILE, AL, INC. KIRKLAND'S OF THE MALL AT BARNES CROSSING, TUPELO, MS, INC. KIRKLAND'S OF CORTANA MALL, BATON ROUGE, LA, INC. KIRKLAND'S OF BELLEVUE CENTER, NASHVILLE, TN, INC. KIRKLAND'S OF TRI-COUNTY MALL, CINCINNATI, OH, INC. KIRKLAND'S OF THE MALL OF THE AVENUES, JACKSONVILLE, FL, INC. KIRKLAND'S OF EASTWOOD MALL, BIRMINGHAM, AL, INC. KIRKLAND'S OF LAKESIDE MALL, NEW ORLEANS, LA, INC. KIRKLAND'S OF CAROLINA PLACE, CHARLOTTE, N.C., INC. KIRKLAND'S OF CARY VILLAGE MALL, RALEIGH, N.C., INC. KIRKLAND'S OF COOL SPRINGS GALLERIA, NASHVILLE, TN, INC. KIRKLAND'S OF KENWOOD TOWNE CENTRE, CINCINNATI, OH, INC. KIRKLAND'S OF ST. LOUIS GALLERIA, ST. LOUIS, MO, INC. KIRKLAND'S OF WIREGRASS COMMONS MALL, DOTHAN, AL, INC. KIRKLAND'S OF REGENCY MALL, RICHMOND, VA, INC. KIRKLAND'S OF FLORENCE, FLORENCE, KY, INC. KIRKLAND'S OF ACADIANA MALL, LAFAYETTE, LA, INC. KIRKLAND'S OF PADRE STAPLES MALL, CORPUS CHRISTI, TX, INC. 4 110 KIRKLAND'S OF BELDEN VILLAGE, CANTON, OH, INC. KIRKLAND'S OF WEST OAKS MALL, HOUSTON, TX, INC. KIRKLAND'S OF CHARLESTON TOWN CENTER, CHARLESTON, W. VA, INC. KIRKLAND'S OF CRESTWOOD PLAZA, ST. LOUIS, MO, INC. KIRKLAND'S OF WHITE MARSH MALL, BALTIMORE, MD, INC. KIRKLAND'S OF COLLIN CREEK MALL, DALLAS, TX, INC. KIRKLAND'S OF BAYBROOK MALL, HOUSTON, TX, INC. KIRKLAND'S OF GOVERNOR'S SQUARE MALL, TALLAHASSEE, FL, INC. KIRKLAND'S OF BARTON CREEK MALL, AUSTIN, TX, INC. KIRKLAND'S OF HIGHLAND MALL, AUSTIN, TX, INC. KIRKLAND'S OF BATTLEFIELD MALL, SPRINGFIELD, MO, INC. KIRKLAND'S OF PENN SQUARE MALL, OKLAHOMA CITY, OK, INC. KIRKLAND'S OF MALL ST. VICENT, SHREVEPORT, LA, INC. KIRKLAND'S OF OWINGS MILLS MALL, BALTIMORE, MD, INC. KIRKLAND'S OF OAKWOOD CENTER, NEW ORLEANS, LA, INC. KIRKLAND'S OF THE MALL AT JOHNSON CITY, JOHNSON CITY, TN, INC. KIRKLAND'S OF GLENNBROOK MALL, FT. WAYNE, IN, INC. KIRKLAND'S OF NORTH POINTE MALL, ATLANTA, GA, INC. KIRKLAND'S OF NORTHPARK MALL, JOPLIN, MO, INC. KIRKLAND'S OF ORLANDO FASHION SQUARE, ORLANDO, FL, INC. KIRKLAND'S OF THE MALL AT FAIRFIELD COMMONS, DAYTON, OH, INC. KIRKLAND'S OF ST. CHARLES TOWNE CENTER, WALDORF, MD, INC. KIRKLAND'S OF REGENCY MALL, FLORENCE, AL, INC. KIRKLAND'S OF SOUTH PLAINS MALL, LUBBOCK, TX, INC. KIRKLAND'S OF THE PARKS AT ARLINGTON, FT. WORTH, TX, INC. KIRKLAND'S OF PARMA TOWN MALL, CLEVELAND, OH, INC. KIRKLAND'S OF ST. CLAIR SQUARE, ST. LOUIS, MO, INC. KIRKLAND'S OF TURTLE CREEK MALL, HATTIESBURG, MS, INC. KIRKLAND'S OF THE WOODLANDS, HOUSTON, TX, INC. KIRKLAND'S OF BRANDON TOWN CENTER, TAMPA, FL, INC. KIRKLAND'S OF MEMORIAL CITY MALL, HOUSTON, TX, INC. KIRKLAND'S OF UNIVERSITY MALL, TUSCALOOSA, AL, INC. KIRKLAND'S OF SANTA ROSA MALL, FORT WALTON, FL, INC. KIRKLAND'S OF PANAMA CITY MALL, PANAMA CITY, FL, INC. KIRKLAND'S OF TOWN EAST MALL, MESQUITE, TX, INC. KIRKLAND'S OF KENTUCKY OAKS MALL, PADUCAH, KY, INC. 5 111 KIRKLAND'S OF CRABTREE VALLEY MALL, RALEIGH, N.C., INC. KIRKLAND'S OF OAK HOLLOW MALL, HIGH POINT, N.C., INC. KIRKLAND'S OF FOX VALLEY MALL, CHICAGO, IL, INC. KIRKLAND'S OF HAWTHRONE MALL, CHICAGO, IL, INC. KIRKLAND'S OF STRAFTFORD SQUARE, CHICAGO, IL, INC. KIRKLAND'S OF ORLAND SQUARE, CHICAGO, IL, INC. KIRKLAND'S OF COASTLAND MALL, NAPLES, FL, INC. KIRKLAND'S OF EDGEWATER MALL, BILOXI, MS, INC. KIRKLAND'S OF TOWN CENTER PLAZA, KANSAS CITY, KS, INC. KIRKLAND'S OF CASTLETON SQUARE, INDIANAPOLIS, IN, INC. KIRKLAND'S OF CORDOVA MALL, PENSACOLA, FL, INC. KIRKLAND'S OF UNIVERSITY PARK, SOUTH BEND IN, INC. KIRKLAND'S OF WESTGATE MALL, AMARILLO, TX, INC. KIRKLAND'S OF WESTGATE MALL, SPARTANBURG, SC, INC. KIRKLAND'S OF MERIDIAN MALL, LANSING, MI, INC. KIRKLAND'S OF COTTONWOOD MALL, ALBUQUERQUE, NM, INC. KIRKLAND'S OF UNIVERSITY MALL, TAMPA, FL, INC. ATTEST: By:/s/ Robert E. Alderson By:/s/ Carl Kirkland ------------------------ ----------------------- Name: Name: Title: Title: LEHMAN COMMERCIAL PAPER INC. By:/s/ Michelle Swanson ------------------------ Name: Michelle Swanson Title: Authorized Signatory 6 112 THE FIRST NATIONAL BANK OF BOSTON By: /s/ Daniel P. Corcoran ______________________________ Name: Daniel P. Corcoran, Jr. Title: Vice President FIRST AMERICAN NATIONAL BANK By: /s/ Mariah G. Lunderberg ______________________________ Name: Mariah G. Lunderberg Title: Assistant Vice President HIBERNIA NATIONAL BANK By: /s/ Troy J. Villafarra ______________________________ Name: Troy J. Villafarra Title: Vice President MITSUI LEASING (U.S.A.) INC. By: /s/ R. Wayne Hutton ______________________________ Name: R. Wayne Hutton Title: Senior Vice President PRIME INCOME TRUST By: ______________________________ Name: Title: 7 113 CRESCENT/MACH I PARTNERS, L.P. By: TCW Asset Management Company Its Investment Manager By: _______________________________ Name: Title: UNION PLANTERS BANK OF JACKSON, N.A. By: /s/ Frank Hudacek ______________________________ Name: Frank Hudacek Title: Vice President VOLUNTEER BANK OF JACKSON, TENNESSEE By: /s/ James N. Craft ______________________________ Name: James N. Craft Title: Executive Vice President VAN KAMPEN AMERICAN CAPITAL PRIME RATE INCOME TRUST By: /s/ Jeffrey W. Maillet ______________________________ Name: Jeffrey W. Maillet Title: Senior Vice President & Director 143110.d1 11/12/96 8 114 - ------------------------------------------------------------------------------- SECOND AMENDMENT TO CREDIT AGREEMENT Dated as of May 2, 1997 Among Kirkland Holdings L.L.C. and The Borrowers Specified Herein, the Borrowers and The Several Lenders Party Hereto, the Lenders and BankBoston, N.A., as Administrative Agent, the Agent - ------------------------------------------------------------------------------- 115 SECOND AMENDMENT TO CREDIT AGREEMENT This SECOND AMENDMENT TO CREDIT AGREEMENT is entered into as of May 2, 1997, by and among KIRKLAND HOLDINGS L.L.C., a Delaware limited liability company (the "Parent"), the Borrowers specified herein (the "Borrowers"), the Lenders party hereto (the "Lenders") and BANKBOSTON, N.A. (f/k/a The First National Bank of Boston), as Administrative Agent (the "Agent") under the Credit Agreement referred to below. Recitals The Parent, the Borrowers, the Lenders and the Agent are parties to a Credit Agreement dated as of June 12, 1996 (as amended the "Credit Agreement"). The Parent and the Borrowers have requested that the Lenders (a) waive the prepayment of the Term Loans required to be made under Section 2.12(c) of the Credit Agreement from Excess Cash Flow for their fiscal year ended December 31, 1996, (b) waive the Borrower's premature payment of certain Management Fees and (c) provide additional availability under the revolving credit facility during the period from September 5, through December 5, 1997. The Lenders are willing to amend the Credit Agreement to provide for such waiver and additional revolving credit availability on the terms and conditions set forth herein. All capitalized terms used herein and not otherwise defined shall have the meanings set forth in the Credit Agreement. NOW, THEREFORE, subject to the satisfaction of the conditions to effectiveness specified in Section 5, the Parent, the Borrowers, the Lenders and the Agent hereby agree as follows: Section 1. Waiver of Excess Cash Flow Prepayment. The Lenders and the Agent hereby waive the prepayment required under Section 2.12(c) of the Credit Agreement with respect to the Excess Cash Flow for the fiscal year ending December 31, 1996; provided, however, that this waiver shall not be deemed to modify or amend any provisions of said Section 2.12(c) with respect to required prepayments from Excess Cash Flow for future fiscal years. Section 2. Waiver of Premature Payment of Management Fees. The Lenders and the Agent hereby waive the Event of Default outstanding under the Credit Agreement resulting from the Borrowers' payment of Management Fees to the Management Shareholders prior to delivery to the Lenders of the Borrowers' financial statements for their fiscal year ending December 31, 1996. The Lenders and the Agent hereby consent to the payment to Robert Kirkland, in connection with amendment of the Consulting Agreement, of an amount not be exceed $8,500. Section 3. Amendment of Schedules. Schedule 1.1A to the Credit Agreement is hereby amended by adding at the end of said Schedule the information contained on the Amendment to Schedule 1.1A attached hereto. Schedule 1.1B to the Credit Agreement is hereby deleted in its entirety and the new Schedule 1.1B attached hereto is substituted therefor. 116 Section 4. Amendment and Extension Fee. The Borrowers, jointly and severally, agree to pay to the Agent, for the account of the Lenders in proportion to the (a) Revolving Credit Commitments of the Revolving Credit Lenders and (b) the principal amount of the Obligations owing to each Term Loan Lender, an amendment and extension fee of $76,000, which shall be due and payable and deemed earned in full by the Lenders upon execution and delivery of this Second Amendment. The Lenders hereby agree that the amendment and extension fee shall be deducted from Combined Interest Expense for purposes of determining the Combined Management Fee Ratio for the Borrower's current fiscal year. Section 5. Effectiveness; Conditions to Effectiveness. This Second Amendment to Credit Agreement shall become effective as of the date hereof upon execution hereof by the Parent, the Borrowers, the Lenders and the Agent and satisfaction of the following conditions: (a) Officers' Certificate. The Borrowers shall have delivered to the Agent an Officers' Certificate in the form of Exhibit A hereto. (b) Opinion of Counsel. The Borrowers shall have delivered to the Agent an opinion of Baker, Donelson, Bearman & Caldwell, counsel to the Borrowers, and an opinion from Pepper, Hamilton & Scheetz, counsel to Parent and special counsel to the Borrowers, in form and substance satisfactory to the Bank. (c) Fee. The Borrowers shall have paid the fee referred to in Section 4 above. (d) Acknowledgment of Subordination. Carl Kirkland, Bruce Moore, Robert Alderson, and Robert Kirkland shall have executed and delivered to the Agent the Acknowledgments of Subordination in the form of Exhibit B hereto. Section 6. Representations and Warranties; No Default. The Borrowers hereby confirm to the Agent and the Lenders, the representations and warranties of the Borrowers set forth in Section 4 of the Credit Agreement (as amended hereby) as of the date hereof, as if set forth herein in full. The Borrowers hereby certify that, after giving effect hereto, no Default exists under the Credit Agreement. Section 7. Miscellaneous. The Borrowers agree to pay on demand all the Agent's reasonable expenses in preparing, executing and delivering this Second Amendment to Credit Agreement, and all related instruments and documents, including, without limitation, the reasonable fees and out-of-pocket expenses of the Agent's special counsel, Goodwin, Procter & Hoar LLP. This Second Amendment to Credit Agreement shall be a Loan Document and shall be governed by and construed and enforced under the laws of the State of New York. 2 117 IN WITNESS WHEREOF, the Parent, the Borrowers, the Lenders and the Agent have caused this Second Amendment to Credit Agreement to be executed by their duly authorized officers as of the date first set forth above. KIRKLAND HOLDINGS L.L.C. By: /s/ David Mussafer ------------------------------ Name: David Mussafer Title: President THE BORROWERS KIRKLAND'S, INC. KIRKLAND'S OF CAROLINA, INC. KIRKLAND'S OF CHARLOTTE, EASTLAND MALL, INC. KIRKLAND'S OF TENNESSEE, INC. K.C. CORP. INC. KIRKLAND'S OF GREENSBORO, FOUR SEASONS MALL, INC. KIRKLAND'S OF FAYETTEVILLE, CROSS CREEK MALL, INC. KIRKLAND'S OF WILMINGTON, INDEPENDENCE MALL, INC. KIRKLAND'S III, JACKSON-METRO CENTER, INC. KIRKLAND'S OF MEMPHIS, TENNESSEE, LAURELWOOD SHOPPING CENTER, INC. KIRKLAND'S OF RIDGELAND, MISSISSIPPI, NORTHPARK MALL, INC. KIRKLAND'S OF KNOXVILLE, EAST TOWNE MALL, INC. KIRKLAND'S OF HUNTSVILLE, MADISON SQUARE MALL, INC. KIRKLAND'S OF VALLEY VIEW MALL, ROANOKE, VA, INC. KIRKLAND'S OF NASHVILLE, HICKORY HOLLOW MALL, INC. KIRKLAND'S OF BIRMINGHAM, RIVERCHASE GALLERIA, INC. KIRKLAND'S OF BRIARCLIFFE MALL, MYRTLE BEACH, SOUTH CAROLINA, INC. KIRKLAND'S OF PEACANLAND MALL, MONROE, LA. INC. KIRKLAND'S OF TOWNE CENTER AT COBB, ATLANTA, GA, INC. KIRKLAND'S OF GWINNETT PLACE, ATLANTA, GA, INC. KIRKLAND'S OF RIVERGATE MALL, NASHVILLE, TN, INC. KIRKLAND'S OF PEACHTREE MALL, COLUMBUS, GA, INC. KIRKLAND'S OF CUMBERLAND MALL, ATLANTA, GA, INC. KIRKLAND'S OF HAMILTON PLACE MALL, CHATTANOOGA, TN, INC. KIRKLAND'S OF HOUSTON GALLERIA, HOUSTON, TX, INC. KIRKLAND'S OF MALL OF MEMPHIS, MEMPHIS, TN, INC. 3 118 KIRKLAND'S OF WOODLAND HILLS MALL, TULSA, OK, INC. KIRKLAND'S OF DAYTON MALL, DAYTON, OH, INC. KIRKLAND'S OF OXMOOR CENTER, LOUISVILLE, KY, INC. KIRKLAND'S OF SOUTH SQUARE MALL, DURHAM, NC, INC. KIRKLAND'S OF VALLEY VIEW CENTER, DALLAS, TX, INC. KIRKLAND'S OF CHESTERFIELD TOWNE CENTER, RICHMOND, VA, INC. KIRKLAND'S OF PARK PLAZA, LITTLE ROCK, AR, INC. KIRKLAND'S OF MONTGOMERY MALL, MONTGOMERY, AL, INC. KIRKLAND'S OF SOUTHLAKE MALL, ATLANTA, GA, INC. KIRKLAND'S OF SOUTHPARK MALL, RICHMOND, VA, INC. KIRKLAND'S OF EASTLAND MALL, EVANSVILLE, IN, INC. KIRKLAND'S OF FAYETTE MALL, LEXINGTON, KY, INC. KIRKLAND'S OF HICKORY RIDGE MALL, MEMPHIS, TN, INC. KIRKLAND'S OF REGENCY SQUARE MALL, JACKSONVILLE, FL, INC. KIRKLAND'S OF MCCAIN MALL, LITTLE ROCK, AR, INC. KIRKLAND'S OF RIVER RIDGE MALL, LYNCHBURG, VA, INC. KIRKLAND'S OF BEL AIR MALL, MOBILE, AL, INC. KIRKLAND'S OF THE MALL AT BARNES CROSSING, TUPELO, MS, INC. KIRKLAND'S OF CORTANA MALL, BATON ROUGE, LA, INC. KIRKLAND'S OF BELLEVUE CENTER, NASHVILLE, TN, INC. KIRKLAND'S OF TRI-COUNTY MALL, CINCINNATI, OH, INC. KIRKLAND'S OF THE MALL OF THE AVENUES, JACKSONVILLE, FL, INC. KIRKLAND'S OF EASTWOOD MALL, BIRMINGHAM, AL, INC. KIRKLAND'S OF LAKESIDE MALL, NEW ORLEANS, LA, INC. KIRKLAND'S OF CAROLINA PLACE, CHARLOTTE, N.C., INC. KIRKLAND'S OF CARY VILLAGE MALL, RALEIGH, N.C., INC. KIRKLAND'S OF COOL SPRINGS GALLERIA, NASHVILLE, TN, INC. KIRKLAND'S OF KENWOOD TOWNE CENTRE, CINCINNATI, OH, INC. KIRKLAND'S OF ST. LOUIS GALLERIA, ST. LOUIS, MO, INC. KIRKLAND'S OF WIREGRASS COMMONS MALL, DOTHAN, AL, INC. KIRKLAND'S OF REGENCY MALL, RICHMOND, VA, INC. KIRKLAND'S OF FLORENCE, FLORENCE, KY, INC. KIRKLAND'S OF ACADIANA MALL, LAFAYETTE, LA, INC. KIRKLAND'S OF PADRE STAPLES MALL, CORPUS CHRISTI, TX, INC. KIRKLAND'S OF BELDEN VILLAGE, CANTON, OH, INC. 4 119 KIRKLAND'S OF WEST OAKS MALL, HOUSTON, TX, INC. KIRKLAND'S OF CHARLESTON TOWN CENTER, CHARLESTON, W. VA, INC. KIRKLAND'S OF CRESTWOOD PLAZA, ST. LOUIS, MO, INC. KIRKLAND'S OF WHITE MARSH MALL, BALTIMORE, MD, INC. KIRKLAND'S OF COLLIN CREEK MALL, DALLAS, TX, INC. KIRKLAND'S OF BAYBROOK MALL, HOUSTON, TX, INC. KIRKLAND'S OF GOVERNOR'S SQUARE MALL, TALLAHASSEE, FL, INC. KIRKLAND'S OF BARTON CREEK MALL, AUSTIN, TX, INC. KIRKLAND'S OF HIGHLAND MALL, AUSTIN, TX, INC. KIRKLAND'S OF BATTLEFIELD MALL, SPRINGFIELD, MO, INC. KIRKLAND'S OF PENN SQUARE MALL, OKLAHOMA CITY, OK, INC. KIRKLAND'S OF OAK PARK MALL, KANSAS CITY, KS, INC. KIRKLAND'S OF MALL ST. VINCENT, SHREVEPORT, LA, INC. KIRKLAND'S OF OWINGS MILLS MALL, BALTIMORE, MD, INC. KIRKLAND'S OF OAKWOOD CENTER, NEW ORLEANS, LA, INC. KIRKLAND'S OF THE MALL AT JOHNSON CITY, JOHNSON CITY, TN, INC. KIRKLAND'S OF GLENBROOK MALL, FT. WAYNE, IN, INC. KIRKLAND'S OF NORTH POINTE MALL, ATLANTA, GA, INC. KIRKLAND'S OF NORTHPARK MALL, JOPLIN, MO, INC. KIRKLAND'S OF ORLANDO FASHION SQUARE, ORLANDO, FL, INC. KIRKLAND'S OF THE MALL AT FAIRFIELD COMMONS, DAYTON, OH, INC. KIRKLAND'S OF ST. CHARLES TOWNE CENTER, WALDORF, MD, INC. KIRKLAND'S OF REGENCY MALL, FLORENCE, AL, INC. KIRKLAND'S OF SOUTH PLAINS MALL, LUBBOCK, TX, INC. KIRKLAND'S OF THE PARKS AT ARLINGTON, FT. WORTH, TX, INC. KIRKLAND'S OF PARMA TOWN MALL, CLEVELAND, OH, INC. KIRKLAND'S OF ST. CLAIR SQUARE, ST. LOUIS, MO, INC. KIRKLAND'S OF TURTLE CREEK MALL, HATTIESBURG, MS, INC. KIRKLAND'S OF THE WOODLANDS, HOUSTON, TX, INC. KIRKLAND'S OF BRANDON TOWN CENTER, TAMPA, FL, INC. KIRKLAND'S OF MEMORIAL CITY MALL, HOUSTON, TX, INC. KIRKLAND'S OF UNIVERSITY MALL, TUSCALOOSA, AL, INC. KIRKLAND'S OF SANTA ROSA MALL, FORT WALTON, FL, INC. 5 120 KIRKLAND'S OF PANAMA CITY MALL, PANAMA CITY, FL, INC. KIRKLAND'S OF TOWN EAST MALL, MESQUITE, TX, INC. KIRKLAND'S OF KENTUCKY OAKS MALL, PADUCAH, KY, INC. KIRKLAND'S OF CRABTREE VALLEY MALL, RALEIGH, N.C., INC. KIRKLAND'S OF OAK HOLLOW MALL, HIGH POINT, N.C., INC. KIRKLAND'S OF FOX VALLEY MALL, CHICAGO, IL, INC. KIRKLAND'S OF HAWTHORNE MALL, CHICAGO, IL, INC. KIRKLAND'S OF STRATFORD SQUARE, CHICAGO, IL, INC. KIRKLAND'S OF ORLAND SQUARE, CHICAGO, IL, INC. KIRKLAND'S OF COASTLAND MALL, NAPLES, FL, INC. KIRKLAND'S OF EDGEWATER MALL, BILOXI, MS, INC. KIRKLAND'S OF TOWN CENTER PLAZA, KANSAS CITY, KS, INC. KIRKLAND'S OF CASTLETON SQUARE, INDIANAPOLIS, IN, INC. KIRKLAND'S OF CORDOVA MALL, PENSACOLA, FL, INC. KIRKLAND'S OF UNIVERSITY PARK, SOUTH BEND, IN, INC. KIRKLAND'S OF WESTGATE MALL, AMARILLO, TX, INC. KIRKLAND'S OF WESTGATE MALL, SPARTANBURG, SC, INC. KIRKLAND'S OF MERIDIAN MALL, LANSING, MI, INC. KIRKLAND'S OF COTTONWOOD MALL, ALBUQUERQUE, NM, INC. KIRKLAND'S OF UNIVERSITY MALL, TAMPA, FL, INC. KIRKLAND'S OF NORTHWEST ARKANSAS MALL, FAYETTEVILLE, AR, INC. KIRKLAND'S OF INDIAN RIVER MALL, VERO BEACH, FL, INC. KIRKLAND'S OF TYRONE SQUARE, ST. PETERSBURG, FL, INC. KIRKLAND'S OF NORTHGATE MALL, CINCINNATI, OH, INC. KIRKLAND'S OF WEST OAKS MALL, ORLANDO, FL, INC. KIRKLAND'S OF PARK CITY CENTER, LANCASTER, PA, INC. KIRKLAND'S OF PERIMETER MALL, ATLANTA, GA, INC. KIRKLAND'S OF WOLFCHASE GALLERIA, MEMPHIS, TN, INC. KIRKLAND'S OF NORTHPARK MALL, DAVENPORT, IA, INC. KIRKLAND'S OF LINDALE MALL, CEDAR RAPIDS, IA, INC. KIRKLAND'S OF CORONADO MALL, ALBUQUERQUE, NM, INC. KIRKLAND'S OF WILLOWBROOK MALL, HOUSTON, TX, INC. By: /s/ Robert E. Alderson - -------------------------- Name: Robert E. Alderson Title: Vice President/Secretary 6 121 BANKBOSTON, N.A., as Administrative Agent and as a Lender By: /s/ Daniel P. Corcoran, Jr. ----------------------------------- Name: Daniel P. Corcoran, Jr. Title: Director LEHMAN COMMERCIAL PAPER INC. By: /s/ Michele Swanson ----------------------------------- Name: Michele Swanson Title: Authorized Signatory HIBERNIA NATIONAL BANK By: /s/ Troy J. Villafarra ----------------------------------- Name: Troy J. Villafarra Title: Vice President FIRST AMERICAN NATIONAL BANK By: /s/ Mariah G. Lundberg ----------------------------------- Name: Mariah G. Lundberg Title: Assistant Vice President MITSUI LEASING (U.S.A.) INC. By: /s/ R. Wayne Hutton ----------------------------------- Name: R. Wayne Hutton Title: Senior Vice President UNION PLANTERS BANK OF JACKSON, TENNESSEE By: /s/ Frank Hudacek, VP ----------------------------------- Name: Frank Hudacek Title: Vice President 7 122 VOLUNTEER BANK OF JACKSON, TENNESSEE By: /s/ James N. Craft -------------------------------------- Name: James N. Craft Title: Executive Vice President CRESCENT/MACH I PARTNERS, L.P. By: TCW Asset Management Company Its Investment Manager By: Justin Driscoll -------------------------------------- Name: Justin Driscoll Title: Vice President INDOSUEZ CAPITAL FUNDING II, LTD. By Indosuez Capital as Portfolio Advisor By: /s/ Francoise Berthelot -------------------------------------- Name: FRANCOISE BERTHELOT Title: VICE PRESIDENT VAN KAMPEN AMERICAN CAPITAL PRIME RATE INCOME TRUST By: [Illegible Signature] -------------------------------------- Name: Title: The ING CAPITAL Senior Secured High Income Fund, L.P. By: ING CAPITAL ADVISORS, INC. AS INVESTMENT ADVISOR By: /s/ Michael P. McAdams -------------------------------------- Name: MICHAEL P. MCADAMS Title: MANAGING DIRECTOR 8 123 Amendment of Schedule 1.1A 1. Additional Borrowers. The following additional Borrowers have been added to the Credit Agreement: Kirkland's of Northwest Arkansas Mall, Fayetteville, AR, Inc. Kirkland's of Indian River Mall, Vero Beach, FL, Inc. Kirkland's of Tyrone Square, St. Petersburg, FL, Inc. Kirkland's of Northgate Mall, Cincinnati, OH, Inc. Kirkland's of West Oaks Mall, Orlando, FL, Inc. Kirkland's of Park City Center, Lancaster, PA, Inc. Kirkland's of Perimeter Mall, Atlanta, GA, Inc. Kirkland's of Wolfchase Galleria, Memphis, TN, Inc. Kirkland's of Northpark Mall, Davenport, IA, Inc. Kirkland's of Lindale Mall, Cedar Rapids, IA, Inc. Kirkland's of Coronado Mall, Albuquerque, NM, Inc. Kirkland's of Willowbrook Mall, Houston TX, Inc. 2. Additional Subsidiaries. The following Persons are additional Subsidiaries of the Parent, which have been formed in anticipation of the opening of new stores but which have not yet commenced any operations. Section 4.14 of the Credit Agreement shall be modified to include reference to these Persons as additional Subsidiaries of the Parent: Kirkland's of Honey Creek Mall, Terre Haute, IN, Inc. Kirkland's of Southpark Mall, Moline, IL, Inc. Kirkland's of Valley West Mall, Des Moines, IA, Inc. Kirkland's of Greenbrier Mall, Chesapeake, VA, Inc. Kirkland's of Cielo Vista Mall, El Paso, TX, Inc. Kirkland's of Tuttle Crossing, Columbus, OH, Inc. Kirkland's of Leigh Mall, Columbus, MS, Inc. Kirkland's of North Shore Square, Slidell, LA, Inc. Kirkland's of Post Oak Mall, College Station, TX, Inc. Kirkland's of Bonita Lakes Mall, Meridian, MS, Inc. Kirkland's of Huntington Mall, Huntington, WV, Inc. Kirkland's of Mall of Louisiana, Baton Rouge, LA, Inc. Kirkland's of Mill Creek Mall, Erie, PA, Inc. Kirkland's of Volusia Mall, Daytona Beach, FL, Inc. Kirkland's of Gateway Mall, Lincoln, NB, Inc. 9 124 - ----------------------------------------------------------------------------- THIRD AMENDMENT TO CREDIT AGREEMENT Dated as of January 5, 1998 Among Kirkland Holdings L.L.C. and The Borrowers Specified Herein, the Borrowers and The Several Lenders Party Hereto, the Lenders and BankBoston, N.A., as Administrative Agent, the Agent - ----------------------------------------------------------------------------- 125 THIRD AMENDMENT TO CREDIT AGREEMENT This THIRD AMENDMENT TO CREDIT AGREEMENT is entered into as of January 5, 1998, by and among KIRKLAND HOLDINGS L.L.C., a Delaware limited liability company (the "Parent"), the Borrowers specified herein (the "Borrowers"), the Lenders party hereto (the "Lenders") and BANKBOSTON, N.A. (f/k/a The First National Bank of Boston), as Administrative Agent (the "Agent") under the Credit Agreement referred to below. Recitals The Parent, the Borrowers, the Lenders and the Agent are parties to a Credit Agreement dated as of June 12, 1996 (as amended, the "Credit Agreement"). All capitalized terms used herein and not otherwise defined shall have the meanings set forth in the Credit Agreement. The Parent and the Borrowers have requested that the Lenders (a) waive the restrictions under Sections 7.7, 7.10 and 7.11 of the Credit Agreement to permit the redemption by the Borrowers from Bruce Moore pursuant to and in accordance with the Redemption Agreement dated December __, 1997 by and among Bruce Moore, Kirkland's, Inc. and the other corporations party thereto (the "Moore Redemption Agreement") of all of his stock of the Borrowers and as set forth on Schedule 1 hereto (the "Redeemed Moore Stock") representing not more than seven million one hundred forty-seven thousand five hundred sixty-six dollars ($7,147,566) aggregate value (the "Moore Redemption"), and (b) provide an additional seven million dollars ($7,000,000) under the Tranche B Term Loan facility, the proceeds of which are to be used for the Moore Redemption. The Lenders are willing to amend the Credit Agreement to provide for such waiver and additional Tranche B Term Loans on the terms and conditions set forth herein. NOW, THEREFORE, subject to the satisfaction of the conditions to effectiveness specified in Section 4, the Parent, the Borrowers, the Lenders and the Agent hereby agree as follows: Section 1. Waiver. The Lenders and the Agent hereby waive (a) the limitation on Restricted Payments under Section 7.7 of the Credit Agreement, (b) the limitation on optional payments and modifications of debt instruments and preferred stock, etc. under Section 7.10 of the Credit Agreement and (c) the limitation on transactions with affiliates under Section 7.11 of the Credit Agreement to the extent required to permit the Moore Redemption and the payment to Bruce Moore, in connection with the Moore Redemption and pursuant to and in accordance with the Moore Redemption Agreement, of an amount not to exceed seven million one hundred forty-seven thousand five hundred sixty-six dollars ($7,147,566). Additionally, the Lenders and the Agent hereby release Bruce Moore as a Pledgor under the Management Pledge Agreement and the New Management Pledge Agreement and the Agent will return the certificates representing the Redeemed Moore Stock to the Borrowers. The Parent and the Borrowers hereby acknowledge that pursuant to Section 7.6 of the Credit Agreement, the Parent, the Borrowers and their respective Subsidiaries may not, directly or indirectly, issue, 126 convey, sell, lease, assign, transfer or otherwise dispose of the Redeemed Moore Stock redeemed pursuant to the Moore Redemption. Section 2. Amendment of Schedules. Schedule 1.1A to the Credit Agreement is hereby amended by adding at the end of said Schedule the information contained on the Amendment to Schedule 1.1A attached hereto. Schedules 1.1B and 1.1E to the Credit Agreement are hereby deleted in their entirety and the new Schedules 1.1B and 1.1E attached hereto are substituted therefor. Section 3. Amendment of Capital Expenditures Covenant. Section 7.8 of the Credit Agreement is hereby amended by deleting the number "$5,000,000" appearing in the second line of the chart for Fiscal Year 1997 and substituting therefor the number "$5,800,000". Section 4. Effectiveness: Conditions to Effectiveness. This Third Amendment to Credit Agreement shall become effective as of January 7, 1998 upon execution hereof by the Parent, the Borrowers, the Lenders and the Agent and satisfaction of the following conditions: (a) Officers' Certificate. The Borrowers shall have delivered to the Agent an Officers' Certificate in the form of Exhibit A hereto. (b) Opinion of Counsel. The Borrowers shall have delivered to the Agent an opinion of Baker, Donelson, Bearman & Caldwell, counsel to the Borrowers, and an opinion from Pepper, Hamilton & Scheetz, counsel to Parent and special counsel to the Borrowers, in form and substance satisfactory to the Agent. (c) Financials. The Borrowers shall have delivered to the Agent, and the Lenders shall have reviewed and approved, the following financial information, in form and substance satisfactory to the Lenders: (i) Unaudited financial information required under Sections 6.1(c) and 6.2(d) of the Credit Agreement for November 1997. (ii) Unaudited, internally prepared, pro forma financial information for fiscal year 1997 consisting of the combined balance sheet and income statement of the Borrowers and their Subsidiaries. Such pro forma financial information to contain actual results through December 23, 1997 and projected results from December 24, 1997 through December 31, 1997. (iii) Analysis for fiscal year 1997, pro forma for actual results through December 23, 1997 and projected results from December 24, 1997 through December 31, 1997, showing each Loan Party has observed or performed all of its covenants and other agreements, and satisfied every condition, contained in the Credit Agreement and the other Loan 2 127 Documents to which it is a party to be observed, performed or satisfied by it, including showing all calculations in determining compliance with each covenant. (d) Consent of Subordinated Debt Holders. The Borrowers shall have delivered to the Agent evidence of the consent of the Subordinated Debt Holders to this Third Amendment to the Credit Agreement, including the $7,000,000 increase of the Trance B Term Loan in form and substance satisfactory to the Agent. (e) Moore Redemption. All conditions precedent to the consummation of the Moore Redemption, except for payment of the redemption price, shall have been satisfied without waiver. (f) Moore Redemption Agreement. The Borrowers shall have delivered to the Agent a certified copy of the Moore Redemption Agreement evidencing the Moore Redemption as duly executed by all the parties thereto, which Moore Redemption Agreement shall be on terms and conditions acceptable to the Agent. (g) Amendment to Management Pledge Agreement and New Management Pledge Agreement. The Borrowers shall have delivered to the Agent an amendment to the Management Pledge Agreement and the New Management Pledge Agreement, dated as of January 5, 1998, in the form of Exhibit B hereto. Section 5. Representations and Warranties; No Default. The Borrowers hereby confirm to the Agent and the Lenders, the representations and warranties of the Borrowers set forth in Section 4 of the Credit Agreement (as amended) as of the date hereof, as if set forth herein in full. The Borrowers hereby certify that, after giving effect hereto, no Default exists under the Credit Agreement. Section 6. Miscellaneous. The Borrowers agree to pay on demand all the Agent's reasonable expenses in preparing, executing and delivering this Third Amendment to Credit Agreement, and all related instruments and documents, including, without limitation, the reasonable fees and out-of-pocket expenses of the Agent's special counsel, Goodwin, Procter & Hoar LLP. This Third Amendment to Credit Agreement shall be a Loan Document and shall be governed by and construed and enforced under the laws of the State of New York. 3 128 IN WITNESS WHEREOF, the Parent, the Borrowers, the Lenders and Agent have caused this Third Amendment to Credit Agreement to be executed by their duly authorized officers as of the date first set forth above. KIRKLAND HOLDINGS L.L.C. By: /s/ David Mussafer --------------------------- Name: David Mussafer Title: President THE BORROWERS ------------- KIRKLAND'S, INC. KIRKLAND'S OF CAROLINA, INC. KIRKLAND'S OF CHARLOTTE, EASTLAND MALL, INC. KIRKLAND'S OF TENNESSEE, INC. K.C. CORP, INC. KIRKLAND'S OF GREENSBORO, FOUR SEASONS MALL, INC. KIRKLAND'S OF FAYETTEVILLE, CROSS CREEK MALL, INC. KIRKLAND'S OF WILMINGTON, INDEPENDENCE MALL, INC. KIRKLAND'S III, JACKSON-METRO CENTER, INC. KIRKLAND'S OF MEMPHIS, TENNESSEE, LAURELWOOD SHOPPING CENTER, INC. KIRKLAND'S OF RIDGELAND, MISSISSIPPI, NORTHPARK MALL, INC. KIRKLAND'S OF KNOXVILLE, EAST TOWNE MALL, INC. KIRKLAND'S OF HUNTSVILLE, MADISON SQUARE MALL, INC. KIRKLAND'S OF VALLEY VIEW MALL, ROANOKE, VA, INC. KIRKLAND'S OF NASHVILLE, HICKORY HOLLOW MALL, INC. KIRKLAND'S OF BIRMINGHAM, RIVERCHASE GALLERIA, INC. KIRKLAND'S OF BRIARCLIFFE MALL, MYRTLE BEACH, SOUTH CAROLINA, INC. KIRKLAND'S OF PEACANLAND MALL, MONROE, LA, INC. KIRKLAND'S OF TOWNE CENTER AT COBB, ATLANTA, GA, INC. KIRKLAND'S OF GWINNETT PLACE, ATLANTA, GA, INC. KIRKLAND'S OF RIVERGATE MALL, NASHVILLE, TN, INC. KIRKLAND'S OF PEACHTREE MALL, COLUMBUS, GA, INC. KIRKLAND'S OF CUMBERLAND MALL, ATLANTA, GA, INC. KIRKLAND'S OF HAMILTON PLACE MALL, CHATTANOOGA, TN, INC. KIRKLAND'S OF HOUSTON GALLERIA, HOUSTON, TX, INC. KIRKLAND'S OF MALL OF MEMPHIS, MEMPHIS, TN, INC. 4 129 KIRKLAND'S OF WOODLAND HILLS MALL, TULSA, OK, INC. KIRKLAND'S OF DAYTON MALL, DAYTON, OH, INC. KIRKLAND'S OF OXMOOR CENTER, LOUISVILLE, KY, INC. KIRKLAND'S OF SOUTH SQUARE MALL, DURHAM, NC, INC. KIRKLAND'S OF VALLEY VIEW CENTER, DALLAS, TX, INC. KIRKLAND'S OF CHESTERFIELD TOWNE CENTER, RICHMOND, VA, INC. KIRKLAND'S OF PARK PLAZA, LITTLE ROCK, AR, INC. KIRKLAND'S OF MONTGOMERY MALL, MONTGOMERY, AL, INC. KIRKLAND'S OF SOUTHLAKE MALL, ATLANTA, GA, INC. KIRKLAND'S OF SOUTHPARK MALL, RICHMOND, VA, INC. KIRKLAND'S OF EASTLAND MALL, EVANSVILLE, IN, INC. KIRKLAND'S OF FAYETTE MALL, LEXINGTON, KY, INC. KIRKLAND'S OF HICKORY RIDGE MALL, MEMPHIS, TN, INC. KIRKLAND'S OF REGENCY SQUARE MALL, JACKSONVILLE, FL, INC. KIRKLAND'S OF MCCAIN MALL, LITTLE ROCK, AR, INC. KIRKLAND'S OF RIVER RIDGE MALL, LYNCHBURG, VA, INC. KIRKLAND'S OF BEL AIR MALL, MOBILE, AL, INC. KIRKLAND'S OF THE MALL AT BARNES CROSSING, TUPELO, MS, INC. KIRKLAND'S OF CORTANA MALL, BATON ROUGE, LA, INC. KIRKLAND'S OF BELLEVUE CENTER, NASHVILLE, IN, INC. KIRKLAND'S OF TRI-COUNTY MALL, CINCINNATI, OH, INC. KIRKLAND'S OF THE MALL OF THE ANENUES, JACKSONVILLE, FL, INC. KIRKLAND'S OF EASTWOOD MALL, BIRMINGHAM, AL, INC. KIRKLAND'S OF LAKESIDE MALL, NEW ORLEANS, LA, INC. KIRKLAND'S OF CAROLINA PLACE, CHARLOTTE, N.C., INC. KIRKLAND'S OF CARY VILLAGE MALL, RALEIGH, N.C., INC. KIRKLAND'S OF COOL SPRINGS GALLERIA, NASHVILLE, TN, INC. KIRKLAND'S OF KENWOOD TOWNE CENTRE, CINCINNATI, OH, INC. KIRKLAND'S OF ST. LOUIS GALLERIA, ST. LOUIS, MO, INC. KIRKLAND'S OF WIREGRASS COMMONS MALL, DOTHAN, AL, INC. KIRKLAND'S OF REGENCY MALL, RICHMOND, VA, INC. KIRKLAND'S OF FLORENCE, FLORENCE, KY, INC. KIRKLAND'S OF ACADIANA MALL, LAFAYETTE, LA, INC. KIRKLAND'S OF PADRE STAPLES MALL, CORPUS CHRISTI, TX, INC. KIRKLAND'S OF BELDEN VILLAGE, CANTON, OH, INC. 5 130 KIRKLAND'S OF WEST OAKS MALL, HOUSTON, TX, INC. KIRKLAND'S OF CHARLESTON TOWN CENTER, CHARLESTON, W. VA, INC. KIRKLAND'S OF CRESTWOOD PLAZA, ST. LOUIS, MO, INC. KIRKLAND'S OF WHITE MARSH MALL, BALTIMORE, MD, INC. KIRKLAND'S OF COLLIN CREEK MALL, DALLAS, TX, INC. KIRKLAND'S OF BAYBROOK MALL, HOUSTON, TX, INC. KIRKLAND'S OF GOVERNOR'S SQUARE MALL, TALLAHASSEE, FL, INC. KIRKLAND'S OF BARTON CREEK MALL, AUSTIN, TX, INC. KIRKLAND'S OF HIGHLAND MALL, AUSTIN, TX, INC. KIRKLAND'S OF BATTLEFIELD MALL, SPRINGFIELD, MO, INC. KIRKLAND'S OF PENN SQUARE MALL, OKLAHOMA CITY, OK, INC. KIRKLAND'S OF OAK PARK MALL, KANSAS CITY, KS, INC. KIRKLAND'S OF MALL ST. VINCENT, SHREVEPORT, LA, INC. KIRKLAND'S OF OWINGS MILLS MALL, BALTIMORE, MD, INC. KIRKLAND'S OF OAKWOOD CENTER, NEW ORLEANS, LA, INC. KIRKLAND'S OF THE MALL AT JOHNSON CITY, JOHNSON CITY, TN, INC. KIRKLAND'S OF GLENBROOK MALL, FT. WAYNE, IN, INC. KIRKLAND'S OF NORTH POINTE MALL, ATLANTA, GA, INC. KIRKLAND'S OF NORTHPARK MALL, JOPLIN, MO, INC. KIRKLAND'S OF ORLANDO FASHION SQUARE, ORLANDO, FL, INC. KIRKLAND'S OF THE MALL AT FAIRFIELD COMMONS, DAYTON, OH, INC. KIRKLAND'S OF ST. CHARLES TOWNE CENTER, WALFDORF, MD, INC. KIRKLAND'S OF REGENCY MALL, FLORENCE, AL, INC. KIRKLAND'S OF SOUTH PLAINS MALL, LUBOCK, TX, INC. KIRKLAND'S OF THE PARKS AT ARLINGTON, FT. WORTH, TX, INC. KIRKLAND'S OF PARMA TOWN MALL, CLEVELAND, OH, INC. KIRKLAND'S OF ST. CLAIR SQUARE, ST. LOUIS, MO, INC. KIRKLAND'S OF TURTLE CREEK MALL, HATTIESBURG, MS, INC. KIRKLAND'S OF THE WOODLANDS, HOUSTON, TX, INC. KIRKLAND'S OF BRANDON TOWN CENTER, TAMPA, FL, INC. KIRKLAND'S OF MEMORIAL CITY MALL, HOUSTON, TX, INC. KIRKLAND'S OF UNIVERSITY MALL, TUSCALOOSA, AL, INC. KIRKLAND'S OF SANTA ROSA MALL, FORT WALTON, FL, INC. 6 131 KIRKLAND'S OF PANAMA CITY MALL, PANAMA CITY, FL, INC. KIRKLAND'S OF TOWN EAST MALL, MESQUITE, TX, INC. KIRKLAND'S OF KENTUCKY OAKS MALL, PADUCAH, KY, INC. KIRKLAND'S OF CRABTREE VALLEY MALL, RALEIGH, N.C., INC. KIRKLAND'S OF OAK HOLLOW MALL, HIGH POINT, N.C., INC. KIRKLAND'S OF FOX VALLEY MALL, CHICAGO, IL, INC. KIRKLAND'S OF HAWTHORNE MALL, CHICAGO, IL, INC. KIRKLAND'S OF STRATFORD SQUARE, CHICAGO, IL, INC. KIRKLAND'S OF ORLAND SQUARE, CHICAGO, IL, INC. KIRKLAND'S OF COASTLAND MALL, NAPLES, FL, INC. KIRKLAND'S OF EDGEWATER MALL, BILOXI, MS, INC. KIRKLAND'S OF TOWN CENTER PLAZA, KANSAS CITY, KS, INC. KIRKLAND'S OF CASTLETON SQUARE, INDIANAPOLIS, IN., INC. KIRKLAND'S OF CORDOVA MALL, PENSACOLA, FL, INC. KIRKLAND'S OF UNIVERSITY PARK, SOUTH BEND, IN, INC. KIRKLAND'S OF WESTGATE MALL, AMARILLO, TX, INC. KIRKLAND'S OF WESTGATE MALL, SPARTANBURG, SC, INC. KIRKLAND'S OF MERIDIAN MALL, LANSING, MI, INC. KIRKLAND'S OF COTTONWOOD MALL, ALBUQUERQUE, NM, INC. KIRKLAND'S OF UNIVERSITY MALL, TAMPA, FL, INC. KIRKLAND'S OF NORTHWEST ARKANSAS MALL, FAYETTEVILLE, AR, INC. KIRKLAND'S OF INDIAN RIVER MALL, VERO BEACH, FL, INC. KIRKLAND'S OF TYRONE SQUARE, ST. PETERSBURG, FL, INC. KIRKLAND'S OF NORTHGATE MALL, CINCINNATI, OH, INC. KIRKLAND'S OF WEST OAKS MALL, ORLANDO, FL, INC. KIRKLAND'S OF PARK CITY CENTER, LANCASTER, PA, INC. KIRKLAND'S OF PERIMETER MALL, ATLANTA, GA, INC. KIRKLAND'S OF WOLFCHASE GALLERIA, MEMPHIS, TN, INC. KIRKLAND'S OF NORTHPARK MALL, DAVENPORT, IA, INC. KIRKLAND'S OF LINDALE MALL, CEDAR RAPIDS, IA, INC. KIRKLAND'S OF CORONADO MALL, ALBUQUERQUE, NM, INC. KIRKLAND'S OF WILLOWBROOK MALL, HOUSTON, TX, INC. KIRKLAND'S OF HONEY CREEK MALL, TERRE HAUTE, IN, INC. KIRKLAND'S OF SOUTHPARK MALL, MOLINE, IL, INC. KIRKLAND'S OF VALLEY WEST MALL, DES MOINES, IA, INC. KIRKLAND'S OF GREENBRIER MALL, CHESAPEAKE, VA, INC. 7 132 KIRKLAND'S OF CIELO VISTA MALL, EL PASO, TX, INC. KIRKLAND'S OF TUTTLE CROSSING, COLUMBUS, OH, INC. KIRKLAND'S OF LEIGH MALL, COLUMBUS, MS, INC. KIRKLAND'S OF NORTH SHORE SQUARE, SLIDELL, LA, INC. KIRKLAND'S OF POST OAK MALL, COLLEGE STATION, TX, INC. KIRKLAND'S OF BONITA LAKES MALL, MERIDIAN, MS, INC. KIRKLAND'S OF HUNTINGTON MALL, HUNTINGTON, WV, INC. KIRKLAND'S OF MALL OF LOUISIANA, BATON ROUGE, LA, INC. KIRKLAND'S OF MILL CREEK MALL, ERIE, PA, INC. KIRKLAND'S OF VOLUSIA MALL, DAYTONA BEACH, FL, INC. KIRKLAND'S OF GATEWAY MALL, LINCOLN, NE, INC. KIRKLAND'S OF GRAPEVINE MILLS, GRAPEVINE, TX, INC. By: /s/ R. E. Alderson --------------------------------------- Name: R. E. Alderson Title: VP/Sec BANKBOSTON, N.A., as Administrative Agent and as a Lender By: /s/ Christopher S. Allen --------------------------------------- Name: Christopher S. Allen Title: Director LEHMAN COMMERCIAL PAPER INC. By: /s/ Michele Swanson --------------------------------------- Name: Michele Swanson Title: Authorized Signatory HIBERNIA NATIONAL BANK By: /s/ Troy J. Villafarra --------------------------------------- Name: Troy J. Villafarra Title: Vice President 8 133 FIRST AMERICAN NATIONAL BANK By: /s/ John W. Teasley --------------------------------------- Name: John W. Teasley Title: Assistant Vice President MITSUI LEASING CAPITAL CORPORATION By: /s/ R. Wayne Hutton --------------------------------------- Name: R. Wayne Hutton Title: Senior Vice President UNION PLANTERS BANK OF JACKSON, TENNESSEE By: /s/ Frank Hudacek --------------------------------------- Name: Frank Hudacek Title: Vice President VOLUNTEER BANK OF JACKSON, TENNESSEE By: --------------------------------------- Name: Title: CRESCENT/MACH I PARTNERS, L.P. By: TCW Asset Management Company Its Investment Manager By: --------------------------------------- Name: Title: INDOSUEZ CAPITAL FUNDING II, LTD. By: --------------------------------------- Name: Title: 9 134 HIBERNIA NATIONAL BANK By: ------------------------------ Name: Title: FIRST AMERICAN NATIONAL BANK By: ------------------------------ Name: Title: MITSUI LEASING CAPITAL CORPORATION By: ------------------------------ Name: Title: UNION PLANTERS BANK OF JACKSON, TENNESSEE By: ------------------------------ Name: Title: VOLUNTEER BANK OF JACKSON, TENNESSEE By: /s/ James N. Craft ------------------------------ Name: James N. Craft Title: Executive Vice President CRESCENT/MACH I PARTNERS, L.P. By: TCW Asset Management Company Its Investment Manager By: /s/ Justin L. Driscoll ------------------------------ Name: Justin L. Driscoll Title: Senior Vice President 10 135 FIRST AMERICAN NATIONAL BANK By: ______________________________ Name: Title: MITSUI LEASING CAPITAL CORPORATION By: ______________________________ Name: Title: UNION PLANTERS BANK OF JACKSON, TENNESSEE By: ______________________________ Name: Title: VOLUNTEER BANK OF JACKSON, TENNESSEE By: ______________________________ Name: Title: CRESCENT/MACH I PARTNERS, L.P. By: TCW Asset Management Company Its Investment Manager By:______________________________ Name: Title: INDOSUEZ CAPITAL FUNDING II, LTD. By: /s/ Francoise Berthelot ______________________________ Name: Francoise Berthelot Title: Vice President 11 136 VAN KAMPEN AMERICAN CAPITAL PRIME RATE INCOME TRUST By: /s/ Jeffrey W. Maillet ______________________________ Name: Jeffrey W. Maillet Title: Senior Vice President & Director 12 137 SCHEDULE 1 SHARES OF STOCK
- ------------------------------------------------------ Corporation Shares Class of Stock Certificate - ------------------------------------------------------ Group A and 7,250 Common 4 B Companies (Voting) - ------------------------------------------------------ 650 Common 1 (Non-Voting) --------------------------------------- 7,900 Class B 3 Preferred --------------------------------------- 2,878 Class C 3 Preferred - ------------------------------------------------------ Group C 7,900 Common 1 Companies (Non-Voting) - ------------------------------------------------------ 3,000 Class B 3 Preferred (Voting) --------------------------------------- 4,900 Class B 1 Preferred (Non-Voting) - ------------------------------------------------------ Group D 7,900 Common 4 Companies (Voting) --------------------------------------- 7,900 Class B 3 Preferred - ------------------------------------------------------ Group E 79 Common 4 Companies - ------------------------------------------------------
The listing of Group A, B, C, D, and E Companies begins on the next page (Schedule 1-2). Schedule 1-1 138 A Kirkland's, Inc. Kirkland's of Pecanland Mall, Monroe, LA, Inc. Kirkland's of Town Center at Cobb, Atlanta, GA, Inc. Kirkland's of Gwinnett Place, Atlanta, GA, Inc. Kirkland's of Peachtree Mall, Columbus, GA, Inc. Kirkland's of Cumberland Mall, Atlanta, GA, Inc. Kirkland's of Hamilton Place Mall, Chattanooga, TN, Inc. Kirkland's of Houston Galleria, Houston, TX, Inc. Kirkland's of Mall of Memphis, Memphis, TN, Inc. Kirkland's of Woodland Hills Mall, Tulsa, OK, Inc. Kirkland's of Dayton Mall, Dayton, OH, Inc. Kirkland's of Oxmoor Center, Louisville, KY, Inc. Kirkland's of South Square Mall, Durham, NC, Inc. Kirkland's of Valley View Center, Dallas, TX, Inc. Kirkland's of Chesterfield Towne Center, Richmond, VA, Inc. Kirkland's of Park Plaza Mall, Little Rock, AR, Inc. Kirkland's of Montgomery Mall, Montgomery, AL, Inc. Kirkland's of Southlake Mall, Atlanta, GA, Inc. Kirkland's of Southpark Mall, Richmond, VA, Inc. Kirkland's of Eastland Mall, Evansville, IN, Inc. Kirkland's of Fayette Mall, Lexington, KY, Inc. Kirkland's of Hickory Ridge Mall, Memphis, TN, Inc. Kirkland's of Regency Square Mall, Jacksonville, FL, Inc. Kirkland's of McCain Mall, Little Rock, AR, Inc. Kirkland's of River Ridge Mall, Lynchburg, VA, Inc. Kirkland's of Bel Air Mall, Mobile, AL, Inc. Kirkland's of The Mall at Barnes Crossing, Tupelo, MS, Inc. Kirkland's of Cortana Mall, Baton Rouge, LA, Inc. Kirkland's of Bellevue Center, Nashville, TN, Inc. Kirkland's of Tri-County Mall, Cincinnati, OH, Inc. Kirkland's of The Mall of the Avenues, Jacksonville, FL, Inc. Kirkland's of Eastwood Mall, Birmingham, AL, Inc. Kirkland's of Lakeside Mall, New Orleans, LA, Inc. Kirkland's of Carolina Place, Charlotte, N.C., Inc. Kirkland's of Cary Village Mall, Raleigh, N.C., Inc. Kirkland's of Cool Springs Galleria, Nashville, TN, Inc. Kirkland's of Kenwood Towne Centre, Cincinnati, OH, Inc. Kirkland's of St. Louis Galleria, St. Louis, MO, Inc. Kirkland's of Wiregrass Commons Mall, Dothan, AL, Inc. Kirkland's of Regency Mall, Richmond, VA, Inc. Kirkland's of Florence Mall, Florence, KY, Inc. Kirkland's of Acadiana Mall, Lafayette, LA, Inc. Kirkland's of Padre Staples Mall, Corpus Christi, TX, Inc. Kirkland's of Belden Village, Canton, OH, Inc. Kirkland's of West Oaks Mall, Houston, TX, Inc. Kirkland's of Charleston Town Center, Charleston, W. VA. Inc. Kirkland's of Crestwood Plaza, St. Louis, MO, Inc. Kirkland's of White Marsh Mall, Baltimore, MD, Inc. Kirkland's of Collin Creek Mall, Dallas, TX, Inc. Schedule 1-2 139 Kirkland's of Baybrook Mall, Houston, TX, Inc. Kirkland's of Governor's Square Mall, Tallahassee, FL, Inc. Kirkland's of Barton Creek Mall, Austin, TX, Inc. Kirkland's of Highland Mall, Austin, TX, Inc. Kirkland's of Battlefield Mall, Springfield, MO, Inc. Kirkland's of Penn Square Mall, Oklahoma City, OK, Inc. Kirkland's of Oak Park Mall, Kansas City, KS, Inc. Kirkland's of Mall St. Vincent, Shreveport, LA, Inc. Kirkland's of Owings Mills Mall, Baltimore, MD, Inc. Kirkland's of Oakwood Center, New Orleans, LA, Inc. Kirkland's of The Mall at Johnson City, Johnson City, TN, Inc. Kirkland's of Glenbrook Mall, Ft. Wayne, IN, Inc. Kirkland's of North Pointe Mall, Atlanta, GA, Inc. Kirkland's of Northpark Mall, Joplin, MO, Inc. Kirkland's of Orlando Fashion Square, Orlando, FL, Inc. Kirkland's of The Mall at Fairfield Commons, Dayton, OH, Inc. Kirkland's of St. Charles Towne Center, Waldorf, MD, Inc. Kirkland's of Regency Mall, Florence, AL, Inc. Kirkland's of South Plains Mall, Lubbock, TX, Inc. Kirkland's of The Parks at Arlington, Ft. Worth, TX, Inc. Kirkland's of Parma Town Mall, Cleveland, OH, Inc. Kirkland's of St. Clair Square, St. Louis, MO, Inc. Kirkland's of Turtle Creek Mall, Hattiesburg, MS, Inc. Kirkland's of The Woodlands, Houston, TX, Inc. Kirkland's of Brandon Town Center, Tampa, FL, Inc. Kirkland's of Memorial City Mall, Houston, TX, Inc. Kirkland's of University Mall, Tuscaloosa, AL, Inc. Kirkland's of Santa Rosa Mall, Fort Walton, FL, Inc. Kirkland's of Panama City Mall, Panama City, FL, Inc. B Kirkland's of Town East Mall, Mesquite, TX, Inc. Kirkland's of Kentucky Oaks Mall, Paducah, KY, Inc. Kirkland's of Crabtree Valley Mall, Raleigh, N.C., Inc. Kirkland's of Oak Hollow Mall, Highpoint, N.C., Inc. Kirkland's of Fox Valley Mall, Chicago, IL, Inc. Kirkland's of Hawthorne Mall, Chicago, IL, Inc. Kirkland's of Stratford Square, Chicago, IL, Inc. Kirkland's of Orland Square, Chicago, IL, Inc. Kirkland's of Coastland Mall, Naples, FL, Inc. C Kirkland's of Carolina, Inc. Kirkland's of Charlotte, Eastland Mall, Inc. Kirkland's of Tennessee, Inc. K. C. Corp., Inc. Kirkland's of Greensboro, Four Seasons Mall, Inc. Schedule 1-3 140 Kirkland's of Fayetteville, Cross Creek Mall, Inc. Kirkland's of Wilmington, Independence Mall, Inc. Kirkland's III, Jackson-Metro Center, Inc. Kirkland's of Memphis, Tennessee, Laurelwood Shopping Center, Inc. Kirkland's of Ridgeland, Mississippi, Northpark Mall, Inc. Kirkland's of Knoxville, East Towne Mall, Inc. Kirkland's of Huntsville, Madison Square Mall, Inc. Kirkland's of Valley View Mall, Roanoke, VA, Inc. Kirkland's of Nashville, Hickory Hollow Mall, Inc. Kirkland's of Birmingham, Riverchase Galleria, Inc. Kirkland's of Briar Cliffe Mall, Myrtle Beach, South Carolina, Inc. Kirkland's of Rivergate Mall, Nashville, TN, Inc. D Kirkland's of Edgewater Mall, Biloxi, MS, Inc. Kirkland's of Town Center Plaza, Kansas City, KS, Inc. Kirkland's of Castleton Square, Indianapolis, IN, Inc. Kirkland's of Cordova Mall, Pensacola, FL, Inc. Kirkland's of University Park, South Bend, IN, Inc. Kirkland's of Westgate Mall, Spartanburg, SC, Inc. Kirkland's of Westgate Mall, Amarillo, TX, Inc. Kirkland's of Meridian Mall, Lansing, MI, Kirkland's of Cottonwood Mall, Albuquerque, NM, Inc. Kirkland's of University Mall, Tampa, FL, Inc. E Kirkland's of Northwest Arkansas Mall, Fayetteville, Ar, Inc. Kirkland's of Indian River Mall, Vero Beach, Fl, Inc. Kirkland's of Tyrone Square, St. Petersburg, Fl, Inc. Kirkland's of Northgate Mall, Cincinnati, Oh, Inc. Kirkland's of West Oaks Mall, Orlando, Fl, Inc. Kirkland's of Park City Center, Lancaster, Pa, Inc. Kirkland's of Northpark Mall, Davenport, Ia, Inc. Kirkland's of Perimeter Mall, Atlanta, Ga, Inc. Kirkland's of Wolfchase Galleria, Memphis, Tn, Inc. Kirkland's of Lindale Mall, Cedar Rapids, Ia, Inc. Kirkland's of Coronado Mall, Albuquerque, Nm, Inc. Kirkland's of Willowbrook Mall, Houston, Tx, Inc. Schedule 1 - 4 141 Amendment of Schedule 1.1A 1. Additional Borrowers. The following additional Borrowers have been added to the Credit Agreement: Kirkland's of Honey Creek Mall, Terre Haute, IN, Inc. Kirkland's of Southpark Mall, Moline, IL, Inc. Kirkland's of Valley West Mall, Des Moines, IA, Inc. Kirkland's of Greenbrier Mall, Chesapeake, VA, Inc. Kirkland's of Cielo Vista Mall, El Paso, TX, Inc. Kirkland's of Tuttle Crossing, Columbus, OH, Inc. Kirkland's of Leigh Mall, Columbus, MS, Inc. Kirkland's of North Shore Square, Slidell, LA, Inc. Kirkland's of Post Oak Mall, College Station, TX, Inc. Kirkland's of Bonita Lakes Mall, Meridian, MS, Inc. Kirkland's of Huntington Mall, Huntington, WV, Inc. Kirkland's of Mall of Louisiana, Baton Rouge, LA, Inc. Kirkland's of Mill Creek Mall, Erie, PA, Inc. Kirkland's of Volusia Mall, Daytona Beach, FL, Inc. Kirkland's of Gateway Mall, Lincoln, NE, Inc. Kirkland's of Grapevine Mills, Grapevine, TX, Inc. 2. Additional Subsidiaries. The following Persons are additional Subsidiaries of the Parent, which have been formed in anticipation of the opening of new stores but which have not yet commenced any operations. Section 4.14 of the Credit Agreement shall be modified to include reference to these Persons as additional Subsidiaries of the Parent: Kirkland's of Southland Mall, Houma, LA, Inc. Kirkland's of First Colony Mall, Houston, TX, Inc. Kirkland's of Oviedo Marketplace, Orlando, FL, Inc. Kirkland's of Coral Springs, Coral Springs, FL, Inc. 11 EX-10.2 10 SENIOR SUBORDINATED NOTE DUE 2003 1 EXHIBIT 10.2 THIS PROMISSORY NOTE HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY APPLICABLE STATE SECURITIES LAWS AND MAY NOT BE SOLD OR TRANSFERRED WITHOUT COMPLIANCE WITH THE REGISTRATION OR QUALIFICATION PROVISIONS OF APPLICABLE FEDERAL AND STATE SECURITIES LAWS OR APPLICABLE EXEMPTIONS THEREFROM. THIS NOTE IS SUBJECT TO A SUBORDINATION AND INTERCREDITOR AGREEMENT DATED ON OR ABOUT THE DATE HEREOF BY AND AMONG CAPITAL RESOURCE LENDERS II, L.P., ALLIED CAPITAL CORPORATION, ALLIED CAPITAL CORPORATION II, THE MARLBOROUGH CAPITAL INVESTMENT FUND, L.P., CAPITAL TRUST INVESTMENTS, LTD. AND THE BORROWERS. SENIOR SUBORDINATED NOTE DUE 2003 $8,000,000.00 June 12, 1996 FOR VALUE RECEIVED, each of the entities listed on the signature pages hereto (hereinafter, together with their successors in title and assigns, called the "Borrowers" and each individually a "Borrower"), hereby jointly and severally promise to pay to Capital Resource Lenders II, L.P. or assigns (hereinafter referred to as the "Payee"), on or before June 30, 2003, the principal sum of EIGHT MILLION DOLLARS ($8,000,000.00) or such part thereof as then remains unpaid, and to pay interest from the date hereof on the whole amount of said principal sum remaining from time to time unpaid at the rate of twelve and one-quarter percent (12.25%) per annum, such interest to be payable quarterly in arrears on the last day of March, June, September and December in each year, the first such payment to be due and payable on June 30, 1996 until the whole amount of the principal hereof remaining unpaid shall become due and payable. Notwithstanding the foregoing, beginning July 1, 1998 this Note shall bear interest at the rate of twelve and one-half percent (12.50%) per annum. Under certain circumstances as indicated in Section 2.06 of the Agreement (as defined), this Note shall bear interest at the rate of thirteen and one-half percent (13.50%) per annum. Principal, premium, if any, and interest shall be payable in lawful money of the United States of America, in immediately available funds, by wire transfer of funds to the account or accounts designated in writing by the Payee or in such other manner as the Payee may designate from time to time in writing to the Borrowers. Interest shall be computed on the basis of a 360-day year for the actual number of days elapsed. Nothing in this Note shall require the Borrowers to pay interest at a rate in excess of the maximum rate permitted by applicable law. If an Event of Default, as defined in the Agreement, has occurred and is continuing, from and after the date such Event of Default occurred any outstanding unpaid principal hereof and any unpaid interest thereon shall bear interest, payable on demand, at the rate of (i) fourteen and one-quarter percent (14.25%) per annum if such Event of Default exists prior to July 1, 1998, (ii) fourteen and one-half percent (14.50%) per annum if such Event of Default exists on or after July 1, 1998, and (iii) fifteen and one-half percent (15.50%) per annum if such Event of Default exists following a Liquidity IPO (as defined in the Agreement), if upon the closing of such Liquidity IPO this Note has not been repaid in full, or such lower rate as then may be the maximum rate permitted by applicable law; provided, however, that upon the cessation or cure of such Event of Default, if no other Event of Default is then continuing, this Note shall again bear interest at the rate of twelve and one-quarter percent (12.25%) per annum, 12.50% per annum or 13.50% per annum, as applicable, as set forth in the Agreement. 2 This Note is issued pursuant to and is entitled to the benefits of a certain Senior Subordinated Note and Warrant Purchase Agreement, dated as of the date hereof, by and among the Borrowers and Capital Resource Lenders II, L.P., Allied Capital Corporation, Allied Capital Corporation II, The Marlborough Capital Investment Fund, L.P., and Capital Trust Investments, Ltd. (as the same may be amended from time to time, referred to herein as the "Agreement"), and each holder of this Note, by his acceptance hereof, agrees to be bound by the provisions of the Agreement. The Borrowers and the Payee further acknowledge and agree that (i) this Note is subject to prepayment, in whole or in part, and to certain mandatory redemption payments, as specified in the Agreement, (ii) the principal of and interest on this Note is subordinated to certain Senior Debt (as defined in the Agreement) of the Borrowers pursuant to the Subordination Agreement (as defined in the Agreement) and (iii) in case of an Event of Default (as defined in the Agreement), the principal of this Note may become or may be declared due and payable in the manner and with the effect provided in the Agreement. As further provided in the Agreement, upon surrender of this Note for transfer or exchange, a new Note or new Notes of the same tenor dated the date to which interest has been paid on the surrendered Note and in an aggregate principal amount equal to the unpaid principal amount of the Note so surrendered will be issued to the transferee or transferees. In case any payment herein provided for shall not be paid when due, each Borrower jointly and severally promises to pay all costs of collection, including all reasonable attorneys' fees. This Note shall be governed by, and construed in accordance with, the laws of the Commonwealth of Massachusetts. Except as expressly set forth in the Agreement, each Borrower and all endorsers and guarantors of this Note hereby waive presentment, demand, notice of nonpayment, protest and all other demands and notices in connection with the delivery, acceptance, performance or enforcement of this Note. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 3 IN WITNESS WHEREOF, each Borrower has executed this Note under seal as of the date first written above. Kirkland's Inc. Kirkland's of Carolina, Inc. Kirkland's of Charlotte, Eastland Mall, Inc. Kirkland's of Tennessee, Inc. K.C. Corp. Inc. Kirkland's of Greensboro, Four Seasons Mall, Inc. Kirkland's of Fayetteville, Cross Creek Mall, Inc. Kirkland's of Wilmington, Independence Mall, Inc. Kirkland's III, Jackson-Metro Center, Inc. Kirkland's of Memphis, Tennessee, Laurelwood Shopping Center, Inc. Kirkland's of Ridgeland, Mississippi, Northpark Mall, Inc. Kirkland's of Knoxville, East Towne Mall, Inc. Kirkland's of Huntsville, Madison Square Mall, Inc. Kirkland's of Valley View Mall, Roanoke, VA, Inc. Kirkland's of Nashville, Hickory Hollow Mall, Inc. Kirkland's of Birmingham, Riverchase Galleria, Inc. Kirkland's of BriarCliffe Mall, Myrtle Beach, South Carolina, Inc. Kirkland's of Pecanland Mall, Monroe, LA, Inc. Kirkland's of Towne Center at Cobb, Atlanta, GA, Inc. Kirkland's of Gwinnett Place, Atlanta, GA, Inc. Kirkland's of Rivergate Mall, Nashville, TN, Inc. Kirkland's of Peachtree Mall, Columbus, GA, Inc. Kirkland's of Cumberland Mall, Atlanta, GA, Inc. Kirkland's of Hamilton Place Mall, Chattanooga, TN, Inc. Kirkland's of Houston Galleria, Houston, TX, Inc. Kirkland's of Mall of Memphis, Memphis, TN, Inc. Kirkland's of Woodland Hills Mall, Tulsa, OK, Inc. Kirkland's of Dayton Mall, Dayton, OH, Inc. Kirkland's of Oxmoor Center, Louisville, KY, Inc. Kirkland's of South Square Mall, Durham, NC, Inc. Kirkland's of Valley View Center, Dallas, TX, Inc. Kirkland's of Chesterfield Towne Center, Richmond, VA, Inc. Kirkland's of Park Plaza, Little Rock, AR, Inc. 4 Kirkland's of Montgomery Mall, Montgomery, AL, Inc. Kirkland's of Southlake Mall, Atlanta, GA, Inc. Kirkland's of Southpark Mall, Richmond, VA, Inc. Kirkland's of Eastland Mall, Evansville, IN, Inc. Kirkland's of Fayette Mall, Lexington, KY, Inc. Kirkland's of Hickory Ridge Mall, Memphis, TN, Inc. Kirkland's of Regency Square Mall, Jacksonville, FL, Inc. Kirkland's of McCain Mall, Little Rock, AR, Inc. Kirkland's of River Ridge Mall, Lynchburg, VA, Inc. Kirkland's of Bel Air Mall, Mobile, AL, Inc. Kirkland's of The Mall at Barnes Crossing, Tupelo, MS, Inc. Kirkland's of Cortana Mall, Baton Rouge, LA, Inc. Kirkland's of Bellevue Center, Nashville, TN, Inc. Kirkland's of Tri-County Mall, Cincinnati, OH, Inc. Kirkland's of The Mall of the Avenues, Jacksonville, FL, Inc. Kirkland's of Eastwood Mall, Birmingham, AL, Inc. Kirkland's of Lakeside Mall, New Orleans, LA, Inc. Kirkland's of Carolina Place, Charlotte, N.C., Inc. Kirkland's of Cary Village Mall, Raleigh, N.C., Inc. Kirkland's of Cool Springs Galleria, Nashville, TN, Inc. Kirkland's of Kenwood Towne Centre, Cincinnati, OH, Inc. Kirkland's of St. Louis Galleria, St. Louis, MO, Inc. Kirkland's of Wiregrass Commons Mall, Dothan, AL, Inc. Kirkland's of Regency Mall, Richmond, VA, Inc. Kirkland's of Florence, Florence, KY, Inc. Kirkland's of Acadiana Mall, Lafayette, LA, Inc. Kirkland's of Padre Staples Mall, Corpus Christi, TX, Inc. Kirkland's of Belden Village, Canton, OH, Inc. Kirkland's of West Oaks Mall, Houston, TX, Inc. Kirkland's of Charleston Town Center, Charleston, W. VA, Inc. Kirkland's of Crestwood Plaza, St. Louis, MO, Inc. 5 Kirkland's of White Marsh Mall, Baltimore, MD, Inc. Kirkland's of Collin Creek Mall, Dallas, TX, Inc. Kirkland's of Baybrook Mall, Houston, TX, Inc. Kirkland's of Governor's Square Mall, Tallahassee, Fl, Inc. Kirkland's of Barton Creek Mall, Austin, TX, Inc. Kirkland's of Highland Mall, Austin, TX, Inc. Kirkland's of Battlefield Mall, Springfield, MO, Inc. Kirkland's of Penn Square Mall, Oklahoma City, OK, Inc. Kirkland's of Oak Park Mall, Kansas City, KS, Inc. Kirkland's of Mall St. Vincent, Shreveport, LA, Inc. Kirkland's of Owings Mills Mall, Baltimore, MD, Inc. Kirkland's of Oakwood Center, New Orleans, LA, Inc. Kirkland's of The Mall at Johnson City, Johnson City, TN, Inc. Kirkland's of Glenbrook Mall, Ft. Wayne, IN, Inc. Kirkland's of North Pointe Mall, Atlanta, GA, Inc. Kirkland's of Northpark Mall, Joplin, MO, Inc. Kirkland's of Orlando Fashion Square, Orlando, FL, Inc. Kirkland's of The Mall at Fairfield Commons, Dayton, OH, Inc. Kirkland's of St. Charles Towne Center, Waldorf, MD Inc. Kirkland's of Regency Mall, Florence, AL, Inc. Kirkland's of South Plains Mall, Lubbock, TX, Inc. Kirkland's of The Parks at Arlington, Ft. Worth, TX, Inc. Kirkland's of Parma Town Mall, Cleveland, OH, Inc. Kirkland's of St. Clair Square, St. Louis, MO, Inc. Kirkland's of Turtle Creek Mall, Hattiesburg, MS, Inc. Kirkland's of The Woodlands, Houston, TX, Inc. Kirkland's of Brandon Town Center, Tampa, FL, Inc. Kirkland's of Memorial City Mall, Houston, TX, Inc. Kirkland's of University Mall, Tuscaloosa, AL, Inc. 6 Kirkland's of Santa Rosa Mall, Fort Walton, FL, Inc. Kirkland's of Panama City Mall Panama City, FL, Inc. Kirkland's of Town East Mall, Mesquite, TX, Inc. Kirkland's of Kentucky Oaks Mall, Paducah, KY, Inc. Kirkland's of Crabtree Valley Mall, Raleigh, N.C., Inc. Kirkland's of Oak Hollow Mall, High Point, N.C., Inc. Kirkland's of Fox Valley Mall, Chicago, IL, Inc. Kirkland's of Hawthorne Mall, Chicago, IL, Inc. Kirkland's of Stratford Square, Chicago, IL, Inc. Kirkland's of Orland Square, Chicago, IL, Inc. Kirkland's of Coastland Mall, Naples, FL, Inc. Kirkland's of Edgewater Mall, Biloxi, MS, Inc. Kirkland's of Town Center Plaza, Kansas City, KS, Inc. Kirkland's of Castleton Square, Indianapolis, IN., Inc. Kirkland's of Cordova Mall, Pensacola, FL, Inc. Kirkland's of University Park, South Bend, IN, Inc. Kirkland's of Westgate Mall, Amarillo, TX, Inc. Kirkland's of Westgate Mall, Spartanburg, SC, Inc. Kirkland's of Meridian Mall, Lansing, MI, Inc. Kirkland's of Cottonwood Mall, Albuquerque, NM, Inc. Kirkland's of University Mall, Tampa, FL, Inc. By: /s/ Carl Kirkland ------------------- Name: Title: ATTEST: By: /s/ Robert E. Alderson -------------------------- Name: Title: Vice President & Secretary EX-10.3 11 ADVENT FEE AGREEMENT DATED AS OF JUNE 12, 1996 1 EXHIBIT 10.3 KIRKLAND'S, INC. P.O. BOX 7222 JACKSON, TN 38303-7222 June 12, 1996 Advent International Corporation 101 Federal Street Boston, MA 02110 RE: Transaction Fees Gentlemen: Kirkland's, Inc., a corporation incorporated under Tennessee law ("Kirkland's"), and the other corporations listed on the signature pages hereto (such other corporations, together with Kirkland's, collectively the "Companies") hereby agree to pay to Advent International Corporation ("Advent"), on the date hereof, an amount equal to One Million Dollars ($1,000,000) (the "Fee") in consideration for the services which have been provided by Advent to the Companies in connection with the structuring of the transactions contemplated by that certain Recapitalization Agreement, dated April 26, 1996, among Kirkland Holdings L.L.C. ("Holdings"), the Companies, Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson, as amended on or about the date hereof (as amended, the "Recapitalization Agreement"). The Fee shall be payable $500,000 in cash and $500,000 through a reduction in the purchase price for the purchase of common stock and Class A Preferred Stock being purchased by Holdings pursuant to the Recapitalization Agreement. This agreement may be signed in counterparts which when taken together will constitute the entire agreement. Please acknowledge your receipt of the sum specified above by signing where indicated below. Sincerely, ATTEST: KIRKLAND'S, INC. By: /s/Robert E. Alderson By: /s/ Carl Kirkland --------------------- ------------------ Robert E. Alderson Carl Kirkland Vice-President President 2 Corporate Name - -------------- 101 Kirkland's of Carolina, Inc. 102 Kirkland's of Charlotte, Eastland Mall, Inc. 103 Kirkland's of Tennessee, Inc. 104 K. C. Corp. Inc. 107 Kirkland's of Greensboro, Four Seasons Mall, Inc. 109 Kirkland's of Fayetteville, Cross Creek Mall, Inc. 110 Kirkland's of Wilmington, Independence Mall, Inc. 111 Kirkland's III, Jackson-Metro Center, Inc. 114 Kirkland's of Memphis, Tennessee, Laurelwood Shopping Center, Inc. 115 Kirkland's of Ridgeland, Mississippi, Northpark Mall, Inc. 116 Kirkland's of Knoxville, East Towne Mall, Inc. 117 Kirkland's of Huntsville, Madison Square Mall, Inc. 118 Kirkland's of Valley View Mall, Roanoke, VA, Inc. 119 Kirkland's of Nashville, Hickory Hollow Mall, Inc. 120 Kirkland's of Birmingham, Riverchase Galleria, Inc. 122 Kirkland's of BriarCliffe Mall, Myrtle Beach, South Carolina, Inc. 123 Kirkland's of Pecanland Mall, Monroe, LA, Inc. 125 Kirkland's of Towne Center at Cobb, Atlanta, GA, Inc. 126 Kirkland's of Gwinnett Place, Atlanta, GA, Inc. 127 Kirkland's of Rivergate Mall, Nashville, TN, Inc. 128 Kirkland's of Peachtree Mall, Columbus, GA, Inc. 129 Kirkland's of Cumberland Mall, Atlanta, GA, Inc. 130 Kirkland's of Hamilton Place Mall, Chattanooga, TN, Inc. 131 Kirkland's of Houston Galleria, Houston, TX, Inc. 132 Kirkland's of Mall of Memphis, Memphis, TN, Inc. 134 Kirkland's of Woodland Hills Mall, Tulsa, OK, Inc. 135 Kirkland's of Dayton Mall, Dayton, OH, Inc. 136 Kirkland's of Oxmoor Center, Louisville, KY, Inc. 137 Kirkland's of South Square Mall, Durham, NC, Inc. 138 Kirkland's of Valley View Center, Dallas, TX, Inc. 139 Kirkland's of Chesterfield Towne Center, Richmond, VA, Inc. 140 Kirkland's of Park Plaza, Little Rock, AR, Inc. 141 Kirkland's of Montgomery Mall, Montgomery, AL, Inc. 142 Kirkland's of Southlake Mall, Atlanta, GA, Inc. 143 Kirkland's of Southpark Mall, Richmond, VA, Inc. 144 Kirkland's of Eastland Mall, Evansville, IN, Inc. 145 Kirkland's of Fayette Mall, Lexington, KY, Inc. 146 Kirkland's of Hickory Ridge Mall, Memphis, TN, Inc. 148 Kirkland's of Regency Square Mall, Jacksonville, FL, Inc. 149 Kirkland's of McCain Mall, Little Rock, AR, Inc. 150 Kirkland's of River Ridge Mall, Lynchburg, VA, Inc. 151 Kirkland's of Bel Air Mall, Mobile, AL, Inc. 152 Kirkland's of The Mall at Barnes Crossing, Tupelo, MS, Inc. 153 Kirkland's of Cortana Mall, Baton Rouge, LA, Inc. 154 Kirkland's of Bellevue Center, Nashville, TN, Inc. 155 Kirkland's of Tri-County Mall, Cincinnati, OH, Inc. 156 Kirkland's of The Mall of the Avenues, Jacksonville, FL, Inc. 157 Kirkland's of Eastwood Mall, Birmingham, AL, Inc. 158 Kirkland's of Lakeside Mall, New Orleans, LA, Inc. 159 Kirkland's of Carolina Place, Charlotte, N.C., Inc. 160 Kirkland's of Cary Village Mall, Raleigh, N.C., Inc. 161 Kirkland's of Cool Springs Galleria, Nashville, TN, Inc. 162 Kirkland's of Kenwood Towne Centre, Cincinnati, OH, Inc. 3 # Corporate Name - - -------------- 163 Kirkland's of St. Louis Galleria, St. Louis, MO, Inc. 164 Kirkland's of Wiregrass Commons Mall, Dothan, AL, Inc. 165 Kirkland's of Regency Mall, Richmond, VA, Inc. 166 Kirkland's of Florence, Florence, KY, Inc. 167 Kirkland's of Acadiana Mall, Lafayette, LA, Inc. 168 Kirkland's of Padre Staples Mall, Corpus Christi, TX, Inc. 169 Kirkland's of Belden Village, Canton, OH, Inc. 170 Kirkland's of West Oaks Mall, Houston, TX, Inc. 171 Kirkland's of Charleston Town Center, Charleston, W. VA, Inc. 172 Kirkland's of Crestwood Plaza, St. Louis, MO, Inc. 173 Kirkland's of White Marsh Mall, Baltimore, MD, Inc. 174 Kirkland's of Collin Creek Mall, Dallas, TX, Inc. 175 Kirkland's of Baybrook Mall, Houston, TX, Inc. 176 Kirkland's of Governor's Square Mall, Tallahassee, FL, Inc. 178 Kirkland's of Barton Creek Mall, Austin, TX, Inc. 179 Kirkland's of Highland Mall, Austin, TX, Inc. 180 Kirkland's of Battlefield Mall, Springfield, MO, Inc. 181 Kirkland's of Penn Square Mall, Oklahoma City, OK, Inc. 182 Kirkland's of Oak Park Mall, Kansas City, KS, Inc. 183 Kirkland's of Mall St. Vincent, Shreveport, LA, Inc. 184 Kirkland's of Owings Mills Mall, Baltimore, MD, Inc. 185 Kirkland's of Oakwood Center, New Orleans, LA, Inc. 186 Kirkland's of The Mall at Johnson City, Johnson City, TN, Inc. 187 Kirkland's of Glenbrook Mall, Ft. Wayne, IN, Inc. 188 Kirkland's of North Pointe Mall, Atlanta, GA, Inc. 189 Kirkland's of Northpark Mall, Joplin, MO, Inc. 190 Kirkland's of Orlando Fashion Square, Orlando, FL, Inc. 191 Kirkland's of The Mall at Fairfield Commons, Dayton, OH, Inc. 192 Kirkland's of St. Charles Towne Center, Waldorf, MD Inc. 193 Kirkland's of Regency Mall, Florence, AL, Inc. 194 Kirkland's of South Plains Mall, Lubbock, TX, Inc. 195 Kirkland's of The Parks at Arlington, Ft. Worth, TX, Inc. 196 Kirkland's of Parma Town Mall, Cleveland, OH, Inc. 197 Kirkland's of St. Clair Square, St. Louis, MO, Inc. 198 Kirkland's of Turtle Creek Mall, Hattiesburg, MS, Inc. 199 Kirkland's of The Woodlands, Houston, TX, Inc. 200 Kirkland's of Brandon Town Center, Tampa, FL, Inc. 201 Kirkland's of Memorial City Mall, Houston, TX, Inc. 202 Kirkland's of University Mall, Tuscaloosa, AL, Inc. 203 Kirkland's of Santa Rosa Mall, Fort Walton, FL, Inc. 204 Kirkland's of Panama City Mall, Panama City, FL, Inc. 205 Kirkland's of Town East Mall, Mesquite, TX, Inc. 206 Kirkland's of Kentucky Oaks Mall, Paducah, KY, Inc. 207 Kirkland's of Crabtree Valley Mall, Raleigh, N.C., Inc. 208 Kirkland's of Oak Hollow Mall, High Point, N.C., Inc. 209 Kirkland's of Fox Valley Mall, Chicago, IL, Inc. 210 Kirkland's of Hawthorne Mall, Chicago, IL, Inc. 211 Kirkland's of Stratford Square, Chicago, IL, Inc. 212 Kirkland's of Orland Square, Chicago, IL, Inc. 214 Kirkland's of Coastland Mall, Naples, FL, Inc. 215 Kirkland's of Edgewater Mall, Biloxi, MS, Inc. 4 216 Kirkland's of Town Center Plaza, Kansas City, KS, Inc. 217 Kirkland's of Castleton Square, Indianapolis, IN., Inc. 218 Kirkland's of Cordova Mall, Pensacola, FL, Inc. 219 Kirkland's of University Park, South Bend, IN, Inc. 220 Kirkland's of Westgate Mall, Amarillo, TX, Inc. 221 Kirkland's of Westgate Mall, Spartanburg, SC, Inc. 222 Kirkland's of Meridian Mall, Lansing, MI, Inc. 223 Kirkland's of Cottonwood Mall, Albuquerque, NM, Inc. 224 Kirkland's of University Mall, Tampa, FL, Inc. ATTEST: By: By: /s/ Carl Kirkland -------------------- --------------------- Title: Carl Kirkland President Accepted: ADVENT INTERNATIONAL CORPORATION By: /s/ David M. Mussafer ------------------------------ David M. Mussafer President EX-10.4 12 REGISTRATION RIGHTS AGREEMENT DATED AS OF 6-12-98 1 EXHIBIT 10.4 EXECUTION REGISTRATION RIGHTS AGREEMENT among KIRKLAND HOLDINGS L.L.C., KIRKLAND'S, INC., AFFILIATES OF KIRKLAND,s INC., CAPITAL RESOURCE LENDERS II, L.P., ALLIED CAPITAL CORPORATION, ALLIED CAPITAL CORPORATION II, THE MARLBOROUGH CAPITAL INVESTMENT FUND, L.P., CAPITAL TRUST INVESTMENTS, LTD., CARL KIRKLAND, ROBERT KIRKLAND, BRUCE MOORE, AND ROBERT ALDERSON June 12, 1996 2 REGISTRATION RIGHTS AGREEMENT THIS REGISTRATION RIGHTS AGREEMENT (the "Agreement") is made as of this 12th day of June, 1996, by and among - KIRKLAND HOLDINGS L.L.C., a Delaware limited liability company ("Holdings"), - KIRKLAND'S INC., a corporation incorporated under Tennessee law ("Kirkland's" or the "Representative"), - the other corporations listed on the signature pages hereto (such other corporations, together with Kirkland's, being herein referred to individually as a "Company" and collectively as the "Company" or the "Companies" as the context requires), - Capital Resource Lenders 11, L.P., a Delaware limited partnership ("CRL"), - Allied Capital Corporation and Allied Capital Corporation II (collectively, "Allied"), - The Marlborough Capital Investment Fund, L.P. ("Marlborough"), - Capital Trust Investments, Ltd. ("CT" and together with CRL, Allied and Marlborough, the "Mezzanine Warrant Holders"), - CARL KIRKLAND, - ROBERT KIRKLAND, - BRUCE MOORE and - ROBERT ALDERSON (Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson being herein referred to collectively as the "Individual Investors"). WHEREAS, on April 26, 1996, Holdings, the Companies and the Individual Investors executed a Recapitalization Agreement (the "Recapitalization Agreement"). Capitalized terms used but not defined herein have the meanings set forth in the Recapitalization Agreement; WHEREAS, pursuant to the Recapitalization Agreement, the Companies have filed amendments to their charters in Preparation for the Preliminary Recapitalization and the Recapitalization. The amended charter of each Company provides 3 for the authorized capital of such Company as described in the Shareholders Agreement. WHEREAS, in connection with the Company's execution of the Senior Subordinated Note and Warrant Purchase Agreement dated on or about the date hereof (the "Mezzanine Purchase Agreement"), pursuant to which the Mezzanine Warrant Holders have loaned a total of $20,000,000 in subordinated debt to the Companies, the Mezzanine Warrant Holders have received (i) warrants to purchase up to 11904.8 shares of Common Stock, subject to adjustment in accordance with the terms of such warrants ("Mezzanine Warrants" and the shares subject to the Mezzanine Warrants, the "Warrant Shares") and (ii) warrants to purchase up to an additional 4335.1 shares of Common Stock, subject to adjustment in accordance with the terms of such warrants, the exercisability of which-is contingent upon the timing of certain events and the valuation of the Companies as evidenced by such event (the "Mezzanine Contingent Warrants" and the shares subject to the Mezzanine Contingent Warrants, the "Contingent Warrant Shares"); and WHEREAS, options to purchase 7,143 shares of Common Stock, subject to adjustment in accordance with the terms of the option Agreements governing such options, (the "Option Agreements"), have been granted to the Management Investors, each having the option under the Option Agreements to purchase one third of such shares (the "Option Shares"); and WHEREAS, as an inducement to completion of the transactions contemplated by the Recapitalization Agreement and the Mezzanine Purchase Agreement, the Companies have agreed to provide certain registration rights pursuant to the terms of this Agreement. NOW THEREFORE, in consideration of the premises and the mutual terms and provisions hereof, the parties hereto hereby agree as follows: 1. Definitions. For purposes of this Agreement, the following terms shall have the following respective meanings: (a) "Act" shall mean the Securities Act of 1933, as amended, or any similar federal statute enacted hereafter, and the rules and regulations of the commission thereunder, all as the same shall be in effect from time to time. (b) "Commission" shall mean the Securities and Exchange Commission or any other federal agency at the time administering the Act. (c) "Common Stock" shall mean (i) the common stock, par value $.Ol of each of the Companies and/or any -2- 4 successor Company, and (ii) any other capital stock of any class or classes (however designated) of the Company, authorized on or after the date hereof, the holders of which shall have the right, without limitation as to amount per share, either to all or to a share of the balance of current dividends and liquidating distributions after the payment of dividends and distributions on any shares entitled to preference in the Payment thereof, and the holders of which shall ordinarily, in the absence of contingencies, be entitled to vote for the election of a majority of directors of the Company (even though the right so to vote has been suspended by the happening of such a contingency), and (iii) any other securities into which or for which any of the securities described in (i) or (ii) above may be converted or exchanged pursuant to a plan of recapitalization, reorganization, merger, sale of assets or otherwise. (d) "Company" shall mean the Companies, and subsequently created affiliated companies, or any successor by merger or similar corporate consolidation thereto, and shall include any subsidiaries thereof. (e) "Counterpart" shall mean a counterpart to this Agreement in the form of Exhibit A hereto, pursuant to the execution of which a Person shall become bound by all of the terms and conditions to this Agreement. (f) "Demand Piggybacker" shall have the meaning set forth in Section 2(c) hereof. (g) "Demand Registration" shall mean a Non-Mezzanine Demand Registration or a Mezzanine Demand Registration. (h) "Holder" shall mean each of the Shareholders if such Shareholder holds Registrable Securities and any other person holding Registrable Securities or such other securities to whom these registration rights have been transferred pursuant to Section 12 of this Agreement; provided, however, that any person who acquires any of the Registrable Securities in a distribution pursuant to a registration statement filed by the Company under the Act or pursuant to a sale under Rule 144 under the Act shall not be considered a Holder. (i) "Management Investors" shall mean Carl Kirkland, Bruce Moore and Robert Alderson. (j) "Mezzanine Demand Registration" shall have the meaning set forth in Section 2(a) hereof. (k) "Mezzanine Warrant Stock" shall mean, as of the applicable date of determination, shares of Common Stock then issued or issuable to the Mezzanine Warrant Holders upon exercise of the Mezzanine Warrants or Contingent Mezzanine Warrants, -3- 5 assuming the maximum potential exercise of the Mezzanine Warrants or Contingent Mezzanine Warrants as of such date of determination. (l) "Non-Mezzanine Demand Registration" shall have the meaning set forth in Section 2(b) hereof. (m) "Person" shall mean an individual, partnership, corporation, limited liability company, limited liability partnership, trust, joint venture, unincorporated association, or other entity or association. (n) "Piggyback Registration" shall have the meaning set forth in Section 3. (o) "Preferred Stock" shall mean shares of the Class A Preferred Stock and Class B Preferred Stock of the Companies from time to time outstanding. (p) "Public Offering" shall mean an underwritten public offering of Common Stock registered pursuant to the Act resulting in gross proceeds to the Companies of at least Thirty Million Dollars ($30,000,000). (q) The terms "register," "registered" and "registration" refer to a registration effected by preparing and filing a registration statement in compliance with the Act and the declaration or ordering of effectiveness of such registration statement by the Commission. (r) "Registered Holder" shall mean, with respect to a registration statement, each Holder of Registrable Securities covered by such registration statement. (s) "Registered Securities" shall mean, with respect to a registration statement, the Registrable Securities covered by such registration statement. (t) "Registrable Securities" shall mean (i) shares of Common Stock held by the Shareholders from time to time and shall include shares of Mezzanine Warrant Stock, provided the Mezzanine Warrants are converted or exercised no later than the effective date of any registration with respect to which the Holder of such Mezzanine Warrants demanded a Demand Registration, is a Demand Piggybacker, or requested a Piggyback Registration as to the Common Stock issuable upon conversion or exercise of such Mezzanine Warrants, (ii) shares of Common Stock acquired by any Shareholder other than pursuant to a registration, either from any other shareholder of the Company in compliance with the terms of the Shareholders Agreement, or directly from the Company, and (iii) securities issued or received in respect of, or in exchange or in substitution for any of the foregoing, including, but not -4- 6 limited to, those arising from a stock dividend, stock split, reclassification, reorganization, merger, consolidation/ sale of assets or other exchange of securities. (u) "Shareholder" shall mean any Person who holds, from time to time, any Common Stock, Preferred Stock or Mezzanine Warrants or Mezzanine Contingent Warrants, and who is or who becomes a party to this Agreement pursuant to the terms hereof. (v) "Shareholders Agreement" shall mean that certain Shareholders Agreement dated the date hereof and among the parties hereto, as amended from time to time. (w) "1934 Act" shall mean the Securities Exchange Act of 1934, as amended, or any similar federal statute enacted hereafter, and the rules and regulations of the Commission thereunder, all as the same shall be in effect from time to time. 2. Demand Registrations. The Holders may make a demand for registration of Common Stock as provided in this Section 2 at any time after the earlier to occur of (x) June 12, 1998 or (y) any time the Company becomes subject to Section 13 or 15(d) of the 1934 Act. (a) Mezzanine Demand. If the Company shall receive a written request from Mezzanine Warrant Holders holding more than sixty-six and two-thirds percent (66.67%) of the Mezzanine Warrant Stock (determined without taking into account any shares of Common Stock previously sold to the public in a public offering) that the Company file a registration statement under the Act covering the registration for the offer and sale of all or part of the Mezzanine Warrant Stock (determined without taking into account any shares of Common Stock previously sold to the public in a public offering) (a "Mezzanine Demand Registration"), then the Company shall promptly notify in writing all other Holders of Registrable Securities (including other Mezzanine Warrant Holders) (a "Company Mezzanine Demand Notice"). (b) Other Demand. If the Company shall receive a written request from Holders of more than fifty percent (50%) of the Registrable Securities other than the Mezzanine Warrant Stock, that the Company file a registration statement under the Act covering the registration for the offer and sale of all or part of such Holders' Registrable Securities (a "Non-Mezzanine Demand Registration"), then the Company shall promptly notify in writing all other Holders of Registrable Securities (including the Mezzanine Warrant Holders) of such request (the "Company Non-Mezzanine Demand Notice"). Upon receipt of the Company Non-Mezzanine Demand Notice, the Mezzanine Warrant Holders holding more than sixty-six and two-thirds percent (66.67 %) of the Mezzanine Warrant Stock (determined without taking into account -5- 7 any shares of Common Stock previously sold to the public in a public offering) shall be entitled to render such demand for a Non-Mezzanine Demand Registration ineffective, null and void by making a demand for registration under subsection (a) of this Section 2 for a Mezzanine Demand Registration within thirty (30) days after the Company Non-Mezzanine Demand Notice is given. In such event, (i) the preempted Non-Mezzanine Demand Registration shall be treated for all purposes, including for purposes of Section 2(d) hereof, as if it had never been made, (ii) the Company shall give a Company Mezzanine Demand Notice to other Holders contemplated by Section 2(a) (with all notices previously given by other Holders in connection with such Non-Mezzanine Demand Registration pursuant to Section 2(c) being void), and (iii) Holders other than the Mezzanine Warrant Holders shall not be entitled to make a demand under this Section 2(b) until the Mezzanine Demand Registration shall have been completed or abandoned and all waiting periods required by this Agreement shall have been complied with. (c) Procedure. Each request for a Mezzanine Demand Registration or a Non-Mezzanine Demand Registration shall specify the number of shares of Registrable Securities requested to be sold. Within thirty (30) calendar days after a Company Mezzanine Demand Notice or Company Non-Mezzanine Demand Notice has been given, any other Holder (a "Demand Piggybacker") may give written notice to the Company of its intent to include its Registrable Securities in the registration (including without limitation any Holder whose demand is preempted under Section 2(b) above). As soon as practicable after the expiration of such thirty (30) day period, the Company shall cause all Registrable Securities that Holders have requested be registered to be registered under the Act, subject to the limitations contained in this Agreement. (d) Number of Demands. Subject to the provisions of Section 8 below, demand not be made unless the reasonably anticipated price to the public of such public offering would exceed Five Million Dollars ($5,000,000), (ii) may be made under Section 2(a) hereof a total of one (1) time and (iii) may be made under Section 2(b) hereof a total of two (2) times. An effective Demand Registration will not count as a Demand Registration for purposes of the preceding sentence if (a) the Holders whose Registrable Securities are to be included in such registration have not registered for sale at least seventy percent (70%) of the Registrable Securities requested to be registered in the registration statement for such registration by such Holders, or (b) the Holders have withdrawn their request for Demand Registration and have paid all fees and expenses as provided in Section 8 hereof. (e) Delay of Registration. If at the time of any request to register Registrable Securities pursuant to Section -6- 8 2(a) or (b) the Company is preparing or within thirty (30) days thereafter commences to prepare a registration statement for a public offering (other than a registration effected solely to implement an employee benefit plan or a transaction to which Rule 145 of the Commission is applicable) which in fact is filed and becomes effective within (90) days after the request, or is engaged in any activity which, in the good faith determination of the Company's board of directors, would be adversely affected by the requested registration to the material detriment of the Company, then the Company may at its option direct that such request be delayed for a period not in excess of four (4) months from the date of such request to register Registrable Securities, such right to delay a request to be exercised by the Company not more than once in any one (1) year period. Nothing in this Section 2(e) shall preclude a holder of Registrable Securities from enjoying registration rights which it might otherwise possess under Section 3 hereof. 3. Piggyback Registration. Subject to Section 9, if at any time the company proposes to register any of its equity securities under the Act, either for its own account or for the account of others (unless already covered by Section 2 hereof) or pursuant to a request under Section 4 hereof, in connection with the public offering of such equity securities solely for cash, on a registration form that would also permit the registration of Registrable Securities (other than registration statement on Form S-8 or any successor form, or a registration in connection with any stock option, stock purchase or other benefit plan or for the purpose of offering such securities to another business entity or the shareholders of such entity in connection with the acquisition of assets or shares of capital stock, respectively, of such entity), the Company shall, each such time, promptly give each Holder written notice of such proposal (a "Piggyback Registration Notice"). Within thirty (30) days after the piggyback Registration Notice is given, the Holders shall give notice as to the number of shares of Registrable Securities, if any, which such Holders request be registered simultaneously with such registration by the Company ("Piggyback Registration"). The Company shall use its best efforts to include any Registrable Securities in such registration statement (or in a separate registration statement concurrently filed) which the Holders thereof request to be so included and to cause such registration statement to become effective with respect to such Registrable Securities in accordance with the registration procedures set forth in Section 5 hereof. Notwithstanding the foregoing, if at any time after giving written notice of its intention to register equity securities and before the effectiveness of the registration statement filed in connection with such registration, the Company determines for any reason either not to effect such registration or to delay such registration, the Company may, at its election, by delivery of prior written notice to each Holder, (i) in the case of a determination not to effect -7- 9 registration, relieve itself of its obligation to register the Registrable Securities in connection with such registration or (ii) in the case of a determination to delay registration, delay the registration of such Registrable Securities for the same period as the delay in the registration of such other equity securities. Each Holder requesting inclusion in a registration pursuant to this Section 3 may, at any time before the effective date of the registration statement relating to such registration, revoke such request by delivering written notice of such revocation to the Company (which notice shall be effective only upon receipt by the Company, notwithstanding the provisions of Section 17 hereof); provided, however, that if the Company, in consultation with its financial and legal advisors, determines that such revocation would require a recirculation of the prospectus contained in the registration statement, then such Holder shall have no right to revoke its request. 4. Registrations on Forms S-2 and S-3. After the conclusion by the Company of an initial public offering of its Common Stock (which for purposes hereof shall include any Registrable Securities sold pursuant to Section 2 above) pursuant to a registration under the Act, at such time as the Company shall have qualified for the use of Forms S-2 and/or S-3 (as the case may be), or any similar form or forms promulgated by the Commission, the Holders of Registrable Securities shall each have the right to request an unlimited number of registrations on Form S-2 and/or Form S-3 (as the case may be). Any such request shall be in writing, shall specify the Registrable Securities intended to be sold or disposed of by the Holders thereof, shall state the intended method of disposition of such Registrable Securities by the Holder(s) requesting such registration and shall relate to Registrable Securities (i) in an amount exceeding two percent (2%) of all shares of Common Stock then outstanding, or (ii) having proposed gross cash offering proceeds (prior to deduction of underwriters commissions and expenses, if any) of Two Million Dollars ($2,000,000) or more for all Registrable Securities to be included, on the basis of a reasonable (in light of the current market price) proposed per share offering price. The Company shall be obligated to effect such registration or registrations on Form S-2 or Form S-3 (as the case may be) as soon as practicable after receipt of such a request; provided, however, that the Company shall not be obligated to effect the filing of a registration pursuant to this Section 4 (i) during the period starting with the date ninety (90) days prior to the Company's estimated date of filing of, and ending on a date one hundred eighty (180) days following the effective date of, a registration statement pertaining to a public offering of Common Stock for the account of the Company, provided that the Company is actively employing in good faith all reasonable efforts to cause such registration statement to become effective and that, in the good faith judgment of the Company's underwriter for an underwritten offering or of the Company's Board of Directors for any other -8- 10 offering, an offering pursuant to such a registration statement would interfere in any material respect with the successful marketing (including pricing) of the Common Stock to be included in the Company's proposed registration statement, or (ii) if the Company's Board of Directors shall determine in good faith that such filing will interfere in any material respect with a pending or contemplated financing, merger, sale or assets, recapitalization or other similar corporate action of the Company. In the event the Company's obligations are abated pursuant to the foregoing proviso, and if any of the Holders on whose behalf the requested registration statement would be filed and who were unable to have all of the Registrable Securities included in the Company's registration statement pursuant to Section 3 then want such registration statement to be filed, the Company shall file such registration statement as promptly as practicable following (x) one hundred eighty (180) days after the effective date of the registration statement with respect to the offering referred to in clause (i) above, or (y) the date on which the transactions referred to in clause (ii) above shall have been completed or abandoned as the case may be); provided further, however, that the Company shall not be obligated to file and cause to become effective (a) more than two (2) registrations on Forms S-2 and/or S-3 in any one twelve (12) month period or (b) any registration on Form S-2 and/or S-3 within six (6) months after the effective date of any previous registration statement filed under Section 2 or Section 3, with respect to which all Holders who had requested the inclusion of any such shares in a registration statement were entitled to include in such registration statement all Registrable Securities requested to be included therein. No registration pursuant to this Section 4 shall count as a Demand Registration pursuant to Section 2. 5. Obligation of the Company. Whenever required under this Agreement to effect the registration of any Registrable Securities, the Company shall, as expeditiously as reasonably possible: (a) Prepare and file with the Commission a registration statement covering such Registrable Securities and use its best efforts to cause such registration statement to be declared effective by the Commission and to keep such registration effective until the earlier of (i) the date when all Registrable Securities covered by the registration statement have been sold or (ii) in the case of a registration under Section 2 or 3 hereof, nine (9) months after the effective date of the registration statement or prospectus or any amendments or supplements thereto, or (iii) in the case of a shelf registration, the applicable period permitted under the Act. The Company will furnish to each Holder of Registrable Securities covered by such registration statement and the underwriters, if any, copies of all such documents proposed to be filed (excluding exhibits, unless any such person shall specifically request -9- 11 exhibits), which documents will be subject to the review (for a reasonable Period of time in light of all facts and circumstances) of each Holder and the underwriters, and the Company will not file such registration statement or any amendment thereto or any prospectus or any Supplement thereto including any documents incorporated by reference therein) with the Commission if (i) the Holders of a majority of the Registrable Securities covered by such registration statement or the underwriters, if any, shall reasonably object to such filing or (ii) information in such registration statement or prospectus concerning a particular Registered Holder is inaccurate. (b) Prepare and file with the Commission such amendments and post-effective amendments to such registration statement as may be necessary to keep such registration statement effective until the earlier of the dates referred to in clauses (i) and (ii) of Section 5(a) hereof and to comply with the provisions of the Act with respect to the disposition of all securities covered by such registration statement, and cause the prospectus to be supplemented by any required prospectus supplement, and as so supplemented to be filed with the commission pursuant to Rule 424 under the Act. (c) Furnish to the Registered Holders such number of copies of such registration statement, each amendment thereto, the prospectus included in such registration statement (including each preliminary prospectus), each supplement thereto and such other documents, as they may reasonably request in order to facilitate the disposition of Registered Securities owned by them. (d) Use its best efforts to register and qualify the Registered Securities under such other securities laws of such jurisdictions as shall be reasonably requested by any Registered Holder and do any and all other acts and things which may be reasonably necessary or advisable to enable each Registered Holder to consummate the disposition of the Registered Securities owned by such Holder in such jurisdictions; provided that the Company shall not be required in connection therewith or as a condition thereto to qualify generally to transact business in any such states or jurisdictions; and provided further that (anything in this Agreement to the contrary notwithstanding with respect to the bearing of expenses) if any jurisdiction in which the Registered Securities shall be qualified shall require that expenses incurred in connection with the qualification of the Registered Securities in that jurisdiction be borne by selling shareholders, then such expenses shall be payable by the Registered Holders pro rata, to the extent required by such jurisdiction. (e) Promptly notify each Registered Holder at any time when a prospectus is required to be delivered under the Act -10- 12 relating to the happening of any event as a result of which the prospectus included in such registration statement contains an untrue statement of a material fact or omits any fact necessary to make the statements therein not misleading and, at the request of any such Holder, the Company will promptly prepare a supplement or amendment to such prospectus so that, as thereafter delivered to the purchasers of such Registered Securities, such prospectus will not contain an untrue statement of a material fact or omit to state any fact necessary to make the statements therein not misleading. (f) Make available for inspection by any Registered Holder, any underwriter participating in any disposition pursuant to such registration statement and any attorney, accountant or other agent retained by any such Registered Holder or underwriter, all financial and other records, pertinent corporate documents and properties of the Company, and cause the officers, directors, employees and independent accountants of the Company to supply all information reasonably requested by any such Registered Holder, underwriter, attorney, accountant or agent in connection with such registration statement, which information shall be subject to reasonable restrictions concerning confidentiality and non-disclosure. (g) Promptly notify the Registered Holders and the underwriters, if any, of the following events and (if requested by any such person) confirm such notification in writing and provide copies of any relevant documents relating to: (1) the filing of the prospectus or any prospectus supplement and the registration statement and any amendment or Post-effective amendment thereto and, with respect to the registration statement and any amendment or post-effective amendment thereto, the declaration of the effectiveness of such documents, (2) any comment letters from or requests by the Commission for amendments or supplements to the registration statement or the prospectus or for additional information, (3) the issuance or threat of issuance by the Commission of any stop order suspending the effectiveness of the registration statement or the initiation of any proceedings for that purpose and (4) the receipt by the Company of any notification with respect to the suspension of the qualification of the Registered Securities for sale in any jurisdiction or the initiation or threat of initiation of any proceeding for such purpose. (h) Make every reasonable effort to prevent the entry of any order suspending the effectiveness of the registration statement and obtain the withdrawal of any such order, if entered. (i) If reasonably requested by any underwriter or a Registered Holder in connection with any underwritten offering, -11- 13 incorporate in a prospectus supplement or post-effective amendment such information as the underwriters and the Holders of a majority of the Registered Securities agree should be included therein relating to the sale of the Registered Securities, including, without limitation, information with respect to the number of Registered Securities being sold to such underwriters, the purchase price being paid therefor by such underwriters and any other terms of the underwritten offering of the Registered Securities to be sold in such offering, and make all required filings of such Prospectus Supplement or Post-effective amendment after being notified of the matters to be incorporated in such prospectus supplement or post-effective amendment. (j) Cooperate with the Registered Holders and the underwriters, if any, to facilitate the timely preparation and delivery of certificates evidencing Registered Securities and not bearing any restrictive legends, and enable such Registered securities to be in such lots and registered in such names as the underwriters may request at least two (2) business days prior to any delivery of Registered Securities to the underwriters. (k) Provide a transfer agent, registrar and CUSIP number for all Registrable Securities not later than the effective date of the registration statement. (l) Prior to the effectiveness of the registration statement and any post-effective amendment thereto and at each closing of any underwritten offering, (i) make such representations and warranties to the Registered Holders and the underwriters, if any, with respect to the Registered Securities and the registration statement as are customarily made by issuers to underwriters in primary underwritten offerings; (ii) obtain opinions of counsel to the Company and updates thereof (which opinions shall be reasonably satisfactory to the underwriters, if any, and to the Holders of a majority of the Registered Securities) addressed to each Registered Holder and the underwriters, if any, covering the matters customarily covered in opinions requested in underwritten offerings and such other matters as may be reasonably requested by such Holders and underwriters or their counsel; (iii) obtain "cold comfort" letters and updates thereof from the Company,s independent certified public accountants addressed to the Registered Holders and the underwriters, if any, such letters to be in customary form and covering matters of the type customarily covered in *cold comfort" letters by underwriters in connection with primary underwritten offerings; and (iv) deliver such documents and certificates as may be reasonably requested by the Holders of a majority of the Registered Securities being sold and by the underwriters, if any, to evidence compliance with clause (i) above and with any customary conditions contained in the underwriting agreement or other agreement entered into by the Company. -12- 14 (m) Enter into such agreements and take all such other reasonable actions in connection therewith in order to expedite or facilitate the disposition of such Registered Securities and in such connection, in the case of an underwritten offering, enter into an underwriting agreement or other similar agreement in form, scope and substance as is customary in underwritten offerings which underwriting agreement shall set forth in full the indemnification provisions and procedures of Section 13 hereof with respect to all parties to be indemnified pursuant to said Section. The above shall be done at each closing under such underwriting or similar agreement or as and to the extent required thereunder. (n) Use its best efforts to cause all Registered Securities included in such registration statement to be listed, by the date of first sale of Registered Securities pursuant to such registration statement, on each securities exchange on which shares of Common Stock are then listed or proposed by the Company to be listed, if any. (o) Provide such reasonable assistance in the marketing of the Registered Securities as is customary of issuers in public offerings (including participation by its senior management in "road shows"), subject to reasonable time and expense constraints. (p) Otherwise use its best efforts to comply with all applicable rules and regulations of the Commission, and make generally available to its security holders earnings statements satisfying the provisions of Section 11(a) of the Act, no later than forty-five (45) days after the end of any twelve (12) month period (i) commencing at the end of any fiscal quarter in which Registered Securities are sold to underwriters in a firm or best efforts underwritten offering, or (ii) if not sold to underwriters in such an offering, beginning with the first day of the first fiscal quarter of the Company commencing after the effective date of the registration statement. 6. Furnish Information. It shall be a condition precedent to the obligations of the Company to take any action pursuant to this Agreement that the Holders shall furnish to the Company such information regarding them, the Registrable Securities held by them, and the intended method of disposition of such Registrable Securities as the Company shall reasonably request and as shall be required in connection with the action to be taken by the Company. 7. Suspension of Disposition of Registrable Securities. Each Registered Holder agrees that, upon receipt of any notice from the Company of the happening of any event of the kind described in Section 5(e) or 5(g)(3) or (4) hereof, such Registered Holder will forthwith discontinue disposition of -13- 15 Registered Securities until such Registered Holder's receipt of copies of a supplemented or amended prospectus contemplated by Section 5(e) hereof, or until it is advised in writing (the "Advice") by the Company that the use of the Prospectus may be resumed, and has received copies of any additional or supplemental filings which are incorporated by reference in the prospectus, and, if so directed by the Company, such Registered Holder will deliver to the Company (at the expense of the company) all copies, other than permanent file copies then in such Registered Holder's possession, of the prospectus covering such Registered Securities at the time of receipt of such notice. In the event the Company shall give any such notice, the time period mentioned in Section 5(a) hereof shall be extended by the number of days during the period from and including the date of the giving of such notice pursuant to Section 5(e) or 5(g)(3) or (4) hereof to and including the date when each Registered Holder shall have received the copies of the supplemented or amended prospectus contemplated by Section 5(e) hereof or the Advice. 8. Expenses of Registration. (a) Except as provided in Section 8(b) through 8(d) hereof, all expenses incurred in connection with a registration pursuant to Sections 2, 3 or 4 (excluding underwriters' discounts and commissions), including, without limitation all registration and qualification fees, fees and disbursements of counsel for the Company, and, the reasonable fees and disbursements of one (1) counsel chosen by the Registered Holders owning a majority of the Registered Securities (or by the Registered Holders owning a majority of the Mezzanine Warrant Stock constituting Registered Securities in the case of a Mezzanine Demand Registration) shall be borne by the Company. (b) If a registration proceeding is begun under Section 2 but subsequently withdrawn at the request of the Registered Holders owning a majority of the Registered Securities (or at the request of Registered Holders owning a majority of the Mezzanine Warrant Stock constituting Registered Securities in the case of a Mezzanine Demand Registration) such Registered Holders shall have the option (exercisable by Registered Holders owning a majority of the Registered Securities, or a majority of the Mezzanine Warrant Stock constituting Registered Securities in the case of a Mezzanine Demand Registration) of either (i) reserving their right to such Demand Registration pursuant to Section 2, in which case the Registered Holders will pay all expenses of such registration proceeding, or (ii) waiving their right to one (1) Demand Registration under Section 2 (Section 2(a) if the registration proceeding originated with a demand under Section 2(a) hereof), in which case the Company will pay the expenses of such registration proceeding. -14- 16 (c) Registered Holders may withdraw a request made within forty-five (45) days after the end of the fiscal year if the audited financial statements of the Company for such year and at such year-end materially and adversely differ from the financial information furnished to such Holders by the Company at the time of their request, in which event such Registered Holders shall not be required to pay any of the expenses of such withdrawn registration and such withdrawn registration shall be treated for all purposes of this Agreement, including without limitation Section 2(d) hereof, as if it had never occurred. (d) All expenses incurred in connection with a registration which are, under this Section 8. to be borne by Registered Holders shall be borne pro rata by the Registered Holders on the basis of the number of such Holder's Registered Securities (or Registrable Securities proposed to be registered, as the case may be); Provided, however, that if any such cost or expense is attributable solely to one Registered Holder and does not constitute a normal cost or expense of such a registration, such cost or expense shall be allocated to and borne by that Registered Holder. 9. Underwriting Requirements: Priorities. (a) (i) With respect to a Mezzanine Demand Registration pursuant to Section 2(a), the Registered Holders owning a majority of the Mezzanine Warrant Stock included in the registration shall have the right to select the investment banker(s) and manager(s), if any, to administer such registration, subject to the approval of the Company, which will not be unreasonably withheld. With respect to a Non-Mezzanine Demand Registration pursuant to Section 2(b), the Registered Holders owning a majority of the Registered Securities shall have the right to select the investment banker(s) and manager(s) to administer such registration, subject to the approval of the Company, which will not be unreasonably withheld. (ii) The Registered Holders owning a majority of the Registered Securities included in any registration under Section 4 shall have the right to select the investment banker(s) and manager(s), if any, to administer the offering, if any, subject to the approval of the Company, which will not be unreasonably withheld. (iii) The Company will have the right to select the investment banker(s) and manager(s), if any, to administer any offering to which Section 3 hereof is applicable. (b) (i) if a registration under Section 2(a) hereof is an underwritten offering and the managing underwriters advise the Company in writing that in their opinion the number of Registrable Securities requested to be registered by the -15- 17 Mezzanine Warrant Holders and Demand Piggybackers exceeds the number of shares which can be sold at the desired price in such offering, the Company will include in such registration (i) first, the Mezzanine Warrant Stock demanded to be registered under Section 2 (a) and the Mezzanine Warrant Stock held by Demand piggybackers (pro rata among the Holders thereof based on the number of shares of Mezzanine Warrant Stock such Holders have requested to be registered), (ii) second, Registrable Securities other than Mezzanine Warrant Stock owned by Demand Piggybackers (Pro rata among the Holders thereof on the basis of the number of Registrable Securities such Holders have requested to be registered); provided that, such aggregate Registered Securities shall not exceed the number of Registrable Securities requested to be included which in the opinion of such underwriters can be sold at the desired price. (ii) If a registration under Section 2(b) hereof is an underwritten offering and the managing underwriters advise the Company in writing that in their opinion the number of shares of Common Stock requested to be registered exceeds the number of shares which can be sold at the desired price in such offering, then the Company will include in such registration Registrable Securities owned by Holders requesting registration of Registrable Securities with respect to such registration pro rata among such Holders on the basis of the number of Registrable Securities such Holders have requested to be registered; Provided that, such aggregate Registered Securities shall not exceed the number of Registrable Securities requested to be included therein which in the opinion of such underwriters can be sold at the desired price. (iii) If a registration under Section 3 hereof is an underwritten registration and the managing underwriters) advise the Company in writing that in their opinion the number of securities requested to be included in such registration exceeds the number which can be sold at the desired price in such offering, the Company will include in such registration (i) first, the securities the Company proposes to sell; (ii) second, the Registrable Securities held by the Holders (other than Management Investors) requesting to be included in such registration pursuant to Section 3 hereof (pro rata among the respective Holders thereof on the basis of the number of Registered Securities such Holders have requested to be registered); and (iii) third, the Registrable Securities held by the Management Investors requesting to be included in such registration pursuant to Section 3 hereof (pro rata among such Management Investors on the basis of the number of Registered Securities such Management Investors have requested to be registered). (iv) If a registration under Section 4 hereof is an underwritten offering and the managing underwriters advise -16- 18 the Company in writing that in their opinion the number of Registrable Securities requested to be registered exceeds the number of shares which can be sold at the desired price in such offering, the.Company will include in such registration the number of Registrable Securities requested to be included which in the opinion of such underwriters can be sold at the desired price. Registrable Securities held by the Holders requesting to be included in such registration shall be included Pro rata among the respective Holders thereof on the basis of the number of Registrable Securities such Holders have requested to be registered. (c) Notwithstanding the priorities set forth in Section 9(b), in the event Individual Investors request registration of Registrable Securities under Sections 2(a) (as Demand Piggybackers), 2(b), 3 or 4 hereof, such Management investors, or any one of them, shall be given priority over all other holders of Registrable Securities (other than Mezzanine warrant Holders) to the extent such priority is necessary to allow such Individual Investors to sell enough Registrable Securities to qualify any redemption of other Company securities from such Individual Investor occurring simultaneously with (or part of a series of related transactions with) such offering for sale or exchange treatment under Section 302(b)(2) of the Internal Revenue Code of 1986, as amended; provided that the priority provided by this subparagraph (c) shall not extend to Registrable Securities which constitute more than one and one-half percent (1.5%) of the outstanding Common Stock of the Company at the time of (and measured prior to) such redemption (the "Priority Inversion Percent"); and provided further that the rights provided to Individual Investors pursuant to this subparagraph (c) may be terminated by Holdings if Holdings shall, or shall cause the Company to, purchase the Priority Inversion Percent from the Individual Investor and thereby reduce the number of Individual Investors' Registrable Securities requested to be registered. (d) In the case of a non-underwritten Demand Registration, the priorities provided in Section 9(b)(i) or (ii) shall apply in the event the number of shares salable (in the opinion of the Board of Directors) is less than the total number of Registrable Securities sought to be registered. (e) No Holder may participate in any underwritten registration hereunder unless such Holder (i) agrees to sell such Holder's Registrable Securities on the basis provided in any underwriting arrangements approved by the persons entitled hereunder to approve such arrangements and (ii) completes and executes all questionnaires, powers of attorney, indemnities, underwriting agreements and other documents reasonably required under the terms of such underwriting arrangements. -17- 19 (f) The Company shall not grant registration rights to any person which impair in any way the priorities for inclusion in a registration set forth in this Section 9, including, without limitation, by providing any such person with higher priority than or equal priority to that provided to the Parties herein with regard to any registration statement filed by be Company, whether upon such person's demand or otherwise. In addition, in any demand registration rights granted to any such person, the Company shall provide that such demand registration rights shall be subject to a right of the Mezzanine Warrant Holders to render such a demand thereunder ineffective by making demand for registration under Section 2(a) of this Agreement in accordance with the procedures set forth in Section 2(b) hereof. Notwithstanding anything to,the contrary contained in this paragraph (f), nothing in this paragraph (f) shall restrict the Company's ability to register on Form S-8 (or any successor form) shares issuable upon exercise of options which may be granted pursuant to any Stock Option Plan adopted by the Company after the date hereof, providing for the issuance of shares of Common Stock to certain employees of the Company. 10. Rule 144. (a) The Company shall not be obligated under Section 2, 3 or 4 hereof to register or include in any registration statement Registrable Securities that any Holder has requested to be registered if the Company shall furnish such Holder with a written opinion of counsel to the Company, which opinion shall be reasonably satisfactory to such Holder, that all Registrable Securities that such Holder holds may be publicly offered, sold and distributed within a single ninety (90) day period without registration under the Act pursuant to Rule 144 promulgated by the Commission under the Act; provided, however, that the provisions of this Section 10(a) shall not apply if such Holder requesting registration shall provide to the Company written advice from a refutable investment banker reasonably satisfactory to such Holder and the Company, that the per share price reasonably likely to be attainable in a sale under Rule 144 (net of expenses of such sale) is not substantially as great as the per share price reasonably likely to be attainable pursuant to a Registration under the applicable section. The cost of obtaining a letter from an investment banker containing such advice shall be borne by the Company. (b) At such time as the Company becomes subject to the reporting requirements of the 1934 Act, the Company will file the reports required to be filed by it under the Act and the 1934 Act and the rules and regulations adopted by the Commission thereunder, and will use its best efforts to take such further action as any Holder of Registrable Securities may reasonably deem to be necessary, all to the extent required from time to time to enable such Holder to sell Registrable Securities without registration under the Act within the limitation of the exemptions provided by (i) Rule 144 under the Act, as such Rule may be amended from time to time, or (ii) any similar rule or -18- 20 regulation hereafter adopted by the Commission. Upon the request of any Holder of Registrable Securities, the Company will deliver to such Holder a written statement as to whether it has complied with such information and requirements. 11. Lockup Agreement. (a) All Holders agree that, upon the request of and to the extent required by the underwriter(s) managing (i) an initial underwritten public offering of Common Stock, or (ii) any other registration of Common Stock at the time of which such Holder is a Restricted Holder (as defined in this section 11(a)), such Holders will not sell, make any short sale of, pledge, grant any option for the purchase of or otherwise dispose of any Registrable Securities (other than those included in the registration) without the Prior written consent o the Company or such underwriters), as the case may be, during the seven (7) days prior to, and during the one hundred twenty (120) day period beginning on, the effective date of such registration as the Company or the underwriters) may specify. For purposes of this section 11(a), "Restricted Holder shall mean any Holder who owns five Percent (5%) or more of the then outstanding Common Stock ("5% Holder"), any director or officer of the Company (without regard to his or her level of ownership of Common Stock), or any Holder whose Registrable Securities are being included in the registration (without regard to the amount of Registrable securities being registered): Any lockup imposed on Holders pursuant to clause (i) of this Section 11(a) shall be imposed on all Holders and any lockup imposed on Restricted Holders pursuant to clause (ii) of this Section 11(a) shall be imposed on all Restricted Holders. (b) The Company agrees (i) not to effect any public sale or distribution of its equity securities, or any securities convertible into or exchangeable or exercisable for such securities, during the seven (7) days prior to and during the one hundred twenty (120) day period beginning on the effective date of any registration statement related to an registered underwritten public offering pursuant to which Registrable Securities are to be sold (except as Part of such underwritten registration or pursuant to registrations on Form S8 or any successor form), unless the underwriters) managing the registered public offering otherwise agree, and (ii) to use its best efforts to cause each holder of at least five percent (5%) (on a fully-diluted basis) of its equity securities, or any securities convertible into or exchangeable or exercisable for such securities, in either case purchased from the Company at any time after the date of this Agreement (other than in a registered public offering) to agree not to effect any sale or distribution of any such securities during such period (except as part of such underwritten registration, if otherwise permitted), unless the underwriters managing the registered public offering otherwise agree. -19- 21 12. Transfer of Registration Rights. Provided that the Company is given written notice by the Holder at the time of such transfer stating the name and address of the transferee and identifying the securities with respect to Which the rights under this Agreement are being assigned, the registration rights under this Agreement may be transferred in whole or in part in connection with the transfer of Registrable Securities. Notwithstanding the foregoing, if such transfer is subject to covenants, agreements or other undertakings restricting transferability thereof the registration rights under this Agreement shall not be transferred in connection with such transfer unless such transfer complies with all such covenants, agreements and other undertakings. In all cases, such registration rights shall not be transferred unless the transferee thereof executes a Counterpart. 13. Indemnification. In the event any Registrable Securities are included in a registration statement under this Agreement: (a) To the full extent permitted by law, the Company will and hereby does (i) indemnify and hold harmless each Holder, each director, officer, partner, employee, or agent of or for such Holder, any underwriter (as defined in the Act) for such Holder, and each person, if any, who controls such Holder or underwriter within the meaning of the Act, against any losses, claims, damages or liabilities, joint or several, to which they may become subject under the Act and applicable state securities laws insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based on any untrue or alleged untrue statement of any material fact contained in such registration statement, including any preliminary prospectus or final prospectus contained therein or any amendments or supplements thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein in light of the circumstances under which it was made or necessary to make the statements therein not misleading, or arise out of any violation by the company of any securities law, rule or regulation applicable to the Company and relating to action or inaction required of the company in connection with any such registration; and (ii) will reimburse each such person or entity for any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement contained in this Section 13(a) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability, or action if such settlement is effected without the consent of the Company (which consent shall not be unreasonably withheld or delayed) nor shall the Company be liable in any such case for any such loss, claim, damage, liability or action to the extent that it arises out of or is based upon an untrue statement or an alleged untrue statement or omission or alleged omission made in connection with such registration statement, preliminary Prospectus, final prospectus, or amendments or supplements -20- 22 thereto in reliance upon and in conformity with written information furnished expressly for use in connection with such registration by or on behalf of any such Holder, underwriter or controlling person. (b) To the full extent permitted by law, each Holder requesting or joining in a registration under this Agreement will and hereby does (i) indemnify and hold harmless the Company, each of its directors, each of its officers who have signed the registration statement, each person, if any, who controls the Company within the meaning of the Act, and any Underwriter (as defined in the Act) for the Company, each other holder and each person, if any, who controls such other Holder within the meaning of Section 15 of the Act, against any losses, claims, damages or liabilities, joint or several, to which the Company or any such director, officer, controlling person, other Holder or underwriter may become subject, under the Act and applicable state securities laws, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in such Registration Statement, including any preliminary prospectus or final prospectus contained therein or any amendments or supplements thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading in light of the circumstances, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in such registration statement, preliminary or final prospectus, or amendments or supplements thereto, in reliance upon and in conformity with written information furnished by such Holder expressly for use in connection with such registration; and (ii) reimburse any legal or other expenses reasonably incurred by the Company or any such director, officer, other Holder, controlling person or underwriter attributable to investigating or defending any loss, claim, damage, liability or action indemnified by such Holder pursuant to clause (i); provided however, that the indemnity agreement contained in this Section 13(b) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability or action if such settlement is effected without the consent of such Holder (which consent shall not be unreasonably withheld or delayed). In no event shall the liability of any Registered Holder be greater than the dollar amount of the proceeds received by such Registered Holder upon the sale of the Registrable Securities giving rise to such indemnification obligation. (c) Promptly after receipt by an indemnified party under this Section 13 of notice of the commencement of any action or knowledge of a claim that would, if asserted, give rise to a claim for indemnity hereunder, such indemnified party will, if a claim in respect thereof is to be made against any indemnifying party under this Section 13, notify the indemnifying -21- 23 party in writing of the commencement thereof or knowledge thereof and the indemnifying party shall have the right to participate in, and, to the extent the indemnifying party so desires, jointly with any other indemnifying party similarly noticed, to assume the defense thereof with counsel mutually satisfactory to the parties. The failure to notify an indemnifying party promptly of the commencement of any such action or of the knowledge of any such claim, if prejudicial to any material extent to his ability to defend such action, shall relieve such indemnifying party of any liability to the indemnified party under this Section 13 to the extent so prejudiced, but the omission so to notify the indemnifying party will not relieve him of any liability that he may have to any indemnified party otherwise than under this Section 13. (d) If the indemnification provided for in this Section 13 is for any reason, other than pursuant to the terms thereof, held to be unavailable to an indemnified party in respect of any losses, claims, damages or liabilities (or actions in respect thereof) referred to therein, then each indemnifying party shall, in lieu of indemnifying such indemnified party, contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions in respect thereof) in such proportion as is appropriate to reflect the relative benefits received by the indemnifying and indemnified parties from the offering of Common Stock. If, however, the allocation provided by the immediately preceding sentence is not permitted by applicable law or otherwise results in a materially inequitable result (as determined by the Board of Directors of the Company in its reasonable discretion), then each indemnifying party shall contribute to such amount paid or payable by such indemnified party in such proportion as is appropriate to reflect not only such relative benefits but also the relative fault of the indemnifying and indemnified parties in connection with the statements) or omissions) which resulted in such losses, claims, damages, liabilities (or actions in respect thereof), as well as any other relevant equitable considerations. The relative benefits received by a party shall be deemed to be in the same proportion as the total net proceeds from the offering (before deducting expenses) received by such party bears to the total net proceeds from the offering received by all parties. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact relates to information supplied by the Company or a Holder and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and the Holders agree that it would not be just and equitable if contribution pursuant to this subsection (d) were determined by pro rata allocation or by any other method of allocation take into account the equitable considerations referred to above in this subsection (d). The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities (or actions in respect thereof) referred to above in this subsection (d) shall be deemed -22- 24 to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. No Person guilty of fraudulent misrepresentation within the meaning of Section 11(f) of the Act shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. 14. Remedies. In addition to being entitled to exercise all rights provided in this Agreement as well as all rights granted by law, including recovery of damages, each Holder of Registrable Securities will be entitled to specific performance of its rights under this Agreement. The Company agrees that monetary damages would not be adequate compensation for any loss incurred by reason of a breach by it of the provisions of this Agreement and hereby agrees not to raise the defense in any action for specific performance that a remedy at law would be adequate. 15. Amendments and Waivers. The provisions of this Agreement, including the provisions of this sentence, may not be amended, modified or supplemented, and waivers or consents to departures from the provisions hereof may not be given unless the Company has obtained the written consent of all of the Holders; provided, however, that any such waiver or consent will be effective against any Holder actually executing a written waiver or consent whether or not other Holders of the outstanding Registrable Securities grant such waiver or consent. 16. Filing Notices and Copies. The Company shall provide to each Holder of Registrable Securities such number of copies of any registration statement, amendment thereto (including post-effective amendments) or other report, document or notice that is filed with the Securities and Exchange Commission or other authority under the securities laws, as may be reasonably requested by such Holder of Registrable Securities. in addition, the Company shall provide prior notice to any Holder of Registrable Securities of any such filing of a registration statement or amendment thereto, provided that the foregoing notice provision shall not shorten any other advance notice provision contained in this Agreement. 17. Notices. All notices and other communications hereunder shall be in writing and shall be given to the person either personally or by sending a copy thereof by first class or express mail, postage prepaid, or by telegram (with messenger service specified), telex or TWX (with answerback received) or courier services, charges prepaid, or by telecopier, to such party's address (or to such party's telex, TWX, telecopier or telephone number). If the notice is sent by mail, it shall be deemed to have been given to the person entitled thereto five (5) business days after being deposited in the United States mail, and if the notice is sent by telegraph or courier services, it shall be deemed to have been given to the person entitled thereto one (1) business day after deposited with a telegraph office or -23- 25 courier service for delivery to that person or, in the case of telex, TWX, or telecopy when dispatched. If to Holdings, to: Kirkland Holdings L.L.C. 101 Federal Street Boston, MA 02110 Attention: David M. Mussafer Telecopy No.: (617) 951-0566 With a copy to: Pepper, Hamilton & Scheetz 3000 Two Logan Square Philadelphia, PA 19103 Attention: Julia D. Corelli, Esq. Telecopy No.: (215) 981-4750 If to the Management Investors or any Company (including the Representative), to: Kirkland's, Inc. P.O. Box 7222 Jackson, TN 38303-7222 Attention: Carl Kirkland Telecopy No.: (901) 664-9345 With a copy to: Baker, Donelson, Bearman & Caldwell 20th Floor First Tennessee Building 165 Madison Avenue Memphis, TN 38103 Attention: Robert Walker, Esq. Telecopy No.: (901)577-2303 If to Robert Kirkland, to: CBK, Ltd. 600 East Sherwood Union City, Tennessee 38261 Attention: Robert Kirkland Telecopy No.: (901) 885-3857 -24- 26 With a copy to: Wyatt, Tarrant & combs 6075 Poplar Avenue, Suite 650 Memphis, Tennessee 38119 Attention: Nash Neyland, Esquire Telecopy No.: (901) 537-1010 If to Mezzanine Warrant Holders, to: Capital Resource Lenders II, L.P. 85 Merrimac Street Suite 200 Boston, MA 02114 Attention: Alexander S. McGrath Telecopy No.: (617) 723-9819 -25- 27 Allied Capital Corporation and Allied Capital Corporation II 1666 K Street, N.W. Suite 901 Washington, D.C. 20006 Attention: Susan Gallagher Telecopy No.: (202) 659-2053 The Marlborough Capital Investment Fund, L.P. 399 Boylston Street Boston, MA 02116 Attention: Margaret Laroix Telecopy No.: (617)421-9631 Capital Trust Investments, Ltd. 575 Fifth Avenue, 40th Floor New York, NY 10017 Attention: John P. Oswald Telecopy No.: (212) 490-6950 With a copy to: Testa, Hurwitz & Thibeault, LLP High Street Tower 125 High Street Boston, MA 02110 Attention: Andrew E. Taylor, Jr., Esquire Telecopy No.: (617) 248-7100 Notice of any change in any such address shall also be given in the manner set forth above. Whenever the giving of notice is required, the giving of such notice may be waived by the party entitled to receive such notice. 18. Counterparts. This Agreement may be executed in any number of counterparts and by the parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. 19. Headings. The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. 20. Governing Law. This Agreement shall be governed by and construes in accordance with the laws of the State of Delaware. 21. Severability. In the event that any one or more of the provisions contained herein, or the application thereof in any circumstance, is held invalid, illegal or unenforceable, the validity, legality and enforceability of any such provision in every other respect and of the remaining provisions contained imp herein shall not be affected or impaired thereby. -26- 28 22. Entire Agreement. This Agreement is intended by the parties as a final expression of their agreement and intended to be a complete and exclusive statement of the agreement and matter contained herein. There are no restrictions, promises, warranties or undertakings, other than those set forth or referred to herein with respect to the registration rights granted by the Company with respect to the Registrable Securities. This Agreement supersedes all prior agreements and understandings between the parties with respect to such subject matter. 23. Parties Benefitted. Nothing in this Agreement, express or implied, is intended to confer upon any third party any rights, remedies, obligations or liabilities. 24. Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective heirs, personal representatives, successors and assigns including, without limitation, subsequent Holders of Registrable Securities agreeing to be bound by all and the terms and conditions of this Agreement. [SPACE INTENTIONALLY LEFT BLANK] -27- 29 IN WITNESS WHEREOF, the parties have executed this Shareholders Agreement under seal on the date first above written. CAPITAL RESOURCE LENDERS II, L.P., by CAPITAL RESOURCE PARTNERS II, L.P., its General Partner By: /s/ Robert C. Ammerman ----------------------------------- Title: General Partner ALLIED CAPITAL CORPORATION By: /s/ Susan Gallagher ----------------------------------- Title: SVP -------------------------------- ALLIED CAPITAL CORPORATION II By: /s/ Susan Gallagher ----------------------------------- Title: SVP -------------------------------- THE MARLBOROUGH CAPITAL INVESTMENT FUND, L.P., by MARLBOROUGH CAPITAL MANAGEMENT, L.P., its general partner, By: /s/ Margaret Lanoix ----------------------------------- Name: Margaret Lanoix, its authorized partner CAPITAL TRUST INVESTMENTS, LTD. By: /s/ John Oswald ----------------------------------- Title: Attorney-in-fact ------------------------------- KIRKLAND HOLDINGS L.L.C. By:/s/ David M. Mussafer ----------------------------------- Title: -------------------------------- ATTEST: KIRKLAND'S, INC. By: /s/ Robert S. Alderson By: /s/ Carl Kirkland ----------------------- ------------------------------------- Title: VP/Sec Title: President ------------------------------- -28- 30 Corporate Name -------------- 101 Kirkland's of Carolina, Inc. 102 Kirkland's of Charlotte, Eastland Mall, Inc. 103 Kirkland's of Tennessee, Inc. 104 K. C. Corp, Inc. 107 Kirkland's of Greensboro, Four Seasons Mall, Inc. 109 Kirkland's of Fayetteville, Cross Creek Mall, Inc. 110 Kirkland's of Wilmington, Independence Mall, Inc. 111 Kirkland's III, Jackson-Metro Center, Inc. 114 Kirkland's of Memphis, TN, Laurelwood Shopping Center, Inc. 115 Kirkland's of Ridgeland, MS, Northpark Mall, Inc. 116 Kirkland's of Knoxville, East Towne Mall, Inc. 117 Kirkland's of Huntsville, Madison Square Mall, Inc. 118 Kirkland's of Valley View Mall, Roanoke, VA, Inc. 119 Kirkland's of Nashville, Hickory Hollow Mall, Inc. 120 Kirkland's of Birmingham, Riverchase Galleria, Inc. 121 Kirkland's of Chattanooga, Eastgate Center Mall, Inc. 122 Kirkland's of Briarcliffe Mall, Myrtle Beach, South Carolina, Inc. 123 Kirkland's of Pecanland Mall, Monroe, LA, Inc. 125 Kirkland's of Towne Center at Cobb, Kennesaw, GA, Inc. 126 Kirkland's of Gwinnett Place, Duluth, GA, Inc. 127 Kirkland's of Rivergate Mall, Nashville, TN, Inc. 128 Kirkland's of Peachtree Mall, Columbus, GA, Inc. 129 Kirkland's of Cumberland Mall, Atlanta, GA, Inc. 130 Kirkland's of Hamilton Place Mall, Chattanooga, TN, Inc. 131 Kirkland's of Houston Galleria, Houston, TX, Inc. 132 Kirkland's of Mall of Memphis, Memphis, TN, Inc. 134 Kirkland's of Woodland Hills Mall, Tulsa, OK, Inc. 135 Kirkland's of Dayton Mall, Dayton, OH, Inc. 136 Kirkland's of Oxmoor Center, Louisville, KY, Inc. 137 Kirkland's of South Square Mall, Durham, NC, Inc. 138 Kirkland's of Valley View Center, Dallas, TX, Inc. 139 Kirkland's of Chesterfield Towne Center, Richmond, VA, Inc. 140 Kirkland's of Park Plaza, Little Rock, AR, Inc. 141 Kirkland's of Montgomery Mall, Montgomery, AL, Inc. 142 Kirkland's of Southlake Mall, Atlanta, GA, Inc. 143 Kirkland's of Southpark Mall, Richmond, VA, Inc. 144 Kirkland's of Eastland Mall, Evansville, IN, Inc. 145 Kirkland's of Fayette Mall, Lexington, KY, Inc. 146 Kirkland's of Hickory Ridge Mall, Memphis, TN, Inc. 148 Kirkland's of Regency Square Mall, Jacksonville, FL, Inc. 149 Kirkland's of McCain Mall, Little Rock, AR, Inc. 150 Kirkland's of River Ridge Mall, Lynchburg, VA, Inc. 151 Kirkland's of Bel Air Mall, Mobile, AL, Inc. 152 Kirkland's of The Mall at Barnes Crossing, Tupelo, MS, Inc. 153 Kirkland's of Cortana Mall, Baton Rouge, LA, Inc. 154 Kirkland's of Bellevue Center, Nashville, TN, Inc. 155 Kirkland's of Tri-County Mall, Cincinnati, OH, Inc. 156 Kirkland's of The Mall of the Avenues, Jacksonville, FL, Inc. 157 Kirkland's of Eastwood Mall, Birmingham, AL, Inc. 158 Kirkland's of Lakeside Mall, New Orleans, LA, Inc. 159 Kirkland's of Carolina Place, Charlotte, NC, Inc. -29- 31 # Corporate Name - - -------------- 160 Kirkland's of Cary Village Mall, Raleigh, NC, Inc. 161 Kirkland's of CoolSprings Galleria, Nashville, TN, Inc. 162 Kirkland's of Kenwood Town Center, Cincinnati, OH, Inc. 163 Kirkland's of Saint Louis Galleria, St. Louis, MO, Inc. 164 Kirkland's of Wiregrass Commons Mall, Dothan, AL, Inc. 166 Kirkland's of Florace, Florace, KY, Inc. 167 Kirkland's of Acadiana Mall, Lafayette, LA, Inc. 168 Kirkland's of Padre Staples Mall, Corpus Christi, TX, Inc. 169 Kirkland's of Belden Village, Canton, OH, Inc. 170 Kirkland's of West Oaks Mall, Houston, TX, Inc. 171 Kirkland's of Charleston Towne Center, Charleston, W.VA, Inc. 172 Kirkland's of Crestwood Plaza, St. Louis, MO, Inc. 173 Kirkland's of White Marsh Mall, Baltimore, MD, Inc. 174 Kirkland's of Collin Creek Mall, Dallas, TX, Inc. 175 Kirkland's of Baybrook Mall, Houston, TX, Inc. 176 Kirkland's of Governor's Square, Tallahassee, FL, Inc. 178 Kirkland's of Barton Creek Mall, Austin, TX, Inc. 179 Kirkland's of Highland Mall, Austin, TX, Inc. 180 Kirkland's of Battlefield Mall, Springfield, MO, Inc. 181 Kirkland's of Penn Square Mall, Oklahoma City, OK, Inc. 182 Kirkland's of Oak Park Mall, Kansas City, KS, Inc. 183 Kirkland's of Mall St. Vincent, Shreveport, LA, Inc. 184 Kirkland's of Owings Mills Mall, Baltimore, MD, Inc. 185 Kirkland's of Oakwood Center, New Orleans, LA, Inc. 186 Kirkland's of The Mall at Johnson City, Johnson City, TN, Inc. 187 Kirkland's of Glenbrook Mall, Ft. Wayne, IN, Inc. 188 Kirkland's of North Pointe Mall, Atlanta, GA, Inc. 189 Kirkland's of Northpark Mall, Joplin, MO, Inc. 190 Kirkland's of Orlando Fashion Square, Orlando, FL, Inc. 191 Kirkland's of The Mall at Fairfield Commons, Dayton, OH, Inc. 192 Kirkland's of St. Charles Towne Center, Waldorf, MD Inc. 193 Kirkland's of Regency Mall, Florence, AL, Inc. 194 Kirkland's of South Plains Mall, Lubbock, TX, Inc. 195 Kirkland's of The Parks at Arlington, Ft. Worth, TX, Inc. 196 Kirkland's of Parma Town Mall, Cleveland, OH, Inc. 197 Kirkland's of St. Clair Square, St. Louis, MO, Inc. 198 Kirkland's of Turtle Creek Mall, Hattiesburg, MS, Inc. 199 Kirkland's of The Woodlands, Houston, TX, Inc. 200 Kirkland's of Brandon Town Center, Tampa, FL, Inc. 201 Kirkland's of Memorial City Mall, Houston, TX, Inc. 202 Kirkland's of University Mall, Tuscaloosa, AL, Inc. 203 Kirkland's of Santa Rosa Mall, Fort Walton, FL, Inc. 204 Kirkland's of Panama City Mall, Panama City, FL, Inc. 205 Kirkland's of Town East Mall, Mesquite, TX, Inc. 206 Kirkland's of Kentucky Oaks Mall, Paducah, KY, Inc. 207 Kirkland's of Crabtree Valley Mall, Raleigh, NC, Inc. 208 Kirkland's of Oak Hollow Mall, High Point, NC, Inc. 209 Kirkland's of Fox Valley Mall, Chicago, IL, Inc. 210 Kirkland's of Hawthorne Mall, Chicago, IL, Inc. -30- 32 # Corporate Name - --- -------------- 212 Kirkland's of Orland Square, Chicago, IL, Inc. 214 Kirkland's of Coastland Mall, Naples, FL, Inc. 215 Kirkland's of Edgewater Mall, Biloxi, MS, Inc. 216 Kirkland's of Town Center Plaza, Kansas City, KS, Inc. 217 Kirkland's of Castleton Square, Indianapolis, IN., Inc. 218 Kirkland's of Cordova Mall, Pensacola, FL, Inc. 219 Kirkland's of University Park, South Bend, IN, Inc. 220 Kirkland's of Westgate Mall, Amarillo, TX, Inc. 221 Kirkland's of Westgate Mall, Spartanburg, SC, Inc. 222 Kirkland's of Meridian Mall, Lansing, MI, Inc. 223 Kirkland's of Cottonwood Mall, Albuquerque, NM, Inc. 224 Kirkland's of University Mall, Tampa, FL, Inc. By: /s/ Carl Kirkland ------------------------------- Title: President ------------------------------- ATTEST: By: /s/ Robert E. Alderson ------------------------------- Title: VP/Sec ------------------------------- -31- 33 /s/ Carl Kirkland ----------------------- Carl Kirkland /s/ Robert Kirkland ----------------------- Robert Kirkland /s/ Bruce Moore ----------------------- Bruce Moore /s/ Robert Alderson ----------------------- Robert Alderson [END OF SIGNATURES] -32- 34 Exhibit A COUNTERPART THIS INSTRUMENT forms part of the Registration Rights Agreement (the "Agreement") made as of the 11th day of June, 1996, among Kirkland Holdings L.L.C., Kirkland's, Inc., affiliates of Kirkland's, Inc., Carl Kirkland, Robert Kirkland, Bruce Moore, Robert Alderson, Capital Resource Lenders II, L.P., Allied Capital Corporation, Allied Capital Corporation II, The Marlborough Capital Investment Fund, L.P. and Capital Trust Investments, Ltd., and any additional Shareholders of the Companies (as defined in the Agreement), from time to time, which Agreement permits execution by counterpart. The undersigned hereby acknowledges having received a copy of the said Agreement (which is annexed hereto as Schedule I) and having read the said Agreement in its entirety, and for good and valuable consideration, receipt and sufficiency of which is hereby acknowledged, hereby agrees that the terms and conditions of the said Agreement shall be binding upon the undersigned as a Shareholder and such terms and conditions shall inure to the benefit of and be binding upon the undersigned and its successors and permitted assigns. IN WITNESS WHEREOF, the undersigned has executed this instrument this ___ day of _________, 199__. ------------------------- (Signature of Shareholder) ------------------------- (Name in block letters) 33 EX-10.5 13 CONSULTING AGREEMENT BY AND BETWEEN THE COMPANY 1 EXHIBIT 10.5 KIRKLAND'S, INC. P.O. Box 7222 Jackson, TN 38303-7222 June 12, 1996 Mr. Robert E. Kirkland CBK, Ltd. 600 East Sherwood Union City, Tennessee 38261 Dear Mr. Kirkland: In recognition of your contribution to the growth and success of Kirkland's, Inc. and its related companies (the "Company"), we are pleased to offer to retain you ("Consultant") as a consultant to the Company, subject to the following terms of this letter agreement (the "Agreement"). 1. Term and Duties. The term of this agreement shall commence on the date hereof and expire on the seventh anniversary of the date hereof (the "Term"). During the Term, Consultant shall provide consulting services and advice to the Company, with regard to the purchasing and marketing of merchandise, leasing, store selection and location, operations, internal management, and such other areas as may be mutually agreed between the Company and Consultant, as shall be directed from time to time by the Company's Board of Directors or the President of the Company (the "Consulting Services"). Any out-of-town travel required in connection with the performance of the Consulting Services shall be scheduled so as not to interfere with other scheduled obligations of Consultant. 2. Independent Contractor Status. Nothing herein shall be construed as evidence of an employment relationship between the Company and Consultant. Consultant shall be treated as an independent contractor for all purposes, including without limitation, federal, state and local withholding, employment and payroll tax purposes. 3. Consulting Fee. The Company shall pay Consultant, and Consultant hereby agrees to accept, as compensation for the Consulting Services rendered hereunder, an annual consulting fee during the Term of $679,000 (the "Consulting Fee") commencing on the date hereof. The Consulting Fee shall be payable in annual installments of $679,000 on April 15 of each year during the Term (each, a "Consulting Payment"). The first Consulting Payment, 2 payable on April 15, 1997, shall be equal to a prorated portion of $679,000 based on the number of days between the date hereof and April 15, 1997. 4. Expenses. The Company shall reimburse Consultant for all pre-approved expenses incurred in connection with the performance of the Consulting Services. 5. Confidential Information. Consultant agrees that, during and after the Term, Consultant shall keep secret and retain in strictest confidence, and shall not use for Consultant's benefit or the benefit of others any proprietary, confidential or secret matters relating to the Company including, without limitation, financial information, trade secrets, customer lists, details of client or consultant contracts, pricing policies, operational methods, marketing plans or strategies, product development techniques or plans, business acquisition plans, new personnel acquisition plans, methods of manufacture, technical processes, designs and design projects, inventions and research projects of the Company, its affiliates or any other entity which may hereafter become an affiliate thereof, learned, acquired or developed by Consultant while retained by the Company. 6. Termination. 6.1. Change in Control, etc. Upon the occurrence of a Change in Control, Qualified Public Offering, Sale or Refinancing (such terms being used herein as they are defined in the Recapitalization Agreement dated April 26, 1996 among the Company, Kirkland Holdings L.L.C. and the Company's former majority shareholders, including Consultant (the "Recapitalization Agreement")) during the Term, this Agreement shall terminate and Consultant shall be paid a pro-rated portion of the applicable Consulting Payment through such termination date. 6.2. Death or Disability. In recognition of Consultant's past services to the Company, the Consulting Payments provided for hereunder shall continue to be made to Consultant or his estate notwithstanding the death or disability of Consultant during the Term, subject to early termination as provided in Section 6.1. 6.3. Continuing Obligation. The Company's obligation to pay the compensation to Consultant under this Agreement may be terminated only as provided in Section 6.1, and shall not be terminated for any other reason. 2 3 7. Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the Company and Consultant and their respective successors, executors, administrators, heirs and/or permitted assigns; provided, however, that neither Consultant nor the Company may make any assignments of this Agreement or any interest herein, by operation of law or otherwise, without the prior written consent of the other party, except that, without such consent, the Company may assign this Agreement to any successor to all or substantially all of its assets and business by means of liquidation, dissolution, merger, consolidation, transfer of assets, or otherwise. 8. Subordination. The obligations of the Company set forth in this letter agreement with respect to the Consulting Fee are intended to be and are subordinated in all respects to the Bank Debt and Mezzanine Debt, as such terms are defined in the Recapitalization Agreement. In the event that any payment of the Annual Salary is deferred by reason of this Section 8, payment shall be made to Consultant as soon as allowable under the terms of the Bank Debt and Mezzanine Debt and the payment shall be increased by nine percent (9%) per annum, compounded semi-annually from the date originally due until the date paid. Except as otherwise required by law, the Company agrees not to treat the Consultant for any purpose as having received any payment of compensation any earlier than the date actually paid to the Consultant by cash or check if the Consultant's compensation is reduced because of subordination under this Section 8 or because of any other reason whatsoever. 9. Notice. Any notice or communication required or permitted under this Agreement shall be made in writing and (i) sent by overnight courier, (ii) mailed by certified or registered mail, return receipt requested or (iii) sent by telecopier, addressed to the addresses of the parties set forth herein (and, in the case of the Company, with a copy to Pepper, Hamilton & Scheetz, 3000 Two Logan Square, 18th and Arch Streets, Philadelphia, PA 19103, Attention: Cary S. Levinson, Esquire); or to such other address as either party may from time to time duly specify by notice given to the other party in the manner specified above. 10. Entire Agreement; Amendments. This Agreement contains the entire agreement and understanding of the parties hereto relating to the subject matter hereof, and merges and supersedes all prior and contemporaneous discussions, agreements and understandings of every nature between the parties hereto relating to the terms of this Agreement. This Agreement may not be changed or modified, except by an Agreement in writing signed by each of the parties hereto. 3 4 11. Waiver. The waiver of the breach of any term or provision of this Agreement shall not operate as or be construed to be a waiver of any other or subsequent breach of this Agreement. 12. Governing Law. This Agreement shall be construed and enforced in accordance with the laws of the State of Tennessee. This provision shall survive the termination of the Agreement. 13. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, and all of which together shall be deemed to be one and the same instrument. Please indicate your acceptance of this offer and your agreement to render Consulting Services to the Company subject to the terms set forth above by executing and returning the enclosed copy of this letter. Sincerely, ATTEST: KIRKLAND'S, INC. By: /s/ Robert E. Alderson By: /s/ Carl Kirkland ------------------------- ------------------------- Title: VP/Sec Name: Title: President Agreed to and Accepted: /s/ Robert E. Kirkland - ----------------------------- Robert Kirkland 4 EX-10.6 14 EMPLOYMENT AGREEMENT DATED JUNE 12, 1996 1 EXHIBIT 10.6 KIRKLAND'S, INC. P.O. Box 7222 Jackson, TN 38303-7222 June 12, 1996 Mr. Carl Kirkland President Kirkland's, Inc. 805 North Parkway Jackson, Tennessee 38305 Dear Mr. Kirkland: In recognition of your contribution to the growth and success of Kirkland's, Inc. and its related companies (the "Company"), we are pleased to offer to you ("Executive") continued employment with the Company as Chairman and Chief Executive Officer, subject to the following terms of this letter agreement (the "Agreement"). 1. Term and Duties. Executive shall be employed for a term commencing on the date hereof and expiring on the fourth anniversary of the date hereof (the "Term"). During the Term, Executive shall devote his best efforts and substantially all of his business time and services to the Company, subject to the direction of and reporting to the Board of Directors of the Company (the "Board"). 2. Annual Salary. Executive hereby agrees to accept, as compensation for all services rendered by Executive in any capacity hereunder and for the Restrictive Covenants made by Executive in Section 6 hereof, an annual salary at the rate of $987,500 (the "Annual Salary") commencing on the date hereof and continuing until expiration or termination of the Term. The Annual Salary shall be inclusive of all applicable income, social security and other taxes and charges which are required by law to be withheld by the Company. The Annual Salary will be paid in the following manner: (a) a minimum of $275,000 in 12 equal monthly installments in arrears and (b) $712,500 payable annually in arrears on April 15 of each year. This minimum amount may be increased from time to time by the approval of the Company's Board of Directors. The annual payment to be made on April 15, 1997 shall be a prorated portion of $712,500 based on the portion of a year which has elapsed from the Closing Date (as defined in the Recapitalization Agreement, dated April 26, 1996 among the Company, Kirkland Holdings L.L.C. and the Company's former 2 majority shareholders, including Executive (the "Recapitalization Agreement") through April 15, 1997. The annual payment to be made with respect to any period during which the Term terminated prior to the applicable April 15 payment date will be prorated based on the portion of a year which has elapsed from April 15 of the prior year until the termination or expiration of the Term. 3. Annual Bonus. Executive will be eligible to receive with respect to each fiscal year of the Company during the Term (each, a "Fiscal Year") commencing with the Fiscal Year ending December 31, 1996, a bonus ("Annual Bonus") consisting of: (i) an annual performance bonus of either (A) $175,000.00 if the Company achieves at least ninety-five (95%) of its Performance Target (as defined below), or (B) $175,000.00 multiplied by the product of (i) the actual percentage of Performance Target achieved minus eighty-five (85%) percent, but not less than zero, times (ii) ten (10); and (ii) up to an additional $75,000.00, subject to the discretion of the Board, which may take performance measures into consideration, including but not limited to team leadership, new store openings, existing store performance and/or customer satisfaction. For purposes of this Agreement, "Performance Target" means the Company's projected annual operating profit, as established by the Board for each Fiscal Year during the Term. The Annual Bonus shall be payable within 30 days after completion of the audit of the Company's financial statements for the prior Fiscal Year. 4. Benefits. Executive shall be entitled to the benefits (the "Benefits") set forth on Schedule A attached hereto. 5. Incentive Stock Options. Simultaneously with the execution of this Agreement, the Company has granted stock options to Executive to purchase two percent (2%) of the Company's common stock (determined on a fully diluted basis), pursuant to and subject to the terms of the 1996 Incentive and Non-Qualified Stock Option Plan of the Kirkland Companies adopted on the date hereof by the Board of Directors of the Company, and further subject to the terms and provisions contained in that certain Stock Option Agreement between the Company and Executive. 6. Non-Compete; Confidentiality; Non-Solicitation. 6.1. Restrictive Covenants. (a) Non-Compete. Executive shall not, during the Term and for a period of three (3) years thereafter (the "Restricted Period"), in the United States, Canada or any other place where the Company, its subsidiaries or affiliates conduct business, directly or indirectly (except in Executive's capacity as an officer of the Company or its subsidiaries or affiliates) -2- 3 do any of the following directly or indirectly without the prior written consent of the Company: (i) engage or participate in any business activity competitive with the Company's business, or in any business activity which sells to or supplies goods or products to a business that is competitive with the Company's business, or in either case, the business of any of the Company's subsidiaries or affiliates ("Competing Business"), as the same are conducted by the Company or its subsidiaries or affiliates at any time during the Restricted Period; (ii) become interested in (as owner, stockholder, lender, partner, co-venturer, director, officer, employee, agent, consultant or otherwise) any person, firm, corporation, association or other entity engaged in any Competing Business. Notwithstanding the foregoing, Executive may hold up to one percent (1%) of the outstanding securities of any class of any publicly-traded securities of any company; (iii) solicit or call on, either directly or indirectly, (A) for purposes of selling goods or products competitive with goods or products sold by the Company, any customer with whom the Company shall have dealt at any time during the two year period immediately preceding the termination of Executive's employment hereunder; or (B) any supplier with whom the Company shall have dealt at any time during the two year period immediately preceding the termination of Executive's employment hereunder; (iv) except by reason of and in his capacity as an officer of the Company, and in the best interests of the Company, directly or indirectly, influence or attempt to influence any supplier, customer or potential customer of the Company to terminate or modify any written or oral agreement or course of dealing with the Company; or (v) except by reason of and in his capacity as an officer of the Company, and in the best interests of the Company, influence or attempt to influence any person to either (i) terminate or modify his employment, consulting, agency, distributorship or other arrangement with the Company, or (ii) employ or retain, or arrange to have any other person or entity employ or retain, any person who has been employed or retained by the Company as an employee, consultant, agent or distributor of the Company at any time during the one year period immediately preceding the termination of Executive's employment hereunder. -3- 4 7. Termination. 7.1. Change in Control. Upon the occurrence of a Change in Control, Qualified Public Offering, Sale or Refinancing (such terms being used herein as defined in the Recapitalization Agreement) during the Term (or any renewal of the Term), this Agreement shall terminate and the Executive and the Company shall enter into a new employment agreement which shall be coextensive with the remaining Term hereunder and which shall provide for an annual salary at the rate of $275,000, a bonus equivalent to that provided for in Section 3 hereof, and a non-competition provision equivalent to that provided for in Section 6 hereof which continues until three years following the end of the remaining Term hereunder. 7.2. Disability. In the event of the disability of the Executive during the Term (or any renewal of the Term), such that Executive is unable to perform his duties and responsibilities hereunder to the full extent required by this Agreement by reasons of illness, injury or incapacity for a period of more than sixty (60) consecutive days or more than ninety (90) days, in the aggregate, during any one hundred twenty (120) day period ("Disability"), the Term will terminate and the Company will cease to pay the Annual Salary and Bonus and will, in recognition of Executive's past services to the Company, pay to Executive: (i) the sum of $712,500 per annum (prorated for any partial year) until the seventh anniversary of the date of this Agreement; provided that such annual payments shall terminate upon the occurrence of a Change in Control, Qualified Public Offering, Sale or Refinancing and (ii) a pro rata portion of his Annual Bonus for the Fiscal Year in which such termination occurs, if the Performance Targets applicable to that Fiscal Year are achieved. 7.3. Death. In the event that Executive dies during the Term (or any renewal of the Term), the Term will terminate and the Company will cease to pay the Annual Salary and Bonus and will, in recognition of Executive's past services to the Company, pay Executive's executors, legal representatives or administrators: (i) a death benefit of $712,500 per annum (prorated for any partial year) until the seventh anniversary of the date of this Agreement; provided that such payments shall terminate upon the occurrence of a Change in Control, Qualified Public Offering, Sale or Refinancing and (ii) a pro rata portion of Executive's Annual Bonus for the Fiscal Year in which the -4- 5 death occurs, if the Performance Targets applicable to that Fiscal Year are achieved. 7.4. Continuing Obligation. The Company's obligation to pay the compensation to Executive under this Agreement may be terminated only to the extent provided in Sections 7 and 8 of this Agreement, and shall not be terminated for any other reason. -5- 6 Please indicate your acceptance of employment and your agreement to render services to the Company subject to the terms set forth above by executing and returning the enclosed copy of this letter. Sincerely, ATTEST: KIRKLAND'S, INC. By: /s/ Illegible Signature By: /s/ Bruce Moore ------------------------- --------------------------- Title: VP/Sec Name: Title: V.P. Agreed to and Accepted: /s/ Carl Kirkland - ----------------------------- Carl Kirkland -6- 7 SCHEDULE A EMPLOYEE BENEFITS 1. Automobile. An allowance of $600 per month during the Term for an automobile. 2. Life Insurance. The Company shall purchase term life insurance in the face amount of $500,000.00 for Executive (with a person designated by Executive as named beneficiary of such insurance) for the period of the Term. The policy for the life insurance shall (i) contain a waiver of premium in the event of Disability (to the extent available at commercially reasonable rates) and (ii) provide for transfer to Executive in the event of Executive's termination under the terms of the Agreement so that Executive may then continue coverage under such policy after such termination. 3. Expense Reimbursement. Executive shall be entitled to receive reimbursement from the Company for all reasonable out-of-pocket expenses incurred by Executive in performing his duties under the Agreement, without regard to applicable deductions available to the Company, upon presentation of expense statements or vouchers and such other supporting information as may be required pursuant to any expense reimbursement policy adopted by the Company and in force from time to time. 4. Vacation. Executive shall be entitled to reasonable vacation time as determined by the Board consistent with past practices of the Company. 5. Other Benefits. Executive shall be permitted, if and to the extent eligible, to participate in any group life, hospitalization or disability insurance plan, health program, pension plan, similar benefit plan or other so-called "fringe benefits" of the Company, which may be no less favorable to Executive than the terms offered to such other senior executives of the Company during the Term. 6. Extended Benefits. Following the expiration or termination of the Term, Executive and his immediate family members shall be permitted to continue to participate, at his own expense, in the Company's health insurance programs, to the extent permitted by the insurance company (if any) then providing such programs for the Company's executives and their immediate family members. -7- EX-10.8 15 EMPLOYMENT AGREEMENT DATED AS OF FEB. 1, 1998 1 EXHIBIT 10.8 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT entered into to be effective as of February 1, 1997, between STEVEN J. COLLINS ("Employee") and KIRKLAND'S, INC., a Tennessee corporation with principal offices in Jackson, Tennessee ("Employer"). RECITALS 1. Employer desires to hire Employee as its Director of Finance and Chief Financial Officer ("CFO"). 2. The parties have agreed concerning the terms of Employee's employment. NOW, THEREFORE, in consideration of the premises and the parties' mutual covenants, it is agreed: 1. Employment: Move Date. Employer hereby employs Employee, and Employee accepts employment as CFO in accordance herewith. Employee hereby agrees that he will commence employment on the effective date and promptly establish his permanent residence in Jackson, Tennessee. Employee understands and agrees that periodic travel may be required in the exercise of his duties as Chief Financial Officer. 2. Scope of Duties. Employee shall serve as CFO for Employer and for its affiliated companies. As CFO, Employee shall perform those duties as from time to time assigned by the President, Senior Vice Presidents, and Board of Directors of Employer. 3. Term. The term of this Agreement shall commence on the Effective Date hereinafter provided and continue until termination as herein provided. 4. Compensation. Employee's compensation for the services rendered hereunder to Employer and its affiliated companies shall include (a) an annual salary of $75,000.00, paid twice monthly, in arrears; (b) an annual year-end bonus up to $35,000.00 based on performance criteria from time to time established by senior management of Kirkland's and the Board of Directors;(1) (c) in the event of implementation of Employer's anticipated stock option plan and completion of six (6) months continuous employment, the award of fully vested options to purchase 9,000 shares of Employer's stock at $.50 per share, in accordance with the terms and conditions of any such stock option plan; (d) in the event of the implementation of Employer's anticipated stock option plan and if Employee is satisfactorily employed continuously for eighteen (18) months, the award of fully - ----------------------- (1) Assumes 10,000,000 fully diluted shares upon issuance of both sets of options referenced in 4.(c) and 4.(d). These option amounts will be adjusted as necessary if the fully diluted shares differs from such to convey the same percentage ownership as inceded with 10,000,000 fully diluted shares outstanding. 1 2 vested options to purchase 9,000 shares of Employer's stock at $4.00 per share, in accordance with the other terms and conditions of any such stock option plan; and (e) the right to participate in such stock option plan, as implemented by Employer, in the future. Provided, however, Employee understands and agrees that the establishment and implementation of an Employee Stock Option Plan or other benefit plan of any type is within the absolute discretion of the Board of Directors of Employer, and the failure to enact such plan(s) and provide stock or stock options to Employee shall not constitute a breach of this Agreement or constitute the basis of any claim whatsoever by Employee against the stock of Employer, its shareholders, officers, directors and employees. Employee shall also be eligible for "individual coverage" (or "family coverage", if applicable), subject to applicable caps on Employer's contribution to the premium as from time to time established by employer, under any group health insurance policy from time to time in force, having such benefits as from time to time provided by Employer in its absolute discretion, together with any life insurance coverage available with such policy (up to such limit as from time to time set by Employer in Employer's absolute discretion). Employee understands and agrees that it is Employee's responsibility to promptly fill out and submit any insurance application(s) necessary for such coverage and that Employer has no control over the assigned effective date of the coverage or the requirement by the insurer for medical "underwriting". Employer shall have no liability to Employee resulting from denial of coverage by the insurer. Employee is solely responsible to make valid claims for benefits thereunder. Employee shall have such other benefits as from time to time provided by Employer in Employer's absolute discretion, including but not limited to paid vacation, in an amount from time to time provided to Kirkland's employees in accordance with existing policies, which shall not accrue in the event of termination. 5. Expense Reimbursement. (a) Moving Expenses. Upon presentation of receipts therefor, Employer agrees to reimburse Employee for customary and reasonable relocation expenses from Boston. Employee hereby agrees to repay this amount to Employer, if Employee voluntarily leaves the employ of Employer at any time during the first year of this agreement. (b) Course of Business Expense. Employee shall be reimbursed for those reasonable expenses (as determined by Employer in accordance with then existing policies) necessarily incurred by Employee in the performance of the duties herein as are specifically approved by Employer and as verified by vouchers, receipts, or other evidence of expenditure and business necessity as from time to time required by Employer. (c) Travel Allowance. Employer agrees to reimburse Employee for travel expenses to the Northeastern United States in amounts not to exceed $3,500.00 per year. 6. Other Employment; Conduct. Employee agrees to devote all working time and efforts to performance of the duties required hereunder so as to maximize the success of the Employer and 2 3 its affiliated companies. Employee shall not engage in other employment or become involved in other business ventures requiring Employee's time, absent the prior written consent of the Chief Executive Officer/President of Employer. Employee shall at all times conduct such duties and employee's personal affairs in a manner as is satisfactory to Employer and so as to not in any manner injure or unfavorably reflect upon the Kirkland's organization or any store or element thereof or any member thereof or third persons or entities connected therewith. 7. Termination. Employee understands and agrees that this Agreement is an "at will" employment agreement and may be terminated without "cause" of any type by either party upon notice, either written or oral. In the event of termination of employment by either party, Employee shall be entitled only to base salary, expense reimbursement, options already awarded, and insurance coverage (as available) up to and including the last day worked as the entire compensation due and owing to Employee. No further payments or benefits shall accrue to or be paid or owing to Employee. Upon termination of employment, Employee will return all property of Kirkland's to Employer or other designated person prior to receiving final compensation for wages and expenses. 8. Confidentiality: Restrictive Covenant. Employee understands and agrees that the financial, operational, leasing and merchandising information used by Employee in the performance of duties hereunder (collectively, the "Information") is proprietary to the Kirkland's chain of retail stores and represents highly confidential and valuable information, the loss of which would be economically injurious to the Kirkland retail stores, individually and as a whole, including Employer. Accordingly, in consideration of this Agreement, and the work experience provided to Employee by reason hereof, Employee agrees not to divulge in any manner, at any time, for any purpose, for any consideration, whether financial or otherwise, to any person or entity, any of the Information. In order to allow Employer to enforce such covenant or confidentiality, Employee agrees, additionally, that for a period of six (6) months after termination hereof, Employee will not, directly or indirectly, own, manage, operate, control, be employed by, participate in, lend money, furnish services to, be compensated in any matter by, or be connected in any way with the management, ownership, or control of any business similar to the type of business conducted by the Employer or as operated by the Kirkland retail stores at the time of termination of this Agreement. Employee understands and acknowledges that the type of business conducted by Employer is national in scope, and Kirkland's business competition is typically national or regional chain retail operations specializing in or having a substantial inventory mix involving "gift and decorative accessories" and related items. During the term of this agreement and for a period of three (3) years following the termination, for whatever reason, of employment, Employee agrees not to enter into or engage in any discussion or negotiation, or assist in such actions to encourage present employees of Kirkland's to disassociate their employment relationship with Kirkland's and induce such present employees to go into the employment of an entity engaged in any competing retail business. Employee understands and agrees that, to enforce the covenants of this paragraph, injunctive relief, in addition to the other remedies available at law or in equity, is necessary since the monetary damage to Employer and the Kirkland's organization may be difficult or impossible to determine. 3 4 9. Waiver of Breach. Any waiver by Employer of a breach of any provision hereof shall not operate as or constitute a waiver of any of the terms hereof with regard to any subsequent breach. 10. Assignment. Neither this Agreement nor any rights or obligations hereunder may be assigned except by Employer to a business entity which is a successor to Employer by merger, stock exchange, consolidation, or other reorganization, or to an entity which results from a purchase or sale or other transfer or transaction involving third parties, or except to an entity owned or controlled by the principals of Employer. This Agreement (nor any rights or benefits thereunder) on the part of the Employee is for Employee's personal services and is, therefore, not assignable by Employee. 11. Entire Agreement; Modification. This Agreement is the entire agreement of the parties with regard to Employee's employment and all other agreements and understandings, whether written or oral, if prior hereto, are merged herein so that the provisions of any Prior Agreement(s) are void and of no further force and effect. This Agreement may not be modified except by a writing signed by both parties. 12. Applicable Law; Venue. This Agreement shall be construed in accordance with the laws of the State of Tennessee, even if Employee executed this Agreement outside Tennessee or Madison County, Tennessee, and Employee's services are to be rendered without Tennessee. All legal disputes between the parties shall have a venue in the courts of Madison County, Tennessee. 13. Notices. All notices required to be sent to Employer shall be in writing and effective upon mailing, postage prepaid, by certified mail, return receipt requested, to the addresses indicated herein, or as from time to time modified by notice. Kirkland's, Inc. ATTN: Chief Administrative Officer P.O. Box 7222 Jackson, TN 38308 14. Provisions Severable. Any provision hereof adjudged void or voidable by a court of competent jurisdiction shall be deemed severable such that the remaining provisions are in full force and effect. 15. Parties Bound. This Agreement shall bind the parties' respective heirs, legal representatives, successors and assigns. 16. Effective Date. The Effective Date hereof for all purposes shall be February 1, 1997. 4 5 EXECUTED by the parties as provided below. EMPLOYEE: EMPLOYER: KIRKLAND'S, INC. /s/ Steven J. Collins BY: /s/ Carl Kirkland - ------------------------ ----------------------- Steven J. Collins TITLE: President DATE: 1-19-97 -------------------- - ------------------------ DATE: 1/20/97 -------------------- 5 EX-10.9 16 1996 EXECUTIVE AND NON-QUALIFIED STOCK OPTION PLAN 1 EXHIBIT 10.9 KIRKLAND'S, INC. 1996 EXECUTIVE INCENTIVE AND NON-QUALIFIED STOCK OPTION PLAN Section 1. Purposes. The purposes of the Plan are to recognize the accomplishments of and compensate selected employees who contribute to the development and success of Kirkland's, Inc. (the "Company") and certain of its affiliates (collectively with Kirkland's, Inc., the "Companies") and to encourage stock ownership by such employees by issuing options to such persons to acquire or increase their proprietary interest in the Companies. The options issued pursuant to this Plan are intended to constitute either incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), or non-qualified stock options, at the discretion of the Board of Directors, as determined at the time of grant. Because this Plan is intended to apply with respect to all of the Companies, references in this Plan to "shares of Common Stock" refer to an equal number of shares of common stock in each of the Companies. Options may not be granted except for an equal number of shares of common stock in each of the Companies. In the event that a new corporation is formed or acquired by the Company (or otherwise becomes affiliated with the Company) and adopts this Plan, each Option granted under this Plan that is unexercised at the time of such adoption shall automatically include rights with respect to an equal number of shares of common stock of such corporation. Such corporation shall thereafter be considered one of the Companies for all purposes of the Plan. Section 2. Definitions. "Aggregate Number" means, with respect to an Option, the number of shares of Common Stock issuable by the Company upon exercise of the Option (whether or not then vested), as such number may be adjusted from time to time pursuant to Section 6(h) hereof. "Board of Directors" means the Board of Directors of the Company, as constituted from time to time. "Change of Control" means the sale, transfer, assignment or other disposition (including by merger or consolidation, but excluding pursuant to a Public Offering) by Stockholders of the Company, in one transaction or a series of related transactions, of more than fifty percent (50%) of the voting power represented by the then outstanding Stock to one or more Persons other than any such sales, transfers, assignments or 2 other dispositions by the Stockholders to (i) other persons who are then Stockholders of the Company pursuant to exercise (in their own right or as assignee) of rights of first refusal with respect to such Shares, (ii) any person the transfer to whom or which is not restricted by the terms of the Shareholders Agreement because such transferee is an Affiliate or Permitted Transferee of such transferor (as such terms are defined in the Shareholders Agreement). "Common Stock" means common stock of each of the Companies. "Convertible Securities" means securities convertible into or exchangeable for shares of Common Stock. "Disabled" means, with respect to an Optionee, (i) when the Optionee is determined to be disabled within the meaning of any long-term disability policy or program sponsored by the Company covering the Optionee, as in effect as of the date of such determination, or (ii) if no such policy or program shall be in effect, when the Optionee is prevented by a physical or mental impairment from engaging in any substantial gainful activity for a period of at least six (6) months or when such physical or mental impairment is likely to result in death. The determination of whether an Optionee is Disabled pursuant to (ii) above shall be determined by the Board of Directors, whose determination shall be conclusive; provided that, (i) if an Optionee is bound by the terms of an Employment Agreement between the Optionee and the Company, whether the Optionee is "Disabled" for purposes of the Plan shall be determined in accordance with the procedures set forth in said Employment Agreement, if such procedures are therein provided; and (ii) an Optionee bound by such an Employment Agreement shall not be determined to be Disabled under the Plan any earlier than he would be determined to be disabled under his Employment Agreement. "Fair Market Value Per Share" means the fair market value per share of Common Stock as determined by the Option Committee or the Board of Directors in good faith. "Option" means an option to purchase Common Stock that is granted pursuant to this Plan. "Optionee" means an employee to whom an Option is granted. "Person" means an individual, partnership, corporation, joint venture, association, trust, limited liability company, limited liability partnership, unincorporated association, other entity or association. "Plan" means this Kirkland's, Inc. 1996 Executive Incentive and Non-Qualified Stock Option Plan. 3 "Sale of the Company" means a sale, transfer, assignment or other disposition (including by merger or consolidation) of all of the Stock of the Company, or of all or substantially all of the assets of the Company, or a liquidation or dissolution of the Company. "Stock" means the Common Stock issued by the Company and from time to time outstanding. "Stock Option Agreement" means the agreement evidencing the grant of an Option, which is more fully described in Section 6 hereof. "Stockholders" mean the holders of Stock from time to time outstanding. "Shareholders Agreement" shall mean the Shareholders Agreement dated as of June 12, 1996 among the Company and its shareholders, which agreement restricts the transferability of the Stock as well as affords certain rights and imposes certain obligations on the holders thereof. Section 3. Administration. (a) The Plan shall be administered by the Board of Directors or a committee appointed by the Board of Directors (the "Option Committee"). The Option Committee shall be composed of three members of the Board of Directors and shall be appointed by the Board of Directors. Every member of the Option Committee shall be a "disinterested person" within the meaning of Rule 16b-3 of the Securities Exchange Act of 1934. (b) Except as provided in the last sentence of this subparagraph (b), all determinations under the Plan shall be made by a majority of the Option Committee or the Board of Directors at a duly convened meeting where at least a quorum is present (including by telephone contact). Any decision or determination reduced to writing and signed by all of the members of the Option Committee or the Board of Directors shall be fully effective as if it had been made by a majority vote at a meeting duly called and convened. (c) Except to the extent otherwise provided in the Plan, the Option Committee or the Board of Directors shall have the authority to interpret the Plan, to prescribe, amend and rescind rules regarding it, and to make all other determinations necessary or advisable for the administration of the Plan. Any determination made pursuant to this provision shall be final. (d) Notwithstanding anything herein to the contrary, no member of the Option Committee or the Board of Directors shall be liable for any good faith determination, action, or failure to act in connection with the Plan or any grant hereunder. -3- 4 Section 4. Eligibility. Options may be granted to any employee (including an employee who is also an officer or a member of the Board of Directors) of the Company. Optionees shall be selected by the Option Committee or the Board of Directors. Section 5. Common Stock Subject to Option. The Stock subject to an Option shall be authorized but unissued shares of Common Stock. Options shall not be issued with respect to more than Twelve Thousand Three Hundred Four (12,304) shares of Common Stock, subject, however, to adjustment as provided in Section 6(h)(i) hereof. Section 6. Terms and Conditions of Options. Each Option granted pursuant to this Plan shall be authorized by the Option Committee or the Board of Directors and shall be evidenced and governed by a Stock Option Agreement in such form as the Option Committee or the Board of Directors may from time to time determine. Each Stock Option Agreement shall include the information required in subsections (a) through (f), (g)(i) and (h)(ii) of this Section 6, may include information contained in other subsections of this Section 6, and shall otherwise be in conformity with and shall incorporate by reference the other terms and conditions of the Plan. (a) Number of Shares. The number of shares of Common Stock subject to the Option shall be stated in the Stock Option Agreement. (b) Option Price. The price per share of Common Stock payable on the exercise of the Option shall be stated in the Stock Option Agreement. In the case of the grant of an incentive stock option, the exercise price shall not be less than the fair market value of the stock at the time such Option is granted; except that, in the event an Option is granted to a person who is a "10-percent shareholder" within the meaning of Section 422 of the Code, the Option price shall not be less than one hundred ten percent (110%) of the fair market value of the Common Stock subject to the Option at the time such Option is granted. The fair market value of Common Stock of the Company shall be determined in good faith by the Option Committee or the Board of Directors. (c) Form of Option. The Stock Option Agreement shall state whether the Option granted is an incentive stock option or a non-qualified stock option. -4- 5 (d) Vesting. The Options granted shall mature and become exercisable in whole or in part in accordance with a vesting schedule set forth in the Stock Option Agreement. Notwithstanding the above, and subject to such vesting conditions as may be set forth in the Stock Option Agreement, in the event of a Sale of the Company or a Change in Control, all Options which have not yet vested shall vest, mature and become exercisable in whole or in part immediately prior to the event constituting the Sale of the Company or Change of Control, provided that such accelerated vesting shall occur sufficiently prior to any such event so as to allow Optionee to exercise any rights he may have in respect of such Options and the stock obtainable upon exercise thereof which rights arise by reason of such event. Furthermore, each Option shall vest, mature and become exercisable eight (8) years from the date it was granted, if such Option has not already become vested or been terminated or forfeited prior to that date. (e) Payment. The price payable on the exercise of the Option in whole or in part shall be equal to the purchase price per Share (provided pursuant to clause (b) above) multiplied by the number of shares as to which the Option is exercised, and shall be paid in full upon exercise of any Option in cash, by check or by delivery to the Company of shares of the Company's Stock having a fair market value equal to the aggregate exercise price of the shares of Common Stock being purchased upon exercise of the Option; provided that shares of Common Stock acquired upon exercise of incentive stock Options may not be so used without the express written consent of the Board of Directors (or Option Committee) and this Optionee if to do so would violate the holding period requirements for such Stock under Section 422 of the Code. (f) Term and Exercise of Options. (i) Options granted hereunder shall be exercisable at such times as the Option Committee or the Board of Directors shall designate in accordance with the terms and provisions of this Plan, such designation to be reflected in the Option Agreement. (ii) An Option shall be exercisable by written notice which shall state the number of shares of Common Stock in respect of which the Option is being exercised. Such notice shall be addressed to the Secretary of the Company and shall be accompanied by a check for the aggregate amount of the exercise price payable to the Company. An Option shall be treated as exercised on the date that proper notice of exercise accompanied by the aggregate exercise price is received by the Company. -5- 6 (g) Termination of Options. (i) Except as otherwise provided in Subsection 6(g)(ii) of this Plan, Options granted hereunder shall terminate at such time as the Option Committee or the Board of Directors shall designate, such designation to be reflected in the Stock Option Agreement; provided, however, that if a Stock Option Agreement does not specify the time at which an Option will terminate, such Option shall terminate three (3) months following the date as of which the Optionee ceases to be employed by the Company for reasons other than the Optionee's death or becoming Disabled. (ii) Upon the death of an Optionee while in the employ of the Company, or if an Optionee becomes Disabled while in the employ of the Company, Options held by such Optionee shall terminate on the date that is twelve (12) months after the date the Optionee dies or becomes Disabled; provided, however, that an Optionee of incentive stock options shall be considered to be Disabled for purposes of this sentence only if he is Disabled within the meaning of Section 22(e)(3) of the Code. If an Optionee of incentive stock options is Disabled within the meaning of this Plan, but not within the meaning of Section 22(e)(3), the incentive stock options held by such Optionee shall terminate three (3) months after the Optionee is terminated from his employment by reason of having become Disabled. Options which are exercisable on the date the Optionee dies or becomes Disabled shall be exercisable by the Optionee, his or her executor(s) or administrator(s) or legal representative for a period of twelve (12) months (in the event of death) or three (3) months (in the event of disability) from the date such Optionee dies or becomes Disabled, subject to the Optionee's, executor's or administrator's obligation to sell the Common Stock acquired upon such exercise to the Company pursuant to the terms of the Shareholders Agreement. (h) Anti-Dilution Adjustments to Aggregate Number. (i) Subject to required action by the stockholders, if any, the number of Shares as to which Options may be awarded under this Plan and the number of Shares subject to outstanding Options and the option prices thereof shall be adjusted proportionately for any increase or decrease in the number of outstanding shares of Common Stock of the Company resulting from stock splits, reverse stock splits, stock dividends, reclassifications and recapitalizations. (ii) The Aggregate Number shall be subject to any anti-dilution protection adjustments set forth in the Stock Option Agreement. (i) Other Terms. Notwithstanding any other provision of this Plan: -6- 7 (i) No Option shall be granted under this Plan after ten (10) years after the date the Plan is adopted. (ii) No Option granted under this Plan shall be exercisable after ten (10) years from the date it is granted. (iii) No Option granted under this Plan that is an incentive stock option shall be exercisable later than five (5) years from the date it is granted if the Optionee thereof is a "10-percent shareholder" within the meaning of Section 422 of the Code. (iv) No Option granted to any Optionee shall be treated as an incentive stock option to the extent such Option would cause the aggregate fair market value (determined as of the date of grant of each such Option) of the shares of Common Stock with respect to which incentive stock options are exercisable by such Optionee for the first time during any calendar year to exceed one hundred thousand dollars ($100,000). For purposes of determining whether an incentive stock option would cause the aggregate fair market value of the shares to exceed the one hundred thousand dollars ($100,000) limitation, such incentive stock options shall be taken into account in the order granted. For purposes of this subsection (iv), incentive stock options include all incentive stock options granted to Optionees under this Plan and all other plans of the Company. (v) Options granted pursuant to this Plan may be exercised in any order elected by the Optionee whether or not the Optionee holds any unexercised Options under this Plan or any other plan of the Company. (j) Rights as a Stockholder. The Optionee shall have no rights as a Stockholder with respect to any shares of Common Stock subject to an Option until such Option has been exercised and a certificate evidencing the shares purchased upon exercise has been issued to him and the condition of Section 6(m) hereof are satisfied. (k) Modification, Extension and Renewal of Option. Subject to the terms and conditions of this Plan, the Board of Directors may modify, extend or renew an Option, or accept the surrender of an unexercised Option, provided that no incentive stock option may be modified, extended, or renewed if such action would cause it to cease to be an incentive stock option. Notwithstanding the foregoing, no modification of an Option shall be made to the extent it adversely affects the Optionee without such Optionee's consent. (l) Purchase for Investment. The issuance of shares of Common Stock on exercise of an Option shall (i) be conditioned on obtaining appropriate representations and warranties of the Optionee that the purchase of shares thereunder will be for investment, and not with a view to the public resale -7- 8 or distribution thereof, unless the shares subject to the Option are registered under the Securities Act of 1933, as amended (the "Act"), and (ii) comply with any other law, regulation or rule applicable thereto. Unless the shares subject to the Option are registered under the Act, the Optionee shall acknowledge that the shares purchased on exercise of the Option are not registered under the Act and may not be sold or otherwise transferred unless the shares have been registered under the Act, or unless counsel satisfactory to the Company provides a written opinion that the sale or other transfer is exempt from registration under the Act, and is in compliance with any other applicable law, including all applicable state securities laws. Certificates evidencing shares of Common Stock purchased upon exercise of Options shall contain a legend in substantially the following form: THE SHARES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY APPLICABLE STATE SECURITIES LAWS. THESE SHARES HAVE NOT BEEN ACQUIRED WITH A VIEW TO DISTRIBUTION OR RESALE AND MAY NOT BE SOLD, ASSIGNED, EXCHANGED, MORTGAGED, PLEDGED, HYPOTHECATED OR OTHERWISE TRANSFERRED OR DISPOSED OF, BY GIFT OR OTHERWISE, OR IN ANY WAY ENCUMBERED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT FOR SUCH SHARES UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND ANY APPLICABLE STATE LAWS, OR A SATISFACTORY OPINION OF COUNSEL SATISFACTORY TO KIRKLAND'S, INC. THAT REGISTRATION IS NOT REQUIRED UNDER SUCH ACT AND UNDER APPLICABLE STATE LAWS. MOREOVER, THE SHARES EVIDENCED BY THIS CERTIFICATE ARE SUBJECT TO AND RESTRICTED BY THE PROVISIONS OF THE SHAREHOLDERS AGREEMENT DATED JUNE 12, 1996, COPIES OF WHICH WILL BE FURNISHED BY KIRKLAND'S, INC. UPON WRITTEN REQUEST AND WITHOUT CHARGE, AND ALL OF THE PROVISIONS OF WHICH ARE INCORPORATED BY REFERENCE IN THIS CERTIFICATE. (m) Stockholders Agreement. Notwithstanding any other provision of this Plan, the Company shall not issue any shares of Common Stock upon the exercise of an Option unless the Optionee executes (i) a counterpart to the Shareholders Agreement, and (ii) a counterpart to the Registration Rights Agreement, in each case among the Company, its stockholders and holders of warrants. Section 7. No Right to Employment. No individual shall have the right to continue in the employment of the Company by reason of the grant of any Option under this Plan. An Optionee whose employment is terminated -8- 9 shall have no rights against the Company by reason of the termination of such Option. Section 8. Term of Plan. Options may be granted from time to time within a period of ten (10) years after the date the Plan is effective. Section 9. No Obligation to Exercise Option. The granting of an Option does not impose any obligation upon the Optionee to exercise such Option. Section 10. Amendment of the Plan. Insofar as permitted by law and the Plan, the Board of Directors may from time to time suspend or discontinue the Plan or revise or amend it in any respect whatsoever; provided, however, that no such suspension, discontinuance, revision or amendment that would constitute a diminution in rights with respect to any Option then outstanding may be accomplished without the consent of the Optionee; and provided further, that no suspension, discontinuance, revision or amendment may change the aggregate number of shares for which Options may be granted, change the designation of the class of individuals eligible to receive Options or decrease the price at which Options may be granted without the approval of the Stockholders. Section 11. Approval of Stockholders. This Plan shall become effective on the date that it is adopted by the Board of Directors; provided, however, that the Plan and all Options and Stock Option Agreements granted under the Plan shall become null and void, ab initio, if the Plan is not approved by a majority of the holders of the Company's outstanding Common Stock within one year (365 days) of its adoption by the Board of Directors. Section 12. Forfeiture. Notwithstanding any other provision of this Plan, if the Board of Directors makes a finding, after full consideration of the facts presented on behalf of both the Company and the Optionee, that the Optionee (i) has engaged in conduct involving any type of disloyalty to the Company or willful misconduct with respect to the Company, including without limitation, fraud, embezzlement, theft, or proven dishonesty in the course of his employment, (ii) has been convicted of a felony, or (iii) has disclosed, without the prior written consent of the Company, to any third party or used for his benefit, or for any purpose other than the exclusive benefit of the Company, any confidential, proprietary, business and technical information or trade secrets of the Company or of any subsidiary or Affiliate of the Company, which is revealed, obtained or developed in the course of -9- 10 Optionee's employment with the Company, then all unexercised Options shall terminate on the date of such finding. In the event of such a finding, in addition to immediate termination of all unexercised Options, the Optionee shall forfeit all Option shares for which the Company has not yet delivered share certificates to the Optionee and the Company shall refund to the Optionee the purchase price therefor paid to it upon exercise of the Option, if any. Notwithstanding anything herein to the contrary, the Company may withhold delivery of share certificates pending the resolution of any inquiry that could lead to a finding resulting in forfeiture. Section 13. Transferability. No Option shall be assignable or transferable otherwise than by will or by the laws of descent and distribution. During the lifetime of the Optionee, his Options shall be exercisable only by him, or, in the event such Optionee is Disabled, by his legal representative. Section 14. Application of Funds. The proceeds received by the Company from the sale of shares pursuant to the exercise of Options shall be used for general corporate purposes. Section 15. Withholding. Anything to the contrary herein notwithstanding, all payments required to be made or Stock required to be issued by the Company hereunder to an Optionee, his legal representative, heir or devisee shall be subject to the withholding of such amounts as the Company may determine that it is required to withhold pursuant to any applicable federal, state or local law or regulation. Optionee may, at his option, pay to Company cash in the amount of such withholding in lieu of shares being withheld upon Optionee's exercise to pay such withholding. -10- EX-10.10 17 1998 INCENTIVE PLAN 1 EXHIBIT 10.10 KIRKLAND'S, INC. 1998 INCENTIVE PLAN SECTION 1. PURPOSE; DEFINITIONS. The purpose of the Kirkland's, Inc. 1998 Incentive Plan (the "Plan") is to offer to certain employees, consultants and Directors of Kirkland's, Inc. (the "Company"), a Tennessee corporation, and its subsidiaries, equity interests in the Company, options to acquire equity interests in the Company, and other performance-based incentive awards, thereby attracting, retaining and motivating such persons, and strengthening the mutuality of interests between such persons and the Company's shareholders. For purposes of the Plan, the following initially capitalized words and phrases shall be defined as set forth below, unless the context clearly requires a different meaning: a. "Affiliate" means, with respect to a person or entity, a person that directly or indirectly controls, or is controlled by, or is under common control with such person or entity. b. "Award" means a grant of Options, SARs or Restricted Shares to an employee, consultant or Director of the Company or a Subsidiary pursuant to the provisions of this Plan. c. "Board" means the Board of Directors of the Company, as constituted from time to time; provided, however, that if the Board appoints a Committee to perform some or all of the Board's administrative functions hereunder pursuant to Section 2, references in this Plan to the "Board" will be deemed to also refer to that Committee in connection with administrative matters to be performed by that Committee. d. "Cause" exists when the Participant (as determined by the Board, (in its sole discretion): (i) engages in any type of disloyalty to the Company, including without limitation, fraud, embezzlement, theft, or dishonesty in the course of his employment or engagement, or otherwise breaches any fiduciary duty owed to the Company; (ii) is convicted of a felony or a misdemeanor involving moral turpitude; (iii) enters a plea of guilty or nolo contendere to a felony or a misdemeanor involving moral turpitude. (iv) discloses any Proprietary Information without the consent of the Company; or (iv) breaches any agreement with or duty to the Company regarding confidentiality, non-disclosure, non-competition or otherwise. 2 e. "Code" means the Internal Revenue Code of 1986, as amended from time to time, and any successor thereto. f. "Committee" shall mean a committee appointed by the Board in accordance with Section 2 of this Plan. g. "Director" means a member of the Board. h. "Disability" shall mean a disability which renders individual unable to perform the full extent of his duties and responsibilities to the Company or its subsidiaries by reason of his illness or incapacity which would entitle that employee or Director to receive Social Security Disability Income under the Social Security Act, as amended, and the regulations promulgated thereunder. "Disabled" shall mean having a Disability. The determination of whether a Participant is Disabled shall be made by the Board, whose determination shall be conclusive; provided that, if a Participant is bound by the terms of an employment or consulting agreement between the Participant and the Company, whether the Participant is "Disabled" for purposes of the Plan shall be determined in accordance with the procedures set forth in said employment agreement, if such procedures are therein provided. i. "Exchange Act" means the Securities Exchange Act of 1934, as amended. j. "Fair Market Value" means, as of any date: (i) the closing price of the Shares as reported on the principal nationally recognized stock exchange on which the Shares are traded on such date, or if no Share prices are reported on such date, the closing price of the Shares on the next preceding date on which there were reported Share prices; or (ii) if the Shares are not listed or admitted to unlisted trading privileges on a nationally recognized stock exchange, the closing price of the Shares as reported by The Nasdaq Stock Market on such date, or if no Share prices are reported on such date, the closing price of the Shares on the next preceding date on which there were reported Share prices; or (3) if the Shares are not listed or admitted to unlisted trading privileges on a nationally recognized stock exchange or traded on The Nasdaq Stock Market, then the Fair Market Value shall be determined by the Board acting in its discretion, which determination shall be conclusive. k. "Incentive Stock Option" means any Option intended to be and designated as an "Incentive Stock Option" within the meaning of Section 422 of the Code. l. "Non-Qualified Stock Option" means any Option that is not an Incentive Stock Option. m. "Participant" means an employee, consultant or Director of the Company or a Subsidiary to whom an award is granted pursuant to the Plan. n. "Proprietary Information" shall mean any and all confidential, proprietary, business and technical information or trade secrets of the Company or of any Subsidiary or affiliate of the Company revealed, obtained or developed in the course of Participant's employment with or engagement by the Company. Such Proprietary Information shall include - 2 - 3 but shall not be limited to, methods of production and manufacture, research, marketing and development plans and efforts, cost information, pricing information, marketing methods and plans, identities of customers and suppliers, the Company's relationship with actual or potential customers and the needs and requirements of any such actual or potential customers, and any other confidential information relating to the business of the Company. Proprietary Information shall not include (i) such information as may be necessary or appropriate for an Participant to disclose in the course of his employment or engagement for the effective and efficient discharge of his duties to the Company or as may be required by law to be disclosed; and (ii) such information as is readily available to the general public, so long as such information did not become available to the general public as a direct or indirect result of Participant's breach of his obligation to maintain confidentiality. o. "Qualified Retirement" means a Retirement that occurs (i) on or after the date the Participant attains ages 62 or (ii) on or after the date the Participant completes ten (10) years of service with the Company or a Subsidiary and attains age 60. p. "Restricted Shares" means Shares that are subject to restrictions pursuant to Section 8 hereof. q. "Retirement" means termination of the employment of a Participant with the Company or Subsidiary other than (i) a termination effected by or at the direction of the Company or Subsidiary (whether or not the Company effects such termination for Cause), (ii) termination on account of Disability, or (iii) termination on account of death. With respect to a Director who is not also an employee of the Company, Retirement shall occur at such time as the individual ceases to be a Director. Retirement will not be deemed to occur with respect to a consultant. r. "SAR" means a share appreciation right granted under the Plan and described in Section 6 hereof. s. "Share" means a common share of common stock, no par value, of the Company, subject to substitution or adjustment as provided in Section 3(c) hereof. t. "Stock Option" or "Option" means any option to purchase Shares (including Restricted Shares, if the Committee so determines) granted pursuant to Section 5 hereof. u. "Subsidiary" means, in respect of the Company, a subsidiary company, whether now or hereafter existing, as defined in Sections 424(f) and (g) of the Code. SECTION 2. ADMINISTRATION. The Plan shall be administered by the Board; provided, however, that the Board may at any time appoint a Committee to perform some or all of the Board's administrative functions hereunder; and provided further, that the authority of any Committee appointed pursuant to this Section 2 will be subject to such terms and conditions as the Board may prescribe and will be coextensive with, and not in lieu of, the authority of the Board hereunder. - 3 - 4 Any Committee established under this Section 2 will be composed of not fewer than two members, each of whom will serve for such period of time as the Board determines. From time to time the Board may increase the size of the Committee and appoint additional members thereto, remove members (with or without cause) and appoint new members in substitution therefor, fill vacancies however caused, or remove all members of the Committee and thereafter directly administer the Plan. Members of the Board or the Committee who are eligible for Awards or have received Awards may vote on any matters affecting the administration of the Plan or the grant of Awards, except that no such member shall act upon the grant of an Award to himself or herself, but any such member may be counted in determining the existence of a quorum at any meeting of the Board or Committee during which action is taken with respect to the grant of Awards to himself or herself. The Board shall have full authority to grant Awards under this Plan. In particular, the Board shall have the authority: a. to select the persons to whom Awards may from time to time be granted hereunder (consistent with the eligibility conditions set forth in Section 4); b. to determine whether and to what extent Incentive Stock Options, Non-Qualified Stock Options, SARs and Restricted Shares, or any combination thereof, are to be granted hereunder; c. to determine the number of Shares, if any, to be covered by each such Award; d. to determine the terms and conditions, not inconsistent with the terms of the Plan, of any Award, including, but not limited to, the exercise price, any restriction or limitation, any vesting provisions, or any vesting acceleration or forfeiture waiver regarding any Option or other Award and/or the Shares relating thereto, or the length of the period following termination of employment of any Participant during which any Option or SAR may be exercised (which, in the case of an Incentive Stock Option, shall be no longer than one year in the case of the termination of employment of a Participant by reason of death or Disability, or three months in the case of the termination of employment of a Participant for any reason other than death or Disability), based on such factors as the Board shall determine, in its sole discretion; e. to determine whether and under what circumstances an Option may be exercised without a payment of cash under Section 5(f); and f. to determine whether, to what extent and under what circumstances Shares and other amounts payable with respect to an Award may be deferred either automatically or at the election of the Participant. - 4 - 5 The Board shall have the authority to adopt, alter and repeal such administrative rules, guidelines and practices governing the Plan as it shall, from time to time, deem advisable; to interpret the terms and provisions of the Plan and any award issued under the Plan (and any agreements relating thereto); to amend the terms of any agreement relating to any Award, provided that the Participant consents to such amendment; and to otherwise supervise the administration of the Plan. The Board may correct any defect, supply any omission or reconcile any inconsistency in the Plan or in any Award in the manner and to the extent it shall deem necessary to carry out the intent of the Plan. All decisions made by the Board pursuant to the provisions of the Plan shall be final and binding on all persons, including the Company and Participants. No member of the Board shall be liable for any good faith determination, act or omission in connection with the Plan or any Award. SECTION 3. SHARES SUBJECT TO THE PLAN. a. Shares Subject to the Plan. The Shares to be subject or related to awards under the Plan shall be authorized and unissued Shares of the Company, whether or not previously issued and subsequently acquired by the Company. The maximum number of Shares that may be the subject of awards under the Plan is 8,000 and the Company shall reserve for the purposes of the Plan, out of its authorized and unissued Shares, such number of Shares. Notwithstanding the foregoing, no individual shall receive, over the term of the Plan, awards for more than an aggregate of 2,667 Shares, or SARs with respect to such Shares, authorized for grant under the Plan. b. Effect of the Expiration or Termination of Awards. If and to the extent that an Award expires, terminates or is canceled or forfeited for any reason without having been exercised in full, the Shares associated with the expired, terminated, canceled or forfeited portion of the Award shall again become available for grant under the Plan. c. Other Adjustment. In the event of any merger, reorganization, consolidation, recapitalization, Share distribution or dividend, Share split or combination, or other change in entity structure affecting the Shares, substitutions or adjustments may be made to the aggregate number, type and issuer of the securities reserved for issuance under the Plan, in the number and exercise price of securities subject to outstanding Options granted under the Plan and in the number and price of securities subject to other Awards made under the Plan, as may be determined to be appropriate by the Board, in its sole discretion. The Board, in its sole discretion, may also make appropriate anti-dilution adjustments to the number of then-outstanding SARs, and to the Fair Market Value upon which the value of such SARs is based. d. Change Control. In addition, upon or in anticipation of any change of control of the Company (as determined by the Board), the Board, in its sole and absolute - 5 - 6 discretion and without the need for consent of any Participant (and contingent upon the occurrence of the change of control, if the change of control has not yet occurred), may take other action with respect to outstanding Awards, including, but not limited to: (i) acceleration of the vesting of Options and SARs and the expiration date of Options and SARs, (ii) cancellation of Options in exchange for options to purchase common stock in a successor corporation, (iii) cancellation of Restricted Shares in exchange for restricted shares of the common stock of any successor corporation, or (iv) cancellation of Options in conjunction with causing the Company to distribute cash and/or other property in an amount equal to and in the same form as would have been received from a successor corporation by an Option holder if that Option holder would have owned the Shares subject to the Option (rather than the Option) at the time of the change of control, provided that any such amount paid to an Participant shall be net of the exercise price the Participant would have paid to exercise such Options. SECTION 4. ELIGIBILITY. Employees, directors, consultants, and other individuals who provide services to the Company or its Subsidiaries are eligible to be granted awards under the Plan; provided, however, that any employee who is covered by a collective bargaining agreement shall not be eligible to be granted Awards, exercise outstanding Awards, receive shares or cash pursuant to outstanding Awards, or have any restrictions lapse with respect to any restricted stock Awards under the Plan, unless such collective bargaining agreement, by specific reference to the Plan, expressly provides for participation in the Plan. Persons who are not employees of the Company or a Subsidiary are eligible to be granted Awards, but are not eligible to be granted Incentive Stock Options. SECTION 5. OPTIONS. Options granted under the Plan may be of two types: (i) Incentive Stock Options or (ii) Non-Qualified Stock Options. Options may be granted alone, in addition to or in tandem with other Awards. Any Option granted under the Plan shall be in such form as the Board may from time to time approve. The Board shall have the authority to grant any Participant eligible under Section 4 Incentive Stock Options, Non-Qualified Stock Options, or both types of Options (in each case with or without SARs). To the extent that any Option does not qualify as an Incentive Stock Option, it shall constitute a separate Non-Qualified Stock Option. Options granted under the Plan shall be subject to the following terms and conditions and shall contain such additional terms and conditions, not inconsistent with the terms of the Plan, as the Board shall deem appropriate; provided, however, that the provisions of Option Awards need to be the same with respect to each Participant: a. Option Price. The exercise price per Share purchasable under a Non-Qualified Stock Option shall be determined by the Board. The exercise price per Share purchasable under an Incentive Stock Option shall be 100% of the Fair Market Value of the Share on the date of the grant. However, any Incentive Stock Option granted to any Participant who, at the time the Option is granted, owns more than 10% of the voting power of all classes of shares of the Company or of a Subsidiary shall have an exercise price per Share of not less than 110% of Fair Market Value per Share on the date of the grant. - 6 - 7 b. Option Term. The term of each Option shall be fixed by the Board, but no Option shall be exercisable more than ten years after the date the Option is granted. However, any Incentive Stock Option granted to any Participant who, at the time such Option is granted, owns more than 10% of the voting power of all classes of shares of the Company or of a Subsidiary may not have a term of more than five years. No Option may be exercised by any person after expiration of the term of the Option. c. Exercisability. Options shall vest and be exercisable at such time or times and subject to such terms and conditions as shall be determined by the Board at the time of grant. If the Board provides, in its discretion, that any Option is exercisable only in installments, the Board may waive such installment exercise provisions at any time at or after grant, in whole or in part, based on such factors as the Board shall determine, in its sole discretion. d. Method of Exercise. Subject to the exercise provisions under Section 5(c) and the termination provisions set forth in Section 7, Options may be exercised in whole or in part at any time and from time to time during the term of the Option, by giving written notice of exercise to the Company specifying the number of Shares to be purchased. Such notice shall be accompanied by payment in full of the purchase price, either by certified or bank check, or such other instrument as the Board may accept. As determined by the Board, in its sole discretion, at or after grant, payment in full or in part of the exercise price of an Option may be made in the form of unrestricted Shares based on the Fair Market Value of the Shares on the date the Option is exercised; provided, however, that, in the case of an Incentive Stock Option, the right to make a payment in the form of already owned Shares may be authorized only at the time the Option is granted. No Shares shall be issued upon exercise of an Option until full payment therefor has been made. A Participant shall not have the right to distributions or dividends or any other rights of a shareholder with respect to Shares subject to the Option until the Participant has given written notice of exercise, has paid in full for such Shares, and, if requested, has given the representation described in Section 11(a) hereof. e. Incentive Stock Option Limitations. To the extent required for "incentive stock option" status under Section 422 of the Code, the aggregate Fair Market Value (determined as of the time of grant) of the Shares with respect to which Incentive Stock Options are exercisable for the first time by the Participant during any calendar year under the Plan and/or any other plan of the Company or any Subsidiary shall not exceed $100,000. For purposes of applying the foregoing limitation, Incentive Stock Options shall be taken into account in the order granted. Any Option not meeting such limitation shall be treated for all purposes as a Non-Qualified Stock Option. f. Cashless Exercise. The Company may, in the sole discretion of the Board, cooperate in a "cashless exercise" of an Option. The cashless exercise shall be effected by the Participant delivering to a registered securities broker instructions to sell a sufficient number of Shares to cover the costs and expenses associated therewith. - 7 - 8 SECTION 6. SHARE APPRECIATION RIGHTS. a. Grant. SARs may be granted alone ("Stand-Alone SARs") or in conjunction with all or part of any Option granted under the Plan ("Tandem SARs"). In the case of a Non-Qualified Stock Option, a Tandem SAR may be granted either at or after the time of the grant of such Option. In the case of an Incentive Stock Option, a Tandem SAR may be granted only at the time of the grant of such Option. b. Exercise. (i) Tandem SARs. A Tandem SAR or applicable portion thereof shall terminate and no longer be exercisable upon the termination or exercise of the related Option or portion thereof, except that, unless otherwise determined by the Board, in its sole discretion at the time of grant, a Tandem SAR granted with respect to less than the full number of Shares covered by a related Option shall be reduced only after such related Option is exercised or otherwise terminated with respect to the number of Shares not covered by the Tandem SAR. A Tandem SAR may be exercised by a Participant by surrendering the applicable portion of the related Option, only at such time or times and to the extent that the Option to which such Tandem SAR relates shall be exercisable in accordance with the provisions of Section 5 and this Section 6. Options which have been so surrendered, in whole or in part, shall no longer be exercisable to the extent the related Tandem SARs have been exercised. Upon the exercise of a Tandem SAR, a Participant shall be entitled to receive, upon surrender to the Company of all (or a portion) of an Option in exchange for cash and/or Shares, an amount equal to the excess of (A) the Fair Market Value, as of the date such Option (or such portion thereof) is surrendered, of the Shares covered by such Option (or such portion thereof) over (B) the aggregate exercise price of such Option (or such portion thereof). Upon the exercise of a Tandem SAR, the Option or part thereof to which such Tandem SAR is related, shall be deemed to have been exercised for the purpose of the limitation set forth in Section 3 of the Plan on the number of Shares to be issued under the Plan, but only to the extent of the number of Shares issued under the Tandem SAR at the time of exercise based on the value of the Tandem SAR at such time. A Tandem SAR may be exercised only if and when the Fair Market Value of the Shares subject to the Option exceeds the exercise price of such Option. (ii) Stand-Alone SARs. A Stand-Alone SAR may be exercised by a Participant giving notice of intent to exercise to the Company, provided that all or a portion of such Stand-Alone SAR shall have become vested and exercisable as of the date of exercise. Upon the exercise of a Stand-Alone SAR, a Participant shall be entitled to receive, in either cash and/or Shares, an amount equal to the excess, if any, of (A) the Fair Market Value, as of the date such SAR (or portion of such SAR) is exercised, of the Shares covered by such SAR (or portion of such SAR) over (B) the Fair Market Value of the Shares covered by - 8 - 9 such SAR (or a portion of such SAR) as of the date such SAR (or a portion of such SAR) was granted. c. Terms and Conditions. SARs shall be subject to such terms and conditions, not inconsistent with the provisions of the Plan, as shall be determined from time to time by the Board, in its sole discretion; provided, however, that the provisions of SAR awards need not be the same with respect to each Participant. Such terms and conditions include the following: (i) Term of SAR. The term of each SAR shall be fixed by the Board, provided that the term of a Tandem SAR shall be determined by the terms of the applicable Option, and provided further that the term of a Stand-Alone SAR shall be ten (10) years, unless another term is specified by the Board. (ii) Exercisability. SARs shall vest and be exercisable at such time or times and subject to such terms and conditions as shall be determined by the Board at the time of grant, provided that the term of a Tandem SAR shall be determined by the terms of the applicable Option. A Participant shall not have any rights as a shareholder with respect to any SAR. (iii) Termination of Employment. Unless otherwise specified in the terms of an Award, SARs shall be subject to the terms of Section 7 with respect to exercise upon termination of employment. SECTION 7. TERMINATION OF SERVICE. Unless otherwise specified with respect to a particular Award, Options or SARs granted hereunder will remain exercisable after termination of employment only to the extent specified in this Section 7. a. Termination by Reason of Death. If a Participant's service with the Company or any Subsidiary terminates by reason of death, any Option or SAR held by such Participant may thereafter be exercised, to the extent then exercisable or on such accelerated basis as the Board may determine, at or after grant, by the legal representative of the estate or by the legatee of the Participant under the will of the Participant, for a period expiring (i) at such time as may be specified by the Board at or after the time of grant, or (ii) if not specified by the Board, then one (1) year from the date of death, or (iii) if sooner than the applicable period specified under (i) or (ii) above, then upon the expiration of the stated term of such Option or SAR. b. Termination by Reason of Disability. If a Participant's service with the Company or any Subsidiary terminates by reason of Disability, any Option or SAR held by such Participant may thereafter be exercised by the Participant or his personal representative, to the extent it was exercisable at the time of termination, or on such accelerated basis as the Board may determine at or after grant, for a period expiring (i) at such time as may be specified by the Board at or after the time of grant, or (ii) if not specified by the Board, then six months from the date of termination of service, or (iii) if sooner than the applicable period specified under (i) or (ii) above, then upon the expiration of the stated term of such Option or SAR; provided, however, that if the Participant dies within such period, any unexercised Option or SAR held by such - 9 - 10 Participant shall, at the sole discretion of the Board, thereafter be exercisable to the extent to which it was exercisable at the time of death for a period of one (1) year from the date of such death (or such other period as may be specified by the Board) or until the expiration of the stated term of such Option or SAR, whichever period is shorter. c. Qualified Retirement. If a Participant's service with the Company or any Subsidiary terminates by reason of Qualified Retirement, any Option or SAR held by such Participant may thereafter be exercised, to the extent then exercisable or on such accelerated basis as the Board may determine, at or after grant, by the Participant for a period expiring (i) at such time as may be specified by the Board at or after the time of grant, or (ii) if not specified by the Board, then six months from the date of Qualified Retirement, or (iii) if sooner than the applicable period specified under (i) or (ii) above, then upon the expiration of the stated term of such Option or SAR; provided, however, that any Option that, at the time of grant, was intended to be an Incentive Stock Option but which is exercised more than three (3) months after termination of employment will then become a Non-Qualified Stock Option. d. Cause. If a Participant's service is terminated for Cause: (i) any Option or SAR not already exercised shall be immediately and automatically forfeited as of the date of such termination, and (ii) any Shares for which the Company has not yet delivered share certificates shall be immediately and automatically forfeited and the Company shall refund to the Participant the Option exercise price paid for such Shares, if any. e. Other Termination. If a Participant's service with the Company or any Subsidiary terminates for any reason other than death, Disability, Qualified Retirement or Cause, any Option or SAR held by such Participant may thereafter be exercised by the Participant, to the extent it was exercisable at the time of such termination or on such accelerated basis as the Board may determine at or after the time of grant, for a period expiring (i) at such time as may be specified by the Board at or after the time of grant, or (ii) if not specified by the Board, then three (3) months from the date of termination of service, or (iii) if sooner than the applicable period specified under (i) or (ii) above, then upon the expiration of the stated term of such Option or SAR. SECTION 8. RESTRICTED SHARES. a. Issuance. Restricted Shares may be issued either alone or in addition to other awards granted under the Plan. The Board shall determine the time or times within which Restricted Shares may be subject to forfeiture, and all other conditions of such awards. The Board may condition the lapse of restrictions on Restricted Shares upon the continued employment or service or the recipient, the attainment of specified individual or corporate performance goals, or such other factors as the Board may determine, in its sole discretion, at the time of the award. The provisions of Restricted Share awards need not be the same with respect to each Participant. b. Awards and Certificates. The prospective recipient of a Restricted Share award shall not have any rights with respect to such award, unless and until such recipient has executed an agreement evidencing the award and has delivered a fully executed copy thereof to - 10 - 11 the Company, and has otherwise complied with the applicable terms and conditions of such award. The purchase price for Restricted Shares may, but need not, be zero. Each Participant receiving a Restricted Share award shall be issued a share certificate in respect of such Restricted Shares. Such certificate shall be registered in the name of such Participant, and shall bear an appropriate legend referring to the terms, conditions, and restrictions applicable to such award, substantially in the following form: THE TRANSFERABILITY OF THIS CERTIFICATE AND THE SHARES REPRESENTED HEREBY ARE SUBJECT TO THE TERMS AND CONDITIONS (INCLUDING FORFEITURE) OF THE KIRKLAND'S, INC. 1998 INCENTIVE PLAN AND AN AGREEMENT ENTERED INTO BETWEEN THE REGISTERED OWNER AND KIRKLAND'S, INC. COPIES OF SUCH PLAN AND AGREEMENT ARE ON FILE IN THE PRINCIPAL OFFICES OF KIRKLAND'S, INC. AND WILL BE MADE AVAILABLE TO ANY SHAREHOLDER WITHOUT CHARGE UPON REQUEST TO THE SECRETARY OF THE COMPANY. The Board shall require that the share certificates evidencing Restricted Shares be held in custody by the Company until the restrictions thereon shall have lapsed, and that, as a condition of any Restricted Share award, the Participant shall have delivered to the Company a share power, endorsed in blank, relating to the Shares covered by such award. c. Restrictions and Conditions. The Restricted Shares awarded pursuant to this Section 8 shall be subject to the following restrictions and conditions: (i) During a period set by the Board commencing with the date of such award (the "Restriction Period"), the Participant shall not be permitted to sell, transfer, pledge, assign or otherwise encumber Restricted Shares awarded under the Plan. The Board, in its sole discretion, may provide for the lapse of such restrictions in installments and may accelerate or waive such restrictions in whole or in part, based on service, performance and/or such other factors or criteria as the Board may determine, in its sole discretion. (ii) Except as provided in this Paragraph (ii) and Section 8(c)(i), once the Participant has been issued a certificate or certificates for Restricted Shares, the Participant shall have, with respect to the Restricted Shares, all of the rights of a shareholder of the Company, including the right to vote the Shares, and the right to receive any cash distributions or dividends. The Board, in its sole discretion, as determined at the time of award, may permit or require the payment of cash distributions or dividends to be deferred and, if the Board so determines, reinvested in additional Restricted Shares to the extent Shares are available under Section 3 of the Plan. (iii) Subject to the applicable provisions of the award agreement and this Section 8, upon termination of a Participant's service with the Company for reasons other than death or Disability, all Restricted Shares still subject to restriction shall be forfeited by the Participant. Upon the death or Disability of a Participant during the Restriction Period: - 11 - 12 (1) restrictions based on continued employment will lapse with respect to a percentage of the Restricted Shares award granted to the Participant that is equal to the percentage of the Restriction Period that has elapsed as of the date of death or the date on which such Disability commenced (as determined by the Board in its sole discretion), (2) restrictions based on individual or corporate performance will lapse to the extent determined by the Board in its sole discretion, and a share certificate or share certificates representing such Shares, without bearing the restrictive legend described in Section 8(b), shall be delivered by the Company to the Participant or the Participant's estate, as the case may be, in exchange for the share certificate or share certificates that contain such restrictive legend. (iv) In the event of hardship or other special circumstances of a Participant whose service with the Company is involuntarily terminated (other than for Cause), the Board may, in its sole discretion, waive in whole or in part any or all remaining restrictions with respect to such Participant's Restricted Shares, based on such factors as the Board may deem appropriate. (v) If and when the Restriction Period expires without a prior forfeiture of the Restricted Shares subject to such Restriction Period, the certificates for such Shares, without bearing the restrictive legend described in Section 8(b), shall be promptly delivered by the Company to the Participant, in exchange for the share certificate or share certificates that contain such restrictive legend. (vi) In the event of a Change of Control, the Board, in its sole discretion, may cause all Restricted Shares remaining subject to forfeiture to immediately cease to be subject to forfeiture and a share certificate or shares certificates representing such Shares, without bearing the restrictive legend described in Section 8(b), shall be issued by the Company and delivered to the Participant, in exchange for the share certificate or share certificates that contain such restrictive legend. SECTION 9. AMENDMENTS AND TERMINATION. The Board may amend, alter or discontinue the Plan at any time, but, except as otherwise provided in Section 3(d) of the Plan, no amendment, alteration or discontinuation shall be made which would impair the rights of a Participant with respect to an Option, SAR or Restricted Share which has been granted under the Plan, without the Participant's consent, or which, without the approval of such amendment within one year (365 days) of its adoption by the Board, by a majority of the votes cast at a duly held shareholder meeting at which a quorum representing a majority of the Company's outstanding voting shares is present (either in person or by proxy), would: a. except as otherwise provided in the Plan, increase the total number of Shares reserved for the purposes of the Plan; b. change the persons or class of persons eligible to participate in the Plan; or - 12 - 13 c. extend the maximum Option term under Section 5(b) of the Plan. Subject to the above provisions, the Board shall have broad authority to amend the Plan to take into account changes in applicable tax laws and accounting rules, as well as other developments. SECTION 10. UNFUNDED STATUS OF PLAN. The Plan is intended to be "unfunded." With respect to any payments not yet made to a Participant by the Company, nothing contained herein shall give any such Participant any rights that are greater than those of a general creditor of the Company. In its sole discretion, the Board may authorize the creation of grantor trusts or other arrangements to meet the obligations created under the Plan to deliver Shares or payments in lieu of Shares or with respect to awards hereunder. SECTION 11. GENERAL PROVISIONS. a. The Board may require each person acquiring Shares or a Share-based Award under the Plan to represent to and agree with the Company in writing that the Participant is acquiring the Shares or Share-based Award for investment purposes and without a view to distribution thereof and as to such other matters as the Board believes are appropriate to ensure compliance with applicable Federal and state securities laws. The certificate evidencing such Award and any securities issued pursuant thereto may include any legend which the Board deems appropriate to reflect any restrictions on transfer and compliance with securities laws. All certificates for Shares or other securities delivered under the Plan shall be subject to such share-transfer orders and other restrictions as the Board may deem advisable under the rules, regulations, and other requirements of the Securities Act of 1933, as amended, the Exchange Act, any stock exchange upon which the Shares are then listed, and any other applicable Federal or state securities laws, and the Board may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. b. Nothing contained in the Plan shall prevent the Board from adopting other or additional compensation arrangements, subject to shareholder approval if such approval is required; and such arrangements may be either generally applicable or applicable only in specific cases. c. The adoption of the Plan shall not confer upon any employee of the Company or a Subsidiary any right to continued employment with the Company or such Subsidiary, nor shall it interfere in any way with the right of the Company or such Subsidiary to terminate the employment of any of its employees at any time. d. No later than the date as of which an amount first becomes includable in the gross income of the Participant for Federal income tax purposes with respect to any award under the Plan, the Participant shall pay to the Company, or make arrangements satisfactory to the Board regarding the payment, of any Federal, state or local taxes of any kind required by law to be withheld with respect to such amount. Unless otherwise determined by the Board, the minimum required withholding obligations may be settled with Shares, including Shares that are - 13 - 14 part of the award that gives rise to the withholding requirement. The obligations of the Company under the Plan shall be conditional on such payment or arrangements and the Company shall, to the extent permitted by law, have the right to deduct any such taxes from any payment of any kind otherwise due to the Participant. e. The Board shall establish such procedures as it deems appropriate for a Participant to designate a beneficiary to whom any amounts payable in the event of the Participant's death are to be paid. f. Except as may otherwise be specifically determined by the Board with respect to a particular award of Non-Qualified Stock Option, SARs or Restricted Shares, no Award will be transferable by the Participant otherwise than by will or by the laws of descent and distribution, and all awards will be exercisable, during the Participant's lifetime, only by the Participant or, in the event of his Disability, by his personal representative. g. The Plan and all Awards made and actions taken thereunder shall be governed by and construed in accordance with the laws of the State of Tennessee. SECTION 12. EFFECTIVE DATE OF PLAN. This Plan shall become effective on the date that it is adopted by the Board; provided, however, that it shall not be an Incentive Stock Option Plan if it is not approved, within one year (365 days) of its adoption by the Board, by a majority of the votes cast at a duly held shareholder meeting at which a quorum representing a majority of Company's outstanding voting shares is present, either in person or by proxy. The Board may make awards hereunder prior to approval of the Plan; provided, however, that any and all Incentive Stock Options so awarded automatically shall be converted into Non-Qualified Stock Options if the Plan is not approved by shareholders within 365 days of its adoption. SECTION 13. TERM OF PLAN. No Option, SAR or Restricted Share will be granted pursuant to the Plan on or after the tenth (10th) anniversary of the date of shareholder approval of the Plan, but awards granted prior to such tenth (10th) anniversary may extend beyond that date. SECTION 14. INVALID PROVISIONS. In the event that any provision of this Plan is found to be invalid or otherwise unenforceable under any applicable law, such invalidity or unenforceability shall not be construed as rendering any other provisions contained herein as invalid or unenforceable, and all such other provisions shall be given full force and effect to the same extent as though the invalid or unenforceable provision was not contained herein. SECTION 15. GOVERNING LAW. This Plan shall be governed by and construed in accordance with the laws and judicial decisions of the State of Tennessee, without regard to the application of the principles of conflicts of laws. SECTION 16. BOARD ACTION. Notwithstanding anything to the contrary set forth in this Plan, any and all actions of the Board or Committee, as the case may be, taken under or in connection with this Plan and any agreements, instruments, documents, certificates or other writings entered into, executed, granted, issued and/or delivered pursuant to the terms hereof, - 14 - 15 shall be subject to and limited by any and all votes, consents, approvals, waivers or other actions of all or certain stockholders of the Company or other persons required by: (i) the Company's Articles of Incorporation (as the same may be amended and/or restated from time to time); (ii) the Company's Bylaws (as the same may be amended and/or restated from time to time); and (iii) any other agreement, instrument, document or writing now or hereafter existing, between or among the Company and its stockholders or other persons (as the same may be amended from time to time). - 15 - EX-10.11 18 EMPLOYEE STOCK PURCHASE PLAN 1 EXHIBIT 10.11 KIRKLAND'S, INC. EMPLOYEE STOCK PURCHASE PLAN 1. PURPOSE. The Kirkland's, Inc. Employee Stock Purchase Plan (the "Plan") is intended to encourage and facilitate the purchase of Shares of the Common Stock of Kirkland's, Inc. (the "Company"), by employees of the Company and any Participating Companies, thereby providing employees with a personal stake in the Company and a long range inducement to remain in the employ of the Company and Participating Companies. It is the intention of the Company that the Plan qualify as an "employee stock purchase plan" within the meaning of Section 423 of the Code. 2. DEFINITIONS. (a) "Account" means a bookkeeping account established by the Committee on behalf of a Participant to hold Payroll Deductions. (b) "Approved Leave of Absence" means a leave of absence that has been approved by the applicable Participating Company in such a manner as the Board may determine from time to time. (c) "Board" means the Board of Directors of the Company. (d) "Code" means the Internal Revenue Code of 1986, as amended. (e) "Committee" means the Committee appointed pursuant to section 14 of the Plan. (f) "Company" means Kirkland's, Inc. (g) "Compensation" means an Employee's total cash compensation payable for services rendered to a Participating Company during a calendar month. (h) "Election Form" means the form acceptable to the Committee which an Employee shall use to make an election to purchase Shares through Payroll Deductions pursuant to the Plan. (i) "Eligible Employee" means an Employee who meets the requirements for eligibility under section 3 of the Plan. (j) "Employee" means a person who is an employee of a Participating Company. (k) "Five Percent Owner" means an Employee who, with respect to a Participating Company, is described in section 423(b) of the Code. 2 (l) "Offering" means an offering of Shares to Eligible Employees pursuant to the Plan. (m) "Offering Commencement Date" means the first day of each January, April, July and October, beginning on or after adoption of the Plan by the Board, until the Plan Termination Date, provided that the first Offering Commencement Date shall be July 1, 1998, or such later date as may be determined by the Committee. (n) "Offering Period" means the period extending from an Offering Commencement Date through the following Offering Termination Date. (o) "Offering Termination Date" means the last day of each three-month period following an Offering Commencement Date. (p) "Option Price" means ___(1) percent of the average of the high and low sales prices per Share on the principal exchange on which the Shares are listed or, if not so listed, on the Nasdaq National Market, on the Offering Termination Date, or if such date is not a trading day, then on the next trading day thereafter. (q) "Participant" means an Employee who meets the requirements for eligibility under section 3 of the Plan and who has timely delivered an Election Form to the Committee. (r) "Participating Company" means, the Company and subsidiaries of the Company, within the meaning of section 424(f) of the Code, if any, that are approved by the Board from time to time and whose employees are designated as Employees by the Board. (s) "Payroll Deductions" means amounts withheld from a Participant's Compensation pursuant to the Plan, as described in section 5 of the Plan. (t) "Plan" means Kirkland's, Inc. Employee Stock Purchase Plan, as set forth in this document, and as may be amended from time to time. (u) "Plan Termination Date" means the earlier of: (1) The Offering Termination Date for the Offering in which the maximum number of Shares specified in section 5 of the Plan have been issued pursuant to the Plan; or (2) The date as of which the Board chooses to terminate the Plan as provided in section 15 of the Plan. (v) "Shares" means shares of Common Stock of the Company, no par value. - -------------- (1)May be any amount from 85% to 100%. - 2 - 3 (w) "Successor-in-Interest" means the Participant's executor or administrator, or such other person or entity to whom the Participant's rights under the Plan shall have passed by will or the laws of descent and distribution. (x) "Termination Form" means the form acceptable to the Committee which an Employee shall use to withdraw from an Offering pursuant to section 8 of the Plan. 3. ELIGIBILITY AND PARTICIPATION. (a) Initial Eligibility. Except as provided in section 3(b) of the Plan, each Employee shall be eligible to participate in the Plan. (b) Ineligibility. An Employee shall not be eligible to participate in the Plan if such Employee: (1) is a Five Percent Owner; (2) has not been employed by a Participating Company for a period of at least six (6) consecutive months; (3) does not customarily perform work for a Participating Company more than 20 hours per week; or (4) is restricted from participating under section 3(d) of the Plan. (c) Leave of Absence. For purposes of participation in the Plan, an Employee on an Approved Leave of Absence shall be deemed to be an Employee for the first 90 days of such Approved Leave of Absence and such Employee's employment shall be deemed to have terminated for purposes of participation under the Plan at the close of business on the 90th day of such Approved Leave of Absence unless such Employee shall have returned to regular non-temporary employment before the close of business on such 90th day. Termination by the Participating Company of an Employee's Approved Leave of Absence, other than termination or return to non-temporary employment, shall terminate an Employee's employment for all purposes of the Plan and shall terminate such Employee's participation in the Plan and the right to exercise any option. An Approved Leave of Absence shall be considered active employment for purposes of sections 3(b)(2) and 3(b)(3) of the Plan. (d) Restrictions on Participation. Notwithstanding any provisions of the Plan to the contrary, no Employee shall be granted an option to participate in the Plan if: (1) Immediately after the grant, such Employee would be a Five Percent Owner; or - 3 - 4 (2) Such option would permit such Employee's rights to purchase stock under all employee stock purchase plans of the Participating Companies which meet the requirements of section 423(b) of the Code to accrue at a rate which exceeds $25,000 in fair market value (as determined pursuant to section 423(b)(8) of the Code) for each calendar year in which such option is outstanding. (e) Commencement of Participation. An Employee who meets the eligibility requirements of sections 3(a) and 3(b) of the Plan and whose participation is not restricted under section 3(d) of the Plan shall become a Participant by completing an Election Form and filing it with the Committee on or before the 15th day of the month immediately preceding the Offering Commencement Date for the first Offering to which such Election Form applies. Payroll Deductions for a Participant shall commence on the applicable Offering Commencement Date when his or her authorization for Payroll Deductions becomes effective, and shall end on the Plan Termination Date, unless sooner terminated by the Participant pursuant to section 8 of the Plan. 4. SHARES PER OFFERING. The Plan shall be implemented by a series of Offerings that shall terminate on the Plan Termination Date. Offerings shall be made with respect to Compensation payable for each calendar month of the Company's fiscal year for the period commencing with the first day of the initial Offering Commencement Date and ending with the Plan Termination Date. Shares available for any Offering shall be the difference between the maximum number of Shares that may be issued under the Plan, as determined pursuant to section 10(a) of the Plan, for all of the Offerings, less the actual number of Shares purchased by Participants pursuant to prior Offerings. If the total number of Shares for which options are exercised on any Offering Termination Date exceeds the maximum number of Shares available, the Committee shall make a pro rata allocation of Shares available for delivery and distribution in as nearly a uniform manner as practicable, and as it shall determine to be fair and equitable, and the unapplied Account balances shall be returned to Participants as soon as practicable following the Offering Termination Date. 5. PAYROLL DEDUCTIONS. (a) Amount of Payroll Deductions. Each Participant's Election Form shall specify the amount of Payroll Deductions to be made from his or her Compensation on each regular payday during the time that he or she participates in the Plan; provided, however, that the Committee may from time to time establish rules or limitations applicable to the amount of Payroll Deductions that may be made from each Participant's Compensation; and provided further that any rules or limitations established by the Committee under this Section 5 shall be consistent with section 423(b)(5) of the Code. (b) Participants' Accounts. All Payroll Deductions with respect to a Participant pursuant to section 5(a) of the Plan shall be credited to the Participant's Account under the Plan. - 4 - 5 (c) Changes in Payroll Deductions. A Participant may discontinue his participation in the Plan as provided in section 8(a) of the Plan, but no other change can be made during an Offering, including, but not limited to, changes in the amount of Payroll Deductions for such Offering. A Participant may change the amount of Payroll Deductions for subsequent Offerings by giving written notice of such change to the Committee on or before the 15th day of the month immediately preceding the Offering Commencement Date for the Offering for which such change is effective. (d) Leave of Absence. A Participant who goes on an Approved Leave of Absence before the Offering Termination Date after having filed an Election Form with respect to such Offering may: (1) Withdraw the balance credited to his or her Account pursuant to section 8(b) of the Plan; (2) Discontinue contributions to the Plan but remain a Participant in the Plan through the Offering Termination Date; (3) Remain a Participant in the Plan during such Approved Leave of Absence through the Offering Termination Date and continue the authorization for the Participating Company to make Payroll Deductions for each payroll period out of continuing payments to such Participant, if any. 6. GRANTING OF OPTIONS. On each Offering Termination Date, each Participant shall be deemed to have been granted an option to purchase a minimum of one (1) Share and a maximum number of Shares that shall be a number of whole Shares equal to the quotient of: (a) the balance credited to the Participant's Account as of the Offering Termination Date, divided by (b) the Option Price. 7. EXERCISE OF OPTIONS. (a) Automatic Exercise. With respect to each Offering, a Participant's option for the purchase of Shares granted pursuant to section 6 of the Plan shall be deemed to have been exercised automatically on the Offering Termination Date applicable to such Offering. (b) Fractional Shares and Minimum Number of Shares. To the extent that a Participant's Account is not sufficient to acquire whole shares only, fractional Shares shall be credited to the Participant. - 5 - 6 (c) Transferability of Option. No option granted to a Participant pursuant to the Plan shall be transferable other than by will or by the laws of descent and distribution, and no such option shall be exercisable during the Participant's lifetime other than by the Participant. (d) Delivery of Certificates for Shares. The Company shall deliver certificates for Shares acquired on the exercise of options during an Offering Period as soon as practicable following the Offering Termination Date. 8. WITHDRAWALS. (a) Withdrawal of Account. A Participant may elect to withdraw the balance credited to the Participant's Account by providing a Termination Form to the Committee at any time before the Offering Termination Date applicable to any Offering. (b) Amount of Withdrawal. A Participant may withdraw all, but not less than all, of the amounts credited to the Participant's Account by giving a Termination Form to the Committee. All amounts credited to such Participant's Account shall be paid as soon as practicable following the Committee's receipt of the Participant's Termination Form, and no further Payroll Deductions will be made with respect to the Participant. (c) Effect of Withdrawal on Subsequent Participation. A Participant who elects to withdraw from an Offering pursuant to section 8(a) of the Plan shall be deemed to have elected not to participate in each of the four succeeding Offerings following the date on which the Participant gives a Termination Form to the Committee. (d) Termination of Employment. Upon termination of a Participant's employment for any reason other than death, including termination due to disability or continuation of a leave of absence beyond 90 days, all amounts credited to such Participant's Account shall be returned to the Participant. In the event of a Participant's (1) termination of employment due to death or (2) death after termination of employment but before the Participant's Account has been returned, all amounts credited to such Participant's Account shall be returned to the Participant's Successor-in-Interest. (e) Leave of Absence. A Participant who is on an Approved Leave of Absence shall, subject to the Participant's election pursuant to section 5(d) of the Plan, continue to be a Participant in the Plan until the end of the first Offering ending after commencement of such Approved Leave of Absence. A Participant who has been on an Approved Leave of Absence for more than 90 days shall not be eligible to participate in any Offering that begins on or after the commencement of such Approved Leave of Absence so long as such leave of absence continues. - 6 - 7 9. INTEREST. No interest shall be paid or allowed with respect to amounts paid into the Plan or credited to any Participant's Account. 10. SHARES. (a) Maximum Number of Shares. No more than 2,700 Shares may be issued under the Plan. Such Shares may be unissued shares or treasury shares of the Company. The number of Shares available for any Offering and all Offerings shall be adjusted if the number of outstanding Shares of the Company is increased or reduced by split-up, reclassification, stock dividend or other similar event. All Shares issued pursuant to the Plan shall be validly issued, fully paid and nonassessable. (b) Participant's Interest in Shares. A Participant shall have no interest in Shares subject to an option until such option has been exercised. (c) Registration of Shares. Shares to be delivered to a Participant under the Plan shall be registered in the name of the Participant. (d) Restrictions on Exercise. The Board may, in its discretion, require as conditions to the exercise of any option such conditions as it may deem necessary to assure that the exercise of options is in compliance with all applicable laws. 11. EXPENSES. The Participating Companies shall pay all fees and expenses incurred (excluding individual Federal, state, local or other taxes) in connection with the Plan. No charge or deduction for any such expenses will be made to a Participant upon the termination of his or her participation under the Plan or upon the distribution of certificates representing Shares purchased with his or her contributions. 12. TAXES. The Participating Companies shall have the right to withhold from each Participant's Compensation an amount equal to all Federal, state, city or other taxes as the Participating Companies shall determine are required to be withheld by them. In connection with such withholding, the Participating Companies may make any such arrangements as are consistent with the Plan as it may deem appropriate, including the right to withhold from Compensation paid to a Participant other than in connection with the Plan. - 7 - 8 13. PLAN AND CONTRIBUTIONS NOT TO AFFECT EMPLOYMENT. The Plan shall not confer upon any Eligible Employee any right to continue in the employ of the Participating Companies. 14. ADMINISTRATION. The Plan shall be administered by the Board, which may delegate responsibility for such administration to a committee of the Board (the "Committee"). If the Board fails to appoint the Committee, any references in the Plan to the Committee shall be treated as references to the Board. The Board, or the Committee, shall have authority to interpret the Plan, to prescribe, amend and rescind rules and regulations relating to it, and to make all other determinations deemed necessary or advisable in administering the Plan, with or without the advice of counsel. The determinations of the Board or the Committee on the matters referred to in this paragraph shall be conclusive and binding upon all persons in interest. 15. AMENDMENT AND TERMINATION. The Board may terminate the Plan at any time and may amend the Plan from time to time in any respect; provided, however, that upon any termination of the Plan, all Shares or Payroll Deductions (to the extent not yet applied to the purchase of Shares) under the Plan shall be distributed to the Participants; provided further, that no amendment to the Plan shall affect the right of a Participant to receive his or her proportionate interest in the Shares or his or her Payroll Deductions (to the extent not yet applied to the purchase of Shares) under the Plan; and provided further that the Company may seek shareholder approval of an amendment to the Plan if such approval is determined to be required by or advisable under the regulations of the Securities or Exchange Commission or the Internal Revenue Service, the rules of any stock exchange or system on which the Shares are listed, or other applicable law, rule or regulation. 16. EFFECTIVE DATE. The Plan shall be effective on the date of adoption by the Board, subject to approval by the Company's shareholders within one year thereafter. Any option granted before the approval of the Plan by the Company's shareholders shall be expressly conditioned upon such approval, and no Share certificates shall be issued until such approval. If shareholder approval is not received within 12 months before or after the date of the initial adoption of the Plan by the Board, no Share certificates shall be issued with respect to any automatic exercises which may have occurred pursuant to section 7 of the Plan, and all amounts credited to Participants' Accounts with respect to such Shares shall be returned to Participants as soon as administratively practicable. - 8 - 9 17. GOVERNMENT AND OTHER REGULATIONS. (a) In General. The purchase of Shares under the Plan shall be subject to all applicable laws, rules and regulations, and to such approvals by any governmental agencies as may be required. (b) Securities Law. The Committee shall have the power to make each grant under the Plan subject to such conditions as it deems necessary or appropriate to comply with the then-existing requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, including Rule 16b-3 (or any similar rule) of the Securities and Exchange Commission. 18. NON-ALIENATION. No Participant shall be permitted to assign, alienate, sell, transfer, pledge or otherwise encumber his interest under the Plan prior to the distribution to him of Share certificates. Any attempt at assignment, alienation, sale, transfer, pledge or other encumbrance shall be void and of no effect. 19. NOTICES. Any notice required or permitted hereunder shall be sufficiently given only if delivered personally, telecopied, or sent by first class mail, postage prepaid, and addressed: If to the Company: Kirkland's, Inc. 805 N. Parkway P.O. Box 7222 Jackson, Tennessee 38308-7222 Attention: Employee Stock Purchase Plan Committee Or any other address provided pursuant to written notice. If to the Participant: At the address on file with the Company from time to time, or to such other address as either party may hereafter designate in writing by notice similarly given by one party to the other. - 9 - 10 20. SUCCESSORS. The Plan shall be binding upon and inure to the benefit of any successor, successors or assigns of the Company. 21. SEVERABILITY. If any part of this Plan shall be determined to be invalid or void in any respect, such determination shall not affect, impair, invalidate or nullify the remaining provisions of this Plan which shall continue in full force and effect. 22. ACCEPTANCE. The election by any Eligible Employee to participate in this Plan constitutes his or her acceptance of the terms of the Plan and his or her agreement to be bound hereby. 23. APPLICABLE LAW. This Plan shall be construed in accordance with the laws of the State of Tennessee, without regard to the application of the principles of conflicts or choice of laws. - 10 - EX-10.12 19 401(K) PLAN 1 EXHIBIT 10.12 AETNA LIFE INSURANCE AND ANNUITY COMPANY 401(k) PROFIT SHARING PLAN 2 AETNA LIFE INSURANCE AND ANNUITY COMPANY 401(k) PROFIT SHARING PLAN (C) 1990 Aetna Life Insurance and Annuity Company 3 TABLE OF CONTENTS ARTICLE I DEFINITIONS ARTICLE II TOP HEAVY PROVISIONS AND ADMINISTRATION 2.1 TOP HEAVY PLAN REQUIREMENTS .................... 11 2.2 DETERMINATION OF TOP HEAVY STATUS .............. 12 2.3 POWERS AND RESPONSIBILITIES OF THE EMPLOYER .... 15 2.4 DESIGNATION OF ADMINISTRATIVE AUTHORITY ........ 15 2.5 ALLOCATION AND DELEGATION OF RESPONSIBILITIES .. 15 2.6 POWERS AND DUTIES OF THE ADMINISTRATOR ......... 16 2.7 RECORDS AND REPORTS ............................ 17 2.8 APPOINTMENT OF ADVISERS ........................ 17 2.9 INFORMATION FROM EMPLOYER ...................... 17 2.10 PAYMENT OF EXPENSES ............................ 17 2.11 MAJORITY ACTIONS ............................... 17 2.12 CLAIMS PROCEDURE ............................... 17 2.13 CLAIMS REVIEW PROCEDURE ........................ 18 ARTICLE III ELIGIBILITY 3.1 CONDITIONS OF ELIGIBILITY ...................... 18 3.2 EFFECTIVE DATE OF PARTICIPATION ................ 18 3.3 DETERMINATION OF ELIGIBILITY ................... 18 3.4 TERMINATION OF ELIGIBILITY ..................... 19 3.5 OMISSION OF ELIGIBLE EMPLOYEE .................. 19 3.6 INCLUSION OF INELIGIBLE EMPLOYEE ............... 19 3.7 ELECTION NOT TO PARTICIPATE .................... 19 3.8 CONTROL OF ENTITIES BY OWNER-EMPLOYEE .......... 19
4
ARTICLE IV CONTRIBUTION AND ALLOCATION 4.1 FORMULA FOR DETERMINING EMPLOYER'S CONTRIBUTION ...... 20 4.2 PARTICIPANT'S SALARY REDUCTION ELECTION .............. 20 4.3 TIME OF PAYMENT OF EMPLOYER'S CONTRIBUTION ........... 23 4.4 ALLOCATION OF CONTRIBUTION, FORFEITURES AND EARNINGS.. 24 4.5 ACTUAL DEFERRAL PERCENTAGE TESTS ..................... 28 4.6 ADJUSTMENT TO ACTUAL DEFERRAL PERCENTAGE TESTS ....... 30 4.7 ACTUAL CONTRIBUTION PERCENTAGE TESTS ................. 33 4.8 ADJUSTMENT TO ACTUAL CONTRIBUTION PERCENTAGE TESTS ... 36 4.9 MAXIMUM ANNUAL ADDITIONS ............................. 38 4.10 ADJUSTMENT FOR EXCESSIVE ANNUAL ADDITIONS ............ 44 4.11 TRANSFERS FROM QUALIFIED PLANS ....................... 44 4.12 VOLUNTARY CONTRIBUTIONS .............................. 46 4.13 DIRECTED INVESTMENT ACCOUNT .......................... 46 4.14 QUALIFIED VOLUNTARY EMPLOYEE CONTRIBUTIONS.. ......... 47 4.15 INTEGRATION IN MORE THAN ONE PLAN .................... 47 ARTICLE V VALUATIONS 5.1 VALUATION OF THE TRUST FUND .......................... 47 5.2 METHOD OF VALUATION .................................. 48 ARTICLE VI DETERMINATION AND DISTRIBUTION OF BENEFITS 6.1 DETERMINATION OF BENEFITS UPON RETIREMENT ............ 48 6.2 DETERMINATION OF BENEFITS UPON DEATH ................. 48 6.3 DETERMINATION OF BENEFITS IN EVENT OF DISABILITY ..... 49 6.4 DETERMINATION OF BENEFITS UPON TERMINATION ........... 49 6.5 DISTRIBUTION OF BENEFITS ............................. 52
5 6.6 DISTRIBUTION OF BENEFITS UPON DEATH ..................................................... 56 6.7 TIME OF SEGREGATION OR DISTRIBUTION ..................................................... 59 6.8 DISTRIBUTION FOR MINOR BENEFICIARY ...................................................... 59 6.9 LOCATION OF PARTICIPANT OR BENEFICIARY UNKNOWN .......................................... 60 6.10 PRE-RETIREMENT DISTRIBUTION ............................................................. 60 6.11 ADVANCE DISTRIBUTION FOR HARDSHIP ....................................................... 60 6.12 LIMITATIONS ON BENEFITS AND DISTRIBUTIONS ............................................... 61 6.13 SPECIAL RULE FOR NON-ANNUITY PLANS ...................................................... 61 ARTICLE VII TRUSTEE 7.1 BASIC RESPONSIBILITIES OF THE TRUSTEE ................................................... 62 7.2 INVESTMENT POWERS AND DUTIES OF THE TRUSTEE ............................................. 62 7.3 OTHER POWERS OF THE TRUSTEE ............................................................. 63 7.4 LOANS TO PARTICIPANTS ................................................................... 65 7.6 TRUSTEE'S COMPENSATION AND EXPENSES AND TAXES ........................................... 67 7.7 ANNUAL REPORT OF THE TRUSTEE ............................................................ 67 7.8 AUDIT ................................................................................... 68 7.9 RESIGNATION, REMOVAL AND SUCCESSION OF TRUSTEE .......................................... 68 7.10 TRANSFER OF INTEREST .................................................................... 69 7.11 TRUSTEE INDEMNIFICATION ................................................................. 69 7.12 EMPLOYER SECURITIES AND REAL PROPERTY ................................................... 69 7.13 POWERS AND DUTIES OF THE CUSTODIAN ...................................................... 70 ARTICLE VIII AMENDMENT, TERMINATION, AND MERGERS 8.1 AMENDMENT............................................................................... 70 8.2 TERMINATION............................................................................. 71 8.3 MERGER OR CONSOLIDATION................................................................. 71
6
ARTICLE IX MISCELLANEOUS 9.1 EMPLOYER ADOPTIONS .................................... 71 9.2 PARTICIPANT'S RIGHTS .................................. 71 9.3 ALIENATION ............................................ 72 9.4 CONSTRUCTION OF PLAN .................................. 72 9.5 GENDER AND NUMBER ..................................... 72 9.6 LEGAL ACTION .......................................... 72 9.7 PROHIBITION AGAINST DIVERSION OF FUNDS ................ 73 9.8 BONDING ............................................... 73 9.9 INSURER'S PROTECTIVE CLAUSE ........................... 73 9.10 RECEIPT AND RELEASE FOR PAYMENTS ...................... 73 9.11 ACTION BY THE EMPLOYER ................................ 73 9.12 NAMED FIDUCIARIES AND ALLOCATION OF RESPONSIBILITY .... 74 9.13 HEADINGS .............................................. 74 9.14 APPROVAL BY INTERNAL REVENUE SERVICE .................. 74 9.15 UNIFORMITY ............................................ 75 9.16 PAYMENT OF BENEFITS ................................... 75 ARTICLE X PARTICIPATING EMPLOYERS 10.1 ELECTION TO BECOME A PARTICIPATING EMPLOYER ........... 75 10.2 REQUIREMENTS OF PARTICIPATING EMPLOYERS ............... 75 10.3 DESIGNATION OF AGENT .................................. 75 10.4 EMPLOYEE TRANSFERS .................................... 76 10.5 PARTICIPATING EMPLOYER'S CONTRIBUTION AND FORFEITURES.. 76
7 10.6 AMENDMENT .......................................... 76 10.7 DISCONTINUANCE OF PARTICIPATION .................... 76 10.8 ADMINISTRATOR'S AUTHORITY .......................... 76 10.9 PARTICIPATING EMPLOYER CONTRIBUTION FOR AFFILIATE .. 76
8 ARTICLE I DEFINITIONS As used in this Plan, the following words and phrases shall have the meanings set forth herein unless a different meaning is clearly required by the context: 1.1 "ACT" means the Employee Retirement Income Security Act of 1974, as it may be amended from time to time. 1.2 "ADMINISTRATOR" means the person(s) or entity designated by the Employer pursuant to Section 2.4 to administer the Plan on behalf of the Employer. 1.3 "ADOPTION AGREEMENT" means the separate Agreement which is executed by the Employer and accepted by the Trustee which sets forth the elective provisions of this Plan and Trust as specified by the Employer. 1.4 "AFFILIATED EMPLOYER" means the Employer and any corporation which is a member of a controlled group of corporations (as defined in Code Section 414(b)) which includes the Employer; any trade or business (whether or not incorporated) which is under common control (as defined in Code Section 414(c)) with the Employer; any organization (whether or not incorporated) which is a member of an affiliated service group (as defined in Code Section 414(m)) which includes the Employer; and any other entity required to be aggregated with the Employer pursuant to Regulations under Code Section 414(o). 1.5 "AGGREGATE ACCOUNT" means with respect to each Participant, the value of all accounts maintained on behalf of a Participant, whether attributable to Employer or Employee contributions, subject to the provisions of Section 2.2. 1.6 "ANNIVERSARY DATE" means the anniversary date specified in C3 of the Adoption Agreement. 1.7 "BENEFICIARY" means the person to whom a share of a deceased Participant's interest in the Plan is payable, subject to the restrictions of Sections 6.2 and 6.6. 1.8 "CODE" means the Internal Revenue Code of 1986, as amended or replaced from time to time. 1.9 "COMPENSATION" with respect to any Participant means such Participant's compensation as specified by the Employer in E1 of the Adoption Agreement that is paid during the applicable period. Compensation for any Self-Employed Individual shall be equal to his Earned Income. In addition, if specified in the Adoption Agreement, Compensation for all Plan purposes shall also include compensation which is not currently includible in the Participant's gross income by reason of the application of Code Sections 125, 402(a)(8), 402(h)(1)(B), or 403(b). Compensation in excess of $200,000 shall be disregarded. Such amount shall be adjusted at the same time and in such manner as permitted under Code Section 415(d). In applying this limitation, the family group of a Highly Compensated Participant who is subject to the Family Member aggregation rules of Code Section 414(q)(6) because such Participant is either a "five percent owner" of the Employer or one of the ten (10) Highly Compensated Employees paid the greatest "415 Compensation" during the year, shall be treated as a single Participant, except that for this purpose Family Members shall include only the affected Participant's spouse and any lineal descendants who have not attained age nineteen (19) before the close of the year. If, 1 9 as a result of the application of such rules, the adjusted $200,000 limitation is exceeded, then (except for purposes of determining the portion of Compensation up to the integration level if this plan is integrated), the limitation shall be prorated among the affected individuals in proportion to each such individual's Compensation as determined under this Section prior to the application of this limitation. For Plan Years beginning prior to January 1, 1989, the $200,000 limit (without regard to Family Member aggregation) shall apply only for Top Heavy Plan Years and shall not be adjusted. 1.10 "CONTRACT" OR "POLICY" means any life insurance policy, retirement income policy, or annuity contract (group or individual) issued by the Insurer. In the event of any conflict between the terms of this Plan and the terms of any insurance contract purchased hereunder, the Plan provisions shall control. 1.11 "CUSTODIAN" means Aetna Life Insurance and Annuity Company. The Custodian may resign at any time by giving thirty (30) days written notice to the Employer, and shall cease to be Custodian upon delivery of all Plan assets in its possession to the Trustee or a successor Custodian. 1.12 "DEFERRED COMPENSATION" means that portion of a Participant's total Compensation that such Participant has elected to defer for a Plan Year pursuant to Section 4.2. 1.13 "EARLY RETIREMENT DATE" means the date specified in the Adoption Agreement on which a Participant or Former Participant has satisfied the age and service requirements specified in the Adoption Agreement (Early Retirement Age). A Participant shall become fully Vested upon satisfying this requirement if still employed at his Early Retirement Age. A Former Participant who terminates employment after satisfying the service requirement for Early Retirement and who thereafter reaches the age requirement contained herein shall be entitled to receive his benefits under this Plan. 1.14 "EARNED INCOME" means with respect to a Self-Employed Individual, the net earnings from self-employment in the trade or business with respect to which the Plan is established, for which the personal services of the individual are a material income-producing factor. Net earnings will be determined without regard to items not included in gross income and the deductions allocable to such items. Net earnings are reduced by contributions by the Employer to a qualified Plan to the extent deductible under Code Section 404. In addition, for Plan Years beginning after December 31, 1989, net earnings shall be determined with regard to the deduction allowed to the Employer by Code Section 164(f). 1.15 "ELECTIVE CONTRIBUTION" means the Employer's contributions to the Plan that are made pursuant to the Participant's deferral election pursuant to Section 4.2. In addition, if selected in E3 of the Adoption Agreement, the Employer's matching contribution made pursuant to Section 4.1(b) shall be considered an Elective Contribution for purposes of the Plan. Elective Contributions shall be subject to the requirements of Sections 4.2(b) and 4.2(c) and shall further be required to satisfy the discrimination requirements of Regulation 1.401(k)-1(b)(3), the provisions of which are specifically incorporated herein by reference. 1.16 "ELIGIBLE EMPLOYEE" means any Employee specified in D1 of the Adoption Agreement. 1.17 "EMPLOYEE" means any person who is employed by the Employer, but excludes any person who is employed as an independent contractor. The term Employee shall also include Leased Employees as provided in Code Section 414(n) or (o). Except as provided in the Non-Standardized Adoption Agreement, all Employees of all entities which are an Affiliated Employer will be treated as employed by a single employer. 2 10 1.18 "EMPLOYER" means the entity specified in the Adoption Agreement, any Participating Employer (as defined in Section 10.1) which shall adopt this Plan, any successor which shall maintain this Plan and any predecessor which has maintained this Plan. 1.19 "EXCESS COMPENSATION" means, with respect to a Plan that is integrated with Social Security, a Participant's Compensation which is in excess of the amount set forth in the Adoption Agreement. 1.20 "EXCESS CONTRIBUTIONS" means, with respect to a Plan Year, the excess of Elective Contributions and Qualified Non-Elective Contributions made on behalf of Highly Compensated Participants for the Plan Year over the maximum amount of such contributions permitted under Section 4.5(a). 1.21 "EXCESS DEFERRED COMPENSATION" means, with respect to any taxable year of a Participant, the excess of the aggregate amount of such Participant's Deferred Compensation and the elective deferrals pursuant to Section 4.2(f) actually made on behalf of such Participant for such taxable year, over the dollar limitation provided for in Code Section 402(g), which is incorporated herein by reference. 1.22 "FAMILY MEMBER" means, with respect to an affected Participant, such Participant's spouse, and such Participant's lineal descendants and ascendants and their spouses, all as described in Code Section 414(q)(6)(B). 1.23 "FIDUCIARY" means any person who (a) exercises any discretionary authority or discretionary control respecting management of the Plan or exercises any authority or control respecting management or disposition of its assets, (b) renders investment advice for a fee or other compensation, direct or indirect, with respect to any monies or other property of the Plan or has any authority or responsibility to do so, or (c) has any discretionary authority or discretionary responsibility in the administration of the Plan, including, but not limited to, the Trustee, the Employer and its representative body, and the Administrator. 1.24 "FISCAL YEAR" means the Employer's accounting year as specified in the Adoption Agreement. 1.25 "FORFEITURE" means that portion of a Participant's Account that is not Vested, and occurs on the earlier of: (a) the distribution of the entire Vested portion of a Participant's Account, or (b) the last day of the Plan Year in which the Participant incurs five (5) consecutive 1-Year Breaks in Service. Furthermore, for purposes of paragraph (a) above, in the case of a Terminated Participant whose Vested benefit is zero, such Terminated Participant shall be deemed to have received a distribution of his Vested benefit upon his termination of employment. In addition, the term Forfeiture shall also include amounts deemed to be Forfeitures pursuant to any other provision of this Plan. 1.26 "FORMER PARTICIPANT" means a person who has been a Participant, but who has ceased to be a Participant for any reason. 1.27 "414(s) COMPENSATION" with respect to any Employee means his Compensation as defined in Section 1.9. However, for purposes of this Section, Compensation shall be Compensation paid and shall be determined by including, in the case of a non-standardized Adoption Agreement, any items that are excluded from Compensation pursuant to the Adoption Agreement. The amount of "414(s) Compensation" with respect to any Employee shall include "414(s) Compensation" during the entire twelve (12) month period ending on the last day of such Plan Year, except that for Plan Years beginning prior to the later of January 1, 1992, or the 3 11 date that is sixty (60) days after the date final Regulations are issued, "414(s) Compensation" shall only be recognized as of an Employee's effective date of participation. In addition, if specified in the Adoption Agreement, "414(s) Compensation" shall also include compensation which is not currently includible in the Participant's gross income by reason of the application of Code Sections 125, 402(a)(8), 402(h)(1)(B), or 403(b), plus Elective Contributions attributable to Deferred Compensation recharacterized as voluntary Employee contributions pursuant to 4.6(a). 1.28 "415 COMPENSATION" means compensation as defined in Section 4.9(f)(2). 1.29 "HIGHLY COMPENSATED EMPLOYEE" means an Employee described in Code Section 414(q) and the Regulations thereunder and generally means an Employee who performed services for the Employer during the "determination year" and is in one or more of the following groups: (a) Employees who at any time during the "determination year" or "look-back year" were "five percent owners" as defined in Section 1.36(c). (b) Employees who received "415 Compensation" during the "look-back year" from the Employer in excess of $75,000. (c) Employees who received "415 Compensation" during the "look-back year" from the Employer in excess of $50,000 and were in the Top Paid Group of Employees for the Plan Year. (d) Employees who during the "look-back year" were officers of the Employer (as that term is defined within the meaning of the Regulations under Code Section 416) and received "415 Compensation" during the "look-back year" from the Employer greater than 50 percent of the limit in effect under Code Section 415(b)(1)(A) for any such Plan Year. The number of officers shall be limited to the lesser of (i) 50 employees; or (ii) the greater of 3 employees or 10 percent of all employees. If the Employer does not have at least one officer whose annual "415 Compensation" is in excess of 50 percent of the Code Section 415(b)(1)(A) limit, then the highest paid officer of the Employer will be treated as a Highly Compensated Employee. (e) Employees who are in the group consisting of the 100 Employees paid the greatest "415 Compensation" during the "determination year" and are also described in (b), (c) or (d) above when these paragraphs are modified to substitute "determination year" for "look-back year". The "determination year" shall be the Plan Year for which testing is being performed, and the "look-back year" shall be the immediately preceding twelve-month period. However, if the Plan Year is a calendar year, or if another Plan of the Employer so provides, then the "look-back year" shall be the calendar year ending with or within the Plan Year for which testing is being performed, and the "determination year" (if applicable) shall be the period of time, if any, which extends beyond the "look-back year" and ends on the last day of the Plan Year for which testing is being performed (the "lag period"). With respect to this election, it shall be applied on a uniform and consistent basis to all plans, entities, and arrangements of the Employer. For purposes of this Section, the determination of "415 Compensation" shall be made by including amounts that would otherwise be excluded from a Participant's gross income by reason of the application of Code Sections 125, 402(a)(8), 402(h)(1)(B) and, in the case of Employer contributions made pursuant to a salary reduction agreement, Code Section 403(b). Additionally, the dollar threshold amounts specified in (b) and (c) above shall be adjusted at such time and in such manner as is provided in Regulations. In the case of such an adjustment, the dollar limits which shall be applied are those for the calendar year in which the "determination year" or "look-back year" begins. 4 12 In determining who is a Highly Compensated Employee, Employees who are non-resident aliens and who received no earned income (within the meaning of Code Section 911(d)) from the Employer constituting United States source income within the meaning of Code Section 861(a)(3) shall not be treated as Employees. Additionally, all Affiliated Employers shall be taken into account as a single employer and Leased Employees within the meaning of Code Sections 414(n)(2) and 414(o)(2) shall be considered Employees unless such Leased Employees are covered by a plan described in Code Section 414(n)(5) and are not covered in any qualified plan maintained by the Employer. The exclusion of Leased Employees for this purpose shall be applied on a uniform and consistent basis for all of the Employer's retirement plans. In addition, Highly Compensated Former Employees shall be treated as Highly Compensated Employees without regard to whether they performed services during the "determination year". 1.30 "HIGHLY COMPENSATED FORMER EMPLOYEE" means a former Employee who had a separation year prior to the "determination year" and was a Highly Compensated Employee in the year of separation from service or in any "determination year" after attaining age 55. Notwithstanding the foregoing, an Employee who separated from service prior to 1987 will be treated as a Highly Compensated Former Employee only if during the separation year (or year preceding the separation year) or any year after the Employee attains age 55 (or the last year ending before the Employee's 55th birthday), the Employee either received "415 Compensation" in excess of $50,000 or was a "five percent owner". For purposes of this Section, "determination year", "415 Compensation" and "five percent owner" shall be determined in accordance with Section 1.29. Highly Compensated Former Employees shall be treated as Highly Compensated Employees. The method set forth in this Section for determining who is a "Highly Compensated Former Employee" shall be applied on a uniform and consistent basis for all purposes for which the Code Section 414(q) definition is applicable. 1.31 "HIGHLY COMPENSATED PARTICIPANT" means any Highly Compensated Employee who is eligible to participate in the Plan. 1.32 "HOUR OF SERVICE" means (1) each hour for which an Employee is directly or indirectly compensated or entitled to compensation by the Employer for the performance of duties during the applicable computation period; (2) each hour for which an Employee is directly or indirectly compensated or entitled to compensation by the Employer (irrespective of whether the employment relationship has terminated) for reasons other than performance of duties (such as vacation, holidays, sickness, jury duty, disability, lay-off, military duty or leave of absence) during the applicable computation period; (3) each hour for which back pay is awarded or agreed to by the Employer without regard to mitigation of damages. The same Hours of Service shall not be credited both under (1) or (2), as the case may be, and under (3). Notwithstanding the above, (i) no more than 501 Hours of Service are required to be credited to an Employee on account of any single continuous period during which the Employee performs no duties (whether or not such period occurs in a single computation period); (ii) an hour for which an Employee is directly or indirectly paid, or entitled to payment, on account of a period during which no duties are performed is not required to be credited to the Employee if such payment is made or due under a plan maintained solely for the purpose of complying with applicable worker's compensation, or unemployment compensation or disability insurance laws; and (iii) Hours of Service are not required to be credited for a payment which solely reimburses an Employee for medical or medically related expenses incurred by the Employee. For purposes of this Section, a payment shall be deemed to be made by or due from the Employer regardless of whether such payment is made by or due from the Employer directly, or indirectly through, among others, a trust fund, or insurer, to which the Employer contributes or pays premiums and regardless of whether contributions made or due to the trust fund, insurer, or other entity are for the benefit of particular Employees or are on behalf of a group of Employees in the aggregate. 5 13 An Hour of Service must be counted for the purpose of determining a Year of Service, a year of participation for purposes of accrued benefits, a 1-Year Break in Service, and employment commencement date (or reemployment commencement date). The provisions of Department of Labor regulations 2530.200b-2(b) and (c) are incorporated herein by reference. Hours of Service will be credited for employment with all Affiliated Employers and for any individual considered to be a Leased Employee pursuant to Code Sections 414(n) or 414(o) and the Regulations thereunder. Hours of Service will be determined on the basis of the method selected in the Adoption Agreement. 1.33 "INSURER" means Aetna Life Insurance and Annuity Company or any of its affiliates or subsidiaries, or any legal reserve insurance company which has issued one or more policies under the Plan prior to the adoption of this Plan. 1.34 "INVESTMENT MANAGER" means an entity that (a) has the power to manage, acquire, or dispose of Plan assets and (b) acknowledges fiduciary responsibility to the Plan in writing. Such entity must be a person, firm, or corporation registered as an investment adviser under the Investment Advisers Act of 1940, a bank, or an insurance company. 1.35 "JOINT AND SURVIVOR ANNUITY" means an annuity for the life of a Participant with a survivor annuity for the life of the Participant's spouse which is not less than 1/2, nor greater than the amount of the annuity payable during the joint lives of the Participant and the Participant's spouse. The Joint and Survivor Annuity will be the amount of benefit which can be purchased with the Participant's Vested interest in the Plan. 1.36 "KEY EMPLOYEE" means an Employee as defined in Code Section 416(i) and the Regulations thereunder. Generally, any Employee or former Employee (as well as each of his Beneficiaries) is considered a Key Employee if he, at any time during the Plan Year that contains the "Determination Date" or any of the preceding four (4) Plan Years, has been included in one of the following categories: (a) an officer of the Employer (as that term is defined within the meaning of the Regulations under Code Section 416) having annual "415 Compensation" greater than 50 percent of the amount in effect under Code Section 415(b)(1)(A) for any such Plan Year. (b) one of the ten employees having annual "415 Compensation" from the Employer for a Plan Year greater than the dollar limitation in effect under Code Section 415(c)(1)(A) for the calendar year in which such Plan Year ends and owning (or considered as owning within the meaning of Code Section 318) both more than one-half percent interest and the largest interests in the Employer. (c) a "five percent owner" of the Employer. "Five percent owner" means any person who owns (or is considered as owning within the meaning of Code Section 318) more than five percent (5%) of the outstanding stock of the Employer or stock possessing more than five percent (5%) of the total combined voting power of all stock of the Employer or, in the case of an unincorporated business, any person who owns more than five percent (5%) of the capital or profits interest in the Employer. In determining percentage ownership hereunder, employers that would otherwise be aggregated under Code Sections 414(b), (c), (m) and (o) shall be treated as separate employers. (d) a "one percent owner" of the Employer having an annual "415 Compensation" from the Employer of more than $150,000. "One percent owner" means any person who owns (or is considered as owning within the meaning of Code Section 318) more than one percent (1%) of the outstanding stock of the Employer or stock possessing more than one percent (1%) of the total 6 14 combined voting power of all stock of the Employer or, in the case of an unincorporated business, any person who owns more than one percent (1%) of the capital or profits interest in the Employer. In determining percentage ownership hereunder, employers that would otherwise be aggregated under Code Sections 414(b), (c), (m) and (o) shall be treated as separate employers. However, in determining whether an individual has "415 Compensation" of more than $150,000, "415 Compensation" from each employer required to be aggregated under Code Sections 414(b), (c), (m) and (o) shall be taken into account. For purposes of this Section, the determination of "415 Compensation" shall be made by including amounts that would otherwise be excluded from a Participant's gross income by reason of the application of Code Sections 125, 402(a)(8), 402(h)(1)(B) and, in the case of Employer contributions made pursuant to a salary reduction agreement, Code Section 403(b). 1.37 "LATE RETIREMENT DATE" means the date of, or the first day of the month or the Anniversary Date coinciding with or next following, whichever corresponds to the election made for the Normal Retirement Date, a Participant's actual retirement after having reached his Normal Retirement Date. 1.38 "LEASED EMPLOYEE" means any person (other than an Employee of the recipient) who pursuant to an agreement between the recipient and any other person ("leasing organization") has performed services for the recipient (or for the recipient and related persons determined in accordance with Code Section 414(n)(6)) on a substantially full time basis for a period of at least one year, and such services are of a type historically performed by employees in the business field of the recipient employer. Contributions or benefits provided a leased employee by the leasing organization which are attributable to services performed for the recipient employer shall be treated as provided by the recipient employer. A leased employee shall not be considered an Employee of the recipient if: (i) such employee is covered by a money purchase pension plan providing: (1) a nonintegrated employer contribution rate of at least 10 percent of compensation, as defined in Code Section 415(c)(3), but including amounts contributed pursuant to a salary reduction agreement which are excludable from the employee's gross income under Code Sections 125, 402(a)(8), 402(h) or 403(b), (2) immediate participation, and (3) full and immediate vesting; and (ii) leased employees do not constitute more than 20 percent of the recipient's nonhighly compensated workforce. 1.39 "NET PROFIT" means with respect to any Fiscal Year the Employer's net income or profit for such Fiscal Year determined upon the basis of the Employer's books of account in accordance with generally accepted accounting principles, without any reduction for taxes based upon income, or for contributions made by the Employer to this Plan and any other qualified plan. 1.40 "NON-ELECTIVE CONTRIBUTION" means the Employer's contributions to the Plan other than those made pursuant to the Participant's deferral election made pursuant to Section 4.2 and any Qualified Non-Elective Contribution. In addition, if selected in E3 of the Adoption Agreement, the Employer's Matching Contribution made pursuant to Section 4.1(b) shall be considered a Non-Elective Contribution for purposes of the Plan. 1.41 "NON-HIGHLY COMPENSATED PARTICIPANT" means any Participant who is neither a Highly Compensated Employee nor a Family Member. 1.42 "NON-KEY EMPLOYEE" means any Employee or former Employee (and his Beneficiaries) who is not a Key Employee. 1.43 "NORMAL RETIREMENT AGE" means the age specified in the Adoption Agreement at which time a Participant shall become fully Vested in his Participant's Account. 7 15 1.44 "NORMAL RETIREMENT DATE" means the date specified in the Adoption Agreement on which a Participant shall become eligible to have his benefits distributed to him. 1.45 "1-YEAR BREAK IN SERVICE" means the applicable computation period during which an Employee has not completed more than 500 Hours of Service with the Employer. Further, solely for the purpose of determining whether a Participant has incurred a 1-Year Break in Service, Hours of Service shall be recognized for "authorized leaves of absence" and "maternity and paternity leaves of absence." "Authorized leave of absence" means an unpaid, temporary cessation from active employment with the Employer pursuant to an established nondiscriminatory policy, whether occasioned by illness, military service, or any other reason. A "maternity or paternity leave of absence" means, for Plan Years beginning after December 31, 1984, an absence from work for any period by reason of the Employee's pregnancy, birth of the Employee's child, placement of a child with the Employee in connection with the adoption of such child, or any absence for the purpose of caring for such child for a period immediately following such birth or placement. For this purpose, Hours of Service shall be credited for the computation period in which the absence from work begins, only if credit therefore is necessary to prevent the Employee from incurring a 1-Year Break in Service, or, in any other case, in the immediately following computation period. The Hours of Service credited for a "maternity or paternity leave of absence" shall be those which would normally have been credited but for such absence, or, in any case in which the Administrator is unable to determine such hours normally credited, eight (8) Hours of Service per day. The total Hours of Service required to be credited for a "maternity or paternity leave of absence" shall not exceed 501. 1.46 "OWNER-EMPLOYEE" means a sole proprietor who owns the entire interest in the Employer or a partner who owns more than 10% of either the capital interest or the profits interest in the Employer and who receives income for personal services from the Employer. 1.47 "PARTICIPANT" means any Eligible Employee who participates in the Plan as provided in Section 3.2 and has not for any reason become ineligible to participate further in the Plan. 1.48 "PARTICIPANT'S ACCOUNT" means the account established and maintained by the Administrator for each Participant with Respect to his total interest under the Plan resulting from the Employer's Non-Elective Contributions. A separate accounting shall be maintained for matching contributions if they are deemed to be Non-Elective Contributions. 1.49 "PARTICIPANT'S COMBINED ACCOUNT" means the total aggregate amount of each Participant's Elective Account, Qualified Non-Elective Account, and Participant's Account. 1.50 "PARTICIPANT'S ELECTIVE ACCOUNT" means the account established and maintained by the Administrator for each Participant with respect to his total interest in the Plan and Trust resulting from the Employer's Elective Contributions. A separate accounting shall be maintained with respect to that portion of the Participant's Elective Account attributable to Elective Contributions made pursuant to Section 4.2, Employer matching contributions if they are deemed to be Elective Contributions, and any Qualified Non-Elective Contributions. 1.51 "PARTICIPANT'S ROLLOVER ACCOUNT" means the account established and maintained by the Administrator for each Participant with respect to his total interest in the Plan resulting from amounts transferred from another qualified plan or "conduit" Individual Retirement Account in accordance with Section 4.11. 8 16 1.52 "PLAN" means this instrument (hereinafter referred to as Aetna Life Insurance and Annuity Company 401(k) Profit Sharing Plan and Trust Basic Plan Document #03) including all amendments thereto, and the Adoption Agreement as adopted by the Employer. 1.53 "PLAN YEAR" means the Plan's accounting year as specified in C2 of the Adoption Agreement. 1.54 "PRE-RETIREMENT SURVIVOR ANNUITY" means an immediate annuity for the life of the Participant's spouse, the payments under which must be equal to the actuarial equivalent of 50% of the Participant's Vested interest in the Plan as of the date of death. 1.55 "QUALIFIED NON-ELECTIVE ACCOUNT" means the account established hereunder to which Qualified Non-Elective Contributions are allocated. 1.56 "QUALIFIED NON-ELECTIVE CONTRIBUTION" means the Employer's contributions to the Plan that are made pursuant to Section 4.1(d) and Section 4.6(b) which are used to satisfy the "Actual Deferral Percentage" tests. Qualified Non-Elective Contributions are nonforfeitable when made and are distributable only as specified in Sections 4.2(c) and 6.11. In addition, the Employer's contributions to the Plan that are made pursuant to Section 4.8(h) and which are used to satisfy the "Actual Contribution Percentage" tests shall be considered Qualified Non-Elective Contributions. 1.57 "QUALIFIED VOLUNTARY EMPLOYEE CONTRIBUTION ACCOUNT" means the account established and maintained by the Administrator for each Participant with respect to his total interest under the Plan resulting from the Participant's tax deductible qualified voluntary employee contributions made pursuant to Section 4.14. 1.58 "REGULATION" means the Income Tax Regulations as promulgated by the Secretary of the Treasury or his delegate, and as amended from time to time. 1.59 "RETIRED PARTICIPANT" means a person who has been a Participant, but who has become entitled to retirement benefits under the Plan. 1.60 "RETIREMENT DATE" means the date as of which a Participant retires for reasons other than Total and Permanent Disability, whether such retirement occurs on a Participant's Normal Retirement Date, Early or Late Retirement Date (see Section 6.1). 1.61 "SELF-EMPLOYED INDIVIDUAL" means an individual who has earned income for the taxable year from the trade or business for which the Plan is established, and, also, an individual who would have had earned income but for the fact that the trade or business had no net profits for the taxable year. A Self-Employed Individual shall be treated as an Employee. 1.62 "SHORT PLAN YEAR" means, if specified in the Adoption Agreement, that the Plan Year shall be less than a 12 month period. If chosen, the following rules shall apply in the administration of this Plan. In determining whether an Employee has completed a Year of Service for benefit accrual purposes in the Short Plan Year, the number of the Hours of Service required shall be proportionately reduced based on the number of days in the Short Plan Year. The determination of whether an Employee has completed a Year of Service for vesting and eligibility purposes shall be made in accordance with Department of Labor Regulation 2530.203-2(c). In addition, if this Plan is integrated with Social Security, the integration level shall also be proportionately reduced based on the number of days in the Short Plan Year. 1.63 "SUPER TOP HEAVY PLAN" means a plan described in Section 2.2(b). 9 17 1.64 "TAXABLE WAGE BASE" means, with respect to any year, the maximum amount of earnings which may be considered wages for such year under Code Section 3121(a)(1). 1.65 "TERMINATED PARTICIPANT" means a person who has been a Participant, but whose employment has been terminated other than by death, Total and Permanent Disability or retirement. 1.66 "TOP HEAVY PLAN" means a plan described in Section 2.2(a). 1.67 "TOP HEAVY PLAN YEAR" means a Plan Year commencing after December 31, 1983 during which the Plan is a Top Heavy Plan. 1.68 "TOP PAID GROUP" shall be determined pursuant to Code Section 414(q) and the Regulations thereunder and generally means the top 20 percent of Employees who performed services for the Employer during the applicable year, ranked according to the amount of "415 Compensation" (as determined pursuant to Section 1.29) received from the Employer during such year. All Affiliated Employers shall be taken into account as a single employer, and Leased Employees shall be treated as Employees pursuant to Code Section 414(n) or (o). Employees who am non-resident aliens who received no earned income (within the meaning of Code Section 911(d)(2)) from the Employer constituting United States source income within the meaning of Code Section 861(a)(3) shall not be treated as Employees. Additionally, for the purpose of determining the number of active Employees in any year, the following additional Employees shall also be excluded, however, such Employees shall still be considered for the purpose of identifying the particular Employees in the Top Paid Group: (a) Employees with less than six (6) months of service; (b) Employees who normally work less than 17 1/2 hours per week; (c) Employees who normally work less than six (6) months during a year; and (d) Employees who have not yet attained age 21. In addition, if 90 percent or more of the Employees of the Employer are covered under agreements the Secretary of Labor finds to be collective bargaining agreements between Employee representatives and the Employer, and the Plan covers only Employees who are not covered under such agreements, then Employees covered by such agreements shall be excluded from both the total number of active Employees as well as from the identification of particular Employees in the Top Paid Group. The foregoing exclusions set forth in this Section shall be applied on a uniform and consistent basis for all purposes for which the Code Section 414(q) definition is applicable. 1.69 "TOTAL AND PERMANENT DISABILITY" means the inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months. The disability of a Participant shall be determined by a licensed physician chosen by the Administrator. However, if the condition constitutes total disability under the federal Social Security Acts, the Administrator may rely upon such determination that the Participant is Totally and Permanently Disabled for the purposes of this Plan. The determination shall be applied uniformly to all Participants. 1.70 "TRUSTEE" means the person or entity named in B6 of the Adoption Agreement and any successors. 1.71 "TRUST FUND" means the assets of the Plan and Trust as the same shall exist from time to time. 10 18 1.72 "VESTED" means the nonforfeitable portion of any account maintained on behalf of a Participant. 1.73 "VOLUNTARY CONTRIBUTION ACCOUNT" means the account established and maintained by the Administrator for each Participant with respect to his total interest in the Plan resulting from the Participant's nondeductible voluntary contributions made pursuant to Section 4.12. Amounts recharacterized as voluntary Employee contributions pursuant to Section 4.6(a) shall remain subject to the limitations of Sections 4.2(b) and 4.2(c). Therefore, a separate accounting shall be maintained with respect to that portion of the Voluntary Contribution Account attributable to voluntary Employee contributions made pursuant to Section 4.12. 1.74 "YEAR OF SERVICE" means the computation period of twelve (12) consecutive months, herein set forth, and during which an Employee has completed at least 1000 Hours of Service. For purposes of eligibility for participation, the initial computation period shall begin with the date on which the Employee first performs an Hour of Service (employment commencement date). The computation period beginning after a 1-Year Break in Service shall be measured from the date on which an Employee again performs an Hour of Service. The succeeding computation periods shall begin with the first anniversary of the Employee's employment commencement date. However, if one (1) Year of Service or less is required as a condition of eligibility, then after the initial eligibility computation period, the eligibility computation period shall shift to the current Plan Year which includes the anniversary of the date on which the Employee first performed an Hour of Service. An Employee who is credited with 1,000 Hours of Service in both the initial eligibility computation period and the first Plan Year which commences prior to the first anniversary of the Employee's initial eligibility computation period will be credited with two Years of Service for purposes of eligibility to participate. For vesting purposes, and all other purposes not specifically addressed in this Section, the computation period shall be the Plan Year, including periods prior to the Effective Date of the Plan unless specifically excluded pursuant to the Adoption Agreement. Years of Service and breaks in service will be measured on the same computation period. Years of Service with any predecessor Employer which maintained this Plan shall be recognized. Years of Service with any other predecessor Employer shall be recognized as specified in the Adoption Agreement. Years of Service with any Affiliated Employer shall be recognized. ARTICLE II TOP HEAVY PROVISIONS AND ADMINISTRATION 2.1 TOP HEAVY PLAN REQUIREMENTS For any Top Heavy Plan Year, the Plan shall provide the special vesting requirements of Code Section 416(b) pursuant to Section 6.4 of the Plan and the special minimum allocation requirements of Code Section 416(c) pursuant to Section 4.4(i) of the Plan. 11 19 2.2 DETERMINATION OF TOP HEAVY STATUS (a) This Plan shall be a Top Heavy Plan for any Plan Year beginning after December 31, 1983, in which, as of the Determination Date, (1) the Present Value of Accrued Benefits of Key Employees and (2) the sum of the Aggregate Accounts of Key Employees under this Plan and all plans of an Aggregation Group, exceeds sixty percent (60%) of the Present Value of Accrued Benefits and the Aggregate Accounts of all Key and Non-Key Employees under this Plan and all plans of an Aggregation Group. If any Participant is a Non-Key Employee for any Plan Year, but such Participant was a Key Employee for any prior Plan Year, such Participant's Present Value of Accrued Benefit and/or Aggregate Account balance shall not be taken into account for purposes of determining whether this Plan is a Top Heavy or Super Top Heavy Plan (or whether any Aggregation Group which includes this Plan is a Top Heavy Group). In addition, if a Participant or Former Participant has not performed any services for any Employer maintaining the Plan at any time during the five year period ending on the Determination Date, any accrued benefit for such Participant or Former Participant shall not be taken into account for the purposes of determining whether this Plan is a Top Heavy or Super Top Heavy Plan. (b) This Plan shall be a Super Top Heavy Plan for any Plan Year beginning after December 31, 1983, in which, as of the Determination Date, (1) the Present Value of Accrued Benefits of Key Employees and (2) the sum of the Aggregate Accounts of Key Employees under this Plan and all plans of an Aggregation Group, exceeds ninety percent (90%) of the Present Value of Accrued Benefits and the Aggregate Accounts of all Key and Non-Key Employees under this Plan and all plans of an Aggregation Group. (c) Aggregate Account: A Participant's Aggregate Account as of the Determination Date is the sum of: (1) his Participant's Combined Account balance as of the most recent valuation occurring within a twelve (12) month period ending on the Determination Date; (2) an adjustment for any contributions due as of the Determination Date. Such adjustment shall be the amount of any contributions actually made after the valuation date but on or before the Determination Date, except for the first Plan Year when such adjustment shall also reflect the amount of any contributions made after the Determination Date that are allocated as of a date in that first Plan Year; (3) any Plan distributions made within the Plan Year that includes the Determination Date or within the four (4) preceding Plan Years. However, in the case of distributions made after the valuation date and prior to the Determination Date, such distributions are not included as distributions for top heavy purposes to the extent that such distributions are already included in the Participant's Aggregate Account balance as of the valuation date. Notwithstanding anything herein to the contrary, all distributions, including distributions made prior to January 1, 1984, and distributions under a terminated plan which if it had not been terminated would have been required to be included in an Aggregation Group, will be counted. Further, distributions from the Plan (including the cash value of life insurance policies) of a Participant's account balance because of death shall be treated as a distribution for the purposes of this paragraph. 12 20 (4) any Employee contributions, whether voluntary or mandatory. However, amounts attributable to tax deductible qualified voluntary employee contributions shall not be considered to be a part of the Participant's Aggregate Account balance. (5) with respect to unrelated rollovers and plan-to-plan transfers (ones which are both initiated by the Employee and made from a plan maintained by one employer to a plan maintained by another employer), if this Plan provides the rollovers or plan-to-plan transfers, it shall always consider such rollovers or plan-to-plan transfers as a distribution for the purposes of this Section. If this Plan is the plan accepting such rollovers or plan-to-plan transfers, it shall not consider such rollovers or plan-to-plan transfers accepted after December 31, 1983 as part of the Participant's Aggregate Account balance. However, rollovers or plan-to-plan transfers accepted prior to January 1, 1984 shall be considered as part of the Participant's Aggregate Account balance. (6) with respect to related rollovers and plan-to-plan transfers (ones either not initiated by the Employee or made to a plan maintained by the same employer), if this Plan provides the rollover or plan-to-plan transfer, it shall not be counted as a distribution for purposes of this Section. If this Plan is the plan accepting such rollover or plan-to-plan transfer, it shall consider such rollover or plan-to-plan transfer as part of the Participant's Aggregate Account balance, irrespective of the date on which such rollover or plan-to-plan transfer is accepted. (7) For the purposes of determining whether two employers are to be treated as the same employer in 2.2(c)(5) and 2.2(c)(6) above, all employers aggregated under Code Section 414(b), (c), (m) and (o) are treated as the same employer. (d) "Aggregation Group" means either a Required Aggregation Group or a Permissive Aggregation Group as hereinafter determined. (1) Required Aggregation Group: In determining a Required Aggregation Group hereunder, each qualified plan of the Employer, including any Simplified Employee Pension Plan, in which a Key Employee is a participant in the Plan Year containing the Determination Date or any of the four preceding Plan Years, and each other qualified plan of the Employer which enables any qualified plan in which a Key Employee participates to meet the requirements of Code Sections 401(a)(4) or 410, will be required to be aggregated. Such group shall be known as a Required Aggregation Group. In the case of a Required Aggregation Group, each plan in the group will be considered a Top Heavy Plan if the Required Aggregation Group is a Top Heavy Group. No plan in the Required Aggregation Group will be considered a Top Heavy Plan if the Required Aggregation Group is not a Top Heavy Group. (2) Permissive Aggregation Group: The Employer may also include any other plan of the Employer, including any Simplified Employee Pension Plan, not required to be included in the Required Aggregation Group, provided the resulting group, taken as a whole, would continue to satisfy the provisions of Code Sections 401(a)(4) and 410. Such group shall be known as a Permissive Aggregation Group. 13 21 In the case of a Permissive Aggregation Group, only a plan that is part of the Required Aggregation Group will be considered a Top Heavy Plan if the Permissive Aggregation Group is a Top Heavy Group. No plan in the Permissive Aggregation Group will be considered a Top Heavy Plan if the Permissive Aggregation Group is not a Top Heavy Group. (3) Only those plans of the Employer in which the Determination Dates fall within the same calendar year shall be aggregated in order to determine whether such plans are Top Heavy Plans. (4) When aggregating plans, the value of Aggregate Accounts and Accrued Benefits will be calculated with reference to the Determination Dates that fall within the same calendar year. (5) An Aggregation Group shall include any terminated plan of the Employer if it was maintained within the last five (5) years ending on the Determination Date. (e) "Determination Date" means (a) the last day of the preceding Plan Year, or (b) in the case of the first Plan Year, the last day of such Plan Year. (f) Present Value of Accrued Benefit: In the case of a defined benefit plan, the Present Value of Accrued Benefit for a Participant other than a Key Employee shall be as determined using the single accrual method used for all plans of the Employer and Affiliated Employers, or if no such single method exists, using a method which results in benefits accruing not more rapidly than the slowest accrual rate permitted under Code Section 411(b)(1)(C). The determination of the Present Value of Accrued Benefit shall be determined as of the most recent valuation date that falls within or ends with the 12-month period ending on the Determination Date, except as provided in Code Section 416 and the Regulations thereunder for the first and second plan years of a defined benefit plan. However, any such determination must include present value of accrued benefit attributable to any Plan distributions referred to in Section 2.2(c)(3) above, any Employee contributions referred to in Section 2.2(c)(4) above or any related or unrelated rollovers referred to in Sections 2.2(c)(5) and 2.2(c)(6) above. (g) "Top Heavy Group" means an Aggregation Group in which, as of the Determination Date, the sum of: (1) the Present Value of Accrued Benefits of Key Employees under all defined benefit plans included in the group, and (2) the Aggregate Accounts of Key Employees under all defined contribution plans included in the group, exceeds sixty percent (60%) of a similar sum determined for all Participants. (h) The Administrator shall determine whether this Plan is a Top Heavy Plan on the Anniversary Date specified in the Adoption Agreement. Such determination of the top heavy ratio shall be in accordance with Code Section 416 and the Regulations thereunder. 14 22 2.3 POWERS AND RESPONSIBILITIES OF THE EMPLOYER (a) The Employer shall be empowered to appoint and remove the Trustee and the Administrator from time to time as it deems necessary for the proper administration of the Plan to assure that the Plan is being operated for the exclusive benefit of the Participants and their Beneficiaries in accordance with the terms of the Plan, the Code, and the Act. (b) The Employer shall establish a "funding policy and method", i.e., it shall determine whether the Plan has a short run need for liquidity (e.g., to pay benefits) or whether liquidity is a long run goal and investment growth (and stability of same) is a more current need, or shall appoint a qualified person to do so. The Employer or its delegate shall communicate such needs and goals to the Trustee, who shall coordinate such Plan needs with its investment policy. The communication of such a "funding policy and method" shall not, however, constitute a directive to the Trustee as to investment of the Trust Funds. Such "funding policy and method" shall be consistent with the objectives of this Plan and with the requirements of Title I of the Act. (c) The Employer may, in its discretion, appoint an Investment Manager to manage all or a designated portion of the assets of the Plan. In such event, the Trustee shall follow the directive of the Investment Manager in investing the assets of the Plan managed by the Investment Manager. (d) The Employer shall periodically review the performance of any Fiduciary or other person to whom duties have been delegated or allocated by it under the provisions of this Plan or pursuant to procedures established hereunder. This requirement may be satisfied by formal periodic review by the Employer or by a qualified person specifically designated by the Employer, through day-to-day conduct and evaluation, or through other appropriate ways. 2.4 DESIGNATION OF ADMINISTRATIVE AUTHORITY The Employer shall appoint one or more Administrators. Any person, including, but not limited to, the Employees of the Employer, shall be eligible to serve as an Administrator. Any person so appointed shall signify his acceptance by filing written acceptance with the Employer. An Administrator may resign by delivering his written resignation to the Employer or be removed by the Employer by delivery of written notice of removal, to take effect at a date specified therein, or upon delivery to the Administrator if no date is specified. The Employer, upon the resignation or removal of an Administrator, shall promptly designate in writing a successor to this position. If the Employer does not appoint an Administrator, the Employer will function as the Administrator. 2.5 ALLOCATION AND DELEGATION OF RESPONSIBILITIES If more than one person is appointed as Administrator, the responsibilities of each Administrator may be specified by the Employer and accepted in writing by each Administrator. In the event that no such delegation is made by the Employer, the Administrators may allocate the responsibilities among themselves, in which event the Administrators shall notify the Employer and the Trustee in writing of such action and specify the responsibilities of each Administrator. The Trustee thereafter shall accept and rely upon any documents executed by the appropriate Administrator until such time as the Employer or the Administrators file with the Trustee a written revocation of such designation. 15 23 2.6 POWERS AND DUTIES OF THE ADMINISTRATOR The primary responsibility of the Administrator is to administer the Plan for the exclusive benefit of the Participants and their Beneficiaries, subject to the specific terms of the Plan. The Administrator shall administer the Plan in accordance with its terms and shall have the power and discretion to construe the terms of the Plan and determine all questions arising in connection with the administration, interpretation, and application of the Plan. Any such determination by the Administrator shall be conclusive and binding upon all persons. The Administrator may establish procedures, correct any defect, supply any information, or reconcile any inconsistency in such manner and to such extent as shall be deemed necessary or advisable to carry out the purpose of the Plan; provided, however, that any procedure, discretionary act, interpretation or construction shall be done in a nondiscriminatory manner based upon uniform principles consistently applied and shall be consistent with the intent that the Plan shall continue to be deemed a qualified plan under the terms of Code Section 401(a), and shall comply with the terms of the Act and all regulations issued pursuant thereto. The Administrator shall have all powers necessary or appropriate to accomplish his duties under this Plan. The Administrator shall be charged with the duties of the general administration of the Plan, including, but not limited to, the following: (a) the discretion to determine all questions relating to the eligibility of Employees to participate or remain a Participant hereunder and to receive benefits under the Plan; (b) to compute, certify, and direct the Trustee with respect to the amount and the kind of benefits to which any Participant shall be entitled hereunder; (c) to authorize and direct the Trustee with respect to all nondiscretionary or otherwise directed disbursements from the Trust Fund; (d) to maintain all necessary records for the administration of the Plan; (e) to interpret the provisions of the Plan and to make and publish such rules for regulation of the Plan as are consistent with the terms hereof; (f) to determine the size and type of any Contract to be purchased from any Insurer, and to designate the Insurer from which such Contract shall be purchased; (g) to determine the size and type of any Contract to be purchased from the Insurer; (h) to compute and certify to the Employer and to the Trustee from time to time the sums of money necessary or desirable to be contributed to the Trust Fund; (i) to consult with the Employer and the Trustee regarding the short and long-term liquidity needs of the Plan in order that the Trustee can exercise any investment discretion in a manner designed to accomplish specific objectives; (j) to prepare and distribute to Employees a procedure for notifying Participants and Beneficiaries of their rights to elect Joint and Survivor Annuities and Pre-Retirement Survivor Annuities if required by the Code and Regulations thereunder; 16 24 (k) to prepare and implement a procedure to notify Eligible Employees that they may elect to have a portion of their Compensation deferred or paid to them in cash; (l) to assist any Participant regarding his rights, benefits, or elections available under the Plan. 2.7 RECORDS AND REPORTS The Administrator shall keep a record of all actions taken and shall keep all other books of account, records, and other data that may be necessary for proper administration of the Plan and shall be responsible for supplying all information and reports to the Internal Revenue Service, Department of Labor, Participants, Beneficiaries and others as required by law. 2.8 APPOINTMENT OF ADVISERS The Administrator, or the Trustee with the consent of the Administrator, may appoint counsel, specialists, advisers, and other persons as the Administrator or the Trustee deems necessary or desirable in connection with the administration of this Plan. 2.9 INFORMATION FROM EMPLOYER To enable the Administrator to perform his functions, the Employer shall supply full and timely information to the Administrator on all matters relating to the Compensation of all Participants, their Hours of Service, their Years of Service, their retirement, death, disability, or termination of employment, and such other pertinent facts as the Administrator may require; and the Administrator shall advise the Trustee of such of the foregoing facts as may be pertinent to the Trustee's duties under the Plan. The Administrator may rely upon such information as is supplied by the Employer and shall have no duty or responsibility to verify such information. 2.10 PAYMENT OF EXPENSES All expenses of administration may be paid out of the Trust Fund unless paid by the Employer. Such expenses shall include any expenses incident to the functioning of the Administrator, including, but not limited to, fees of accountants, counsel, and other specialists and their agents, and other costs of administering the Plan. Until paid, the expenses shall constitute a liability of the Trust Fund. However, the Employer may reimburse the Trust Fund for any administration expense incurred. Any administration expense paid to the Trust Fund as a reimbursement shall not be considered an Employer contribution. 2.11 MAJORITY ACTIONS Except where there has been an allocation and delegation of administrative authority pursuant to Section 2.5, if there shall be more than one Administrator, they shall act by a majority of their number, but may authorize one or more of them to sign all papers on their behalf. 2.12 CLAIMS PROCEDURE Claims for benefits under the Plan may be filed in writing with the Administrator. Written notice of the disposition of a claim shall be furnished to the claimant within 90 days after the application is filed. In the event the claim is denied, the reasons for the denial shall be specifically set forth in the notice in language calculated to be understood by the claimant, pertinent provisions of the Plan shall be cited, and, where appropriate, an explanation as to how the claimant can perfect the claim will be provided. In addition, the claimant shall be furnished with an explanation of the Plan's claims review procedure. 17 25 2.13 CLAIMS REVIEW PROCEDURE Any Employee, former Employee, or Beneficiary of either, who has been denied a benefit by a decision of the Administrator pursuant to Section 2.12 shall be entitled to request the Administrator to give further consideration to his claim by filing with the Administrator a written request for a hearing. Such request, together with a written statement of the reasons why the claimant believes his claim should be allowed, shall be filed with the Administrator no later than 60 days after receipt of the written notification provided for in Section 2.12. The Administrator shall then conduct a hearing within the next 60 days, at which the claimant may be represented by an attorney or any other representative of his choosing and expense and at which the claimant shall have an opportunity to submit written and oral evidence and arguments in support of his claim. At the hearing (or prior thereto upon 5 business days written notice to the Administrator) the claimant or his representative shall have an opportunity to review all documents in the possession of the Administrator which are pertinent to the claim at issue and its disallowance. Either the claimant or the Administrator may cause a court reporter to attend the hearing and record the proceedings. In such event, a complete written transcript of the proceedings shall be furnished to both parties by the court reporter. The full expense of any such court reporter and such transcripts shall be borne by the party causing the court reporter to attend the hearing. A final decision as to the allowance of the claim shall be made by the Administrator within 60 days of receipt of the appeal (unless there has been an extension of 60 days due to special circumstances, provided the delay and the special circumstances occasioning it are communicated to the claimant within the 60 day period). Such communication shall be written in a manner calculated to be understood by the claimant and shall include specific reasons for the decision and specific references to the pertinent Plan provisions on which the decision is based. ARTICLE III ELIGIBILITY 3.1 CONDITIONS OF ELIGIBILITY Any Eligible Employee shall be eligible to participate hereunder on the date he has satisfied the requirements specified in the Adoption Agreement. 3.2 EFFECTIVE DATE OF PARTICIPATION An Eligible Employee who has become eligible to be a Participant shall become a Participant effective as of the day specified in the Adoption Agreement. In the event an Employee who has satisfied the Plan's eligibility requirements and would otherwise have become a Participant shall go from a classification of a noneligible Employee to an Eligible Employee, such Employee shall become a Participant as of the date he becomes an Eligible Employee. In the event an Employee who has satisfied the Plan's eligibility requirements and would otherwise become a Participant shall go from a classification of an Eligible Employee to a noneligible Employee and becomes ineligible to participate and has not incurred a 1-Year Break in Service, such Employee shall participate in the Plan as of the date he returns to an eligible class of Employees. If such Employee does incur a 1-Year Break in Service, eligibility will be determined under the Break in Service rules of the Plan. 3.3 DETERMINATION OF ELIGIBILITY The Administrator shall determine the eligibility of each Employee for participation in the Plan based upon information furnished by the Employer. Such determination shall be conclusive and binding upon all 18 26 persons, as long as the same is made pursuant to the Plan and the Act. Such determination shall be subject to review per Section 2.13. 3.4 TERMINATION OF ELIGIBILITY In the event a Participant shall go from a classification of an Eligible Employee to an ineligible Employee, such Former Participant shall continue to vest in his interest in the Plan for each Year of Service completed while a noneligible Employee, until such time as his Participant's Account shall be forfeited or distributed pursuant to the terms of the Plan. Additionally, his interest in the Plan shall continue to share in the earnings of the Trust Fund. 3.5 OMISSION OF ELIGIBLE EMPLOYEE If, in any Plan Year, any Employee who should be included as a Participant in the Plan is erroneously omitted and discovery of such omission is not made until after a contribution by his Employer for the year has been made, the Employer shall make a subsequent contribution, if necessary after the application of Section 4.4(e), so that the omitted Employee receives a total amount which the said Employee would have received had he not been omitted. Such contribution shall be made regardless of whether or not it is deductible in whole or in part in any taxable year under applicable provisions of the Code. 3.6 INCLUSION OF INELIGIBLE EMPLOYEE If, in any Plan Year, any person who should not have been included as a Participant in the Plan is erroneously included and discovery of such incorrect inclusion is not made until after a contribution for the year has been made, the Employer shall not be entitled to recover the contribution made with respect to the ineligible person regardless of whether or not a deduction is allowable with respect to such contribution. In such event, the amount contributed with respect to the ineligible person shall constitute a Forfeiture for the Plan Year in which the discovery is made. 3.7 ELECTION NOT TO PARTICIPATE An Employee may, subject to the approval of the Employer, elect voluntarily not to participate in the Plan. The election not to participate must be communicated to the Employer, in writing, at least thirty (30) days before the beginning of a Plan Year. For Standardized Plans, a Participant or an Eligible Employee may not elect not to participate. Furthermore, the foregoing election not to participate shall not be available with respect to partners in a partnership. 3.8 CONTROL OF ENTITIES BY OWNER-EMPLOYEE (a) If this Plan provides contributions or benefits for one or more Owner-Employees who control both the business for which this Plan is established and one or more other entities, this Plan and the plan established for other trades or businesses must, when looked at as a single Plan, satisfy Code Sections 401(a) and (d) for the Employees of this and all other entities. (b) If the Plan provides contributions or benefits for one or more Owner-Employees who control one or more other trades or businesses, the employees of the other trades or businesses must be included in a plan which satisfies Code Sections 401(a) and (d) and which provides contributions and benefits not less favorable than provided for Owner-Employees under this Plan. (c) If an individual is covered as an Owner-Employee under the plans of two or more trades or businesses which are not controlled and the individual controls a trade or business, then the benefits 19 27 or contributions of the employees under the plan of the trades or businesses which are controlled must be as favorable as those provided for him under the most favorable plan of the trade or business which is not controlled. (d) For purposes of the preceding paragraphs, an Owner-Employee, or two or more Owner-Employees, will be considered to control an entity if the Owner-Employee, or two or more Owner-Employees together: (1) own the entire interest in an unincorporated entity, or (2) in the case of a partnership, own more than 50 percent of either the capital interest or the profits interest in the partnership. (e) For purposes of the preceding sentence, an Owner-Employee, or two or more Owner-Employees shall be treated as owning any interest in a partnership which is owned, directly or indirectly, by a partnership which such Owner-Employee, or such two or more Owner-Employees, are considered to control within the meaning of the preceding sentence. ARTICLE IV CONTRIBUTION AND ALLOCATION 4.1 FORMULA FOR DETERMINING EMPLOYER'S CONTRIBUTION For each Plan Year, the Employer shall contribute to the Plan: (a) The amount of the total salary reduction elections of all Participants made pursuant to Section 4.2(a), which amount shall be deemed an Employer's Elective Contribution, plus (b) If specified in E3 of the Adoption Agreement, a matching contribution equal to the percentage specified in the Adoption Agreement of the Deferred Compensation of each Participant eligible to share in the allocations of the matching contribution, which amount shall be deemed an Employer's Non-Elective or Elective Contribution as selected in the Adoption Agreement, plus (c) If specified in E4 of the Adoption Agreement, a discretionary amount, if any, which shall be deemed an Employer's Non-Elective Contribution, plus (d) If specified in E5 of the Adoption Agreement, a Qualified Non-Elective Contribution. (e) Notwithstanding the foregoing, however, the Employer's contributions for any Fiscal Year shall not exceed the maximum amount allowable as a deduction to the Employer under the provisions of Code Section 404. All contributions by the Employer shall be made in cash or in such property as is acceptable to the Trustee. (f) Except, however, to the extent necessary to provide the top heavy minimum allocations, the Employer shall make a contribution even if it exceeds current or accumulated Net Profit or the amount which is deductible under Code Section 404. 4.2 PARTICIPANT'S SALARY REDUCTION ELECTION (a) Each Participant may elect to defer his Compensation which would have been received in the Plan Year, but for the deferral election, subject to the limitations of this Section and the Adoption 20 28 Agreement. A deferral election (or modification of an earlier election) may not be made with respect to Compensation which is currently available on or before the date the Participant executed such election, or if later, the latest of the date the Employer adopts this cash or deferred arrangement, or the date such arrangement first became effective. Any elections made pursuant to this Section shall become effective as soon as is administratively feasible. Additionally, if elected in the Adoption Agreement, each Participant may elect to defer and have allocated for a Plan Year all or a portion of any cash bonus attributable to services performed by the Participant for the Employer during such Plan Year and which would have been received by the Participant on or before two and one-half months following the end of the Plan Year but for the deferral. A deferral election may not be made with respect to cash bonuses which are currently available on or before the date the Participant executed such election. Notwithstanding the foregoing, cash bonuses attributable to services performed by the Participant during a Plan Year but which are to be paid to the Participant later than two and one-half months after the close of such Plan Year will be subjected to whatever deferral election is in effect at the time such cash bonus would have otherwise been received. The amount by which Compensation and/or cash bonuses are reduced shall be that Participant's Deferred Compensation and be treated as an Employer Elective Contribution and allocated to that Participant's Elective Account. Once made, a Participant's election to reduce Compensation shall remain in effect until modified or terminated. Modifications may be made as specified in the Adoption Agreement, and terminations may be made at any time. Any modification or termination of an election will become effective as soon as is administratively feasible. (b) The balance in each Participant's Elective Account shall be fully Vested at all times and shall not be subject to Forfeiture for any reason. (c) Amounts held in the Participant's Elective Account and Qualified Non-Elective Account may be distributable as permitted under the Plan, but in no event prior to the earlier of: (1) a Participant's termination of employment, Total and Permanent Disability, or death; (2) a Participant's attainment of age 59 1/2; (3) the proven financial hardship of a Participant, subject to the limitations of Section 6.11; (4) the termination of the Plan without the existence at the time of Plan termination of another defined contribution plan (other than an employee stock ownership plan as defined in Code Section 4975(e)(7)) or the establishment of a successor defined contribution plan (other than an employee stock ownership plan as defined in Code Section 4975(e)(7)) by the Employer or an Affiliated Employer within the period ending twelve months after distribution of all assets from the Plan maintained by the Employer; (5) the date of the sale by the Employer to an entity that is not an Affiliated Employer of substantially all of the assets (within the meaning of Code Section 409(d)(2)) with respect to a Participant who continues employment with the corporation acquiring such assets; or (6) the date of the sale by the Employer or an Affiliated Employer of its interest in a subsidiary (within the meaning of Code Section 409(d)(3)) to an entity that is not an 21 29 Affiliated Employer with respect to a Participant who continues employment with such subsidiary. (d) In any Plan Year beginning after December 31, 1987, a Participant's Deferred Compensation made under this Plan and all other plans, contracts or arrangements of the Employer maintaining this Plan shall not exceed the limitation imposed by Code Section 402(g), as in effect for the calendar year in which such Plan Year began. This dollar limitation shall be adjusted annually pursuant to the method provided in Code Section 415(d) in accordance with Regulations. (e) In the event a Participant has received a hardship distribution pursuant to Regulation 1.401(k)-1(d)(2)(iii)(B) from any other plan maintained by the Employer or from his Participant's Elective Account pursuant to Section 6.11(c), then such Participant shall not be permitted to elect to have Deferred Compensation contributed to the Plan on his behalf for a period of twelve (12) months following the receipt of the distribution. Furthermore, the dollar limitation under Code Section 402(g) shall be reduced, with respect to the Participant's taxable year following the taxable year in which the hardship distribution was made, by the amount of such Participant's Deferred Compensation, if any, made pursuant to this Plan (and any other plan maintained by the Employer) for the taxable year of the hardship distribution. (f) If a Participant's Deferred Compensation under this Plan together with any elective deferrals (as defined in Regulation 1.402(g)-1(b)) under another qualified cash or deferred arrangement (as defined in Code Section 401(k)), a simplified employee pension (as defined in Code Section 408(k)), a salary reduction arrangement (within the meaning of Code Section 3121(a)(5)(D)), a deferred compensation plan under Code Section 457, or a trust described in Code Section 501(c)(18) cumulatively exceed the limitation imposed by Code Section 402(g) (as adjusted annually in accordance with the method provided in Code Section 415(d) pursuant to Regulations) for such Participant's taxable year, the Participant may, not later than Match 1st following the close of his taxable year, notify the Administrator in writing of such excess and request that his Deferred Compensation under this Plan be reduced by an amount specified by the Participant. In such event, the Administrator shall direct the Trustee to distribute such excess amount (and any Income allocable to such excess amount) to the Participant not later than the first April 15th following the close of the Participant's taxable year. Distributions in accordance with this paragraph may be made for any taxable year of the Participant which begins after December 31, 1986. Any distribution of less than the entire amount of Excess Deferred Compensation and Income shall be treated as a pro rata distribution of Excess Deferred Compensation and Income. The amount distributed shall not exceed the Participant's Deferred Compensation under the Plan for the taxable year. Any distribution on or before the last day of the Participant's taxable year must satisfy each of the following conditions: (1) the Participant shall designate the distribution as Excess Deferred Compensation; (2) the distribution must be made after the date on which the Plan received the Excess Deferred Compensation; and (3) the Plan must designate the distribution as a distribution of Excess Deferred Compensation. For the purpose of this Section, "Income" means the amount of income or loss allocable to a Participant's Excess Deferred Compensation and shall be equal to the sum of the allocable gain or loss for the taxable year of the Participant and the allocable gain or loss for the period between the end of the taxable year of the Participant and the date of distribution ("gap period"). The income or 22 30 loss allocable to each such period is calculated separately and is determined by multiplying the income or loss allocable to the Participant's Deferred Compensation for the respective period by a fraction. The numerator of the fraction is the Participant's Excess Deferred Compensation for the taxable year of the Participant. The denominator is the balance, as of the last day of the respective period, of the Participant's Elective Account that is attributable to the Participant's Deferred Compensation reduced by the gain allocable to such total amount for the respective period and increased by the loss allocable to such total amount for the respective period. In lieu of the "fractional method" described above, a "safe harbor method" may be used to calculate the allocable income or loss for the "gap period". Under such "safe harbor method", allocable income or loss for the "gap period" shall be deemed to equal ten percent (10%) of the income or loss allocable to a Participant's Excess Deferred Compensation for the taxable year of the Participant multiplied by the number of calendar months in the "gap period". For purposes of determining the number of calendar months in the "gap period", a distribution occurring on or before the fifteenth day of the month shall be treated as having been made on the last day of the preceding month and a distribution occurring after such fifteenth day shall be treated as having been made on the first day of the next subsequent month. Income or loss allocable to any distribution of Excess Deferred Compensation on or before the last day of the taxable year of the Participant shall be calculated from the first day of the taxable year of the Participant to the date on which the distribution is made pursuant to either the "fractional method" or the "safe harbor method". Notwithstanding the above, for the 1987 calendar year, Income during the "gap period" shall not be taken into account. (g) Notwithstanding Section 4.2(f) above, a Participant's Excess Deferred Compensation shall be reduced, but not below zero, by any distribution and/or recharacterization of Excess Contributions pursuant to Section 4.6(a) for the Plan Year beginning with or within the taxable year of the Participant. (h) At Normal Retirement Date, or such other date when the Participant shall be entitled to receive benefits, the fair market value of the Participant's Elective Account shall be used to provide benefits to the Participant or his Beneficiary. (i) Employer Elective Contributions made pursuant to this Section may be segregated into a separate account for each Participant in a federally insured savings account, certificate of deposit in a bank or savings and loan association, money market certificate, or other short-term debt security acceptable to the Trustee until such time as the allocations pursuant to Section 4.4 have been made. (j) The Employer and the Administrator shall adopt a procedure necessary to implement the salary reduction elections provided for herein. 4.3 TIME OF PAYMENT OF EMPLOYER'S CONTRIBUTION The Employer shall generally pay to the Trustee its contribution to the Plan for each Plan Year within the time prescribed by law, including extensions of time, for the filing of the Employer's federal income tax return for the Fiscal Year. However, Employer Elective Contributions accumulated through payroll deductions shall be paid to the Trustee as of the earliest date on which such contributions can reasonably be segregated from the 23 31 Employer's general assets, but in any event within ninety (90) days from the date on which such amounts would otherwise have been payable to the Participant in cash. The provisions of Department of Labor regulations 2510.3-102 are incorporated herein by reference. Furthermore, any additional Employer contributions which are allocable to the Participant's Elective Account for a Plan Year shall be paid to the Plan no later than the twelve-month period immediately following the close of such Plan Year. 4.4 ALLOCATION OF CONTRIBUTION, FORFEITURES AND EARNINGS (a) The Administrator shall establish and maintain an account in the name of each Participant to which the Administrator shall credit as of each Anniversary Date, or other valuation date, all amounts allocated to each such Participant as set forth herein. (b) The Employer shall provide the Administrator with all information required by the Administrator to make a proper allocation of the Employer's contributions for each Plan Year. Within a reasonable period of time after the date of receipt by the Administrator of such information, the Administrator shall allocate such contribution as follows: (1) With respect to the Employer's Elective Contribution made pursuant to Section 4. 1 (a), to each Participant's Elective Account in an amount equal to each such Participant's Deferred Compensation for the year. (2) With respect to the Employer's Matching Contribution made pursuant to Section 4. 1 (b), to each Participant's Account, or Participant's Elective Account as selected in E3 of the Adoption Agreement, in accordance with Section 4.1(b). Except, however, a Participant who is not credited with a Year of Service during any Plan Year shall or shall not share in the Employer's Matching Contribution for that year as provided in E3 of the Adoption Agreement. However, for Plan Years beginning after 1989, if this is a standardized Plan, a Participant shall share in the Employer's Matching Contribution regardless of Hours of Service. (3) With respect to the Employer's Non-Elective Contribution made pursuant to Section 4.1(c), to each Participant's Account in accordance with the provisions of E4 of the Adoption Agreement. However, if an integrated allocation formula is selected at E4 of the Adoption Agreement, then such contribution shall be allocated to each Participant's Combined Account in a dollar amount equal to 5.7% of the sum of each Participant's total Compensation plus Excess Compensation. If the Employer does not contribute such amount for all Participants, each Participant will be allocated a share of the contribution in the same proportion that his total Compensation plus his total Excess Compensation for the Plan Years bears to the total Compensation plus the total Excess Compensation of all Participants for that year. The balance of the contribution, if any, will be allocated in the same proportion that his total Compensation bears to the total Compensation of all Participant's eligible to share in the allocation. Regardless of the preceding, 4.3% shall be substituted for 5.7% above if Excess Compensation is based on more than 20% and less than or equal to 80% of the Taxable Wage Base. If Excess Compensation is based on less than 100% and more than 80% of the Taxable Wage Base, then 5.4% shall be substituted for 5.7% above. 24 32 (4) With respect to the Employer's Qualified Non-Elective Contribution made pursuant to Section 4.1(d), to each Participant's Qualified Non-Elective Contribution Account in the same proportion that each such Participant's Compensation for the year bears to the total Compensation of all Participants for such year. (5) Regardless of the preceding, a Participant who is not credited with a Year of Service during a Plan Year shall not share in the allocation of the Employer's Non-Elective Contribution made pursuant to Section 4.1(c) and the Employer's Qualified Non-Elective Contribution made pursuant to Section 4.1(d), unless reduced pursuant to Section 4.4(h). However, for Plan Years beginning after 1989 for a standardized plan, and if elected in the non-standardized Adoption Agreement, a Participant shall share in the allocation of such contributions regardless of whether a Year of Service was completed during the Plan Year. (c) As of each Anniversary Date or other valuation date, before allocation of Employer contributions and Forfeitures, any earnings or losses (no appreciation or net depreciation) of the Trust Fund shall be allocated in the same proportion that each Participant's and Former Participant's nonsegregated accounts bear to the total of all Participants' and Former Participants' nonsegregated accounts as of such date. If any nonsegregated account of a Participant has been distributed prior to the Anniversary Date or other valuation date subsequent to a Participant's termination of employment, no earnings or losses shall be credited to such account. (d) Participants' Accounts shall be debited for any insurance or annuity premiums paid, if any, and credited with any dividends or interest received on insurance contracts. (e) As of each Anniversary Date any amounts which became Forfeitures since the last Anniversary Date shall first be made available to reinstate previously forfeited account balances of Former Participants, if any, in accordance with Section 6.4(g)(2) or be used to satisfy any contribution that may be required pursuant to Section 3.5 and/or 6.9. The remaining Forfeitures, if any, shall be treated in accordance with the Adoption Agreement. Provided, however, that in the event the allocation of Forfeitures provided herein shall cause the "annual addition" (as defined in Section 4.9) to any Participant's Account to exceed the amount allowable by the Code, the excess shall be reallocated in accordance with Section 4.10. Except, however, for any Plan Year beginning prior to January 1, 1990, and if elected in the non-standardized Adoption Agreement for any Plan Year beginning on or after January 1, 1990, a Participant who performs less than a Year of Service during any Plan Year shall not share in the Plan Forfeitures for that year, unless there is a Short Plan Year or a contribution required pursuant to Section 4.4(h). (f) Minimum Allocations Required for Top Heavy Plan Years: Notwithstanding the foregoing, for any Top Heavy Plan Year, the sum of the Employer's contributions and Forfeitures allocated to the Participant's Combined Account of each Non-Key Employee shall be equal to at least three percent (3%) of such Non-Key Employee's "415 Compensation" (reduced by contributions and forfeitures, if any, allocated to each Non-Key Employee in any defined contribution plan included with this plan in a Required Aggregation Group). However, if (i) the sum of the Employer's contributions and Forfeitures allocated to the Participant's Combined Account of each Key Employee for such Top Heavy Plan Year is less than three percent (3%) of each Key Employee's "415 Compensation" and (ii) this Plan is not required to be included in an Aggregation Group to enable a defined benefit plan to meet the requirements of Code Section 401(a)(4) or 410, the sum of the Employer's contributions and Forfeitures allocated to the Participant's Combined Account of each Non-Key Employee shall be equal to the largest percentage allocated to do Participant's Combined Account of any Key Employee. However, for Plan years beginning after December 31, 1988, in determining whether a Non-Key Employee has received the required minimum allocation, such 25 33 Non-Key Employee's Deferred Compensation and matching contributions used to satisfy the "Actual Deferral Percentage" test pursuant to Section 4.5(a) or the "Actual Contribution Percentage" test of Section 4.7(a) shall not be taken into account. If this is an integrated Plan, then for any Top Heavy Plan Year the Employer's contribution shall be allocated as follows: (1) An amount equal to 3% multiplied by each Participant's Compensation for the Plan Year shall be allocated to each Participant's Account. If the Employer does not contribute such amount for all Participants, the amount shall be allocated to each Participant's Account in the same proportion that his total Compensation for the Plan Year bears to the total Compensation of all Participants for such year. (2) The balance of the Employer's contribution over the amount allocated under subparagraph (1) hereof shall be allocated to each Participant's Account in a dollar amount equal to 3% multiplied by a Participant's Excess Compensation. If the Employer does not contribute such amount for all Participants, each Participant will be allocated a share of the contribution in the same proportion that his Excess Compensation bears to the total Excess Compensation of all Participants for that year. (3) The balance of the Employer's contribution over the amount allocated under subparagraph (2) hereof shall be allocated to each Participant's Account in a dollar amount equal to 2.7% multiplied by the sum of each Participant's total Compensation plus Excess Compensation. If the Employer does not contribute such amount for all Participants, each Participant will be allocated a share of the contribution in the same proportion that his total Compensation plus his total Excess Compensation for the Plan Year bears to the total Compensation plus the total Excess Compensation of all Participants for that year. Regardless of the preceding, 1.3% shall be substituted for 2.7% above if Excess Compensation is based on more than 20% and less than or equal to 80% of the Taxable Wage Base. If Excess Compensation is based on less than 100% and more than 80% of the Taxable Wage Base, then 2.4% shall be substituted for 2.7% above. (4) The balance of the Employer's contributions over the amount allocated above, if any, shall be allocated to each Participant's Account in the same proportion that his total Compensation for the Plan Year bears to the total Compensation of all Participants for such year. For each Non-Key Employee who is a Participant in this Plan and another non-paired defined contribution plan maintained by the Employer, the minimum 3% allocation specified above shall be provided as specified in F3 of the Adoption Agreement. (g) For purposes of the minimum allocations set forth above, the percentage allocated to the Participant's Combined Account of any Key Employee shall be equal to the ratio of the sum of the Employer's contributions and Forfeitures allocated on behalf of such Key Employee divided by the "415 Compensation" for such Key Employee. (h) For any Top Heavy Plan Year, the minimum allocations set forth above shall be allocated to the Participant's Combined Account of all Non-Key Employees who are Participants and who are employed by the Employer on the last day of the Plan Year, including Non-Key Employees who have 26 34 (1) failed to complete a Year of Service; or (2) declined to make mandatory contributions (if required) or salary reduction contributions to the Plan. (i) Notwithstanding anything herein to the contrary, in any Plan Year in which the Employer maintains both this Plan and a defined benefit pension plan included in a Required Aggregation Group which is top heavy, the Employer shall not be required to provide a Non-Key Employee with both the full separate minimum defined benefit plan benefit and the full separate defined contribution plan allocations. Therefore, if the Employer maintains both a Defined Benefit and a Defined Contribution Plan that are a Top Heavy Group, the top heavy minimum benefits shall be provided as follows: Applies if F1b of the Adoption Agreement is selected - (1) The requirements of Section 2.1 shall apply except that each Non-Key Employee who is a Participant in this Plan or a Money Purchase Plan and who is also a Participant in the Defined Benefit Plan shall receive a minimum allocation of five percent (5%) of such Participant's "415 Compensation" from the applicable Defined Contribution Plan(s). (2) For each Non-Key Employee who is a Participant only in the Defined Benefit Plan, the Employer will provide a minimum non-integrated benefit in the Defined Benefit Plan equal to 2% of his highest five consecutive year average "415 Compensation" for each Year of Service while a Participant in the Plan, in which the Plan is top heavy, not to exceed ten. (3) For each Non-Key Employee who is a Participant only in this Defined Contribution Plan, the Employer will provide a contribution equal to 3% of his "415 Compensation". Applies if F1c of the Adoption Agreement is selected - (4) The minimum allocation specified in Section 4.4(i)(1) shall be 7 1/2% for years in which the Plan is Top Heavy, but not Super Top Heavy. (5) The minimum benefit specified in Section 4.4(i)(2) shall be 3% for years in which the Plan is Top Heavy, but not Super Top Heavy. (6) The minimum allocation specified in Section 4.4(i)(3) shall be 4% for years in which the Plan is Top Heavy, but not Super Top Heavy. (j) For the purposes of this Section, "415 Compensation" shall be limited to $200,000 (unless adjusted in such manner as permitted under Code Section 415(d)). However, for Plan Years beginning prior to January 1, 1989, the $200,000 limit shall apply only for Top Heavy Plan Years and shall not be adjusted. (k) Notwithstanding anything herein to the contrary, participants who terminated employment during the Plan Year shall share in the salary reduction contributions made by the Employer for the year of termination without regard to the Hours of Service credited. (l) Notwithstanding anything herein to the contrary (other than Sections 4.4(k) and 6.6(h)(1)), any Participant who terminated employment during the Plan Year for reasons other than death, Total and Permanent Disability, or retirement shall or shall not share in the allocations of the Employer's Matching Contribution made pursuant to Section 4.1(b), the Employer's Non-Elective Contributions made pursuant to Section 4.1(c), the Employer's Qualified Non-Elective Contribution made pursuant to Section 4.1(d), and Forfeitures as provided in the Adoption Agreement. Notwithstanding the 27 35 foregoing, for Plan Years beginning after 1989, if this is a standardized Plan, any such terminated Participant shall share in such allocations provided the terminated Participant completed more than 500 Hours of Service. (m) Notwithstanding anything herein to the contrary, Participants terminating for reasons of death, Total and Permanent Disability, or retirement shall share in the allocation of the Employer's Matching Contribution made pursuant to Section 4.1(b), the Employer's Non-Elective Contributions made pursuant to Section 4.1(c), the Employer's Qualified Non-Elective Contribution made pursuant to Section 4.1(d), and Forfeitures as provided in this Section regardless of whether they completed a Year of Service during the Plan Year. (n) If a Former Participant is reemployed after five (5) consecutive 1-Year Breaks in Service, then separate accounts shall be maintained as follows: (1) one account for nonforfeitable benefits attributable to pre-break service; and (2) one account representing his status in the Plan attributable to post-break service. (o) Notwithstanding any election in the Adoption Agreement to the contrary, if this is a non-standardized Plan that would otherwise fail to meet the requirements of Code Sections 401(a)(26), 410(b)(1), or 410(b)(2)(A)(i) and the Regulations thereunder because Employer matching Contributions made pursuant to Section 4.1(b), Employer Non-Elective Contributions made pursuant to Section 4.1(c) or Employer Qualified Non-Elective Contributions made pursuant to Section 4.1(d) have not been allocated to a sufficient number or percentage of Participants for a Plan Year, then the following rules shall apply: (1) Allocations of the respective contribution and Forfeitures shall first be made to all active Participants who are employed on the last day of the Plan Year, regardless of the number of Hours of Service completed; and (2) If after application of paragraph (1) above, the applicable test is still not satisfied, then the group of Participants eligible to share in the Employer's contribution and Forfeitures for the Plan Year shall be further expanded to include the minimum number of Participants who are not actively employed on the last day of the Plan Year as are necessary to satisfy the applicable test. The specific Participants who shall become eligible to share shall be those Participants, when compared to similarly situated Participants, who have completed the greatest number of Hours of Service in the Plan Year before terminating employment. Nothing in this Section shall permit the reduction of a Participant's accrued benefit. Therefore any amounts that have previously been allocated to Participants may not be reallocated to satisfy these requirements. In such event, the Employer shall make an additional contribution equal to the amount such affected Participants would have received had they been included in the allocations, even if it exceeds the amount which would be deductible under Code Section 404. Any adjustment to the allocations pursuant to this paragraph shall be considered a retroactive amendment adopted by the last day of the Plan Year. 4.5 ACTUAL DEFERRAL PERCENTAGE TESTS (a) Maximum Annual Allocation: For each Plan Year beginning after December 31, 1986, the annual allocation derived from Employer Elective Contributions and Qualified Non-Elective 28 36 Contributions to a Participant's Elective Account and Qualified Non-Elective Account shall satisfy one of the following tests: (1) The "Actual Deferral Percentage" for the Highly Compensated Participant group shall not be more than the "Actual Deferral Percentage" of the Non-Highly Compensated Participant group multiplied by 1.25, or (2) The excess of the "Actual Deferral Percentage" for the Highly Compensated Participant group over the "Actual Deferral Percentage" for the Non-Highly Compensated Participant group shall not be more than two percentage points. Additionally, the "Actual Deferral Percentage" for the Highly Compensated Participant group shall not exceed the "Actual Deferral Percentage" for the Non-Highly Compensated Participant group multiplied by 2. The provisions of Code Section 401(k)(3) and Regulation 1.401(k)-1(b) are incorporated herein by reference. However, for Plan Years beginning after December 31, 1988, to prevent the multiple use of the alternative method described in (2) above and Code Section 401(m)(9)(A), any Highly Compensated Participant eligible to make elective deferrals pursuant to Section 4.2 and to make Employee contributions or to receive matching contributions under this Plan or under any other plan maintained by the Employer or an Affiliated Employer shall have his actual contribution ratio reduced pursuant to Regulation 1.401(m)-2, the provisions of which are incorporated herein by reference. (b) For the purposes of this Section "Actual Deferral Percentage" means, with respect to the Highly Compensated Participant group and Non-Highly Compensated Participant group for a Plan Year, the average of the ratios, calculated separately for each Participant in such group, of the amount of Employer Elective Contributions and Qualified Non-Elective Contributions allocated to each Participant's Elective Account and Qualified Non-Elective Account for such Plan Year, to such Participant's "414(s) Compensation" for such Plan Year. The actual deferral ratio for each Participant and the "Actual Deferral Percentage" for each group, for Plan Years beginning after December 31, 1988, shall be calculated to the nearest one-hundredth of one percent of the Participant's "414(s) Compensation". Employer Elective Contributions allocated to each Non-Highly Compensated Participant's Elective Account shall be reduced by Excess Deferred Compensation to the extent such excess amounts are made under this Plan or any other plan maintained by the Employer. (c) For the purpose of determining the actual deferral ratio of a Highly Compensated Participant who is subject to the Family Member aggregation rules of Code Section 414(q)(6) because such Participant is either a "five percent owner" of the Employer or one of the ten (10) Highly Compensated Employees paid the greatest "415 Compensation" during the year, the following shall apply: (1) The combined actual deferral ratio for the family group (which shall be treated as one Highly Compensated Participant) shall be the greater of: (i) the ratio determined by aggregating Employer Elective Contributions and "414(s) Compensation" of all eligible Family Members who are Highly Compensated Participants without regard to family aggregation; and (ii) the ratio determined by aggregating Employer Elective Contributions and "414(s) Compensation" of all eligible Family Members (including Highly Compensated Participants). However, in applying the $200,000 limit to "414(s) Compensation" for Plan 29 37 Years beginning after December 31, 1988, Family Members shall include only the affected Employee's spouse and any lineal descendants who have not attained age 19 before the close of the Plan Year. (2) The Employer Elective Contributions and "414(s) Compensation" of all Family Members shall be disregarded for purposes of determining the "Actual Deferral Percentage" of the Non-Highly Compensated Participant group except to the extent taken into account in paragraph (1) above. (3) If a Participant is required to be aggregated as a member of more than one family group in a plan, all Participants who are members of those family groups that include the Participant are aggregated as one family group in accordance with paragraphs (1) and (2) above. (d) For the purposes of Sections 4.5(a) and 4.6, a Highly Compensated Participant and a Non-Highly Compensated Participant shall include any Employee eligible to make a deferral election pursuant to Section 4.2, whether or not such deferral election was made or suspended pursuant to Section 4.2. (e) For the purposes of this Section and Code Sections 401(a)(4), 410(b) and 401(k), if two or more plans which include cash or deferred arrangements are considered one plan for the purposes of Code Section 401(a)(4) or 410(b)(other than Code Section 401(b)(2)(A)(ii)as in effect for Plan Years beginning after December 31, 1988), the cash or deferred arrangements included in such plans shall be treated as one arrangement. In addition, two or more cash or deferred arrangements may be considered as a single arrangement for purposes of determining whether or not such arrangements satisfy Code Sections 401(a)(4),410(b) and 401(k). In such a case, the cash or deferred arrangements included in such plans and the plans including such arrangements shall be treated as one arrangement and as one plan for purposes of this Section and Code Sections 401(a)(4), 410(b) and 401(k). For plan years beginning after December 31, 1989, plans may be aggregated under this paragraph (e) only if they have the same plan year. Notwithstanding the above, for Plan Years beginning after December 31, 1988, an employee stock ownership plan described in Code Section 4975(e)(7) may not be combined with this Plan for purposes of determining whether the employee stock ownership plan or this Plan satisfies this Section and Code Sections 401(a)(4), 410(b) and 401(k). (f) For the purposes of this Section, if a Highly Compensated Participant is a Participant under two (2) or more cash or deferred arrangements (other than a cash or deferred arrangement which is part of an employee stock ownership plan as defined in Code Section 4975(e)(7) for Plan Years beginning after December 31, 1988) of the Employer or an Affiliated Employer, all such cash or deferred arrangements shall be treated as one cash or deferred arrangement for the purpose of determining the actual deferral ratio with respect to such Highly Compensated Participant. However, for Plan Years beginning after December 31, 1988, if the cash or deferred arrangements have different Plan Years, this paragraph shall be applied by treating all cash or deferred arrangements ending with or within the same calendar year as a single arrangement. 4.6 ADJUSTMENT TO ACTUAL DEFERRAL PERCENTAGE TESTS In the event that the initial allocations of the Employer's Elective Contributions and Qualified Non-Elective Contributions made pursuant to Section 4.4 do not satisfy one of the tests set forth in Section 30 38 4.5, for Plan Years beginning after December 31, 1986, the Administrator shall adjust Excess Contributions pursuant to the options set forth below: (a) On or before the fifteenth day of the third month following the end of each Plan Year, the Highly Compensated Participant having the highest actual deferral ratio shall have his portion of Excess Contributions distributed to him and/or at his election recharacterized as a voluntary Employee contribution pursuant to Section 4.12 until one of the tests set forth in Section 4.5 is satisfied, or until his actual deferral ratio equals the actual deferral ratio of the Highly Compensated Participant having the second highest actual deferral ratio. This process shall continue until one of the tests set forth in Section 4.5 is satisfied. For each Highly Compensated Participant, the amount of Excess Contributions is equal to the Elective Contributions and Qualified Non-Elective Contributions made on behalf of such Highly Compensated Participant (determined prior to the application of this paragraph) minus the amount determined by multiplying the Highly Compensated Participant's actual deferral ratio (determined after application of this paragraph) by his "414(s) Compensation". However, in determining the amount of Excess Contributions to be distributed and/or recharacterized with respect to an affected Highly Compensated Participant as determined herein, such amount shall be reduced by any Excess Deferred Compensation previously distributed to such affected Highly Compensated Participant for his taxable year ending with or within such Plan Year. Any distribution and/or recharacterization of Excess Contributions shall be made in accordance with the following: (1) With respect to the distribution of Excess Contributions pursuant to (a) above, such distribution: (i) may be postponed but not later than the close of the Plan Year following the Plan Year to which they are allocable; (ii) shall be made first from unmatched Deferred Compensation and, thereafter, simultaneously from Deferred Compensation which is matched and matching contributions which relate to such Deferred Compensation. However, any such matching contributions which are not Vested shall be forfeited in lieu of being distributed; (iii) shall be made from Qualified Non-Elective Contributions only to the extent that Excess Contributions exceed the balance in the Participant's Elective Account attributable to Deferred Compensation and Employer matching contributions. (iv) shall be adjusted for Income; and (v) shall be designated by the Employer as a distribution of Excess Contributions (and Income). (2) With respect to the recharacterization of Excess Contributions pursuant to (a) above, such recharacterized amounts: (i) shall be deemed to have occurred on the date on which the last of those Highly Compensated Participants with Excess Contributions to be recharacterized is notified of the recharacterization and the tax consequences of such recharacterization; (ii) for Plan Years ending on or before August 8, 1988, may be postponed but not later than October 24, 1988; 31 39 (iii) shall not exceed the amount of Deferred Compensation on behalf of any Highly Compensated Participant for any Plan Year; (iv) shall be treated as voluntary Employee contributions for purposes of Code Section 401(a)(4) and Regulation 1.401(k)-1(b). However, for purposes of Sections 2.2 and 4.4(f), recharacterized Excess Contributions continue to be treated as Employer contributions that are Deferred Compensation. For Plan Years beginning after December 31, 1988, Excess Contributions recharacterized as voluntary Employee contributions shall continue to be nonforfeitable and subject to the same distribution rules provided for in Section 4.9(f); (v) which relate to Plan Years ending on or before October 24, 1988, may be treated as either Employer contributions or voluntary Employee contributions and therefore shall not be subject to the restrictions of Section 4.2(c); (vi) are not permitted if the amount recharacterized plus voluntary Employee contributions actually made by such Highly Compensated Participant, exceed the maximum amount of voluntary Employee contributions (determined prior to application of Section 4.7(a)) that such Highly Compensated Participant is permitted to make under the Plan in the absence of recharacterization; (vii) shall be adjusted for Income. (3) Any distribution and/or recharacterization of less than the entire amount of Excess Contributions shall be treated as a pro rata distribution and/or recharacterization of Excess Contributions and Income. (4) The determination and correction of Excess Contributions of a Highly Compensated Participant whose actual deferral ratio is determined under the family aggregation rules shall be accomplished as follows: (i) If the actual deferral ratio for the Highly Compensated Participant is determined in accordance with Section 4.5(c)(1)(ii), then the actual deferral ratio shall be reduced as required herein and the Excess Contributions for the family unit shall be allocated among the Family Members in proportion to the Elective Contributions of each Family Member that were combined to determine the group actual deferral ratio. (ii) If the actual deferral ratio for the Highly Compensated Participant is determined under Section 4.5(c)(1)(i), then the actual deferral ratio shall first be reduced as required herein, but not below the actual deferral ratio of the group of Family Members who are not Highly Compensated Participants without regard to family aggregation. The Excess Contributions resulting from this initial reduction shall be allocated (in proportion to Elective Contributions) among the Highly Compensated Participants whose Elective Contributions were combined to determine the actual deferral ratio. If further reduction is still required, then Excess Contributions resulting from this further reduction shall be determined by taking into account the contributions of all Family Members and shall be allocated among them in proportion to their respective Elective Contributions. 32 40 (b) Within twelve (12) months after the end of the Plan Year, the Employer shall make a special Qualified Non-Elective Contribution on behalf of Non-Highly Compensated Participants in an amount sufficient to satisfy one of the tests set forth in Section 4.5(a). Such contribution shall be allocated to the Participant's Qualified Non-Elective Account of each Non-Highly Compensated Participant in the same proportion that each Non-Highly Compensated Participant's Compensation for the year bears to the total Compensation of all Non-Highly Compensated Participants. (c) For purposes of this Section, "Income" means the income or loss allocable to Excess Contributions which shall equal the sum of the allocable gain or loss for the Plan Year and the allocable gain or loss for the period between the end of the Plan Year and the date of distribution ("gap period"). The income or loss allocable to Excess Contributions for the Plan Year and the "gap period" is calculated separately and is determined by multiplying the income or loss for the Plan Year or the "gap period" by a fraction. The numerator of the fraction is the Excess Contributions for the Plan Year. The denominator of the fraction is the total of the Participant's Elective Account attributable to Elective Contributions and the Participant's Qualified Non-Elective Account as of the end of the Plan Year or the "gap period", reduced by the gain allocable to such total amount for the Plan Year or the "gap period" and increased by the loss allocable to such total amount for the Plan Year or the "gap period". In lieu of the "fractional method" described above, a "safe harbor method" may be used to calculate the allocable Income for the "gap period". Under such "safe harbor method", allocable Income for the "gap period" shall be deemed to equal ten percent (10%) of the Income allocable to Excess Contributions for the Plan Year of the Participant multiplied by the number of calendar months in the "gap period". For purposes of determining the number of calendar months in the "gap period", a distribution occurring on or before the fifteenth day of the mouth shall be treated as having been made on the last day of the preceding month and a distribution occurring after such fifteenth day shall be treated as having been made on the first day of the next subsequent month. Notwithstanding the above, for Plan Years which began in 1987, Income during the "gap period" shall not be taken into account. (d) Any amounts not distributed or recharacterized within 2 1/2 months after the end of the Plan Year shall be subject to the 10% Employer excise tax imposed by Code Section 4979. 4.7 ACTUAL CONTRIBUTION PERCENTAGE TESTS (a) The "Actual Contribution Percentage", for Plan Years beginning after the later of the Effective Date of this Plan or December 31, 1986, for the Highly Compensated Participant group shall not exceed the greater of: (1) 125 percent of such percentage for the Non-Highly Compensated Participant group; or (2) the lesser of 200 percent of such percentage for the Non-Highly Compensated Participant group, or such percentage for the Non-Highly Compensated Participant group plus 2 percentage points. However, for Plan Years beginning after December 31, 1988, to prevent the multiple use of the alternative method described in this paragraph and Code Section 401(m)(9)(A), any Highly Compensated Participant eligible to make elective deferrals pursuant to Section 4.2 or any other cash or deferred arrangement maintained by the Employer or an Affiliated Employer and to make Employee contributions or to receive matching contributions under any plan maintained by the Employer or an Affiliated Employer shall have his actual contribution ratio reduced pursuant to Regulation 1.401(m)-2. The 33 41 provisions of Code Section 401(m) and Regulations 1.401(m)-1(b) and 1.401(m)-2 are incorporated herein by reference. (b) For the purposes of this Section and Section 4.8, "Actual Contribution Percentage" for a Plan Year means, with respect to the Highly Compensated Participant group and Non-Highly Compensated Participant group, the average of the ratios (calculated separately for each Participant in each group) of: (1) the sum of Employer matching contributions pursuant to Section 4.1(b) (to the extent such matching contributions are not used to satisfy the tests set forth in Section 4.5), voluntary Employee contributions made pursuant to Section 4.12 and Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 4.6(a) contributed under the Plan on behalf of each such Participant for such Plan Year; to (2) the Participant's "414(s) Compensation" for such Plan Year. (c) For purposes of determining the "Actual Contribution Percentage" and the amount of Excess Aggregate Contributions pursuant to Section 4.8(e), only Employer matching contributions contributed to the Plan prior to the end of the succeeding Plan Year shall be considered. In addition, the Administrator may elect to take into account, with respect to Employees eligible to have Employer matching contributions made pursuant to Section 4.1(b) or voluntary Employee contributions made pursuant to Section 4.12 allocated to their accounts, elective deferrals (as defined in Regulation 1.402(g)-1(b)) and qualified non-elective contributions (as defined in Code Section 401(m)(4)(C)) contributed to any plan maintained by the Employer. Such elective deferrals and qualified non-elective contributions shall be treated as Employer matching contributions subject to Regulation 1.401(m)-1(b)(2) which is incorporated herein by reference. However, for Plan Years beginning after December 31, 1988, the Plan Year must be the same as the plan year of the plan to which the elective deferrals and the qualified non-elective contributions are made. (d) For the purpose of determining the actual contribution ratio of a Highly Compensated Employee who is subject to the Family Member aggregation rules of Code Section 414(q)(6) because such Employee is either a "five percent owner" of the Employer or one of the ten (10) Highly Compensated Employees paid the greatest "415 Compensation" during the year, the following shall apply: (1) The combined actual contribution ratio for the family group (which shall be treated as one Highly Compensated Participant) shall be the greater of: (i) the ratio determined by aggregating Employer matching contributions made pursuant to Section 4.1(b) (to the extent such matching contributions are not used to satisfy the tests set forth in Section 4.5), voluntary Employee contributions made pursuant to Section 4.12, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 4.6(a) and "414(s) Compensation" of all eligible Family Members who are Highly Compensated Participants without regard to family aggregation; and (ii) the ratio determined by aggregating Employer matching contributions made pursuant to Section 4.1(b) (to the extent such matching contributions are not used to satisfy the tests set forth in Section 4.5), voluntary Employee contributions made pursuant to Section 4.12, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 4.6(a) and "414(s) Compensation" of all eligible Family Members (including Highly Compensated Participants). However, in applying the $200,000 limit to "414(s) Compensation" for Plan Years beginning after December 31, 1988, Family Members shall include only the affected Employee's spouse and any lineal descendants who have not attained age 19 before the close of the Plan Year. 34 42 (2) The Employer matching contributions made pursuant to Section 4.1(b) (to the extent such matching contributions are not used to satisfy the tests set forth in Section 4.5), voluntary Employee contributions made pursuant to Section 4.12, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 4.6(a) and "414(s) Compensation" of all Family Members shall be disregarded for purposes of determining the "Actual Contribution Percentage" of the Non-Highly Compensated Participant group except to the extent taken into account in paragraph (1) above. (3) If a Participant is required to be aggregated as a member of more than one family group in a plan, all Participants who are members of those family groups that include the Participant are aggregated as one family group in accordance with paragraphs (1) and (2) above. (e) For purposes of this Section and Code Sections 40l(a)(4), 410(b) and 4Ol(m), if two or more plans of the Employer to which matching contributions, Employee contributions, or both, are made are treated as one plan for purposes of Code Sections 401(a)(4) or 410(b) (other than the average benefits test under Code Section 410(b)(2)(A)(ii) as in effect for Plan Years beginning after December 31, 1988), such plans shall be treated as one plan. In addition, two or more plans of the Employer to which matching contributions, Employee contributions, or both, are made may be considered as a single plan for purposes of determining whether or not such plans satisfy Code Sections 401(a)(4), 410(b) and 401(m). In such a case, the aggregated plans must satisfy this Section and Code Sections 401(a)(4), 410(b) and 401(m) as though such aggregated plans were a single plan. For plan years beginning after December 31, 1989, plans may be aggregated under this paragraph only if they have the same plan year. Notwithstanding the above, for Plan Years beginning after December 31, 1988, an employee stock ownership plan described in Code Section 4975(e)(7) may not be aggregated with this Plan for purposes of determining whether the employee stock ownership plan or this Plan satisfies this Section and Code Sections 401(a)(4), 410(b) and 401(m). (f) If a Highly Compensated Participant is a Participant under two or more plans (other than an employee stock ownership plan as defined in Code Section 4975(e)(7) for Plan Years beginning after December 31, 1988) which are maintained by the Employer or an Affiliated Employer to which matching contributions, Employee contributions, or both, are made, all such contributions on behalf of such Highly Compensated Participant shall be aggregated for purposes of determining such Highly Compensated Participant's actual contribution ratio. However, for Plan Years beginning after December 31, 1988, if the plans have different plan years, this paragraph shall be applied by treating all plans ending with or within the same calendar year as a single plan. (g) For purposes of Section 4.7(a) and 4.8, a Highly Compensated Participant and a Non-Highly Compensated Participant shall include any Employee eligible to have matching contributions made pursuant to Section 4.1(b) (whether or not a deferred election was made or suspended pursuant to Section 4.2(e)) allocated to his account for the Plan Year or to make salary deferrals pursuant to Section 4.2 (if the Employer uses salary deferrals to satisfy the provisions of this Section) or voluntary Employee contributions pursuant to Section 4.12 (whether or not voluntary Employee contributions are made) allocated to his account for the Plan Year. (h) For purposes of this Section, "Matching Contribution" shall mean an Employee contribution made to the Plan, or to a contract described in Code Section 403(b), on behalf of a Participant on account of an Employee contribution made by such Participant, or on account of a participant's deferred compensation, under a plan maintained by the Employer. 35 43 4.8 ADJUSTMENT TO ACTUAL CONTRIBUTION PERCENTAGE TESTS (a) In the event that for Plan Years beginning after December 31, 1986, the "Actual Contribution Percentage" for the Highly Compensated Participant group exceeds the "Actual Contribution Percentage" for the Non-Highly Compensated Participant group pursuant to Section 4.7(a), the Administrator (on or before the fifteenth day of the third month following the end of the Plan Year, but in no event later than the close of the following Plan Year) shall direct the Trustee to distribute to the Highly Compensated Participant having the highest actual contribution ratio, his portion of Excess Aggregate Contributions (and Income allocable to such contributions) or, if forfeitable, forfeit such non-Vested Excess Aggregate Contributions attributable to Employer matching contributions (and Income allocable to such Forfeitures) until either one of the tests set forth in Section 4.7(a) is satisfied, or until his actual contribution ratio equals the actual contribution ratio of the Highly Compensated Participant having the second highest actual contribution ratio. This process shall continue until one of the tests set forth in Section 4.7(a) is satisfied. The distribution and/or Forfeiture of Excess Aggregate Contributions shall be made in the following order: (1) Employer matching contributions distributed and/or forfeited pursuant to Section 4.6(a)(1); (2) Voluntary Employee contributions including Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 4.6(a)(2); (3) Remaining Employer matching contributions. (b) Any distribution or Forfeiture of less than the entire amount of Excess Aggregate Contributions (and Income) shall be treated as a pro rata distribution of Excess Aggregate Contributions and Income. Distribution of Excess Aggregate Contributions shall be designated by the Employer as a distribution of Excess Aggregate Contributions (and Income). Forfeitures of Excess Aggregate Contributions shall be treated in accordance with Section 4.4. However, no such Forfeiture may be allocated to a Highly Compensated Participant whose contributions are reduced pursuant to this Section. (c) Excess Aggregate Contributions attributable to amounts other than voluntary Employee contributions, including forfeited matching contributions, shall be treated as Employer contributions for purposes of Code Sections 404 and 415 even if distributed from the Plan. (d) For the purposes of this Section and Section 4.7, "Excess Aggregate Contributions" means, with respect to any Plan Year, the excess of: (1) the aggregate amount of Employer matching contributions made pursuant to Section 4.1(b) (to the extent such contributions are taken into account pursuant to Section 4.7(b)), voluntary Employee contributions made pursuant to Section 4.12, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 4.6(a) and any Qualified Non-Elective Contributions or elective deferrals taken into account pursuant to Section 4.7(c) actually made on behalf of the Highly Compensated Participant group for such Plan Year, over (2) the maximum amount of such contributions permitted under the limitations of Section 4.7(a). 36 44 (e) For each Highly Compensated Participant, the amount of Excess Aggregate Contributions is equal to the total Employer matching contributions made pursuant to Section 4.1(b) (to the extent taken into account pursuant to Section 4.7(b)), voluntary Employee contributions made pursuant to Section 4.12, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 4.6(a) and any Qualified Non-Elective Contributions or elective deferrals taken into account pursuant to Section 4.7(c) on behalf of the Highly Compensated Participant (determined prior to the application of this paragraph) minus the amount determined by multiplying the Highly Compensated Participant's actual contribution ratio (determined after application of this paragraph) by his "414(s) Compensation". The actual contribution ratio must be rounded to the nearest one-hundredth of one percent for Plan Years beginning after December 31, 1988. In no case shall the amount of Excess Aggregate Contribution with respect to any Highly Compensated Participant exceed the amount of Employer matching contributions made pursuant to Section 4.1(b) (to the extent taken into account pursuant to Section 4.7(b)), voluntary Employee contributions made pursuant to Section 4.12, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 4.6(a) and any Qualified Non-Elective Contributions or elective deferrals taken into account pursuant to Section 4.7(c) on behalf of such Highly Compensated Participant for such Plan Year. (f) The determination of the amount of Excess Aggregate Contributions with respect to any Plan Year shall be made after first determining the Excess Contributions, if any, to be treated as voluntary Employee contributions due to recharacterization for the plan year of any other qualified cash or deferred arrangement (as defined in Code Section 401(k)) maintained by the Employer that ends with or within the Plan Year or which are treated as voluntary Employee contributions due to recharacterization pursuant to Section 4.6(a). (g) The determination and correction of Excess Aggregate Contributions of a Highly Compensated Participant whose actual contribution ratio is determined under the family aggregation rules shall be accomplished as follows: (1) If the actual contribution ratio for the Highly Compensated Participant is determined in accordance with Section 4.7(d)(1)(ii), then the actual contribution ratio shall be reduced and the Excess Aggregate Contributions for the family unit shall be allocated among the Family Members in proportion to the sum of Employer matching contributions made pursuant to Section 4.1(b) (to the extent taken into account pursuant to Section 4.7(b)), voluntary Employee contributions made pursuant to Section 4.12, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 4.6(a) and any Qualified Non-Elective Contributions or elective deferrals taken into account pursuant to Section 4.7(c) of each Family Member that were combined to determine the group actual contribution ratio. (2) If the actual contribution ratio for the Highly Compensated Participant is determined under Section 4.7(d)(1)(i), then the actual contribution ratio shall first be reduced, as required herein, but not below the actual contribution ratio of the group of Family Members who are not Highly Compensated Participants without regard to family aggregation. The Excess Aggregate Contributions resulting from this initial reduction shall be allocated among the Highly Compensated Participants whose Employer matching contributions made pursuant to Section 4.1(b) (to the extent taken into account pursuant to Section 4.7(b)), voluntary Employee contributions made pursuant to Section 4.12, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 4.6(a) and any Qualified Non-Elective Contributions or elective deferrals taken into account pursuant to Section 4.7(c) were combined to determine the actual contribution ratio. If further reduction is still required, then Excess Aggregate Contributions resulting from this further reduction shall be determined by taking into account the contributions of all Family Members and shall be allocated among 37 45 them in proportion to their respective Employer matching contributions made pursuant to Section 4.1(b) (to the extent taken into account pursuant to Section 4.7(b)), voluntary Employee contributions made pursuant to Section 4.12, Excess Contributions recharacterized as voluntary Employee contributions pursuant to Section 4.6(a) and any Qualified Non-Elective Contributions or elective deferrals taken into account pursuant to Section 4.7(c). (h) Notwithstanding the above, within twelve (12) months after the end of the Plan Year, the Employer may make a special Qualified Non-Elective Contribution on behalf of Non-Highly Compensated Participants in an amount sufficient to satisfy one of the tests set forth in Section 4.7(a). Such contribution shall be allocated to the Participant's Qualified Non-Elective Account of each Non-Highly Compensated Participant in the same proportion that each Non-Highly Compensated Participant's Compensation for the year bears to the total Compensation of all Non-Highly Compensated Participants. A separate accounting shall be maintained for the purpose of excluding such contributions from the "Actual Deferral Percentage" tests pursuant to Code Section 4.5(a). (i) For purposes of this Section, "Income" means the income or loss allocable to Excess Aggregate Contributions which shall equal the sum of the allocable gain or loss for the Plan Year and the allocable gain or loss for the period between the end of the Plan Year and the date of distribution ("gap period"). The income or loss allocable to Excess Aggregate Contributions for the Plan Year and the "gap period" is calculated separately and is determined by multiplying the income or loss for the Plan Year or the "gap period" by a fraction. The numerator of the fraction is the Excess Aggregate Contributions for the Plan Year. The denominator of the fraction is the total Participant's Account and Voluntary Contribution Account attributable to Employer matching contributions subject to Section 4.7, voluntary Employee contributions made pursuant to Section 4.12, and any Qualified Non-Elective Contributions and elective deferrals taken into account pursuant to Section 4.7(c) as of the end of the Plan Year or the "gap period", reduced by the gain allocable to such total amount for the Plan Year or the "gap period" and increased by the loss allocable to such total amount for the Plan Year or the "gap period". In lieu of the "fractional method" described above, a "safe harbor method" may be used to calculate the allocable Income for the "gap period". Under such "safe harbor method", allocable Income for the "gap period" shall be deemed to equal ten percent (10%) of the Income allocable to Excess Aggregate Contributions for the Plan Year of the Participant multiplied by the number of calendar months in the "gap period". For purposes of determining the number of calendar months in the "gap period", a distribution occurring on or before the fifteenth day of the month shall be treated as having been made on the last day of the preceding month and a distribution occurring after such fifteenth day shall be treated as having been made on the first day of the next subsequent month. The Income allocable to Excess Aggregate Contributions resulting from recharacterization of Elective Contributions shall be determined and distributed as if such recharacterized Elective Contributions had been distributed as Excess Contributions. Notwithstanding the above, for Plan Years which began in 1987, Income during the "gap period" shall not be taken into account. 4.9 MAXIMUM ANNUAL ADDITIONS (a)(1) If the Participant does not participate in, and has never participated in another qualified plan maintained by the Employer, or a welfare benefit fund (as defined in Code Section 419(e)), maintained by the Employer, or an individual medical account (as defined in Code Section 415(l)(2)) maintained by the Employer, which provides Annual Additions, the amount of Annual Additions 38 46 which may be credited to the Participant's accounts for any Limitation Year shall not exceed the lesser of the Maximum Permissible Amount or any other limitation contained in this Plan. If the Employer contribution that would otherwise be contributed or allocated to the Participant's accounts would cause the Annual Additions for the Limitation Year to exceed the Maximum Permissible Amount, the amount contributed or allocated will be reduced so that the Annual Additions for the Limitation Year will equal the Maximum Permissible Amount. (2) Prior to determining the Participant's actual Compensation for the Limitation Year, the Employer may determine the Maximum Permissible Amount for a Participant on the basis of a reasonable estimation of the Participant's Compensation for the Limitation Year, uniformly determined for all Participants similarly situated. (3) As soon as is administratively feasible after the end of the Limitation Year, the Maximum Permissible Amount for such Limitation Year shall be determined on the basis of the Participant's actual compensation for such Limitation Year. (4) If pursuant to Section 4.9(a)(2) or as a result of the allocation of Forfeitures, there is an Excess Amount, the excess will be disposed of as follows: (i) Any nondeductible Voluntary Employee Contributions, to the extent they would reduce the Excess Amount, will be returned to the Participant; (ii) If, after the application of subparagraph (i), an Excess Amount still exists, and the Participant is covered by the Plan at the end of the Limitation Year, the Excess Amount in the Participant's account will be used to reduce Employer contributions (including any allocation of Forfeitures) for such Participant in the next Limitation Year, and each succeeding Limitation Year if necessary; (iii) If, after the application of subparagraph (i), an Excess Amount still exists, and the Participant is not covered by the Plan at the end of a Limitation Year, the Excess Amount will be held unallocated in a suspense account. The suspense account will be applied to reduce future Employer contributions (including allocation of any Forfeitures) for all remaining Participants in the next Limitation Year, and each succeeding Limitation Year if necessary; (iv) If a suspense account is in existence at any time during a Limitation Year pursuant to this Section, it will not participate in the allocation of investment gains and losses. If a suspense account is in existence at any time during a particular limitation year, all amounts in the suspense account must be allocated and reallocated to participants' accounts before any employer contributions or any employee contributions may be made to the plan for that limitation year. Excess amounts may not be distributed to participants or former participants. (b)(1) This subsection applies if, in addition to this Plan, the Participant is covered under another qualified Prototype defined contribution plan maintained by the Employer, or a welfare benefit fund (as defined in Code Section 419(e)) maintained by the Employer, or an individual medical account (as defined in Code Section 415(l)(2)) maintained by the Employer, which provides Annual Additions, during any Limitation Year. The Annual Additions which way be credited to a Participant's accounts under this Plan for any such Limitation Year shall not exceed the Maximum Permissible Amount reduced by the Annual Additions credited to a Participant's accounts under the other plans and welfare benefit funds for the same Limitation Year. If the Annual Additions with 39 47 respect to the Participant under other defined contribution plans and welfare benefit funds maintained by the Employer are less than the Maximum Permissible Amount and the Employer contribution that would otherwise be contributed or allocated to the Participant's accounts under this Plan would cause the Annual Additions for the Limitation Year to exceed this limitation, the amount contributed or allocated will be reduced so that the Annual Additions under all such plans and welfare benefit funds for the Limitation Year will equal the Maximum Permissible Amount. If the Annual Additions with respect to the Participant under such other defined contribution plans and welfare benefit funds in the aggregate are equal to or greater than the Maximum Permissible Amount, no amount will be contributed or allocated to the Participant's account under this Plan for the Limitation Year. (2) Prior to determining the Participant's actual Compensation for the Limitation Year, the Employer may determine the Maximum Permissible Amount for a Participant in the manner described in Section 4.9(a)(2). (3) As soon as is administratively feasible after the end of the Limitation Year, the Maximum Permissible Amount for the Limitation Year will be determined on the basis of the Participant's actual Compensation for the Limitation Year. (4) If, pursuant to Section 4.9(b)(2) or as a result of the allocation of Forfeitures, a Participant's Annual Additions under this Plan and such other plans would result in an Excess Amount for a Limitation Year, the Excess Amount will be deemed to consist of the Annual Additions last allocated, except that Annual Additions attributable to a welfare benefit fund or individual medical account will be deemed to have been allocated first regardless of the actual allocation date. (5) If an Excess Amount was allocated to a Participant on an allocation date of this Plan which coincides with an allocation date of another plan, the Excess Amount attributed to this Plan will be the product of, (i) the total Excess Amount allocated as of such date, times (ii) the ratio of (1) the Annual Additions allocated to the Participant for the Limitation Year as of such date under this Plan to (2) the total Annual Additions allocated to the Participant for the Limitation Year as of such date under this and all the other qualified defined contribution plans. (6) Any Excess Amount attributed to this Plan will be disposed in the manner described in Section 4.9(a)(4). (c) If the Participant is covered under another qualified defined contribution plan maintained by the Employer which is not a Prototype Plan, Annual Additions which may be credited to the Participant's account under this Plan for any Limitation Year will be limited in accordance with Section 4.9(b), unless the Employer provides other limitations in the Adoption Agreement. (d) If the Employer maintains, or at any time maintained, a qualified defined benefit plan covering any Participant in this Plan the sum of the Participant's Defined Benefit Plan Fraction and Defined Contribution Plan Fraction will not exceed 1.0 in any Limitation Year. The Annual Additions which may be credited to the Participant's account under this Plan for any Limitation Year will be limited in accordance with the Limitation on Allocations Section of the Adoption Agreement. 40 48 (e) For purposes of applying the limitations of Code Section 415, the transfer of funds from one qualified plan to another is not an "annual addition". In addition, the following are not Employee contributions for the purposes of Section 4.9(f)(1)(2): (1) rollover contributions (as defined in Code Sections 402(a)(5), 403(a)(4), 403(b)(8) and 408(d)(3)); (2) repayments of loans made to a Participant from the Plan; (3) repayments of distributions received by an Employee pursuant to Code Section 411(a)(7)(B) (cash-outs); (4) repayments of distributions received by an Employee pursuant to Code Section 411(a)(3)(D) (mandatory contributions); and (5) Employee contributions to a simplified employee pension excludable from gross income under Code Section 408(k)(6). (f) For purposes of this Section, the following terms shall be defined as follows: (1) Annual Additions means the sum credited to a Participant's accounts for any Limitation Year of (1) Employer contributions, (2) effective with respect to "limitation years" beginning after December 31, 1986, Employee contributions, (3) forfeitures, (4) amounts allocated, after March 31, 1984, to an individual medical account, as defined in Code Section 415(l)(2), which is part of a pension or annuity plan maintained by the Employer and (5) amounts derived from contributions paid or accrued after December 31, 1985, in taxable years ending after such date, which are attributable to post-retirement medical benefits allocated to the separate account of a key employee (as defined in Code Section 419A(d)(3)) under a welfare benefit fund (as defined in Code Section 419(e)) maintained by the Employer. Except, however, the "415 Compensation" percentage limitation referred to in paragraph (a)(2) above shall not apply to: (1) any contribution for medical benefits (within the meaning of Code Section 419A(f)(2)) after separation from service which is otherwise treated as an "annual addition", or (2) any amount otherwise treated as an "annual addition" under Code Section 415(l)(1). Notwithstanding the foregoing, for "limitation years" beginning prior to January 1, 1987, only that portion of Employee contributions equal to the lesser of Employee contributions in excess of six percent (6%) of "415 Compensation" or one-half of Employee contributions shall be considered an "annual addition". For this purpose, any Excess Amount applied under Sections 4.9(a)(4) and 4.9(b)(6) in the Limitation Year to reduce Employer contributions shall be considered Annual Additions for such Limitation Year. (2) Compensation means a Participant's earned income, wages, salaries, fees for professional services and other amounts received for personal services actually rendered in the course of employment with the Employer maintaining the Plan (including, but not limited to, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, and bonuses) and excluding the following: (i) Employer contributions to a plan of deferred compensation which are not includible in the Employee's gross income for the taxable year in which contributed, or Employer contributions under a simplified employee pension plan to the extent such contributions are excludable from the Employee's gross income, or any distributions from a plan of deferred compensation; (ii) contributions made by the Employer to a plan of deferred compensation to the extent that all or a portion of such contributions are recharacterized as a voluntary Employee contribution; 41 49 (iii) amounts realized from the exercise of a non-qualified stock option, or when restricted stock (or property) held by an Employee becomes freely transferable or is no longer subject to a substantial risk of forfeiture; (iv) amounts realized from the sale, exchange or other disposition of stock acquired under a qualified stock option; and (v) other amounts which received special tax benefits, or contributions made by an Employer (whether or not under a salary reduction agreement) towards the purchase of an annuity contract described in Code Section 403(b) (whether or not the contributions are excludable from the gross income of the Employee). For purposes of applying the limitations of this Section 4.9, Compensation for any Limitation Year is the Compensation actually paid or includible in gross income during such year. Notwithstanding the preceding sentence, Compensation for a Participant in a profit-sharing plan who is permanently and totally disabled (as defined in Code Section 22(e)(3)) is the Compensation such Participant would have received for the Limitation Year if the Participant had been paid at the rate of Compensation paid immediately before becoming permanently and totally disabled; such imputed Compensation for the disabled Participant may be taken into account only if the Participant is not a Highly Compensated Employee and contributions made on behalf of such Participant are nonforfeitable when made. (3) Defined Benefit Fraction means a fraction, the numerator of which is the sum of the Participant's Projected Annual Benefits under all the defined benefit plans (whether or not terminated) maintained by the Employer, and the denominator of which is the lesser of 125 percent of the dollar limitation determined for the Limitation Year under Code Sections 415(b) and (d) or 140 percent of his Highest Average Compensation including any adjustments under Code Section 415(b). Notwithstanding the above, if the Participant was a Participant as of the first day of the first Limitation Year beginning after December 31, 1986, in one or more defined benefit plans maintained by the Employer which were in existence on May 6, 1986, the denominator of this fraction will not be less than 125 percent of the sum of the annual benefits under such plans which the Participant had accrued as of the end of the close of the last Limitation Year beginning before January 1, 1987, disregarding any changes in the terms and conditions of the plan after May 5, 1986. The preceding sentence applies only if the defined benefit plans individually and in the aggregate satisfied the requirements of Code Section 415 for all Limitation Years beginning before January 1, 1987. Notwithstanding the foregoing, for any Top Heavy Plan Year, 100 shall be substituted for 125 unless the extra minimum allocation is being made pursuant to the Employer's election in F1 of the Adoption Agreement. However, for any Plan Year in which this Plan is a Super Top Heavy Plan, 100 shall be substituted for 125 in any event. (4) Defined Contribution Dollar Limitation means $30,000, or, if greater, one-fourth of the defined benefit dollar limitation set forth in Code Section 415(b)(1) as in effect for the Limitation Year. (5) Defined Contribution Fraction means a fraction, the numerator of which is the sum of the Annual Additions to the Participant's account under all the defined contribution plans (whether or not terminated) maintained by the Employer for the current and all prior 42 50 Limitation Years, (including the Annual Additions attributable to the Participant's nondeductible voluntary employee contributions to any defined benefit plans, whether or not terminated, maintained by the Employer and the annual additions attributable to all welfare benefit funds, as defined in Code Section 419(e), and individual medical accounts, as defined in Code Section 415(l)(2), maintained by the Employer), and the denominator of which is the sum of the maximum aggregate amounts for the current and all prior Limitation Years of Service with the Employer (regardless of whether a defined contribution plan was maintained by the Employer). The maximum aggregate amount in any Limitation Year is the lesser of 125 percent of the Defined Contribution Dollar Limitation or 35 percent of the Participant's Compensation for such year. For Limitation Years beginning prior to January 1, 1987, the "annual addition" shall not be recomputed to treat all Employee contributions as an Annual Addition. If the Employee was a Participant as of the end of the first day of the first Limitation Year beginning after December 31, 1986, in one or more defined contribution plans maintained by the Employer which were in existence on May 5, 1986, the numerator of this fraction will be adjusted if the sum of this fraction and the Defined Benefit Fraction would otherwise exceed 1.0 under the terms of this Plan. Under the adjustment, an amount equal to the product of (1) the excess of the sum of the fractions over 1.0 times (2) the denominator of this fraction, will be permanently subtracted from the numerator of this fraction. The adjustment is calculated using the fractions as they would be computed as of the end of the last Limitation Year beginning before January 1, 1987, and disregarding any changes in the term and conditions of the plan made after May 5, 1986, but using the Code Section 415 limitation applicable to the first Limitation Year beginning on or after January 1, 1987. Notwithstanding the foregoing, for any Top Heavy Plan Year, 100 shall be substituted for 125 unless the extra minimum allocation is being made pursuant to the Employer's election in F1 of the Adoption Agreement. However, for any Plan Year in which this Plan is a Super Top Heavy Plan, 100 shall be substituted for 125 in any event. (6) Employer means the Employer that adopts this Plan and all Affiliated Employers, except that for purposes of this Section, Affiliated Employers shall be determined pursuant to the modification made by Code Section 415(h). (7) Excess Amount means the excess of the Participant's Annual Additions for the Limitation Year over the Maximum Permissible Amount. (8) Highest Average Compensation means the average Compensation for the three consecutive Years of Service with the Employer that produces the highest average. A Year of Service with the Employer is the 12 consecutive month period defined in Section E1 of the Adoption Agreement which is used to determine Compensation under the Plan. (9) Limitation Year means the Compensation Year (a 12 consecutive month period) as elected by the Employer in the Adoption Agreement. All qualified plans maintained by the Employer must use the same Limitation Year. If the Limitation Year is amended to a different 12 consecutive month period, the new Limitation Year must begin on a date within the Limitation Year in which the amendment is made. (10) Master or Prototype Plan means a plan the form of which is the subject of a favorable opinion letter from the Internal Revenue Service. 43 51 (11) Maximum Permissible Amount means the maximum Annual Addition that may be contributed or allocated to a Participant's account under the plan for any Limitation Year, which shall not exceed the lesser of: (i) the Defined Contribution Dollar Limitation, or (ii) 25 percent of the Participant's Compensation for the Limitation Year. The Compensation Limitation referred to in (ii) shall not apply to any contribution for medical benefits (within the meaning of Code Sections 401(h) or 419A(f)(2)) which is otherwise treated as an annual addition under Code Sections 415(l)(1) or 419A(d)(2). If a short Limitation Year is created because of an amendment changing the Limitation Year to a different 12 consecutive month period, the Maximum Permissible Amount will not exceed the Defined Contribution Dollar Contribution multiplied by the following fraction: number of months in the short Limitation Year -------------------------- 12 (12) Projected Annual Benefit means the annual retirement benefit (adjusted to an actuarially equivalent straight life annuity if such benefit is expressed in a form other than a straight life annuity or qualified Joint and Survivor Annuity) to which the Participant would be entitled under the terms of the plan assuming: (13) the Participant will continue employment until Normal Retirement Age (or current age, if later), and (14) the Participant's Compensation for the current Limitation Year and all other relevant factors used to determine benefits under the Plan will remain constant for all future Limitation Years. (g) Notwithstanding anything contained in this Section to the contrary, the limitations, adjustments and other requirements prescribed in this Section shall at all times comply with the provisions of Code Section 415 and the Regulations thereunder, the terms of which are specifically incorporated herein by reference. 4.10 ADJUSTMENT FOR EXCESSIVE ANNUAL ADDITIONS (a) If as a result of the allocation of Forfeitures, a reasonable error in estimating a Participant's annual Compensation, or other facts and circumstances to which Regulation 1.415-6(b)(6) shall be applicable, the "annual additions" under this Plan would cause the maximum provided in Section 4.9 to be exceeded, the Administrator shall treat the excess in accordance with Section 4.9(a)(4). 4.11 TRANSFERS FROM QUALIFIED PLANS (a) If specified in the Adoption Agreement and with the consent of the Administrator, amounts may be transferred from other qualified plans, provided that the trust from which such funds are transferred permits the transfer to be made and the transfer will not jeopardize the tax exempt status of the Plan or create adverse tax consequences for the Employer. The amounts transferred shall be 44 52 set up in a separate account herein referred to as a "Participant's Rollover Account". Such account shall be fully Vested at all times and shall not be subject to forfeiture for any reason. (b) Amounts in a Participant's Rollover Account shall be held by the Trustee pursuant to the provisions of this Plan and may not be withdrawn by, or distributed to the Participant, in whole or in part, except as provided in Paragraphs (c) and (d) of this Section. (c) Amounts attributable to elective contributions (as defined in Regulation 1.401(k)-1(g)(4)), including amounts treated as elective contributions, which are transferred from another qualified plan in a plan-to-plan transfer shall be subject to the distribution limitations provided for in Regulation 1.401(k)-1(d). (d) At Normal Retirement Date, or such other date when the Participant or his Beneficiary shall be entitled to receive benefits, the fair market value of the Participant's Rollover Account shall be used to provide additional benefits to the Participant or his Beneficiary. Any distributions of amounts held in a Participant's Rollover Account shall be made in a manner which is consistent with and satisfies the provisions of Section 6.5, including, but not limited to, all notice and consent requirements of Code Sections 411(a)(11) and 417 and the Regulations thereunder. Furthermore, such amounts shall be considered as part of a Participant's benefit in determining whether an involuntary cash-out of benefits without Participant consent may be made. (e) The Administrator may direct that employee transfers made after a valuation date be segregated into a separate account for each Participant until such time as the allocations pursuant to this Plan have been made, at which time they may remain segregated or be invested as part of the general Trust Fund, to be determined by the Administrator. (f) For purposes of this Section, the term "qualified plan" shall mean any tax qualified plan under Code Section 401(a). The term "amounts transferred from other qualified plans" shall mean: (i) amounts transferred to this Plan directly from another qualified plan; (ii) lump-sum distributions received by an Employee from another qualified plan which are eligible for tax free rollover to a qualified plan and which are transferred by the Employee to this Plan within sixty (60) days following his receipt thereof, (iii) amounts transferred to this Plan from a conduit individual retirement account provided that the conduit individual retirement account has no assets other than assets which (A) were previously distributed to the Employee by another qualified plan as a lump-sum distribution (B) were eligible for tax-free rollover to a qualified plan and (C) were deposited in such conduit individual retirement account within sixty (60) days of receipt thereof and other than earnings on said assets; and (iv) amounts distributed to the Employee from a conduit individual retirement account meeting the requirements of clause (iii) above, and transferred by the Employee to this Plan within sixty (60) days of his receipt thereof from such conduit individual retirement account. (g) Prior to accepting any transfers to which this Section applies, the Administrator may require the Employee to establish that the amounts to be transferred to this Plan meet the requirements of this Section and may also require the Employee to provide an opinion of counsel satisfactory to the Employer that the amounts to be transferred meet the requirements of this Section. (h) Notwithstanding anything herein to the contrary, a transfer directly to this Plan from another qualified plan (or a transaction having the effect of such a transfer) shall only be permitted if it will not result in the elimination or reduction of any "Section 411(d)(6) protected benefit" as described in Section 8.1. 45 53 4.12 VOLUNTARY CONTRIBUTIONS (a) If elected in the Adoption Agreement, each Participant may, at the discretion of the Administrator in a nondiscriminatory manner, elect to voluntarily contribute a portion of his compensation earned while a Participant under this Plan. Such contributions shall be paid to the Trustee within a reasonable period of time but in no event later than 90 days after the receipt of the contribution. (b) The balance in each Participant's Voluntary Contribution Account shall be fully Vested at all times and shall not be subject to Forfeiture for any reason. (c) A Participant may elect to withdraw his voluntary contributions from his Voluntary Contribution Account and the actual earnings thereon in a manner which is consistent with and satisfies the provisions of Section 6.5, including, but not limited to, all notice and consent requirements of Code Sections 411(a)(11) and 417 and the Regulations thereunder. If the Administrator maintains sub-accounts with respect to voluntary contributions (and earnings thereon) which were made on or before a specified date, a Participant shall be permitted to designate which sub-account shall be the source for his withdrawal. No Forfeitures shall occur solely as a result of an Employee's withdrawal of Employee contributions. In the event such a withdrawal is made, or in the event a Participant has received a hardship distribution pursuant to Regulation 1.401(k)-l(d)(2)(iii)(B) from any other plan maintained by the Employer or from his Participant's Elective Account pursuant to Section 6.11, then such Participant shall be barred from making any voluntary contributions to the Trust Fund for a period of twelve (12) months after receipt of the withdrawal or distribution. (d) At Normal Retirement Date, or such other date when the Participant or his Beneficiary shall be entitled to receive benefits, the fair market value of the Voluntary Contribution Account shall be used to provide additional benefits to the Participant or his Beneficiary. (e) The Administrator may direct that voluntary contributions made after a valuation date be segregated into a separate account until such time as the allocations pursuant to this Plan have been made, at which time they may remain segregated or be invested as part of the general Trust Fund, to be determined by the Administrator. 4.13 DIRECTED INVESTMENT ACCOUNT (a) If elected in the Adoption Agreement, all Participants may direct the Trustee as to the investment of all or a portion of any one or more of their individual account balances. Participants may direct the Trustee in writing to invest their account in specific assets as permitted by the Administrator provided such investments are in accordance with the Department of Labor regulations and are permitted by the Plan. That portion of the account of any Participant so directing will thereupon be considered a Directed Investment Account. (b) A separate Directed Investment Account shall be established for each Participant who has directed an investment. Transfers between the Participant's regular account and their Directed Investment Account shall be charged and credited as the case may be to each account. The Directed Investment Account shall not share in Trust Fund Earnings, but it shall be charged or credited as appropriate with the net earnings, gains, losses and expenses as well as any appreciation or depreciation in market value during each Plan Year attributable to such account. 46 54 (c) The Administrator shall establish a procedure, to be applied in a uniform and nondiscriminatory manner, setting forth the permissible investment options under this Section, how often changes between investments may be made, and any other limitations that the Administrator shall impose on a Participant's right to direct investments. 4.14 QUALIFIED VOLUNTARY EMPLOYEE CONTRIBUTIONS (a) If this is an amendment to a Plan that previously permitted deductible voluntary contributions, then each Participant who made a "Qualified Voluntary Employee Contribution" within the meaning of Code Section 219(e)(2) as it existed prior to the enactment of the Tax Reform Act of 1986, shall have his contribution held in a separate Qualified Voluntary Employee Contribution Account which shall be fully Vested at all times. Such contributions, however, shall not be permitted if they are attributable to taxable years beginning after December 31, 1986. (b) A Participant may, upon written request delivered to the Administrator, make withdrawals from his Qualified Voluntary Employee Contribution Account. Any distribution shall be made in a manner which is consistent with and satisfies the provisions of Section 6.5, including, but not limited to, all notice and consent requirements of Code Sections 411(a)(11) and 417 and the Regulations thereunder. (c) At Normal Retirement Date, or such other date when the Participant or his Beneficiary shall be entitled to receive benefits, the fair market value of the Qualified Voluntary Employee Contribution Account shall be used to provide additional benefits to the Participant or his Beneficiary. (d) Unless the Administrator directs Qualified Voluntary Employee Contributions made pursuant to this Section be segregated into a separate account for each Participant, they shall be invested as part of the general Trust Fund and share in earnings and losses. 4.15 INTEGRATION IN MORE THAN ONE PLAN If the Employer and/or an Affiliated Employer maintain qualified retirement plans integrated with Social Security such that any Participant in this Plan is covered under more than one of such plans, then such plans will be considered to be one plan and will be considered to be integrated if the extent of the integration of all such plans does not exceed 100%. For purposes of the preceding sentence, the extent of integration of a plan is the ratio, expressed as a percentage, which the actual benefits, benefit rate, offset rate, or employer contribution rate, whatever is applicable, under the Plan bears to the limitation applicable to such Plan. If the Employer maintains two or more standardized paired plans, only one plan may be integrated with Social Security. ARTICLE V VALUATIONS 5.1 VALUATION OF THE TRUST FUND The Administrator shall direct the Trustee, as of each Anniversary Date, and at such other date or dates deemed necessary by the Administrator, herein called "valuation date", to determine the net worth of the assets comprising the Trust Fund as it exists on the "valuation date". In determining such net worth, the Trustee shall value the assets comprising the Trust Fund at their fair market value as of the "valuation date" and shall deduct all expenses for which the Trustee has not yet obtained reimbursement from the Employer or the Trust Fund. 47 55 5.2 METHOD OF VALUATION In determining the fair market value of securities held in the Trust Fund which are listed on a registered stock exchange, the Administrator shall direct the Trustee to value the same at the prices they were last traded on such exchange preceding the close of business on the "valuation date". If such securities were not traded on the "valuation date", or if the exchange on which they are traded was not open for business on the "valuation date", then the securities shall be valued at the prices at which they were last traded prior to the "valuation date". Any unlisted security held in the Trust Fund shall be valued at its bid price next preceding the close of business on the "valuation date", which bid price shall be obtained from a registered broker or an investment banker. In determining the fair market value of assets other than securities for which trading or bid prices can be obtained, the Trustee may appraise such assets itself, or in its discretion, employ one or more appraisers for that purpose and rely on the values established by such appraiser or appraisers. ARTICLE VI DETERMINATION AND DISTRIBUTION OF BENEFITS 6.1 DETERMINATION OF BENEFITS UPON RETIREMENT Every Participant may terminate his employment with the Employer and retire for the purposes hereof on or after his Normal Retirement Date or Early Retirement Date. Upon such Normal Retirement Date or Early Retirement Date, all amounts credited to such Participant's Combined Account shall become distributable. However, a Participant may postpone the termination of his employment with the Employer to a later date, in which event the participation of such Participant in the Plan, including the right to receive allocations pursuant to Section 4.4, shall continue until his Late Retirement Date. Upon a Participant's Retirement Date, or as soon thereafter as is practicable, the Administrator shall direct the distribution of all amounts credited to such Participant's Combined Account in accordance with Section 6.5. 6.2 DETERMINATION OF BENEFITS UPON DEATH (a) Upon the death of a Participant before his Retirement Date or other termination of his employment, all amounts created to such Participant's Combined Account shall become fully Vested. The Administrator shall direct, in accordance with the provisions of Sections 6.6 and 6.7, the distribution of the deceased Participant's accounts to the Participant's Beneficiary. (b) Upon the death of a Former Participant, the Administrator shall direct, in accordance with the provisions of Sections 6.6 and 6.7, the distribution of any remaining amounts credited to the accounts of such deceased Former Participant to such Former Participant's Beneficiary. (c) The Administrator may require such proper proof of death and such evidence of the right of any person to receive payment of the value of the account of a deceased Participant or Former Participant as the Administrator may deem desirable. The Administrator's determination of death and of the right of any person to receive payment shall be conclusive. (d) Unless otherwise elected in the manner prescribed in Section 6.6, the Beneficiary of the Pre-Retirement Survivor Annuity shall be the Participant's spouse. Except, however, the Participant may designate a Beneficiary other than his spouse for the Pre-Retirement Survivor Annuity if: (1) the Participant and his spouse have validly waived the Pre-Retirement Survivor Annuity in the manner prescribed in Section 6.6, and the spouse has waived his or her right to be the Participant's Beneficiary, or 48 56 (2) the Participant is legally separated or has been abandoned (within the meaning of local law) and the Participant has a court order to such effect (and there is no "qualified domestic relations order" as defined in Code Section 414(p) which provides otherwise), or (3) the Participant has no spouse, or (4) the spouse cannot be located. In such event, the designation of a Beneficiary shall be made on a form satisfactory to the Administrator. A Participant may at any time revoke his designation of a Beneficiary or change his Beneficiary by filing written notice of such revocation or change with the Administrator. However, the Participant's spouse must again consent in writing to any change in Beneficiary unless the original consent acknowledged that the spouse had the right to limit consent only to a specific Beneficiary and that the spouse voluntarily elected to relinquish such right. The Participant may, at any time, designate a Beneficiary for death benefits payable under the Plan that are in excess of the Pre-Retirement Survivor Annuity. In the event no valid designation of Beneficiary exists at the time of the Participant's death, the death benefit shall be payable to his estate. (e) If the Plan provides an insured death benefit and a Participant dies before any insurance coverage to which he is entitled under the Plan is effected, his death benefit from such insurance coverage shall be limited to the standard rated premium which was or should have been used for such purpose. (f) In the event of any conflict between the terms of this Plan and the terms of any Contract issued hereunder, the Plan provisions shall control. 6.3 DETERMINATION OF BENEFITS IN EVENT OF DISABILITY In the event of a Participant's Total and Permanent Disability prior to his Retirement Date or other termination of his employment, all amounts credited to such Participant's Combined Account shall become fully Vested. In the event of a Participant's Total and Permanent Disability, the Administrator, in accordance with the provisions of Sections 6.5 and 6.7, shall direct the distribution to such Participant of all amounts credited to such Participant's Combined Account as though he had retired. 6.4 DETERMINATION OF BENEFITS UPON TERMINATION (a) On or before the Anniversary Date coinciding with or subsequent to the termination of a Participant's employment for any reason other than retirement, death, or Total and Permanent Disability, the Administrator may direct the Trustee to segregate the amount of the Vested portion of such Terminated Participant's Combined Account and invest the aggregate amount thereof in a separate, federally insured savings account, certificate of deposit, common or collective trust fund of a bank or a deferred annuity. In the event the Vested portion of a Participant's Combined Account is not segregated, the amount shall remain in a separate account for the Terminated Participant and share in allocations pursuant to Section 4.4 until such time as a distribution is made to the Terminated Participant. The amount of the portion of the Participant's Combined Account which is not Vested may be credited to a separate account (which will always share in gains and losses of the Trust) and at such time as the amount becomes a Forfeiture shall be treated in accordance with the provisions of the Plan regarding Forfeitures. Regardless of whether distributions in kind are permitted, in the event that the amount of the Vested portion of the Terminated Participant's Combined Account equals or exceeds the fair market 49 57 value of any insurance Contracts, the Trustee, when so directed by the Administrator and agreed to by the Terminated Participant, shall assign, transfer, and set over to such Terminated Participant all Contracts on his life in such form or with such endorsements, so that the settlement options and forms of payment are consistent with the provisions of Section 6.5. In the event that the Terminated Participant's Vested portion does not at least equal the fair market value of the Contracts, if any, the Terminated Participant may pay over to the Trustee the sum needed to make the distribution equal to the value of the Contracts being assigned or transferred, or the Trustee, pursuant to the Participant's election, may borrow the cash value of the Contracts from the Insurer so that the value of the Contracts is equal to the Vested portion of the Terminated Participant's Combined Account and then assign the Contracts to the Terminated Participant. Distribution of the funds due to a Terminated Participant shall be made on the occurrence of an event which would result in the distribution had the Terminated Participant remained in the employ of the Employer (upon the Participant's death, Total and Permanent Disability, Early or Normal Retirement). However, at the election of the Participant, the Administrator shall direct that the entire Vested portion of the Terminated Participant's Combined Account to be payable to such Terminated Participant provided the conditions, if any, set forth in the Adoption Agreement have been satisfied. Any distribution under this paragraph shall be made in a manner which is consistent with and satisfies the provisions of Section 6.5, including but not limited to, all notice and consent requirements of Code Sections 411(a)(11) and 417 and the Regulations thereunder. Notwithstanding the above, if the value of a Terminated Participant's Vested benefit derived from Employer and Employee contributions does not exceed, and at the time of any prior distribution, has never exceeded $3,500, the Administrator shall direct that the entire Vested benefit be paid to such Participant in a single lump-sum without regard to the consent of the Participant or the Participant's spouse. A Participant's Vested benefit shall not include Qualified Voluntary Employee Contributions within the meaning of Code Section 72(o)(5)(B) for Plan Years beginning prior to January 1, 1989. (b) The Vested portion of any Participant's Account shall be a percentage of such Participant's Account determined on the basis of the Participant's number of Years of Service according to the vesting schedule specified in the Adoption Agreement. (c) For any Top Heavy Plan Years, one of the minimum top heavy vesting schedules as elected by the Employer in the Adoption Agreement will automatically apply to the Plan. The minimum top heavy vesting schedule applies to all benefits within the meaning of Code Section 411(a)(7) except those attributable to Employee contributions, including benefits accrued before the effective date of Code Section 416 and benefits accrued before the Plan became top heavy. Further, no decrease in a Participant's Vested percentage may occur in the event the Plan's status as top heavy changes for any Plan Year. However, this Section does not apply to the account balances of any Employee who does not have an Hour of Service after the Plan has initially become top heavy and the Vested percentage of such Employee's Participant's Account shall be determined without regard to this Section 6.4(c). If in any subsequent Plan Year, the Plan ceases to be a Top Heavy Plan, the Administrator shall continue to use the vesting schedule in effect while the Plan was a Top Heavy Plan for each Employee who had an Hour of Service during a Plan Year when the Plan was Top Heavy. (d) Notwithstanding the vesting schedule above, upon the complete discontinuance of the Employer's contributions to the Plan or upon any full or partial termination of the Plan, all amounts credited to the account of any affected Participant shall become 100% Vested and shall not thereafter be subject to Forfeiture. 50 58 (e) If this is an amended or restated Plan, then notwithstanding the vesting schedule specified in the Adoption Agreement, the Vested percentage of a Participant's Account shall not be less than the Vested percentage attained as of the later of the effective date or adoption date of this amendment and restatement. The computation of a Participant's nonforfeitable percentage of his interest in the Plan shall not be reduced as the result of any direct or indirect amendment to this Article, or due to changes in the Plan's status as a Top Heavy Plan. (f) If the Plan's vesting schedule is amended, or if the Plan is amended in any way that directly or indirectly affects the computation of the Participant's nonforfeitable percentage or if the Plan is deemed amended by an automatic change to a top heavy vesting schedule, then each Participant with at least 3 Years of Service as of the expiration date of the election period may elect to have his nonforfeitable percentage computed under the Plan without regard to such amendment or change. Notwithstanding the foregoing, for Plan Years beginning before January 1, 1989, or with respect to Employees who fail to complete at least one (1) Hour of Service in a Plan Year beginning after December 31, 1988, five (5) shall be substituted for three (3) in the preceding sentence. If a Participant fails to make such election, then such Participant shall be subject to the new vesting schedule. The Participant's election period shall commence on the adoption date of the amendment and shall end 60 days after the latest of: (1) the adoption date of the amendment, (2) the effective date of the amendment, or (3) the date the Participant receives written notice of the amendment from the Employer or Administrator. (g)(1) If any Former Participant shall be reemployed by the Employer before a 1-Year Break in Service occurs, he shall continue to participate in the Plan in the same manner as if such termination had not occurred. (2) If any Former Participant shall be reemployed by the Employer before five (5) consecutive 1-Year Breaks in Service, and such Former Participant had received a distribution of his entire Vested interest prior to his reemployment, his forfeited account shall be reinstated only if he repays the full amount distributed to him before the earlier of five (5) years after the first date on which the Participant is subsequently reemployed by the Employer or the close of the first period of 5 consecutive 1-Year Breaks in Service commencing after the distribution. If a distribution occurs for any reason other than a separation from service, the time for repayment may not end earlier than five (5) years after the date of separation. In the event the Former Participant does repay the full amount distributed to him, the undistributed portion of the Participant's Account must be restored in full, unadjusted by any gains or losses occurring subsequent to the Anniversary Date or other valuation date preceding his termination. If an employee receives a distribution pursuant to this section and the employee resumes employment covered under this plan, the employee's employer-derived account balance will be restored to the amount on the date of distribution if the employee repays to the plan the full amount of the distribution attributable to employer contribution before the earlier, of 5 years after the first date on which the participant is subsequently re-employed by the employer, or the date the participant incurs 5 consecutive 1-year breaks in service following the date of the distribution. If a non-Vested Former Participant was deemed to have received a distribution and such Former Participant is 51 59 reemployed by the Employer before five (5) consecutive 1-Year Breaks in Service, then such Participant will be deemed to have repaid the deemed distribution as of the date of reemployment. (3) If any Former Participant is reemployed after a 1-Year Break in Service has occurred, Years of Service shall include Years of Service prior to his 1-Year Break in Service subject to the following rules: (i) Any Former Participant who under the Plan does not have a nonforfeitable right to any interest in the Plan resulting from Employer contributions shall lose credits if his consecutive 1-Year Breaks in Service equal or exceed the greater of (A) five (5) or (B) the aggregate number of his pre-break Years of Service; (ii) After five (5) consecutive 1-Year Breaks in Service, a Former Participant's Vested Account balance attributable to pre-break service shall not be increased as a result of post-break service; (iii) A Former Participant who is reemployed and who has not had his Years of Service before a 1-Year Break in Service disregarded pursuant to (i) above, shall participate in the Plan as of his date of reemployment; (iv) If a Former Participant completes a Year of Service (a 1-Year Break in Service previously occurred, but employment had not terminated), he shall participate in the Plan retroactively from the first day of the Plan Year during which he completes one (1) Year of Service. (h) In determining Years of Service for purposes of vesting under the Plan, Years of Service shall be excluded as specified in the Adoption Agreement. 6.5 DISTRIBUTION OF BENEFITS (a)(1) Unless otherwise elected as provided below, a Participant who is married on the "annuity starting date" and who does not die before the "annuity starting date" shall receive the value of all of his benefits in the form of a Joint and Survivor Annuity. The Joint and Survivor Annuity is an annuity that commences immediately and shall be equal in value to a single life annuity. Such joint and survivor benefits following the Participant's death shall continue to the spouse during the spouse's lifetime at a rate equal to 50% of the rate at which such benefits were payable to the Participant. This Joint and Survivor Annuity shall be considered the designated qualified Joint and Survivor Annuity and automatic form of payment for the purposes of this Plan. However, the Participant may elect to receive a smaller annuity benefit with continuation of payments to the spouse at a rate of seventy-five percent (75%) or one hundred percent (100%) of the rate payable to a Participant during his lifetime which alternative Joint and Survivor Annuity shall be equal in value to the automatic Joint and 50% Survivor Annuity. An unmarried Participant shall receive the value of his benefit in the form of a life annuity. Such unmarried Participant, however, may elect in writing to waive the life annuity. The election must comply with the provisions of this Section as if it were an election to waive the Joint and Survivor Annuity by a married Participant, but without the spousal consent requirement. The Participant way elect to have any annuity provided for in this Section distributed upon the attainment of the "earliest retirement age" under the Plan. The "earliest retirement age" is the earliest date on which, under the Plan, the Participant could elect to receive retirement benefits. 52 60 (2) Any election to waive the Joint and Survivor Annuity must be made by the Participant in writing during the election period and be consented to by the Participant's spouse. If the spouse is legally incompetent to give consent, the spouse's legal guardian, even if such guardian is the Participant, may give consent. Such election shall designate a Beneficiary (or a form of benefits) that may not be changed without spousal consent (unless the consent of the spouse expressly permits designations by the Participant without the requirement of further consent by the spouse). Such spouse's consent shall be irrevocable and must acknowledge the effect of such election and be witnessed by a Plan representative or a notary public. Such consent shall not be required if it is established to the satisfaction of the Administrator that the required consent cannot be obtained because there is no spouse, the spouse cannot be located, or other circumstances that may be prescribed by Regulations. The election made by the Participant and consented to by his spouse may be revoked by the Participant in writing without the consent of the spouse at any time during the election period. The number of revocations shall not be limited. Any new election must comply with the requirements of this paragraph. A former spouse's waiver shall not be binding on a new spouse. (3) The election period to waive the Joint and Survivor Annuity shall be the 90 day period ending on the "annuity starting date." (4) For purposes of this Section and Section 6.6, the "annuity starting date" means the first day of the first period for which an amount is paid as an annuity, or, in the case of a benefit not payable in the form of an annuity, the first day on which all events have occurred which entitles the Participant to such benefit. (5) With regard to the election, the Administrator shall provide to the Participant no less than 30 days and no more than 90 days before the "annuity starting date" a written explanation of: (i) the terms and conditions of the Joint and Survivor Annuity, and (ii) the Participant's right to make and the effect of an election to waive the Joint and Survivor Annuity, and (iii) the right of the Participant's spouse to consent to any election to waive the Joint and Survivor Annuity, and (iv) the right of the Participant to revoke such election, and the effect of such revocation. (b) In the event a married Participant duly elects pursuant to paragraph (a)(2) above not to receive his benefit in the form of a Joint and Survivor Annuity, or if such Participant is not married, in the form of a life annuity, the Administrator, pursuant to the election of the Participant, shall direct the distribution to a Participant or his Beneficiary any amount to which he is entitled under the Plan in one or more of the following methods which are permitted pursuant to the Adoption Agreement: (1) One lump-sum payment in cash or in property; (2) Payments over a period certain in monthly, quarterly, semiannual, or annual cash installments. In order to provide such installment payments, the Administrator may direct that the Participant's interest in the Plan be segregated and invested separately, and that the funds 53 61 in the segregated account be used for the payment of the installments. The period over which such payment is to be made shall not extend beyond the Participant's life expectancy (or the life expectancy of the Participant and his designated Beneficiary); (3) Purchase of or providing an annuity. However, such annuity may not be in any form that will provide for payments over a period extending beyond either the life of the Participant (or the lives of the Participant and his designated Beneficiary) or the life expectancy of the Participant (or the life expectancy of the Participant and his designated Beneficiary). (c) The present value of a Participant's Joint and Survivor Annuity derived from Employer and Employee contributions may not be paid without his written consent if the value exceeds, or has ever exceeded at the time of any prior distribution, $3,500. Further, the spouse of a Participant must consent in writing to any immediate distribution. If the value of the Participant's benefit derived from Employer and Employee contributions does not exceed $3,500 and has never exceeded $3,500 at the time of any prior distribution, the Administrator may immediately distribute such benefit without such Participant's consent. No distribution may be made under the preceding sentence after the "annuity starting date" unless the Participant and his spouse consent in writing to such distribution. Any written consent required under this paragraph must be obtained not more than 90 days before commencement of the distribution and shall be made in a manner consistent with Section 6.5(a)(2). (d) Any distribution to a Participant who has a benefit which exceeds, or has ever exceeded at the time of any prior distribution, $3,500 shall require such Participant's consent if such distribution commences prior to the later of his Normal Retirement Age or age 62. With regard to this required consent: (1) No consent shall be valid unless the Participant has received a general description of the material features and an explanation of the relative values of the optional forms of benefit available under the Plan that would satisfy the notice requirements of Code Section 417. (2) The Participant must be informed of his right to defer receipt of the distribution. If a Participant fails to consent, it shall be deemed an election to defer the commencement of payment of any benefit. However, any election to defer the receipt of benefits shall not apply with respect to distributions which are required under Section 6.5(e). (3) Notice of the rights specified under this paragraph shall be provided no less than 30 days and no more than 90 days before the "annuity starting date". (4) Written consent of the Participant to the distribution must not be made before the Participant receives the notice and must not be made more than 90 days before the "annuity starting date". (5) No consent shall be valid if a significant detriment is imposed under the Plan on any Participant who does not consent to the distribution. (e) Notwithstanding any provision in the Plan to the contrary, the distribution of a Participant's benefits, made on or after January 1, 1985, whether under the Plan or through the purchase of an annuity Contract, shall be made in accordance with the following requirements and shall otherwise comply with Code Section 401(a)(9) and the Regulations thereunder (including Regulation Section 1.401(a)(9)-2), the provisions of which are incorporated herein by reference: 54 62 (1) A Participant's benefits shall be distributed to him not later than April 1st of the calendar year following the later of (i) the calendar year in which the Participant attains age 70 1/2 or (ii) the calendar year in which the Participant retires, provided, however, that this clause (ii) shall not apply in the case of a Participant who is a "five (5) percent owner" at any time during the "five (5) Plan Year period ending in the calendar year in which he attains age 70 1/2 or, in the case of a Participant who becomes a "five (5) percent owner" during any subsequent Plan Year, clause (ii) shall no longer apply and the required beginning date shall be the April 1st of the calendar year following the calendar year in which such subsequent Plan Year ends. Alternatively, distributions to a Participant must begin no later than the applicable April 1st as determined under the preceding sentence and must be made over the life of the Participant (or the lives of the Participant and the Participant's designated Beneficiary) or, if benefits are paid in the form of a Joint and Survivor Annuity, the life expectancy of the Participant (or the life expectancies of the Participant and his designated Beneficiary) in accordance with Regulations. For Plan Years beginning after December 31, 1988, clause (ii) above shall not apply to any Participant unless the Participant had attained age 70 1/2 before January 1, 1988 and was not a "five (5) percent owner" at any time during the Plan Year ending with or within the calendar year in which the Participant attained age 66 1/2 or any subsequent Plan Year. (2) Distributions to a Participant and his Beneficiaries shall only be made in accordance with the incidental death benefit requirements of Code Section 401(a)(9)(G) and the Regulations thereunder. Additionally, for calendar years beginning before 1989, distributions may also be made under an alternative method which provides that the then present value of the payments to be made over the period of the Participant's life expectancy exceeds fifty percent (50%) of the then present value of the total payments to be made to the Participant and his Beneficiaries. (f) For purposes of this Section, the life expectancy of a Participant and a Participant's spouse (other than in the case of a life annuity) shall be redetermined annually in accordance with Regulations if permitted pursuant to the Adoption Agreement. If the Participant or the Participant's spouse may elect whether recalculations will be made, then the election, once made, shall be irrevocable. If no election is made by the time distributions must commence, then the life expectancy of the Participant and the Participant's spouse shall not be subject to recalculation. Life expectancy and joint and last survivor expectancy shall be computed using the return multiples in Tables V and VI of Regulation 1.72-9. (g) All annuity Contracts under this Plan shall be non- transferable when distributed. Furthermore, the terms of any annuity Contract purchased and distributed to a Participant or spouse shall comply with all of the requirements of this Plan. (h) Subject to the spouse's right of consent afforded under the Plan, the restrictions imposed by this Section shall not apply if a Participant has, prior to January 1, 1984, made a written designation to have his retirement benefit paid in an alternative method acceptable under Code Section 401(a) as in effect prior to the enactment of the Tax Equity and Fiscal Responsibility Act of 1982. (i) If a distribution is made at a time when a Participant who has not terminated employment is not fully Vested in his Participant's Account and the Participant may increase the Vested percentage in such account: 55 63 (1) A separate account shall be established for the Participant's interest in the Plan as of the time of the distribution, and (2) At any relevant time the Participant's Vested portion of the separate account shall be equal to an amount ("X") determined by the formula: X equals P(AB plus (RxD)) - (R x D) For purposes of applying the formula: P is the Vested percentage at the relevant time, AB is the account balance at the relevant time, D is the amount of distribution, and R is the ratio of the account balance at the relevant time to the account balance after distribution. 6.6 DISTRIBUTION OF BENEFITS UPON DEATH (a) Unless otherwise elected as provided below, a Vested Participant who dies before the annuity starting date and who has a surviving spouse shall have the Pre-Retirement Survivor Annuity paid to his surviving spouse. The Participant's spouse may direct that payment of the Pre-Retirement Survivor Annuity commence within a reasonable period after the Participant's death. If the spouse does not so direct, payment of such benefit will commence at the time the Participant would have attained the later of his Normal Retirement Age or age 62. However, the spouse may elect a later commencement date. Any distribution to the Participant's spouse shall be subject to the rules specified in Section 6.6(h). (b) Any election to waive the Pre-Retirement Survivor Annuity before the Participant's death must be made by the Participant in writing during the election period and shall require the spouse's irrevocable consent in the same manner provided for in Section 6.5(a)(2). Further, the spouse's consent must acknowledge the specific nonspouse Beneficiary. Notwithstanding the foregoing, the nonspouse Beneficiary need not be acknowledged, provided the consent of the spouse acknowledges that the spouse has the right to limit consent only to a specific Beneficiary and that the spouse voluntarily elects to relinquish such right. (c) The election period to waive the Pre-Retirement Survivor Annuity shall begin on the first day of the Plan Year in which the Participant attains age 35 and end on the date of the Participant's death. An earlier waiver (with spousal consent) may be made provided a written explanation of the Pre-Retirement Survivor Annuity is given to the Participant and such waiver becomes invalid at the beginning of the Plan Year in which the Participant turns age 35. In the event a Vested Participant separates from service prior to the beginning of the election period, the election period shall begin on the date of such separation from service. (d) With regard to the election, the Administrator shall provide each Participant within the applicable period, with respect to such Participant (and consistent with Regulations), a written explanation of the Pre-Retirement Survivor Annuity containing comparable information to that required pursuant to Section 6.5(a)(5). For the purposes of this paragraph, the term "applicable period" means, with respect to a Participant, whichever of the following periods ends last: (1) The period beginning with the first day of the Plan Year in which the Participant attains age 32 and ending with the close of the Plan Year preceding the Plan Year in which the Participant attains age 35, 56 64 (2) A reasonable period after the individual becomes a Participant. For this purpose, in the case of an individual who becomes a Participant after age 32, the explanation must be provided by the end of the three-year period beginning with the first day of the first Plan Year for which the individual is a Participant; (3) A reasonable period ending after the Plan no longer fully subsidizes the cost of the Pre-Retirement Survivor Annuity with respect to the Participant; (4) A reasonable period ending after Code Section 401(a)(11) applies to the Participant; or (5) A reasonable period after separation from service in the case of a Participant who separates before attaining age 35. For this purpose, the Administrator must provide the explanation beginning one year before the separation from service and ending one year after separation. (e) The Pre-Retirement Survivor Annuity provided for in this Section shall apply only to Participants who are credited with an Hour of Service on or after August 23, 1984. Former Participants who are not credited with an Hour of Service on or after August 23, 1984 shall be provided with rights to the Pre-Retirement Survivor Annuity in accordance with Section 303(e)(2) of the Retirement Equity Act of 1984. (f) If the value of the Pre-Retirement Survivor Annuity derived from Employer and Employee contributions does not exceed $3,500 and has never exceeded $3,500 at the time of any prior distribution, the Administrator shall direct the immediate distribution of such amount to the Participant's spouse. No distribution may be made under the preceding sentence after the annuity starting date unless the spouse consents in writing. If the value exceeds, or has ever exceeded at the time of any prior distribution, $3,500, an immediate distribution of the entire amount may be made to the surviving spouse, provided such surviving spouse consents in writing to such distribution. Any written consent required under this paragraph must be obtained not more than 90 days before commencement of the distribution and shall be made in a manner consistent with Section 6.5(a)(2). (g)(1) In the event there is an election to waive the Pre-Retirement Survivor Annuity, and for death benefits in excess of the Pre-Retirement Survivor Annuity, such death benefits shall be paid to the Participant's Beneficiary by either of the following methods, as elected by the Participant (or if no election has been made prior to the Participant's death, by his Beneficiary) subject to the rules specified in Section 6.6(h) and the selections made in the Adoption Agreement: (i) One lump-sum payment in cash or in property; (ii) Payment in monthly, quarterly, semi-annual, or annual cash installments over a period to be determined by the Participant or his Beneficiary. After periodic installments commence, the Beneficiary shall have the right to reduce the period over which such periodic installments shall be made, and the cash amount of such periodic installments shall be adjusted accordingly. (iii) If death benefits in excess of the Pre-Retirement Survivor Annuity are to be paid to the surviving spouse, such benefits may be paid pursuant to (i) or (ii) above, or used to purchase an annuity so as to increase the payments made pursuant to the Pre-Retirement Survivor Annuity; 57 65 (2) In the event the death benefit payable pursuant to Section 6.2 is payable in installments, then, upon the death of the Participant, the Administrator may direct that the death benefit be segregated and invested separately, and that the funds accumulated in the segregated account be used for the payment of the installments. (h) Notwithstanding any provision in the Plan to the contrary, distributions upon the death of a Participant made on or after January 1, 1985, shall be made in accordance with the following requirements and shall otherwise comply with Code Section 401(a)(9) and the Regulations thereunder. (1) If it is determined, pursuant to Regulations, that the distribution of a Participant's interest has begun and the Participant dies before his entire interest has been distributed to him, the remaining portion of such interest shall be distributed at least as rapidly as under the method of distribution selected pursuant to Section 6.5 as of his date of death. (2) If a Participant dies before he has begun to receive any distributions of his interest in the Plan or before distributions are deemed to have begun pursuant to Regulations, then his death benefit shall be distributed to his Beneficiaries in accordance with the following rules subject to the selections made in the Adoption Agreement and Subsections 6.6(h)(3) and 6.6(i) below: (i) The entire death benefit shall be distributed to the Participant's Beneficiaries by December 31st of the calendar year in which the fifth anniversary of the Participant's death occurs; (ii) The 5-year distribution requirement of (i) above shall not apply to any portion of the deceased Participant's interest which is payable to or for the benefit of a designated Beneficiary. In such event, such portion shall be distributed over the life of such designated Beneficiary (or over a period not extending beyond the life expectancy of such designated Beneficiary) provided such distribution begins not later than December 31st of the calendar year immediately following the calendar year in which the Participant died; (iii) However, in the event the Participant's spouse (determined as of the date of the Participant's death) is his designated Beneficiary, the provisions of (ii) above shall apply except that the requirement that distributions commence within one year of the Participant's death shall not apply. In lieu thereof, distributions must commence on or before the later of: (1) December 31st of the calendar year immediately following the calendar year in which the Participant died; or (2) December 31st of the calendar year in which the Participant would have attained age 70 1/2. If the surviving spouse dies before distributions to such spouse begin, then the 5-year distribution requirement of this Section shall apply as if the spouse was the Participant. (3) Notwithstanding subparagraph (2) above, or any selections made in the Adoption Agreement, if a Participant's death benefits are to be paid in the form of a Pre-Retirement Survivor Annuity, then distributions to the Participant's surviving spouse must commence on or before the later of: (1) December 31st of the calendar year immediately following the calendar year in which the Participant died; or (2) December 31st of the calendar year in which the Participant would have attained age 70 1/2. (i) For purposes of Section 6.6(h)(2), the election by a designated Beneficiary to be excepted from the 5-year distribution requirement (if permitted in the Adoption Agreement) must be made no later than December 31st of the calendar year following the calendar year of the Participant's death. 58 66 Except, however, with respect to a designated Beneficiary who is the Participant's surviving spouse, the election must be made by the earlier of: (1) December 31st of the calendar year immediately following the calendar year in which the Participant died or, if later, the calendar year in which the Participant would have attained age 70 1/2; or (2) December 31st of the calendar year which contains the fifth anniversary of the date of the Participant's death. An election by a designated Beneficiary must be in writing and shall be irrevocable as of the last day of the election period stated herein. In the absence of an election by the Participant or a designated Beneficiary, the 5-year distribution requirement shall apply. (j) For purposes of this Section, the life expectancy of a Participant and a Participant's spouse (other than in the case of a life annuity) shall or shall not be redetermined annually as provided in the Adoption Agreement and in accordance with Regulations. If the Participant or the Participant's spouse may elect, pursuant to the Adoption Agreement, to have life expectancies recalculated, then the election, once made shall be irrevocable. If no election is made by the time distributions must commence, then the life expectancy of the Participant and the Participant's spouse shall not be subject to recalculation. Life expectancy and joint and last survivor expectancy shall be computed using the return multiples in Tables V and VI of Regulation Section 1.72-9. (k) In the event that less than 100% of a Participant's interest in the Plan is distributed to such Participant's spouse, the portion of the distribution attributable to the Participant's Voluntary Contribution Account shall be in the same proportion that the Participant's Voluntary Contribution Account bears to the Participant's total interest in the Plan. (l) Subject to the spouse's right of consent afforded under the Plan, the restrictions imposed by this Section shall not apply if a Participant has, prior to January 1, 1984, made a written designation to have his death benefits paid in an alternative method acceptable under Code Section 401(a) as in effect prior to the enactment of the Tax Equity and Fiscal Responsibility Act of 1982. 6.7 TIME OF SEGREGATION OR DISTRIBUTION Except as limited by Sections 6.5 and 6.6, whenever a distribution is to be made, or a series of payments are to commence, on or as of an Anniversary Date, the distribution or series of payments may be made or begun on such date or as soon thereafter as is practicable, but in no event later than 180 days after the Anniversary Date. However, unless a Former Participant elects in writing to defer the receipt of benefits (such election may not result in a death benefit that is more than incidental), the payment of benefits shall begin not later than the 60th day after the close of the Plan Year in which the latest of the following events occurs: (a) the date on which the Participant attains the earlier of age 65 or the Normal Retirement Age specified herein; (b) the 10th anniversary of the year in which the Participant commenced participation in the Plan; or (c) the date the Participant terminates his service with the Employer. Notwithstanding the foregoing, the failure of a Participant and, if applicable, the Participant's spouse, to consent to a distribution pursuant to Section 6.5(d), shall be deemed to be an election to defer the commencement of payment of any benefit sufficient to satisfy this Section. 6.8 DISTRIBUTION FOR MINOR BENEFICIARY In the event a distribution is to be made to a minor, then the Administrator may direct that such distribution be paid to the legal guardian, or if none, to a parent of such Beneficiary or a responsible adult with whom the Beneficiary maintains his residence, or to the custodian for such Beneficiary under the Uniform Gift to Minors Act or Gift to Minors Act, if such is permitted by the laws of the state in which said 59 67 Beneficiary resides. Such a payment to the legal guardian, custodian or parent of a minor Beneficiary shall fully discharge the Trustee, Employer, and Plan from further liability on account thereof. 6.9 LOCATION OF PARTICIPANT OR BENEFICIARY UNKNOWN In the event that all, or any portion, of the distribution payable to a Participant or his Beneficiary hereunder shall, at the later of the Participant's attainment of age 62 or his Normal Retirement Age, remain unpaid solely by reason of the inability of the Administrator, after sending a registered letter, return receipt requested, to the last known address, and after further diligent effort, to ascertain the whereabouts of such Participant or his Beneficiary, the amount so distributable shall be treated as a Forfeiture pursuant to the Plan. In the event a Participant or Beneficiary is located subsequent to his benefit being reallocated, such benefit shall be restored, first from Forfeitures, if any, and then from an additional Employer contribution if necessary. 6.10 PRE-RETIREMENT DISTRIBUTION If elected in the Adoption Agreement, at such time as a Participant shall have attained the age specified in the Adoption Agreement, the Administrator, at the election of the Participant, shall direct the Trustee to distribute up to the entire amount then credited to the accounts maintained on behalf of the Participant. However, no such distribution may be made to any Participant unless his Participant's Account has become fully Vested. In the event that the Administrator makes such a distribution, the Participant shall continue to be eligible to participate in the Plan on the same basis as any other Employee. Any distribution made pursuant to this Section shall be made in a manner consistent with Section 6.5, including but not limited to, all notice and consent requirements required by Code Sections 411(a)(11) and 417 and the Regulations thereunder. Notwithstanding the above, pre-retirement distributions from a Participant's Elective Account and Qualified Non-Elective Account shall not be permitted prior to the Participants attaining 59 1/2 except as otherwise permitted under the terms of the Plan. 6.11 ADVANCE DISTRIBUTION FOR HARDSHIP (a) The Administrator, at the election of the Participant, shall direct the Trustee to distribute to any Participant in any one Plan Year up to the lesser of (1) 100% of his accounts as specified in the Adoption Agreement valued as of the last Anniversary Date or other valuation date or (2) the amount necessary to satisfy the immediate and heavy financial need of the Participant. Any distribution made pursuant to this Section shall be deemed to be made as of the first day of the Plan Year or, if later, the valuation date immediately preceding the date of distribution, and the account from which the distribution is made shall be reduced accordingly. Withdrawal under this Section shall be authorized only if the distribution is on account of one of the following or any other items permitted by the Internal Revenue Service: (1) Medical expenses described in Code Section 213(d) incurred by the Participant, his spouse, or any of his dependents (as defined in Code Section 152); (2) The purchase (excluding mortgage payments) of a principal residence for the Participant; (3) Funeral expenses for a member of the Participant's family; (4) Payment of tuition for the next semester or quarter of post-secondary education for the Participant, his spouse, children, or dependents; or 60 68 (5) The need to prevent the eviction of the Participant from his principal residence or foreclosure on the mortgage of the Participant's principal residence. (b) No such distribution shall be made from the Participant's Account until such Account has become fully Vested. (c) No distribution shall be made pursuant to this Section unless the Administrator, based upon the Participant's representation and such other facts as are known to the Administrator, determines that all of the following conditions are satisfied: (1) The distribution is not in excess of the amount of the immediate and heavy financial need of the Participant; (2) The Participant has obtained all distributions, other than hardship distributions, and all nontaxable loans currently available under all plans maintained by the Employer; (3) The Plan, and all other plans maintained by the Employer, provide that the Participant's elective deferrals and voluntary Employee contributions will be suspended for at least twelve (12) months after receipt of the hardship distribution; and (4) The Plan, and all other plans maintained by the Employer, provide that the Participant may not make elective deferrals for the Participant's taxable year immediately following the taxable year of the hardship distribution in excess of the applicable limit under Code Section 402(g) for such next taxable year less the amount of such Participant's elective deferrals for the taxable year of the hardship distribution. (d) Notwithstanding the above, distributions from the Participant's Elective Account and Qualified Non-Elective Account pursuant to this Section shall be limited solely to the Participant's Deferred Compensation and any income attributable thereto credited to the Participant's Elective Account as of December 31, 1988. (e) Any distribution made pursuant to this Section shall be made in a manner which is consistent with and satisfies the provisions of Section 6.5, including, but not limited to, all notice and consent requirements of Code Sections 411 (a)(11) and 417 and the Regulations thereunder. 6.12 LIMITATIONS ON BENEFITS AND DISTRIBUTIONS All rights and benefits, including elections, provided to a Participant in this Plan shall be subject to the rights afforded to any "alternate payee" under a "qualified domestic relations order." Furthermore, a distribution to an "alternate payee" shall be permitted if such distribution is authorized by a "qualified domestic relations order," even if the affected Participant has not reached the "earliest retirement age" under the Plan. For the purposes of this Section, "alternate payee", "qualified domestic relations order" and "earliest retirement age" shall have the meaning set forth under Code Section 414(p). 6.13 SPECIAL RULE FOR NON-ANNUITY PLANS If elected in the Adoption Agreement, the following shall apply to a Participant in a Profit Sharing Plan and to any distribution, made on or after the first day of the first plan year beginning after December 31, 1988, from or under a separate account attributable solely to accumulated deductible employee contributions, as defined in Code Section 72(o)(5)(B), and maintained on behalf of a participant in a money purchase pension plan, (including a target benefit plan): 61 69 (a) The Participant shall be prohibited from electing benefits in the form of a life annuity; (b) Upon the death of the Participant, the Participant's entire Vested account balances will be paid to his or her surviving spouse, or, if there is no surviving spouse or the surviving spouse has already consented to waive his or her benefit, in accordance with Section 6.6, to his designated Beneficiary; and (c) Except to the extent otherwise provided in this Section and Section 6.5(h), the other provisions of Sections 6.2, 6.5 and 6.6 regarding spousal consent and the forms of distributions shall be inoperative with respect to this Plan. This Section shall not apply to any Participant if it is determined that this Plan is a direct or indirect transferee of a defined benefit plan or money purchase plan, or a target benefit plan, stock bonus or profit sharing plan which would otherwise provide for a life annuity form of payment to the Participant. ARTICLE VII TRUSTEE 7.1 BASIC RESPONSIBILITIES OF THE TRUSTEE The Trustee shall have the following categories of responsibilities: (a) Consistent with the "funding policy and method" determined by the Employer to invest, manage, and control the Plan assets subject, however, to the direction of an Investment Manager if the Employer should appoint such manager as to all or a portion of the assets of the Plan; (b) At the direction of the Administrator, to pay benefits required under the Plan to be paid to Participants, or, in the event of their death, to their Beneficiaries; (c) To maintain records of receipts and disbursements and furnish to the Employer and/or Administrator for each Plan Year a written annual report per Section 7.6; and (d) If there shall be more than one Trustee, they shall act by a majority of their number, but may authorize one or more of them to sign papers on their behalf. 7.2 INVESTMENT POWERS AND DUTIES OF THE TRUSTEE (a) The Trustee shall invest and reinvest the Trust Fund to keep the Trust Fund invested without distinction between principal and income and in such securities or property, real or personal, wherever situated, as the Trustee shall deem advisable, including, but not limited to, stocks, common or preferred, bonds and other evidences of indebtedness or ownership, and real estate or any interest therein. The Trustee shall at all times in making investments of the Trust Fund consider, among other factors, the short and long-term financial needs of the Plan on the basis of information furnished by the Employer. In making such investments, the Trustee shall not be restricted to securities or other property of the character expressly authorized by the applicable law for trust investments; however, the Trustee shall give due regard to any limitations imposed by the Code or the Act so that at all times this Plan may qualify as a qualified Plan and Trust. 62 70 (b) The Trustee may employ a bank or trust company pursuant to the terms of its usual and customary bank agency agreement, under which the duties of such bank or trust company shall be of a custodial, clerical and record-keeping nature. (c) The Trustee, at the direction of the Administrator and pursuant to instructions from the individual designated in the Adoption Agreement for such purpose shall ratably apply for, own, and pay all premiums on Contracts on the lives of the Participants. Any initial or additional Contract purchased on behalf of a Participant shall have a face amount of not less than $1,000 or the limitation of the Insurer, whichever is greater. If a life insurance Contract is to be purchased for a Participant, the aggregate premium for ordinary life insurance for each Participant must be less than 50% of the aggregate contributions and Forfeitures allocated to a Participant's Combined Account. For purposes of this limitation, ordinary life insurance Contracts are Contracts with both non-decreasing death benefits and non-increasing premiums. If term insurance or universal life insurance is purchased with such contributions, the aggregate premium must be 25% or less of the aggregate contributions and Forfeitures allocated to a Participant's Combined Account. If both term insurance and ordinary life insurance are purchased with such contributions, the amount expended for term insurance plus one-half of the premium for ordinary life insurance may not in the aggregate exceed 25% of the aggregate Employer contributions and Forfeitures allocated to a Participant's Combined Account. The Trustee must distribute the Contracts to the Participant or convert the entire value of the Contracts at or before retirement into cash or provide for a periodic income so that no portion of such value may be used to continue life insurance protection beyond retirement. Notwithstanding the above, the limitations imposed herein with respect to the purchase of life insurance shall not apply, in the case of a Profit Sharing Plan, to the portion of a Participant's Account that has accumulated for at least two (2) Plan Years. Notwithstanding anything hereinabove to the contrary, amounts credited to a Participant's Qualified Voluntary Employee Contribution Account pursuant to Section 4.14, shall not be applied to the purchase of life insurance contracts. (d) The Trustee will be the owner of any life insurance Contract purchased under the terms of this Plan. The Contract must provide that the proceeds will be payable to the Trustee; however, the Trustee shall be required to pay over all proceeds of the Contract to the Participant's designated Beneficiary in accordance with the distribution provisions of Article VI. A Participant's spouse will be the designated Beneficiary pursuant to Section 6.2, unless a qualified election has been made in accordance with Sections 6.5 and 6.6 of the Plan, if applicable. Under no circumstances shall the Trust retain any part of the proceeds. However, the Trustee shall not pay the proceeds in a method that would violate the requirements of the Retirement Equity Act, as stated in Article VI of the Plan, or Code Section 401(a)(9) and the Regulations thereunder. (e) Notwithstanding anything in the Plan to contrary, investments under this Plan shall include a product of Aetna Life Insurance and Annuity Company, or any of its affiliates or subsidiaries. 7.3 OTHER POWERS OF THE TRUSTEE The Trustee, in addition to all powers and authorities under common law, statutory authority, including the Act, and other provisions of this Plan, shall have the following powers and authorities to be exercised in the Trustee's sole discretion: (a) To purchase, or subscribe for, any securities or other property and to retain the same. In conjunction with the purchase of securities, margin accounts may be opened and maintained; 63 71 (b) To sell, exchange, convey, transfer, grant options to purchase, or otherwise dispose of any securities or other property held by the Trustee, by private contract or at public auction. No person dealing with the Trustee shall be bound to see to the application of the purchase money or to inquire into the validity, expediency, or propriety of any such sale or other disposition, with or without advertisement; (c) To vote upon any stocks, bonds, or other securities; to give general or special proxies or powers of attorney with or without power of substitution; to exercise any conversion privileges, subscription rights or other options, and to make any payments incidental thereto; to oppose, or to consent to, or otherwise participate in, corporate reorganizations or other changes affecting corporate securities, and to delegate discretionary powers, and to pay any assessments or charges in connection therewith; and generally to exercise any of the powers of an owner with respect to stocks, bonds, securities, or other property. (d) To cause any securities or other property to be registered in the Trustee's own name or in the name of one or more of the Trustee's nominees, and to hold any investments in bearer form, but the books and records of the Trustee shall at all times show that all such investments are part of the Trust Fund; (e) To borrow or raise money for the purposes of the Plan in such amount, and upon such terms and conditions, as the Trustee shall deem advisable; and for any sum so borrowed, to issue a promissory note as Trustee, and to secure the repayment thereof by pledging all, or any part, of the Trust Fund; and no person lending money to the Trustee shall be bound to see to the application of the money lent or to inquire into the validity, expediency, or propriety of any borrowing; (f) To keep such portion of the Trust Fund in cash or cash balances as the Trustee may, from time to time, deem to be in the best interests of the Plan, without liability for interest thereon; (g) To accept and retain for such time as the Trustee may deem advisable any securities or other property received or acquired as Trustee hereunder, whether or not such securities or other property would normally be purchased as investments hereunder; (h) To make, execute, acknowledge, and deliver any and all documents of transfer and conveyance and any and all other instruments that may be necessary or appropriate to carry out the powers herein granted; (i) To settle, compromise, or submit to arbitration any claims, debts, or damages due or owing to or from the Plan, to commence or defend suits or legal or administrative proceedings, and to represent the Plan in all suits and legal and administrative proceedings; (j) To employ suitable agents and counsel and to pay their reasonable expenses and compensation, and such agent or counsel may or may not be agent or counsel for the Employer; (k) To apply for and procure from the Insurer as an investment of the Trust Fund such annuity, or other Contracts (on the life of any Participant) as the Administrator shall deem proper; to exercise, at any time or from time to time, whatever rights and privileges may be granted under such annuity, or other Contracts; to collect, receive, and settle for the proceeds of all such annuity, or other Contracts as and when entitled to do so under the provisions thereof; (l) To invest funds of the Trust in time deposits or savings accounts bearing a reasonable rate of interest in the Trustee's bank; 64 72 (m) To invest in Treasury Bills and other forms of United States government obligations; (n) To sell, purchase and acquire put or call options if the options are traded on and purchased through a national securities exchange registered under the Securities Exchange Act of 1934, as amended, or, if the options are not traded on a national securities exchange, are guaranteed by a member firm of the New York Stock Exchange; (o) To deposit monies in federally insured savings accounts or certificates of deposit in banks or savings and loan associations; (p) To pool all or any of the Trust Fund, from time to time, with assets belonging to any other qualified employee pension benefit trust created by the Employer or any Affiliated Employer, and to commingle such assets and make joint or common investments and carry joint accounts on behalf of this Plan and such other trust or trusts, allocating undivided shares or interests in such investments or accounts or any pooled assets of the two or more trusts in accordance with their respective interests; (q) To do all such acts and exercise all such rights and privileges, although not specifically mentioned herein, as the Trustee may deem necessary to carry out the purposes of the Plan; (r) Directed Investment Account. The powers granted to the Trustee shall be exercised in the sole fiduciary discretion of the Trustee. However, if elected in the Adoption Agreement, each Participant may direct the Trustee to separate and keep separate all or a portion of his interest in the Plan; and further each Participant is authorized and empowered, in his sole and absolute discretion, to give directions to the Trustee in such form as the Trustee may require concerning the investment of the Participant's Directed Investment Account, which directions must be followed by the Trustee subject, however, to restrictions on payment of life insurance premiums. Neither the Trustee nor any other persons including the Administrator or otherwise shall be under any duty to question any such direction of the Participant or to review any securities or other property, real or personal, or to make any suggestions to the Participant in connection therewith, and the Trustee shall comply as promptly as practicable with directions given by the Participant hereunder. Any such direction may be of a continuing nature or otherwise and may be revoked by the Participant at any time in such form as the Trustee may require. The Trustee may refuse to comply with any direction from the Participant in the event the Trustee, in its sole and absolute discretion, deems such directions improper by virtue of applicable law, and in such event, the Trustee shall not be responsible or liable for any loss or expense which may result. Any costs and expenses related to compliance with the Participant's directions shall be borne by the Participant's Directed Investment Account. Notwithstanding anything hereinabove to the contrary, the Trustee shall not, at any time after December 31, 1981, invest any portion of a Directed Investment Account in "collectibles" within the meaning of that term as employed in Code Section 408(m). 7.4 LOANS TO PARTICIPANTS (a) If specified in the Adoption Agreement, the Trustee may, in the Trustee's sole discretion, make loans to Participants or Beneficiaries under the following circumstances: (1) loans shall be made available to all Participants and Beneficiaries on a reasonably equivalent basis; (2) loans shall not be made available to Highly Compensated Employees in an amount greater than the amount made available to other Participants; (3) loans shall bear a reasonable rate of interest; (4) loans shall be adequately secured; and (5) shall provide for periodic repayment over a reasonable period of time. 65 73 (b) Loans shall not be made to any Shareholder-Employee or Owner-Employee unless an exemption for such loan is obtained pursuant to Act Section 408 and further provided that such loan would not be subject to tax pursuant to Code Section 4975. (c) Loans shall not be granted to any Participant that provide for a repayment period extending beyond such Participant's Normal Retirement Date. (d) Loans made pursuant to this Section (when added to the outstanding balance of all other loans made by the Plan to the Participant) shall be limited to the lesser of: (1) $50,000 reduced by the excess (if any) of the highest outstanding balance of loans from the Plan to the Participant during the one year period ending on the day before the date on which such loan is made, over the outstanding balance of loans from the Plan to the Participant on the date on which such loan was made, or (2) one-half (1/2) of the present value of the non-forfeitable accrued benefit of the Employee under the Plan. For purposes of this limit, all plans of the Employer shall be considered one plan. Additionally, with respect to any loan made prior to January 1, 1987, the $50,000 limit specified in (1) above shall be unreduced. (e) No Participant loan shall take into account the present value of such Participant's Qualified Voluntary Employee Contribution Account. (f) Loans shall provide for level amortization with payments to be made not less frequently than quarterly over a period not to exceed five (5) years. However, loans used to acquire any dwelling unit which, within a reasonable time, is to be used (determined at the time the loan is made) as a principal residence of the Participant shall provide for periodic repayment over a reasonable period of time that may exceed five (5) years. Notwithstanding the foregoing, loans made prior to January 1, 1987 which are used to acquire, construct, reconstruct or substantially rehabilitate any dwelling unit which, within a reasonable period of time is to be used (determined at the time the loan is made) as a principal residence of the Participant or a member of his family (within the meaning of Code Section 267(c)(4)) may provide for periodic repayment over a reasonable period of time that may exceed five (5) years. Additionally, loans made prior to January 1, 1987, may provide for periodic payments which are made less frequently than quarterly and which do not necessarily result in level amortization. (g) An assignment or pledge of any portion of a Participant's interest in the Plan and a loan, pledge, or assignment with respect to any insurance Contract purchased under the Plan, shall be treated as a loan under this Section. (h) Any loan made pursuant to this Section after August 18, 1985 where the Vested interest of the Participant is used to secure such loan shall require the written consent of the Participant's spouse in a manner consistent with Section 6.5(a) provided the spousal consent requirements of such Section apply to the Plan. Such written consent must be obtained within the 90-day period prior to the date the loan is made. Any security interest held by the Plan by reason of an outstanding loan to the Participant shall be taken into account in determining the amount of the death benefit or Pre-Retirement Survivor Annuity. However, no spousal consent shall be required under this paragraph if the total accrued benefit subject to the security is not in excess of $3,500. 66 74 (i) With regard to any loans granted or renewed on or after the last day of the first Plan Year beginning after December 31, 1988, a Participant loan program shall be established which must include, but need not be limited to, the following: (1) the identity of the person or positions authorized to administer the Participant loan program; (2) a procedure for applying for loans; (3) the basis on which loans will be approved or denied; (4) limitations, if any, on the types and amounts of loans offered, including what constitutes a hardship or financial need if selected in the Adoption Agreement; (5) the procedure under the program for determining a reasonable rate of interest; (6) the types of collateral which may secure a Participant loan; and (7) the events constituting default and the steps that will be taken to preserve plan assets. Such Participant loan program shall be contained in a separate written document which, when properly executed, is hereby incorporated by reference and made a part of this Plan. Furthermore, such Participant loan program may be modified or amended in writing from time to time without the necessity of amending this Section of the Plan. 7.5 DUTIES OF THE TRUSTEE REGARDING PAYMENTS At the direction of the Administrator, the Trustee shall, from time to time, in accordance with the terms of the Plan, make payments out of the Trust Fund. The Trustee shall not be responsible in any way for the application of such payments. 7.6 TRUSTEE'S COMPENSATION AND EXPENSES AND TAXES The Trustee shall be paid such reasonable compensation as set forth in the Trustee's fee schedule (if the Trustee has such a schedule) or as agreed upon in writing by the Employer and the Trustee. An individual serving as Trustee who already receives full-time pay from the Employer shall not receive compensation from this Plan. In addition, the Trustee shall be reimbursed for any reasonable expenses, including reasonable counsel fees incurred by it as Trustee. Such compensation and expenses shall be paid from the Trust Fund unless paid or advanced by the Employer. All taxes of any kind and all kinds whatsoever that may be levied or assessed under existing or future laws upon, or in respect of, the Trust Fund or the income thereof, shall be paid from the Trust Fund. 7.7 ANNUAL REPORT OF THE TRUSTEE Within a reasonable period of time after the later of the Anniversary Date or receipt of the Employer's contribution for each Plan Year, the Trustee, or its agent, shall furnish to the Employer and Administrator a written statement of account with respect to the Plan Year for which such contribution was made setting forth: 67 75 (a) the net income, or loss, of the Trust Fund; (b) the gains, or losses, realized by the Trust Fund upon sales or other disposition of the assets; (c) the increase, or decrease, in the value of the Trust Fund; (d) all payments and distributions made from the Trust Fund; and (e) such further information as the Trustee and/or Administrator deems appropriate. The Employer, forthwith upon its receipt of each such statement of account, shall acknowledge receipt thereof in writing and advise the Trustee and/or Administrator of its approval or disapproval thereof. Failure by the Employer to disapprove any such statement of account within thirty (30) days after its receipt thereof shall be deemed an approval thereof. The approval by the Employer of any statement of account shall be binding as to all matters embraced therein as between the Employer and the Trustee to the same extent as if the account of the Trustee had been settled by judgment or decree in an action for a judicial settlement of its account in a court of competent jurisdiction in which the Trustee, the Employer and all persons having or claiming an interest in the Plan were parties; provided, however, that nothing herein contained shall deprive the Trustee of its right to have its accounts judicially settled if the Trustee so desires. 7.8 AUDIT (a) If an audit of the Plan's records shall be required by the Act and the regulations thereunder for any Plan Year, the Administrator shall direct the Trustee to engage on behalf of all Participants an independent qualified public accountant for that purpose. Such accountant shall, after an audit of the books and records of the Plan in accordance with generally accepted auditing standards, within a reasonable period after the close of the Plan Year, furnish to the Administrator and the Trustee a report of his audit setting forth his opinion as to whether any statements, schedules or lists, that are required by Act Section 103 or the Secretary of Labor to be filed with the Plan's annual report, are presented fairly in conformity with generally accepted accounting principles applied consistently. (b) All auditing and accounting fees shall be an expense of and may, at the election of the Administrator, be paid from the Trust Fund. (c) If some or all of the information necessary to enable the Administrator to comply with Act Section 103 is maintained by a bank, insurance company, or similar institution, regulated and supervised and subject to periodic examination by a state or federal agency, it shall transmit and certify the accuracy of that information to the Administrator as provided in Act Section 103(b) within one hundred twenty (120) days after the end of the Plan Year or such other date as may be prescribed under regulations of the Secretary of Labor. 7.9 RESIGNATION, REMOVAL AND SUCCESSION OF TRUSTEE (a) The Trustee may resign at any time by delivering to the Employer, at least thirty (30) days before its effective date, a written notice of his resignation. (b) The Employer may remove the Trustee by mailing by registered or certified mail, addressed to such Trustee at his last known address, at least thirty (30) days before its effective date, a written notice of his removal. 68 76 (c) Upon the death, resignation, incapacity, or removal of any Trustee, a successor may be appointed by the Employer; and such successor, upon accepting such appointment in writing and delivering same to the Employer, shall, without further act, become vested with all the estate, rights, powers, discretions, and duties of his predecessor with like respect as if he were originally named as a Trustee herein. Until such a successor is appointed, the remaining Trustee or Trustees shall have full authority to act under the terms of the Plan. (d) The Employer may designate one or more successors prior to the death, resignation, incapacity, or removal of a Trustee. In the event a successor is so designated by the Employer and accepts such designation, the successor shall, without further act, become vested with all the estate, rights, powers, discretions, and duties of his predecessor with the like effect as if he were originally named as Trustee herein immediately upon the death, resignation, incapacity, or removal of his predecessor. (e) Whenever any Trustee hereunder ceases to serve as such, he shall furnish to the Employer and Administrator a written statement of account with respect to the portion of the Plan Year during which he served as Trustee. This statement shall be either (i) included as part of the annual statement of account for the Plan Year required under Section 7.6 or (ii) set forth in a special statement. Any such special statement of account should be rendered to the Employer no later than the due date of the annual statement of account for the Plan Year. The procedures set forth in Section 7.6 for the approval by the Employer of annual statements of account shall apply to any special statement of account rendered hereunder and approval by the Employer of any such special statement in the manner provided in Section 7.6 shall have the same effect upon the statement as the Employer's approval of an annual statement of account. No successor to the Trustee shall have any duty or responsibility to investigate the acts or transactions of any predecessor who has rendered all statements of account required by Section 7.6 and this subparagraph. 7.10 TRANSFER OF INTEREST Notwithstanding any other provision contained in this Plan, the Trustee at the direction of the Administrator shall transfer the Vested interest, if any, of such Participant in his account to another trust forming part of a pension, profit sharing, or stock bonus plan maintained by such Participant's new employer and represented by said employer in writing as meeting the requirements of Code Section 401(a), provided that the trust to which such transfers are made permits the transfer to be made. 7.11 TRUSTEE INDEMNIFICATION The Employer agrees to indemnify and save harmless the Trustee against any and all claims, losses, damages, expenses and liabilities the Trustee may incur in the exercise and performance of the Trustee's powers and duties hereunder, unless the same are determined to be due to gross negligence or willful misconduct. 7.12 EMPLOYER SECURITIES AND REAL PROPERTY The Trustee shall be empowered to acquire and hold "qualifying Employer securities" and "qualifying Employer real property," as those terms are defined in the Act. However, no more than 100% of the fair market value of all the assets in the Trust Fund may be invested in "qualifying Employer securities" and "qualifying Employer real property". 69 77 7.13 POWERS AND DUTIES OF THE CUSTODIAN The Custodian herein named shall have no duties other than those of an administrative or custodial nature, and shall keep records of its activities, to be furnished from time to time to the Trustee and/or Administrator. The Custodian shall have possession of the assets of the Trust Fund and shall invest them and distribute them only in accordance with directions received from the Trustee and/or Administrator. The Custodian shall have no responsibility with respect to any assets of the Trust Fund not delivered to the Custodian. The Custodian shall be entitled to be paid fees in accordance with its published fee schedule and reimbursement for its expenses, to be paid from the assets of the Trust. ARTICLE VIII AMENDMENT, TERMINATION, AND MERGERS 8.1 AMENDMENT (a) The Employer shall have the right at any time to amend this Plan subject to the limitations of this Section. However, any amendment which affects the rights, duties or responsibilities of the Trustee and Administrator may only be made with the Trustee's and Administrator's written consent. Any such amendment shall become effective as provided therein upon its execution. The Trustee shall not be required to execute any such amendment unless the amendment affects the duties of the Trustee hereunder. (b) The Employer may (1) change the choice of options in the Adoption Agreement, (2) add overriding language in the Adoption Agreement when such language is necessary to satisfy Code Sections 415 or 416 because of the required aggregation of multiple plans, and (3) add certain model amendments published by the Internal Revenue Service which specifically provide that their adoption will not cause the Plan to be treated as an individually designed plan. An Employer that amends the Plan for any other reason, including a waiver of the minimum funding requirement under Code Section 412(d), will no longer participate in this Prototype Plan and will be considered to have an individually designed plan. (c) The Employer expressly delegates authority to the sponsoring organization of this Plan, the right to amend this Plan by submitting a copy of the amendment to each Employer who has adopted this Plan after first having received a ruling or favorable determination from the Internal Revenue Service that the Plan as amended qualifies under Code Section 401(a) and the Act. For purposes of this Section, the mass submitter shall be recognized as the agent of the sponsoring organization. If the sponsoring organization does not adopt the amendments made by the mass submitter, it will no longer be identical to or a minor modifier of the mass submitter plan. (d) No amendment to the Plan shall be effective if it authorizes or permits any part of the Trust Fund (other than such part as is required to pay taxes and administration expenses) to be used for or diverted to any purpose other than for the exclusive benefit of the Participants or their Beneficiaries or estates; or causes any reduction in the amount credited to the account of any Participant; or causes or permits any portion of the Trust Fund to revert to or become property of the Employer. (e) Except as permitted by Regulations (including Regulation 1.411(d)-4), no Plan amendment or transaction having the effect of a Plan amendment (such as a merger, plan transfer or similar transaction) shall be effective if it eliminates or reduces any "Section 411(d)(6) protected benefit" or adds or modifies conditions relating to "Section 411(d)(6) protected benefits" the result of which is a further restriction on such benefit unless such protected benefits are preserved with respect to benefits accrued as of the later of the adoption date or effective date of the amendment. "Section 70 78 411(d)(6) protected benefits" are benefits described in Code Section 411(d)(6)(A), early retirement benefits and retirement-type subsidies, and optional forms of benefit. 8.2 TERMINATION (a) The Employer shall have the right at any time to terminate the Plan by delivering to the Trustee and Administrator written notice of such termination. Upon any full or partial termination all amounts credited to the affected Participants' Combined Accounts shall become 100% Vested and shall not thereafter be subject to forfeiture, and all unallocated amounts shall be allocated to the accounts of all Participants in accordance with the provisions hereof. (b) Upon the full termination of the Plan, the Employer shall direct the distribution of the assets to Participants in a manner which is consistent with and satisfies the provisions of Section 6.5. Distributions to a Participant shall be made in cash (or in property if permitted in the Adoption Agreement) or through the purchase of irrevocable nontransferable deferred commitments from the Insurer. Except as permitted by Regulations, the termination of the Plan shall not result in the reduction of "Section 411(d)(6) protected benefits" as described in Section 8. 1. 8.3 MERGER OR CONSOLIDATION This Plan may be merged or consolidated with, or its assets and/or liabilities may be transferred to any other plan only if the benefits which would be received by a Participant of this Plan, in the event of a termination of the plan immediately after such transfer, merger or consolidation, are at least equal to the benefits the Participant would have received if the Plan had terminated immediately before the transfer, merger or consolidation and such merger or consolidation does not otherwise result in the elimination or reduction of any "Section 411(d)(6) protected benefits" as described in Section 8.1(e). ARTICLE IX MISCELLANEOUS 9.1 EMPLOYER ADOPTIONS (a) Any organization may become the Employer hereunder by executing the Adoption Agreement in form satisfactory to the Trustee, and it shall provide such additional information as the Trustee may require. The consent of the Trustee to act as such shall be signified by its execution of the Adoption Agreement. (b) Except as otherwise provided in this Plan, the affiliation of the Employer and the participation of its Participants shall be separate and apart from that of any other employer and its participants hereunder. 9.2 PARTICIPANT'S RIGHTS This Plan shall not be deemed to constitute a contract between the Employer and any Participant or to be a consideration or an inducement for the employment of any Participant or Employee. Nothing contained in this Plan shall be deemed to give any Participant or Employee the right to be retained in the service of the Employer or to interfere with the right of the Employer to discharge any Participant or Employee at any time regardless of the effect which such discharge shall have upon him as a Participant of this Plan. 71 79 9.3 ALIENATION (a) Subject to the exceptions provided below, no benefit which shall be payable to any person (including a Participant or his Beneficiary) shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, or charge, and any attempt to anticipate, alienate, sell, transfer, assign, pledge, encumber, or charge the same shall be void; and no such benefit shall in any manner be liable for, or subject to, the debts, contracts, liabilities, engagements, or torts of any such person, nor shall it be subject to attachment or legal process for or against such person, and the same shall not be recognized except to such extent as may be required by law. (b) This provision shall not apply to the extent a Participant or Beneficiary is indebted to the Plan, for any reason, under any provision of this Plan. At the time a distribution is to be made to or for a Participant's or Beneficiary's benefit, such proportion of the amount to be distributed as shall equal such indebtedness shall be paid to the Plan, to apply against or discharge such indebtedness. Prior to making a Payment, however, the Participant or Beneficiary must be given written notice by the Administrator that such indebtedness is to be so paid in whole or part from his Participant's Combined Account. If the Participant or Beneficiary does not agree that the indebtedness is a valid claim against his Vested Participant's Combined Account, he shall be entitled to a review of the validity of the claim in accordance with procedures provided in Sections 2.12 and 2.13. (c) This provision shall not apply to a "qualified domestic relations order" defined in Code Section 414(p), and those other domestic relations orders permitted to be so treated by the Administrator under the provisions of the Retirement Equity Act of 1984. The Administrator shall establish a written procedure to determine the qualified status of domestic relations orders and to administer distributions under such qualified orders. Further, to the extent provided under a "qualified domestic relations order", a former spouse of a Participant shall be treated as the spouse or surviving spouse for all purposes under the Plan. 9.4 CONSTRUCTION OF PLAN This Plan and Trust shall be construed and enforced according to the Act and the laws of the State or Commonwealth in which the Employer's principal office is located, other than its laws respecting choice of law, to the extent not pre-empted by the Act. 9.5 GENDER AND NUMBER Wherever any words are used herein in the masculine, feminine or neuter gender, they shall be construed as though they were also used in another gender in all cases where they would so apply, and whenever any words are used herein in the singular or plural form, they shall be construed as though they were also used in the other form in all cases where they would so apply. 9.6 LEGAL ACTION In the event any claim, suit, or proceeding is brought regarding the Trust and/or Plan established hereunder to which the Trustee or the Administrator may be a party, and such claim, suit, or proceeding is resolved in favor of the Trustee or Administrator, they shall be entitled to be reimbursed from the Trust Fund for any and all costs, attorney's fees, and other expenses pertaining thereto incurred by them for which they shall have become liable. 72 80 9.7 PROHIBITION AGAINST DIVERSION OF FUNDS (a) Except as provided below and otherwise specifically permitted by law, it shall be impossible by operation of the Plan or of the Trust, by termination of either, by power of revocation or amendment, by the happening of any contingency, by collateral arrangement or by any other means, for any part of the corpus or income of any Trust Fund maintained pursuant to the Plan or any funds contributed thereto to be used for, or diverted to, purposes other than the exclusive benefit of Participants, Retired Participants, or their Beneficiaries. (b) In the event the Employer shall make a contribution under a mistake of fact pursuant to Section 403(c)(2)(A) of the Act, the Employer may demand repayment of such contribution at any time within one (1) year following the time of payment and the Trustees shall return such amount to the Employer within the one (1) year period. Earnings of the Plan attributable to the contributions may not be returned to the Employer but any losses attributable thereto must reduce the amount so returned. 9.8 BONDING Every Fiduciary, except a bank or an insurance company, unless exempted by the Act and regulations thereunder, shall be bonded in an amount not less than 10% of the amount of the funds such Fiduciary handles; provided, however, that the minimum bond shall be $1,000 and the maximum bond, $500,000. The amount of funds handled shall be determined at the beginning of each Plan Year by the amount of funds handled by such person, group, or class to be covered and their predecessors, if any, during the preceding Plan Year, or if there is no preceding Plan Year, then by the amount of the funds to be handled during the then current year. The bond shall provide protection to the Plan against any loss by reason of acts of fraud or dishonesty by the Fiduciary alone or in connivance with others. The surety shall be a corporate surety company (as such term is used in Act Section 412(a)(2)), and the bond shall be in a form approved by the Secretary of Labor. Notwithstanding anything in the Plan to the contrary, the cost of such bonds shall be an expense of and may, at the election of the Administrator, be paid from the Trust Fund or by the Employer. 9.9 INSURER'S PROTECTIVE CLAUSE The Insurer who shall issue Contracts hereunder shall not have any responsibility for the validity of this Plan or for the tax or legal aspects of this Plan. The Insurer shall be protected and held harmless in acting in accordance with any written direction of the Trustee, and shall have no duty to see to the application of any funds paid to the Trustee, nor be required to question any actions directed by the Trustee. Regardless of any provision of this Plan, the Insurer shall not be required to take or permit any action or allow any benefit or privilege contrary to the terms of any Contract which it issues hereunder, or the rules of the Insurer. 9.10 RECEIPT AND RELEASE FOR PAYMENTS Any payment to any Participant, his legal representative, Beneficiary, or to any guardian or committee appointed for such Participant or Beneficiary in accordance with the provisions of this Plan, shall, to the extent thereof, be in full satisfaction of all claims hereunder against the Trustee and the Employer. 9.11 ACTION BY THE EMPLOYER Whenever the Employer under the terms of the Plan is permitted or required to do or perform any act or matter or thing, it shall be done and performed by a person duly authorized by its legally constituted authority. 73 81 9.12 NAMED FIDUCIARIES AND ALLOCATION OF RESPONSIBILITY The "named Fiduciaries" of this Plan are (1) the Employer, (2) the Administrator, (3) the Trustee, and (4) any Investment Manager appointed hereunder. The named Fiduciaries shall have only those specific powers, duties, responsibilities, and obligations as are specifically given them under the Plan. In general, the Employer shall have the sole responsibility for making the contributions provided for under Section 4.1; and shall have the sole authority to appoint and remove the Trustee and the Administrator; to formulate the Plan's "funding policy and method"; and to amend the elective provisions of the Adoption Agreement or terminate, in whole or in part, the Plan. The Administrator shall have the sole responsibility for the administration of the Plan, which responsibility is specifically described in the Plan. The Trustee shall have the sole responsibility of management of the assets held under the Trust, except those assets, the management of which has been assigned to an Investment Manager or Administrator, who shall be solely responsible for the management of the assets assigned to it, all as specifically provided in the Plan. Each named Fiduciary warrants that any directions given, information furnished, or action taken by it shall be in accordance with the provisions of the Plan, authorizing or providing for such direction, information or action. Furthermore, each named Fiduciary may rely upon any such direction, information or action of another named Fiduciary as being proper under the Plan, and is not required under the Plan to inquire into the propriety of any such direction, information or action. It is intended under the Plan that each named Fiduciary shall be responsible for the proper exercise of its own powers, duties, responsibilities and obligations under the Plan. No named Fiduciary shall guarantee the Trust Fund in any manner against investment loss or depreciation in asset value. Any person or group may serve in more than one Fiduciary capacity. 9.13 HEADINGS The headings and subheadings of this Plan have been inserted for convenience of reference and are to be ignored in any construction of the provisions hereof. 9.14 APPROVAL BY INTERNAL REVENUE SERVICE (a) Notwithstanding anything herein to the contrary, if, pursuant to a timely application filed by or in behalf of the Plan, the Commissioner of Internal Revenue Service or his delegate should determine that the Plan does not initially qualify as a tax-exempt plan under Code Sections 401 and 501, and such determination is not contested, or if contested, is finally upheld, then if the Plan is a new plan, it shall be void ab initio and all amounts contributed to the Plan, by the Employer, less expenses paid, shall be returned within one year and the Plan shall terminate, and the Trustee shall be discharged from all further obligations. If the disqualification relates to an amended plan, then the Plan shall operate as if it had not been amended and restated. In the event that a contribution is made to the Plan conditioned upon qualification of the Plan as amended, such contribution must be returned to Employer upon the determination that the amended Plan fails to qualify under the Code. (b) Notwithstanding any provisions to the contrary, except Sections 3.5, 3.6, and 4.1(f), any contribution by the Employer to the Trust Fund is conditioned upon the deductibility of the contribution by the Employer under the Code and, to the extent any such deduction is disallowed, the Employer may within one (1) year following the disallowance of the deduction, demand repayment of such disallowed contribution and the Trustee shall return such contribution within one (1) year following the disallowance. Earnings of the Plan attributable to the excess contribution may not be returned to the Employer, but any losses attributable thereto must reduce the amount so returned. (c) If an Employer's Plan fails to attain or retain qualification, then such Plan will no longer participate in this Prototype Plan and will be considered an individually designed plan. 74 82 9.15 UNIFORMITY All provisions of this Plan shall be interpreted and applied in a uniform, nondiscriminatory manner. 9.16 PAYMENT OF BENEFITS Benefits under this Plan shall be paid, subject to Section 6.10 and Section 6.11 only upon death, Total and Permanent Disability, normal or early retirement, termination of employment, or upon Plan Termination. ARTICLE X PARTICIPATING EMPLOYERS 10.1 ELECTION TO BECOME A PARTICIPATING EMPLOYER Notwithstanding anything herein to the contrary, with the consent of the Employer and Trustee, any Affiliated Employer may adopt this Plan and all of the provisions hereof, and participate herein and be known as a Participating Employer, by a properly executed document evidencing said intent and will of such Participating Employer. 10.2 REQUIREMENTS OF PARTICIPATING EMPLOYERS (a) Each Participating Employer shall be required to select the same Adoption Agreement provisions as those selected by the Employer other than the Plan Year, the Fiscal Year, and such other items that must, by necessity, vary among employers. (b) Each such Participating Employer shall be required to use the same Trustee as provided in this Plan. (c) The Trustee may, but shall not be required to, commingle, hold and invest as one Trust Fund all contributions made by Participating Employers, as well as all increments thereof. (d) The transfer of any Participant from or to an Employer participating in this Plan, whether he be an Employee of the Employer or a Participating Employer, shall not affect such Participant's rights under the Plan, and all amounts credited to such Participant's Combined Account as well as his accumulated service time with the transferor or predecessor, and his length of participation in the Plan, shall continue to his credit. (e) Any expenses of the Plan which are to be paid by the Employer or borne by the Trust Fund shall be paid by each Participating Employer in the same proportion that the total amount standing to the credit of all Participants employed by such Employer bears to the total standing to the credit of all Participants. 10.3 DESIGNATION OF AGENT Each Participating Employer shall be deemed to be a part of this Plan; provided, however, that with respect to all of its relations with the Trustee and Administrator for the purpose of this Plan, each Participating Employer shall be deemed to have designated irrevocably the Employer as its agent. Unless the context of the Plan clearly indicates the contrary, the word "Employer" shall be deemed to include each Participating Employer as related to its adoption of the Plan. 75 83 10.4 EMPLOYEE TRANSFERS It is anticipated that an Employee may be transferred between Participating Employers, and in the event of any such transfer, the Employee involved shall carry with him his accumulated service and eligibility. No such transfer shall effect a termination of employment hereunder, and the Participating Employer to which the Employee is transferred shall thereupon become obligated hereunder with respect to such Employee in the same manner as was the Participating Employer from whom the Employee was transferred. 10.5 PARTICIPATING EMPLOYER'S CONTRIBUTION AND FORFEITURES Any contribution or Forfeiture subject to allocation during each Plan Year shall be allocated among all Participants of all Participating Employers in accordance with the provisions of this Plan. On the basis of the information furnished by the Administrator, the Trustee shall keep separate books and records concerning the affairs of each Participating Employer hereunder and as to the accounts and credits of the Employees of each Participating Employer. The Trustee may, but need not, register Contracts so as to evidence that a particular Participating Employer is the interested Employer hereunder, but in the event of an Employee transfer from one Participating Employer to another, the employing Employer shall immediately notify the Trustee thereof. 10.6 AMENDMENT Amendment of this Plan by the Employer at any time when there shall be a Participating Employer hereunder shall only be by the written action of each and every Participating Employer and with the consent of the Trustee where such consent is necessary in accordance with the terms of this Plan. 10.7 DISCONTINUANCE OF PARTICIPATION Except in the case of a Standardized Plan, any Participating Employer shall be permitted to discontinue or revoke its participation in the Plan at any time. At the time of any such discontinuance or revocation, satisfactory evidence thereof and of any applicable conditions imposed shall be delivered to the Trustee. The Trustee shall thereafter transfer, deliver and assign Contracts and other Trust Fund assets allocable to the Participants of such Participating Employer to such new Trustee as shall have been designated by such Participating Employer, in the event that it has established a separate pension plan for its Employees provided, however, that no such transfer shall be made if the result is the elimination or reduction of any "Section 411(d)(6) protected benefits" in accordance with Section 8.1(e). If no successor is designated, the Trustee shall retain such assets for the Employees of said Participating Employer pursuant to the provisions of Article VII hereof. In no such event shall any part of the corpus or income of the Trust Fund as it relates to such Participating Employer be used for or diverted for purposes other than for the exclusive benefit of the Employees of such Participating Employer. 10.8 ADMINISTRATOR'S AUTHORITY The Administrator shall have authority to make any and all necessary rules or regulations, binding upon all Participating Employers and all Participants, to effectuate the purpose of this Article. 10.9 PARTICIPATING EMPLOYER CONTRIBUTION FOR AFFILIATE If any Participating Employer is prevented in whole or in part from making a contribution which it would otherwise have made under the Plan by reason of having no current or accumulated earnings or profits, or because such earnings or profits are less than the contribution which it would otherwise have made, then, pursuant to Code Section 404(a)(3)(B), so much of the contribution which such Participating Employer was 76 84 so prevented from making may be made, for the benefit of the participating employees of such Participating Employer, by other Participating Employers who are members of the same affiliated group within the meaning of Code Section 1504 to the extent of their current or accumulated earnings or profits, except that such contribution by each such other Participating Employer shall be limited to the proportion of its total current and accumulated earnings or profits remaining after adjustment for its contribution to the Plan made without regard to this paragraph which the total prevented contribution bears to the total current and accumulated earnings or profits of all the Participating Employers remaining after adjustment for all contributions made to the Plan without regard to this paragraph. A Participating Employer on behalf of whose employees a contribution is made under this paragraph shall not be required to reimburse the contributing Participating Employers. 77 85 AMENDMENT NUMBER ONE TO AETNA LIFE INSURANCE COMPANY, AETNA LIFE INSURANCE AND ANNUITY COMPANY 401(K) PROFIT SHARING PLAN AND TRUST Aetna Life Insurance Company, Aetna Life Insurance and Annuity Company 401(k) Profit Sharing Plan and Trust is hereby amended as follows: 1. Section 1.9 is amended by replacing the first paragraph with the following paragraphs: "Compensation" with respect to any Participant means one of the following as elected in the Adoption Agreement. However, compensation for any Self-Employed Individual shall be equal to his Earned Income. i. Information required to be reported under sections 6041, 6051 and 6052 (Wages, Tips and Other Compensation Box on Form W-2). Compensation is defined as wages as defined in section 3401(a) and all other payments of compensation to an employee by the employer (in the course of the employer's trade or business) for which the employer is required to furnish the employee a written statement under sections 6041(d) and 6051(a)(3) of the Code. Compensation must be determined without regard to any rules under section 3401(a) that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in section 3401(a)(2)). ii. Section 3401(a) wages. Compensation is defined as wages within the meaning of section 3401(a) for the purposes of income tax withholding at the source but determined without regard to any rules that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in section 3401(a)(2)). iii. 415 safe-harbor compensation. Compensation is defined as wages, salaries, and fees for professional services and other amounts received (without regard to whether or not an amount is paid in cash) for personal services actually rendered in the course of employment with the employer maintaining the plan to the extent that the amounts are includible in gross income (including, but not limited to, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses, fringe benefits and reimbursements or other expense allowances under a nonaccountable plan (as described in 1.62-2(c)), and excluding the following: 1 86 a. Employer contributions to a plan of deferred compensation which are not includible in the employee's gross income for the taxable year in which contributed, or employer contributions under a simplified employee pension plan to the extent such contributions are deductible by the employee, or any distributions from a plan of deferred compensation; b. Amounts realized from the exercise of a non-qualified stock option, or when restricted stock (or property) held by the employee either becomes freely transferable or is no longer subject to a substantial risk of forfeiture; c. Amounts realized from the sale, exchange or other disposition of stock acquired under a qualified stock option; and d. Other amounts which received special tax benefits, or contributions made by the employer (whether or not under a salary reduction agreement) towards the purchase of an annuity contract described in section 403(b) of the Code (whether or not the contributions are actually excludable from the gross income of the employee). If, in connection with the adoption of this or any other amendment, the definition of Compensation has been modified, then, for Plan Years prior to the Plan Year which includes the adoption date of such amendment, Compensation means compensation determined pursuant to the Plan then in effect. 2. Section 1.15 is amended in its entirety to read as follows: "Elective Contribution" means the Employer's contributions to the Plan that are made pursuant to the Participant's deferral election pursuant to Section 4.2, excluding any such amounts distributed as "excess annual additions" pursuant to Section 4.4. In addition, if selected in E3 of the Adoption Agreement, the Employer's matching contribution shall or shall not be considered an Elective Contribution for purposes of the Plan, as provided in Section 4.1(b). Elective Contributions shall be subject to the requirements of Sections 4.2(b) and 4.2(c) and shall further be required to satisfy the discrimination requirements of Regulation 1.401(k)-l(b)(3), the provisions of which are specifically incorporated herein by reference. 3. Section 1.21 is amended in its entirety to read as follows: "Excess Deferred Compensation" means, with respect to any taxable year of a Participant, the excess of the aggregate amount of such Participant's Deferred Compensation and the elective deferrals pursuant to Section 4.2(f) actually made on behalf of 2 87 such Participant for such taxable year, over the dollar limitation provided for in Code Section 402(g), which is incorporated herein by reference. Excess Deferred Compensation shall be treated as an "annual addition" pursuant to Section 4.9 when contributed to the Plan unless distributed to the affected Participant not later than the first April 15th following the close of the Participant's taxable year. 4. Section 1.27 is amended in its entirety to read as follows: "414(s) Compensation" with respect to any Employee means his Compensation as defined in Section 1.9. However, for purposes of this Section, Compensation shall be Compensation paid and, if selected in the Adoption Agreement, shall only be recognized as of an Employee's effective date of participation. If, in connection with the adoption of this or any other amendment, the definition of "414(s) Compensation" has been modified, then, for Plan Years prior to the Plan Year which includes the adoption date of such amendment, "414(s) Compensation" means compensation determined pursuant to the Plan then in effect. 5. Section 1.28 ("415 Compensation") is amended by the addition of the following paragraph: If, in connection with the adoption of this or any other amendment, the definition of "415 Compensation" has been modified, then, for Plan Years prior the Plan Year which includes the adoption date of such amendment, "415 Compensation" means compensation determined pursuant to the Plan then in effect. 6. Section 4.9(a)(4) and 4.9(a)(4)(i) are amended to read as follows: (4) If there is an excess amount pursuant to Section 4.9(a)(2) or Section 4.10, the excess will be disposed of in one of the following manners, as uniformly determined by the Plan Administrator for all Participants similarly situated: (i) Any Deferred Compensation or nondeductible Voluntary Employee Contributions, to the extent they would reduce the Excess Amount will be distributed to the Participant; 7. Section 4.9(f)(2) is amended in its entirety to read as follows: Compensation means a Participant's Compensation as elected in the Adoption Agreement. However, regardless of any selection made in the Adoption Agreement, "415 Compensation" shall exclude compensation which is not currently includible in the Participant's gross income by reason of the application of Code Sections 125, 402(a)(8), 402(h)(1)(B), or 403(b). 3 88 For limitation years beginning after December 31, 1991, for purposes of applying the limitations of this article, compensation for a limitation year is the compensation actually paid or made available during such limitation year. Notwithstanding the preceding sentence, compensation for a participant in a defined contribution plan who is permanently and totally disabled (as defined in section 22(e)(3) of the Internal Revenue Code) is the compensation such participant would have received for the limitation year if the participant had been paid at the rate of compensation paid immediately before becoming permanently and totally disabled; such imputed compensation for the disabled participant may be taken into account only if the participant is not a Highly Compensated Employee and contributions made on behalf of such participant are nonforfeitable when made. 8. Section 4.10 is amended in its entirety to read as follows: (a) If as a result of the allocation of Forfeitures, a reasonable error in estimating a Participant's annual Compensation, a reasonable error in determining the amount of elective deferrals (within the meaning of Code Section 402(g)(3)) that may be made with respect to any Participant under the limits of Section 4.9, or other facts and circumstances to which Regulation 1.415-6(b)(6) shall be applicable, the "annual additions" under this Plan would cause the maximum provided in Section 4.9 to be exceeded, the Administrator shall treat the excess in accordance with Section 4.9(a)(4). 9. Sections 6.11(a)(1) and (a)(4) are amended in their entirety to read as follows: (1) Medical expenses described in Code Section 213(d) incurred by the Participant, his spouse, or any of his dependents (as defined in Code Section 152) or expenses necessary for these persons to obtain medical care; (4) Payment of tuition and related educational fees for the next 12 months of post-secondary education for the Participant, his spouse, children, or dependents; 10. Section 7.10 is amended by the addition of the following paragraphs: (a) Notwithstanding any provision of the plan to the contrary, with respect to distributions made after December 31, 1992, a Participant shall be permitted to elect to have any "eligible rollover distribution" transferred directly to an "eligible retirement plan" specified by the Participant. The Plan provisions otherwise applicable to distributions continue to apply to the direct transfer option. The Participant shall, in the time and manner prescribed by the Administrator, specify the amount to be directly transferred and the "eligible retirement 4 89 plan" to receive the transfer. Any portion of a distribution which is not transferred shall be distributed to the Participant. (b) For purposes of this Section, the term "eligible rollover distribution" means any distribution other than a distribution of substantially equal periodic payments over the life or life expectancy of the Participant (or joint life or joint life expectancies of the Participant and the designated beneficiary) or a distribution over a period certain of ten years or more. Amounts required to be distributed under Code Section 401(a)(9) are not eligible rollover distributions. The direct transfer option described in subsection (a) applies only to eligible rollover distributions which would otherwise be includible in gross income if not transferred. (c) For purposes of this Section, the term "eligible retirement plan" means an individual retirement account as described in Code Section 408(a), an individual retirement annuity as described in Code Section 408(b), an annuity plan as described in Code Section 403(a), or a defined contribution plan as described in Code Section 401(a) which is exempt from tax under Code Section 501(a) and which accepts rollover distributions. (d) The election described in subsection (a) also applies to the surviving spouse after the Participant's death; however, distributions to the surviving spouse may only be transferred to an individual retirement account or individual retirement annuity. For purposes of subsection (a), a spouse or former spouse who is the alternate payee under a qualified domestic relations order as defined in Code Section 414(p) will be treated as the Participant. 11. Section 4.2(d) is amended in its entirety to read as follows: (d) In any Plan Year beginning after December 31, 1986, a Participant's Deferred Compensation made under this Plan and all other plans, contracts or arrangements of the Employer maintaining this Plan shall not exceed the limitation imposed by Code Section 402(g), as in effect for the calendar year in which such Plan Year began. If such dollar limitation is exceeded solely from elective deferrals made under this Plan or any other Plan maintained by the Employer, a Participant will be deemed to have notified the Administrator of such excess amount which shall be distributed in a manner consistent with Section 4.2(f). This dollar limitation shall be adjusted annually pursuant to the method provided in Code Section 415(d) in accordance with Regulations. 12. Section 4.2(f) is amended by the addition of the following paragraph after paragraph (f)(3) to read as follows: 5 90 Any distribution under this Section shall be made first from unmatched Deferred Compensation and, thereafter, simultaneously from Deferred Compensation which is matched and matching contributions which relate to such Deferred Compensation. However, any such matching contributions which are not Vested shall be forfeited in lieu of being distributed. 13. Section 4.2(f) is amended by the addition of the following paragraph as the second to the last paragraph of such subsection: Notwithstanding the above, for any distribution under this Section which is made after August 15, 1991, such distribution shall not include any income for the "gap period". Further provided, for any distribution under this Section which is made after August 15, 1991, the amount of Income may be computed using a reasonable method that is consistent with Section 4.3(c), provided such method is used consistently for all Participants and for all such distributions for the Plan Year. 14. Section 4.6(c) is amended by the addition of the following paragraph as the second to the last paragraph of such subsection: Notwithstanding the above, for any distribution under this Section which is made after August 15, 1991, such distribution shall not include any income for the "gap period". Further provided, for any distribution under this Section which is made after August 15, 1991, the amount of Income may be computed using a reasonable method that is consistent with Section 4.3(c), provided such method is used consistently for all Participants and for all such distributions for the Plan Year. 15. Section 4.7(c) is amended in its entirety to read as follows: (c) For purposes of determining the "Actual Contribution Percentage" and the amount of Excess Aggregate Contributions pursuant to Section 4.8(d), only Employer matching contributions (excluding matching contributions forfeited or distributed pursuant to Section 4.2(f), 4.6(a), or 4.8(a)) contributed to the Plan prior to the end of the succeeding Plan Year shall be considered. In addition, the Administrator may elect to take into account, with respect to Employees eligible to have Employer matching contributions made pursuant to Section 4.1(b) or voluntary Employee contributions made pursuant to Section 4.12 allocated to their accounts, elective deferrals (as defined in Regulation 1.402(g)-1(b)) and qualified non-elective contributions (as defined in Code Section 401(m)(4)(C)) contributed to any plan maintained by the Employer. Such elective deferrals and qualified non-elective contributions shall be treated as Employer matching contributions subject to Regulation 1.401(m)-1(b)(2) which is incorporated herein by reference. However, for Plan Years beginning after December 31, 1988, the Plan Year must be the same as the plan year of the plan to which 6 91 the elective deferrals and the qualified non-elective contributions are made. 16. Section 4.8(i) is amended by the addition of the following paragraph as the second to the last paragraph of such subsection: Notwithstanding the above, for any distribution under this Section which is made after August 15, 1991, such distribution shall not include any Income for the "gap period". Further provided, for any distribution under this Section which is made after August 15, 1991, the amount of Income may be computed using a reasonable method that is consistent with Section 4.3(c), provided such method is used consistently for all Participants and for all such distributions for the Plan Year. 17. Section 6.11(c) (1) is amended in its entirety to read as follows: (1) The distribution is not in excess of the amount of the immediate and heavy financial need of the Participant. The amount of the immediate and heavy financial need may include any amounts necessary to pay any federal, state or local income taxes or penalties reasonably anticipated to result from the distribution. 18. Article IV is amended by the addition of the following: Notwithstanding anything in this Article to the contrary, effective as of the Plan Year in which this amendment becomes effective, the Actual Deferral Percentage Test and the Actual Contribution Percentage Test shall be applied (and adjusted) by applying the Family Member aggregation rules of Code Section 414(q)(6). 19. Section E1a. of the Adoption Agreement is amended in its entirety to read as follows: Compensation with respect to any Participant means: 1. ( ) Wages, Tips and other Compensation (Box 10 on Form W-2). 2. ( ) Section 3401(a) wages (wages for withholding purposes). 3. ( ) 415 Safe-harbor compensation. AND Compensation ( ) shall ( ) shall not exclude (even if includible in gross income) reimbursements or other expense allowances, fringe benefits (cash or 7 92 noncash), moving expenses, deferred compensation, and welfare benefits. 20. Section E3 of the 401(k) Adoption Agreement(s) is amended by the addition of the following: ( ) Notwithstanding anything in the Plan to the contrary, all matching contributions which relate to distributions of Excess Deferred Compensation, Excess Contributions and Excess Aggregate Contributions shall be Forfeited. (Select this option only if it is applicable.) NOTE: THIS AMENDMENT ONLY NEEDS TO BE EXECUTED BELOW BY THE EMPLOYER IF THE PLAN IS BEING AMENDED TO UTILIZE THE MODIFICATIONS MADE TO SECTION E1 OR E3 OF THE ADOPTION AGREEMENT. IN WITNESS WHEREOF, the Employer hereby causes this amendment to be executed on this ________ day of ___________________, 19___. EMPLOYER: PARTICIPATING EMPLOYER: ______________________________ _____________________________ (enter name) (enter name) By:___________________________ By:__________________________ 8 93 AMENDMENT TO AETNA LIFE INSURANCE COMPANY AETNA LIFE INSURANCE AND ANNUITY COMPANY 401(K) PROFIT SHARING PLAN AND TRUST 1. Section 1.9 is amended by the addition of the following: In addition to other applicable limitations set forth in the plan, and notwithstanding any other provision of the plan to the contrary, for plan years beginning on or after January 1, 1994, the annual compensation of each employee taken into account under the plan shall not exceed the OBRA '93 annual compensation limit. The OBRA '93 annual compensation limit is $150,000, as adjusted by the Commissioner for increases in the cost of living in accordance with Section 401(a)(17)(B) of the Internal Revenue Code. The cost-of-living adjustment in effect for a calendar year applies to any period, not exceeding 12 months, over which compensation is determined (determination period) beginning in such calendar year. If a determination period consists of fewer than 12 months, the OBRA '93 annual compensation limit will be multiplied by a fraction, the numerator of which is the number of months in the determination period, and the denominator of which is 12. For plan years beginning on or after January 1, 1994, any reference in this plan to the limitation under Section 401(a)(17) of the Code shall mean the OBRA '93 annual compensation limit set forth in this provision. If compensation for any prior determination period is taken into account in determining an employee's benefits accruing in the current plan year, the compensation for that prior determination period is subject to the OBRA '93 annual compensation limit in effect for that prior determination period. For this purpose, for determination periods beginning before the first day of the plan year beginning on or after January 1, 1994, the OBRA '93 annual compensation limit is $150,000. 2. Section 6.13 is amended by the addition of the following: If a distribution is one to which Sections 401(a)(11) and 417 of the Internal Revenue Code do not apply, such distribution may commence less than 30 days after the notice required under Section 1.411(a)-11(c) of the Income Tax Regulations is given, provided that: (1) the plan administrator clearly informs the participant that the participant has a right to a period of at least 30 days after receiving the notice to consider the decision of whether or not to elect a distribution (and, if applicable, a particular distribution option), and 94 (2) the participant, after receiving the notice, affirmatively elects a distribution. 3. Section 7.9 is amended by the addition of the following: (a) Notwithstanding any provision of the plan to the contrary, with respect to distributions made after December 31, 1992, a Participant shall be permitted to elect to have any "eligible rollover distribution" transferred directly to an "eligible retirement plan" specified by the Participant. The Plan provisions otherwise applicable to distributions continue to apply to the direct transfer option. The Participant shall, in the time and manner prescribed by the Administrator, specify the amount to be directly transferred and the "eligible retirement plan" to receive the transfer. Any portion of a distribution which is not transferred shall be distributed to the Participant. (b) For purposes of this Section, the term "eligible rollover distribution" means any distribution other than a distribution of substantially equal periodic payments over the life or life expectancy of the Participant (or joint life or joint life expectancies of the Participant and the designated beneficiary) or a distribution over a period certain of ten years or more. Amounts required to be distributed under Code Section 401(a)(9) are not eligible rollover distributions. The direct transfer option described in subsection (a) applies only to eligible rollover distributions which would otherwise be includible in gross income if not transferred. (c) For purposes of this Section, the term "eligible retirement plan" means an individual retirement account as described in Code Section 408(a), an individual retirement annuity as described in Code Section 408(b), an annuity plan as described in Code Section 403(a), or a defined contribution plan as described in Code Section 401(a) which is exempt from tax under Code Section 501(a) and which accepts rollover distributions. (d) The election described in subsection (a) also applies to the surviving spouse after the Participant's death; however, distributions to the surviving spouse may only be transferred to an individual retirement account or individual retirement annuity. For purposes of subsection (a), a spouse or former spouse who is the alternate payee under a qualified domestic relations order as defined in Code Section 414(p) will be treated as the Participant. 95 ADOPTION AGREEMENT FOR AETNA LIFE INSURANCE AND ANNUITY COMPANY NON-STANDARDIZED 401(K) PROFIT SHARING PLAN AND TRUST The undersigned Employer adopts the Aetna Life Insurance and Annuity Company Non-Standardized 401(k) Profit Sharing Plan for those Employees who shall qualify as Participants hereunder, to be known as the Al KIRKLAND'S, INC. RETIREMENT PLAN ------------------------------------------ (ENTER PLAN NAME) It shall be effective as of the date specified below. The Employer hereby selects the following Plan specifications: CAUTION: The failure to properly fill out this Adoption Agreement may result in disqualification of the Plan. EMPLOYER INFORMATION B1 NAME OF EMPLOYER Kirkland's Inc. and Affiliated Companies -------------------------------------------------------- -------------------------------------------------------- B2 ADDRESS 529 Old Hickory Boulevard, P. 0. Box 7222 -------------------------------------------------------- Jackson, Tennessee 38308-7222 ------------- ----------- ---------- CITY STATE ZIP TELEPHONE (901) 668-2444 -------------- B3 EMPLOYER IDENTIFICATION NUMBER 62 - 1287151 ----- -------- B4 DATE BUSINESS COMMENCED 1984 ------ B5 TYPE OF ENTITY a. /X/ S Corporation b. / / Professional Service Corporation c. / / Corporation d. / / Sole Proprietorship e. / / Partnership f. / / Other ------------------- AND, is the Employer a member of... g. a controlled group? /x/ Yes / / No h. an affiliated service group? / / Yes /x/ No (c) 1990-N Aetna Life Insurance and Annuity Company 96 B6 NAME(S) OF TRUSTEE(S) a. Robert E. Alderson ---------------------------------- b. Carl T. Kirkland ---------------------------------- c. Bruce Moore ---------------------------------- B7 TRUSTEES' ADDRESS a. /x/ Use Employer Address b. / / ------------------------------------------------------ Street , -------------------- ----------- --------- City State Zip B8 LOCATION OF EMPLOYER'S PRINCIPAL OFFICE: a. /x/ state b. / / commonwealth of c. Tennessee --------- and this Plan and Trust shall be governed under the same. B9 EMPLOYER FISCAL YEAR means the 12 consecutive month period: commencing on a. January 1 (e.g., January 1st) ------------ month day and ending on b. December 31. ------------- month day PLAN INFORMATION C1 EFFECTIVE DATE This Adoption Agreement of the Aetna Life Insurance and Annuity Company Standardized 401(k) Profit Sharing Plan and Trust shall: a. /x/ establish a new Plan and Trust effective as of September --------- 15, 1991 (hereinafter called the "Effective Date"). -------- b. / / constitute an amendment and restatement in its entirety of a previously established qualified Plan and Trust of the Employer which was effective ___________ (hereinafter called the "Effective Date"). Except as specifically provided in the Plan, the effective date of this amendment and restatement is __________ (For TRA '86 amendments, enter the first day of the first Plan Year beginning in 1989). C2 PLAN YEAR means the 12 consecutive month period: Commencing on a. January 1 (e.g., January 1st) ------------ and ending on b. December 31. ------------ 2 97 IS THERE A SHORT PLAN YEAR? c. / / No d. /x/ Yes, beginning September 15, 1991 ------------------- and ending December 31, 1991. ------------------ C3 ANNIVERSARY DATE of Plan (Annual Valuation Date) a. --------- month day C4 PLAN NUMBER assigned by the Employer (select one) a. /x/ 001 b./ / 002 c./ / 003 d./ / Other . ----- C5 NAME OF PLAN ADMINISTRATOR (Document provides for the Employer to appoint an Administrator. If none is named, the Employer will become the Administrator.) a. /x/ Employer (Use Employer Address) b. / / Name ---------------------------------------- Address -------------------------------------- , ------------------ --------- --------- City State Zip Telephone ------------------- Administrator's I.D. Number - -------------- ----------- C6 PLAN'S AGENT FOR SERVICE OF LEGAL PROCESS a. / / Employer (Use Employer Address) b. / / Name ---------------------------------------- Address -------------------------------------- , ------------------ --------- --------- City State Zip 3 98 ELIGIBILITY, VESTING AND RETIREMENT AGE D1 ELIGIBLE EMPLOYEES (Plan Section l.16) shall mean: a. /X/ all Employees who have satisfied the eligibility requirements. b. / / all Employees who have satisfied the eligibility requirements except those checked below: 1. / / Employees paid by commissions only. 2. / / Employees hourly paid. 3. / / Employees paid by salary. 4. / / Employees whose employment is governed by a collective bargaining agreement between the Employer and "employee representatives" under which retirement benefits were the subject of good faith bargaining. For this purpose, the term "employee representatives" does not include any organization more than half of whose members are employees who are owners, officers, or executives of the Employer. 5. / / Highly Compensated Employees. 6. / / Employees who are non-resident aliens who received no earned income (within the meaning of Code Section 911 (d)(2)) from the Employer which constitutes income from sources within the United States (within the meaning of Code Section 861(a)(3)). 7. / / Other__________________________________________________ NOTE: For purposes of this section, the term Employee shall include all Employees of this Employer and any leased employees deemed to be Employees under Code Section 414(n) or 414(o). D2 EMPLOYEES OF AFFILIATED EMPLOYERS (Plan Section 1.17) Employees of Affiliated Employers: a. / / will not or N/A b. /X/ will be treated as Employees of the Employer adopting the Plan. NOTE: If D2b is elected each Affiliated Employer should execute this Adoption Agreement as a participating Employer. D3 HOURS OF SERVICE (Plan Section 1.32) will be determined on the basis of the method selected below. Only one method may be selected. The method selected will be applied to all Employees covered under the Plan. a. /X/ On the basis of actual hours for which an Employee is paid or entitled to payment. b. / / On the basis of days worked. An Employee will be credited with ten (10) Hours of Service if under the Plan such Employee would be credited with at least one (1) Hour of Service during the day. c. / / On the basis of weeks worked. An Employee will be credited forty- five (45) Hours of Service if under the Plan such Employee would be credited with at least one (1) Hour of Service during the week. d. / / On the basis of semi-monthly payroll periods. An Employee will be credited with ninety-five (95) Hours of Service if under the Plan such Employee would be credited with at least one (1) Hour of Service during the semi-monthly payroll period. 4 99 e. / / On the basis of months worked. An Employee will be credited with one hundred ninety (190) Hours of Service if under the Plan such Employee would be credited with at least one (1) Hour of Service during the month. D4 CONDITIONS OF ELIGIBILITY (Plan Section 3.1) (Check either a OR b and c, and if applicable, d) Any Eligible Employee will be eligible to participate in the Plan if such Eligible Employee has satisfied the service and age requirements, if any, specified below: a. / / NO AGE OR SERVICE REQUIRED. b. /X/ SERVICE REQUIREMENT. (may not exceed 1 year.) 1. / / None 2. / / 1/2 Year of Service 3. /XX/ 1 Year of Service 4. / / Other____________________________________________________ NOTE: If the Year(s) of Service selected is or includes a fractional year, an Employee will not be required to complete any specified number of Hours of Service to receive credit for such fractional year. If expressed in Months of Service, an Employee will not be required to complete any specified number of Hours of Service in a particular month. c. /X/ AGE REQUIREMENT (may not exceed 21) 1. / / N/A - No Age Requirement. 2. / / 20 1/2 3. /XX/ 21 4. / / Other__________________________________________________ d. / / FOR NEW PLANS ONLY - Regardless of any of the above age or service requirements, any Eligible Employee who was employed on the Effective Date of the Plan shall be eligible to participate hereunder and shall enter the Plan as of such date. D5 EFFECTIVE DATE OF PARTICIPATION (Plan Section 3.2) An Eligible Employee shall become a Participant as of: a. / / the first day of the Plan Year in which he met the requirements. b. / / the first day of the Plan Year in which he met the requirements, if he met the requirements in the first 6 months of the Plan Year, or as of the first day of the next succeeding Plan Year if he met the requirements in the last 6 months of the Plan Year. c. /XX/ the earlier of the first day of the seventh month or the first day of the Plan Year coinciding with or next following the date on which he met the requirements. d. / / the first day of the Plan Year next following the date on which he met the requirements. (Eligibility must be 1/2 Year of Service or less or 1 1/2 Years of Service or less if 100% immediate vesting is selected and age 20 1/2 or less.) e. / / the first day of the month coinciding with or next following the date on which he met the requirements. 5 100 f. / / Other: ______________________________________________, provided that an Employee who has satisfied the maximum age and service requirements that are permissible in Section D4 above and who is otherwise entitled to participate, shall commence participation no later than the earlier of (a) 6 months after such requirements are satisfied, or (b) the first day of the first Plan Year after such requirements are satisfied, unless the Employee separates from service before such participation date. D6 VESTING OF PARTICIPANT'S INTEREST (Plan Section 6.4(b)) The vesting schedule, based on number of Years of Service, shall be as follows: a. / / 100% upon entering Plan. (Required if eligibility requirement is greater than one (1) Year of Service.) b. / / 0-2 years 0% c. / / 0-4 years 0% 3 years 100% 5 years 100% d. /XX/ 0-1 year 0% e. / / 1 year 25% 2 years 20% 2 years 50% 3 years 40% 3 years 75% 4 years 60% 4 years 100% 5 years 80% 6 years 100% f. / / 1 year 20% g. / / 0-2 years 0% 2 years 40% 3 years 20% 3 years 60% 4 years 40% 4 years 80% 5 years 60% 5 years 100% 6 years 80% 7 years 100% h. / / Other - Must be at least as liberal as either c or g above. Years of Service Percentage ________________ __________ ________________ __________ ________________ __________ ________________ __________ ________________ __________ ________________ __________ ________________ __________ 6 101 D7 FOR AMENDED PLANS (Plan Section 6.4(f)) If the vesting schedule has been amended to a less favorable schedule, enter the pre-amended schedule below: N/A - NEW PLAN a. / / Vesting schedule has not been amended or amended schedule is more favorable in all years. b. / / Years of Service Percentage ________________ __________ ________________ __________ ________________ __________ ________________ __________ ________________ __________ ________________ __________ ________________ __________ D8 TOP HEAVY VESTING (Plan Section 6.4(c)) If this Plan becomes a Top Heavy Plan, the following vesting schedule, based on number of Years of Service, for such Plan Year and each succeeding Plan Year, whether or not the Plan is a Top Heavy Plan, shall apply and shall be treated as a Plan amendment pursuant to this Plan. Once effective, this schedule shall also apply to any contributions made prior to the effective date of Code Section 416 and/or before the Plan became a Top Heavy Plan. a. /X/ N/A (D6a, b, d, e or f was selected) b. / / 0-1 year 0% c. / / 0-2 years 0% 2 years 20% 3 years 100% 3 years 40% 4 years 60% 5 years 80% 6 years 100% NOTE: This section does not apply to the Account balances of any Participant who does not have an Hour of Service after the Plan has initially become top heavy. Such Participant's Account balance attributable to Employer contributions and Forfeitures will be determined without regard to this section. D9 VESTING (Plan Section 6.4(h)) In determining Years of Service for vesting purposes, Years of Service attributable to the following shall be EXCLUDED: a. / / Service prior to the Effective Date of the Plan or a predecessor plan. b. /X/ N/A c. / / Service prior to the time an Employee attained age 18. d. /X/ N/A D10 PLAN SHALL RECOGNIZE SERVICE WITH PREDECESSOR EMPLOYER a. / / No. b. /X/ Yes: Years of Service with KIRKLAND'S CONSOLIDATED AND AFFILIATED COMPANIES shall be recognized for the purpose of this Plan. NOTE: If the predecessor Employer maintained this qualified Plan, then Years of Service with such predecessor Employer shall be recognized pursuant to Section 1.74 and b. must be marked. 7 102 D11 NORMAL RETIREMENT AGE ("NRA") (Plan Section 1.43) means: a. /X/ the date a Participant attains his 65TH birthday. (not to exceed 65th) b. / / the later of the date a Participant attains his ______ birthday (not to exceed 65th) or the c. ______ (not to exceed 5th) anniversary of the first day of the Plan Year in which participation in the Plan commenced. D12 NORMAL RETIREMENT DATE (Plan Section 1.44) shall commence: a. /X/ as of the Participant's "NRA". OR (must select b. or c. AND 1. or 2.) b. / / as of the first day of the month... c / / as of the Anniversary Date... 1. / / coinciding with or next following the Participant's "NRA". 2. / / nearest the Participant's "NRA". D13 EARLY RETIREMENT DATE (Plan Section 1.13) means the: a. / / No Early Retirement provision provided. b. /X/ date on which a Participant... c. / / first day of the month coinciding with or next following the date on which a Participant... d. / / Anniversary Date coinciding with or next following the date on which a Participant... AND, if b, c or d was selected... 1. /X/ attains his 55TH birthday and has 2. /X/ completed at least 6 Years of Service. CONTRIBUTIONS, ALLOCATIONS AND DISTRIBUTIONS El a. COMPENSATION (Plan Section 1.9) with respect to any Participant means: 1. / / "415 Compensation." 2. /X/ Compensation reportable as wages on Form W-2. b. COMPENSATION shall be 1. /X/ actually paid (must be selected if Plan is integrated) 2. / / accrued c. HOWEVER, for non-integrated plans, Compensation shall exclude (select all that apply): 1. /X/ N/A. No exclusions 2. / / overtime 3. / / bonuses 4. / / commissions 5. / / other ___________ 8 103 d. FOR PURPOSES OF THIS SECTION El, Compensation shall be based on: 1. /XX/ the Plan Year. 2. / / the Fiscal Year coinciding with or ending within the Plan Year. 3. / / the Calendar Year coinciding with or ending within the Plan Year. NOTE: The Limitation Year shall be the same as the year on which Compensation is based. e. HOWEVER, for an Employee's first year of participation, Compensation shall be recognized as of: 1. / / the first day of the Plan Year. 2. /XX/ the date the Participant entered the Plan. f. IN ADDITION, COMPENSATION and "414(s) Compensation" 1. / / shall 2. /X/ shall not include compensation which is not currently includible in the Participant's gross income by reason of the application of Code Sections 125, 402(a)(8), 402(h)(1)(B), or 403(b). E2 SALARY REDUCTION ARRANGEMENT - ELECTIVE CONTRIBUTION (Plan Section 4.2) Each Employee may elect to have his Compensation reduced by: a. / / ___________% b. / / up to ___________% c. / / from ___________% to ___________% d. /XX/ up to the maximum percentage allowable not to exceed the limits of Code Sections 401(k), 404 and 415. AND... e. /XX/ A Participant may elect to commence salary reductions as of 01/01 & 07/01 (ENTER AT LEAST ONE DATE OR PERIOD). A Participant may modify the amount of salary reductions as of 01/01 & 07/01 (ENTER AT LEAST ONE DATE OR PERIOD). AND... Shall cash bonuses paid within 2 1/2 months after the end of the Plan Year be subject to the salary reduction election? f. /X/ Yes g. / / No E3 FORMULA FOR DETERMINING EMPLOYER'S MATCHING CONTRIBUTION (Plan Section 4.1(b)) a. / / N/A. There shall be no matching contributions. b. / / The Employer shall make matching contributions equal to ___________% (e.g. 50%) of the Participant's salary reductions. c. /XX/ The Employer may make matching contributions equal to a discre- tionary percentage, to be determined by the Employer, of the Participant's salary reductions. 9 104 d. / / The Employer shall make matching contributions equal to the sum of ___________% of the portion of the Participant's salary reduction which does not exceed ___________% of the Participant's Compensation plus ___________% of the portion of the Participant's salary reduction which exceeds ___________% of the Participant's Compensation, but does not exceed ___________% of the Participant's Compensation. e. / / The Employer shall make matching contributions equal to the percentage determined under the following schedule: Participant's Total Matching Percentage Years of Service ---------- ---------- ---------- ---------- ---------- ---------- FOR PLANS WITH MATCHING CONTRIBUTIONS f. /XX/ Matching contributions g. / / shall h. /XX/ shall not be used in satisfying the deferral percentage tests. (If used, full vesting and restrictions on withdrawals will apply and the match will be deemed to be an Elective Contribution). i. /X/ Shall a Year of Service be required in order to share in the matching contributions? With respect to Plan Years beginning after 1989... 1. / / Yes (Could cause Plan to violate minimum participation and coverage requirements under Code Sections 401(a)(26) and 410) 2. /X/ No With respect to Plan Years beginning before 1990... 1. /XX/ N/A New Plan or same as year beginning after 1990. 2. / / Yes 3. / / No j. /X/ In determining matching contributions, only salary reductions up to 5% of a Participant's Compensation will be matched. k. / / N/A l. / / The matching contribution made on behalf of a Participant for any Plan Year shall not exceed $____________________. m. ( ) N/A n. /XX/ Matching contributions shall be made on behalf of 1. /XX/ all Participants. 2. / / only Non-Highly Compensated Employees. 10 105 E4 WILL A DISCRETIONARY EMPLOYER CONTRIBUTION BE PROVIDED (OTHER THAN A DISCRETIONARY MATCHING OR QUALIFIED NON-ELECTIVE CONTRIBUTION) (Plan Section 4.1)? a. / / No. b. / / Yes, the Employer may make a discretionary contribution out of its current or accumulated Net Profit. c. /XX/ Yes, the Employer may make a discretionary contribution which is not limited to its current or accumulated Net Profit. IF YES (b. or c. is selected above), the Employer's discretionary contribution shall be allocated as follows: d. /XX/ FOR A NON-INTEGRATED PLAN The Employer discretionary contribution for the Plan Year shall be allocated in the same ratio as each Participant's Compensation bears to the total of such Compensation of all Participants. e. / / FOR AN INTEGRATED PLAN The Employer discretionary contribution for the Plan Year shall be allocated in accordance with Plan Section 4.4(b)(3) based on a Participant's Compensation in excess of: f. / / The Taxable Wage Base. g. / / The greater of $10,000 or 20% of the Taxable Wage Base. h. / / __________% of the Taxable Wage Base. (See Note below) i. / / $________________. (see Note below) NOTE: The integration percentage of 5.7% shall be reduced to: 1. 4.3% if h. or i. above is more than 20% and less than or equal to 80% of the Taxable Wage Base. 2. 5.4% if h. or i. above is less than 100% and more than 80% of the Taxable Wage Base. E5 QUALIFIED NON-ELECTIVE CONTRIBUTIONS (Plan Section 4.1) a. /XX/ N/A. There shall be no Qualified Non-Elective Contributions except as provided in Section 4.6 and 4.8. b. / / The Employer shall make a Qualified Non-Elective Contribution equal to _____% of the total Compensation of all Participants eligible to share in the allocations. c. / / The Employer may make a Qualified Non-Elective Contribution in an amount to be determined by the Employer. E6 FORFEITURES (Plan Section 4.4(e)) a. Forfeitures of contributions other than matching contributions shall be... 1. /XX/ added to the Employer's contribution under the Plan. 2. / / allocated to all Participants eligible to share in the allocations in the same proportion that each Participant's Compensation for the year bears to the Compensation of all Participants for such year. 11 106 b. Forfeitures of matching contributions shall be... 1. / / N/A. No matching contributions or match is fully vested. 2. /XX/ used to reduce the Employer's matching contribution. 3. / / allocated to all Participant's eligible to share in the allocations in proportion to each such Participant's Compensation for the year. 4. / / allocated to all Non-Highly Compensated Employee's eligible to share in the allocations in proportion to each such Participant's Compensation for the year. E7 ALLOCATIONS TO ACTIVE PARTICIPANTS (Plan Section 4.4) With respect to Plan Years beginning after 1989, a Participant... a. /XX/ shall (Plan may become discriminatory) b. / / shall not be required to complete a Year of Service in order to share in any Non-Elective Contributions (other than matching contributions) or Qualified Non-Elective Contributions. For Plan Years beginning before 1990, the Plan provides that a Participant must complete a Year of Service to share in the allocations. E8 ALLOCATIONS TO TERMINATED PARTICIPANTS (Plan Section 4.4(l)) Any Participant who terminated employment during the Plan Year (i.e. not actively employed on the last day of the Plan Year) for reasons other than death, Total and Permanent Disability or retirement: a. With respect to Employer Non-Elective Contributions (other than matching), Qualified Non-Elective Contributions, and Forfeitures: 1. For Plan Years beginning after 1989, i. / / N/A, Plan does not provide for such contributions. ii. / / shall share in the allocations provided such Participant completed more than 500 Hours of Service. iii. / / shall share in such allocations provided such Participant completed a Year of Service. iv. /X/ shall not share in such allocations, regardless of Hours of Service. 2. For Plan Years beginning before 1990, i. /XX/ N/A, new Plan, or same as for Plan Years beginning after 1989. ii. / / shall share in such allocations provided such Participant completed a Year of Service. iii. / / shall not share in such allocations, regardless of Hours of Service. NOTE: If a.1.iii or iv is selected, the Plan could violate minimum participation and coverage requirements under Code Sections 401(a)(26) and 410. 12 107 b. With respect to the allocation of Employer Matching Contributions, a Participant: 1. For Plan Years beginning after 1989, i. / / N/A, Plan does not provide for matching contribu- tions. ii. /X/ shall share in the allocations, regardless of Hours of Service. iii. / / shall share in the allocations provided such Participant completed more than 500 Hours of Service. iv. / / shall share in such allocations provided such Participant completed a Year of Service. v. / / shall not share in such allocations, regardless of Hours of Service. 2. For Plan Years beginning before 1990, i. /XX/ N/A, new Plan, or same as years beginning after 1989. ii. / / shall share in the allocations, regardless of Hours of Service. iii. / / shall share in such allocations provided such Participant completed a Year of Service. iv. / / shall not share in such allocations, regardless of Hours of Service. NOTE: If b.l.iv or v is selected, the Plan could violate minimum participation and coverage requirements under Code Section 401(a)(26) and 410. E9 LIMITATIONS ON ALLOCATIONS (Plan Section 4.9) a. If any Participant is or was covered under another qualified defined contribution plan maintained by the Employer, other than a Master or Prototype Plan, or if the Employer maintains a welfare benefit fund, as defined in Code Section 419(e), or an individual medical account, as defined in Code Section 415(1)(2), under which amounts are treated as Annual Additions with respect to any participant in this Plan: 1. /XX/ N/A. 2. / / The provisions of Section 4.9(b) of the Plan will apply as if the other plan were a Master or Prototype Plan. 3. / / Provide the method under which the Plans will limit total Annual Additions to the Maximum Permissable Amount, and will properly reduce any Excess Amounts, in a manner that precludes Employer discretion. _______________________________________________________ _______________________________________________________ 13 108 b. If any Participant is or ever has been a Participant in a defined benefit plan maintained by the Employer: 1. /XX/ N/A. 2. / / In any Limitation Year, the Annual Additions credited to the Participant under this Plan may not cause the sum of the Defined Benefit Plan Fraction and the Defined contribution Fraction to exceed 1.0. If the Employer's contribution that would otherwise be made on the Participant's behalf during the limitation year would cause the 1.0 limitation to be exceeded, the rate of contribution under this Plan will be reduced so that the sum of the fractions equals 1.0. If the 1.0 limitation is exceeded because of an Excess Amount, such Excess Amount will be reduced in accordance with Section 4.9(a)(4) of the Plan. 3. / / Provide the method under which the Plans involved will satisfy the 1.0 limitation in a manner that precludes Employer discretion. _______________________________________________________________ _______________________________________________________________ E10 DISTRIBUTIONS UPON DEATH (Plan Section 6.6(h)) Distributions upon the death of a Participant prior to receiving any benefits shall... a. / / be made pursuant to the election of the Participant or beneficiary. b. / / begin within 1 year of death for a designated beneficiary and be payable over the life (or over a period not exceeding the life expectancy) of such beneficiary, except that if the beneficiary is the Participant's spouse, begin within the time the Participant would have attained age 70 1/2. c. /X/ be made within 5 years of death for all beneficiaries. d. / / other___________________________________________________________ E11 LIFE EXPECTANCIES (Plan Section 6.5(f)) for minimum distributions required pursuant to Code Section 401(a)(9) shall... a. / / be recalculated at the Participant's election. b. /XX/ be recalculated. c. / / not be recalculated. E12 CONDITIONS FOR DISTRIBUTIONS UPON TERMINATION Distributions upon termination of employment pursuant to Section 6.4(a) of the Plan shall not be made unless the following conditions have been satisfied: a. / / N/A. Immediate distributions may be made at Participant's election. b. / / The Participant has incurred __________ 1-Year Break(s) in Service. c. / / The Participant has reached his or her Early or Normal Retirement Age. d. / / Distributions may be made at the Participant's election on or after the Anniversary Date following termination of employment. e. /XX/ Other JANUARY 1 AND JULY 1 14 109 E13 FORM OF DISTRIBUTIONS (Plan Sections 6.5 and 6.6) Distributions under the Plan may be made... a. 1. / / in lump sums. 2. /XX/ in lump sums or installments. b. AND, pursuant to Plan Section 6.13, 1. / / no annuities are allowed (avoids Joint and Survivor rules). 2. /XX/ annuities are allowed (Plan Section 6.13 shall not apply). NOTE: b.1. above way not be elected if this is an amendment to a plan which permitted annuities as a form of distribution or if this Plan has accepted a plan to plan transfer of assets from a plan which permitted annuities as a form of distribution. c. AND may be made in... 1. /XX/ cash only (except for insurance or annuity contracts). 2. / / cash or property. TOP HEAVY REQUIREMENTS F1 TOP HEAVY DUPLICATIONS (Plan Section 4.4(i)): When a Non-Key Employee is a Participant in this Plan and a Defined Benefit Plan maintained by the Employer, indicate which method shall be utilized to avoid duplication of top heavy minimum benefits. a. /X/ The Employer does not maintain a Defined Benefit Plan. b. / / A minimum, non-integrated contribution of 5% of each Non-Key Employee's total Compensation shall be provided in this Plan, as specified in Section 4.4(i). (The Defined Benefit and Defined Contribution Fractions will be computed using 100% if this choice is selected.) c. / / A minimum, non-integrated contribution of 7 1/2% of each Non-Key Employee's total Compensation shall be provided in this Plan, as specified in Section 4.4(i). (If this choice is selected, the Defined Benefit and Defined Contribution Fractions will be computed using 125% for all Plan Years in which the Plan is Top Heavy, but not Super Top Heavy.) d. / / Specify the method under which the Plans will provide top heavy minimum benefits for Non-Key Employees that will preclude Employer discretion and avoid inadvertent omissions, including any adjustments required under Code Section 415(e). _________________________________________________________________ _________________________________________________________________ _________________________________________________________________ _________________________________________________________________ 15 110 F2 PRESENT VALUE OF ACCRUED BENEFIT (Plan Section 2.2) for Top Heavy purposes where the Employer maintains a Defined Benefit Plan in addition to this Plan, shall be based on... a. /X/ N/A. The Employer does not maintain a defined benefit plan. b. / / Interest Rate:__________________________________________________ Mortality Table:________________________________________________ F3 TOP HEAVY DUPLICATIONS: Employer maintaining two (2) or more Defined Contribution Plans. a. /X/ N/A. b. / / A minimum, non-integrated contribution of 3% of each Non-Key Employee's total Compensation shall be provided in the Money Purchase Plan (or other plan subject to Code Section 412), where the Employer maintains two (2) or more non-paired Defined Contribution Plans. c. / / Specify the method under which the Plans will provide top heavy minimum benefits for Non-Key Employees that will preclude Employer discretion and avoid inadvertent omissions, including any adjustments required under Code Section 415(e). ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ MISCELLANEOUS G1 LOANS TO PARTICIPANTS (Plan Section 7.4) a. / / Yes, loans may be made up to $50,000 or 1/2 Vested interest. b. /X/ No, loans may not be made. If YES, (check all that apply)... c. / / loans shall be treated as a Directed Investment. d. / / loans shall only be made for hardship or financial necessity. e. / / the minimum loan shall be $1,000. f. / / $10,000 de minimis loans may be made regardless of Vested interest. (If selected, plan may need security in addition to Vested interest) NOTE: Department of Labor Regulations require the adoption of a separate written loan program setting forth the requirements outlined in Plan Section 7.4. G2 DIRECTED INVESTMENT ACCOUNTS (Plan Section 4.13) are permitted for the interest in any one or more accounts. a. /X/ Yes, regardless of the Participant's Vested interest in the Plan. b. / / Yes, but only with respect to the Participant's Vested interest in the Plan. c. / / Yes, but only with respect to those accounts which are 100% Vested. d. / / No directed investments are permitted. 16 111 G3 TRANSFERS FROM QUALIFIED PLANS (Plan Section 4.11) a. /XX/ Yes, transfers from qualified plans (and rollovers) will be allowed. b. / / No, transfers from qualified plans (and rollovers) will not be allowed. AND, transfers shall be permitted... c. /XX/ from any Employee, even if not a Participant. d. / / from Participants only. G4 EMPLOYEES' VOLUNTARY CONTRIBUTIONS (Plan Section 4.12) a. / / Yes, Voluntary Contributions are allowed subject to the limits of Section 4.7. b. /XX/ No, Voluntary Contributions will not be allowed. NOTE: TRA '86 subjects voluntary contributions to strict discrimination rules. G5 HARDSHIP DISTRIBUTIONS (Plan Section 6.11) a. / / Yes, from any accounts which are 100% Vested. b. /XX/ Yes, from Participant's Elective Account only. c. / / Yes, but limited to the Participant's Account only. d. / / No. NOTE: Distributions from a Participant's Elective Account are limited to the portion of such account attributable to such Participant's Deferred Compensation and earnings attributable thereto up to December 31, 1988. Also hardship distributions are not permitted from a Participant's Qualified Non-Elective Account. G6 PRE-RETIREMENT DISTRIBUTION (Plan Section 6.10) a. / / If a Participant has reached the age of _________, distributions may be made, at the Participant's election, from any accounts which are 100% Vested without requiring the Participant to terminate employment. b. /XX/ No pre-retirement distribution may be made. NOTE: Distributions from a Participant's Elective Account and Qualified Non-Elective Account are not permitted prior to age 59 1/2. G7 LIFE INSURANCE (Plan Section 7.2(d)) may be purchased with Plan contributions. a. /XX/ No life insurance may be purchased. b. / / Yes, at the option of the Administrator. c. / / Yes, at the option of the Participant. 17 112 The adopting Employer may not rely on an opinion letter issued by the National Office of the Internal Revenue Service as evidence that the plan is qualified under Code Section 401. In order to obtain reliance with respect to plan qualification, the Employer must apply to the appropriate Key District Office for a determination letter. This Adoption Agreement may be used only in conjunction with basic Plan document #03. This Adoption Agreement and the basic Plan document shall together be known as Aetna Life Insurance and Annuity Company Non-Standardized 401(k) Profit Sharing Plan #03-001. The adoption of this Plan, its qualification by the IRS, and the related tax consequences are the responsibility of the Employer and its independent tax and legal advisors. Aetna Life Insurance and Annuity Company will notify the Employer of any amendments made to the Plan or of the discontinuance or abandonment of the Plan provided this Plan has been acknowledged by Aetna Life Insurance and Annuity Company or its authorized representative. Furthermore, in order to be eligible to receive such notification, we agree to notify Aetna life Insurance and Annuity Company of any change in address. 18 113 IN WITNESS WHEREOF, the Employer and Trustee hereby cause this Plan to be executed on this 8th day of July, 1991. Furthermore, this Plan may not be used unless acknowledged by Aetna Life Insurance and Annuity Company or its authorized representative. EMPLOYER: KIRKLAND'S, INC. AND AFFILIATED COMPANIES /s/ Robert E. Alderson - -------------------------------------------- -------------------- (enter name) TRUSTEE By: /s/ Robert E. Alderson Sr VP/Sec /s/ Bruce S. Moore ----------------------------------------- -------------------- TRUSTEE PARTICIPATING EMPLOYER: /s/ Carl Kirkland -------------------- TRUSTEE - -------------------------------------------- (enter name) By: ----------------------------------------- This Plan may not be used, and shall not be deemed to be a Prototype Plan, unless an authorized representative of Aetna Life Insurance and Annuity Company has acknowledged the use of the Plan. Such acknowledgment is for administerial purposes only. It acknowledges that the Employer is using the Plan but does not represent that this Plan, including the choices selected on the Adoption Agreement, has been reviewed by a representative of the sponsor or constitutes a qualified retirement plan. Aetna Life Insurance and Annuity Company By: /s/ Edward A. Fish ------------------------------- With regard to any questions regarding the provisions of the Plan, adoption of the Plan, or the effect of an opinion letter from the IRS, call or write (this information must be completed by the sponsor of this Plan or its designated representative): Name DAVID S. PICKETT, ATTORNEY AT LAW ------------------------------------------------------------------------- AETNA LIFE INSURANCE AND ANNUITY COMPANY Address 151 FARMINGTON, AVENUE, HARTFORD, CONNECTICUT 06156 ----------------------------------------------------------------------- Telephone (203) 273-3664 --------------------------------------------------------------------- 19 EX-10.13 20 SHAREHOLDERS AGREEMENT DATED AS OF JUNE 12, 1996 1 EXHIBIT 10.13 EXECUTION SHAREHOLDERS AGREEMENT among KIRKLAND HOLDINGS L.L.C., KIRKLAND'S, INC., AFFILIATES OF KIRKLAND'S INC., CAPITAL RESOURCE LENDERS II, L.P., ALLIED CAPITAL CORPORATION, ALLIED CAPITAL CORPORATION II, THE MARLBOROUGH CAPITAL INVESTMENT FUND, L.P., CAPITAL TRUST INVESTMENTS, LTD., CARL KIRKLAND, ROBERT KIRKLAND, BRUCE MOORE, AND ROBERT ALDERSON Dated as of June 12, 1996 2 TABLE OF CONTENTS
Sections Page - -------- ---- 1. Certain Defined Terms......................................................................... 3 2. Prohibited Transfers.......................................................................... 10 3. Preemptive Rights............................................................................. 12 4. Third Party Offers to Shareholders; Participation Rights...................................... 15 5. Stock Splits, Etc............................................................................. 19 6. Joinder Requirements.......................................................................... 19 7. Failure to Deliver Shares..................................................................... 21 8. Termination................................................................................... 22 9. Registration Rights........................................................................... 22 10. Financial Reports and Information............................................................. 22 11. Company Governance Provisions................................................................. 23 12. Specific Performance.......................................................................... 27 13. Legend........................................................................................ 28 14. Notices....................................................................................... 28 15. Entire Agreement and Amendments............................................................... 30 16. Expenses...................................................................................... 31 17. Dividends..................................................................................... 31 18. Amendment to Charter.......................................................................... 31 19. Company Joinders.............................................................................. 31 20. Governing Law; Successors and Assigns......................................................... 32 21. Waivers....................................................................................... 32 22. Severability.................................................................................. 32 23. Captions...................................................................................... 32
-i- 3
Sections Page - -------- ---- 24. Counterparts.................................................................................. 32 25. Attorney's Fees............................................................................... 32 26. Parties Benefitted............................................................................ 33 27. Successors and Assigns........................................................................ 33
-ii- 4 SHAREHOLDERS AGREEMENT THIS SHAREHOLDERS AGREEMENT (the "Agreement") is made as of this 12th day of June, 1996, by and among - KIRKLAND HOLDINGS L.L.C., a Delaware limited liability company ("Holdings"), - KIRKLAND'S, INC., a corporation incorporated under Tennessee law ("Kirkland's" or the "Representative"), - the other corporations listed on the signature pages hereto (such other corporations, together with Kirkland's, being herein referred to individually as a "Company" and collectively as the "Companies"), - Capital Resource Lenders II, L.P. ("CRL"), - Allied Capital Corporation and Allied Capital Corporation II (collectively, "Allied"), - The Marlborough Capital Investment Fund, L.P. ("Marlborough"), - Capital Trust Investments, Ltd. ("Capital Trust" and together with CRL, Allied, and Marlborough, the "Mezzanine Warrant Holders", - CARL KIRKLAND, - ROBERT KIRKLAND, - BRUCE MOORE, and - ROBERT ALDERSON (Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson being herein referred to collectively as the "Individual Investors"). WHEREAS, on April 26, 1996, Holdings, the Companies and the Individual Investors executed a Recapitalization Agreement (the "Recapitalization Agreement"). Capitalized terms used but not defined herein have the meanings set forth in the Recapitalization Agreement; WHEREAS, pursuant to the Recapitalization Agreement, the Companies have filed amendments to their charters in preparation for the Preliminary Recapitalization and the Recapitalization. The amended charter of each Company provides that the authorized capital of such Company consists of 500,000 shares of common stock, no par value (the "Common Stock") and 100,000 shares of Preferred Stock, of which Preferred Stock 68,400 shares are designated as Class A Preferred Stock (the 5 "Class A Preferred Stock") and 31,600 shares are designated as Class B Preferred Stock (the "Class B Preferred Stock"). The amended charters of all Group A Companies and Group B Companies also provide that the authorized capital of each Group A and Group B Company includes 20,000 shares of Preferred Stock which are designated as Class C Preferred Stock (the "Class C Preferred Stock", and collectively with the Class A Preferred Stock and the Class B Preferred Stock, the "Preferred Stock"); and WHEREAS, the 500,000 shares of authorized Common Stock have been designated as Voting Common Stock ("Voting Common Stock" and with Voting Preferred Stock (defined herein), "Voting Stock") and Non-Voting Common Stock, depending on whether the Company is a Group A Company, Group B Company, Group C Company or Group D Company; and WHEREAS, of the 31,600 shares of authorized Class B Preferred Stock of each Group C Company and Group D Company, 21,800 have been designated as Voting Class B Preferred Stock ("Voting Class B Preferred Stock") and 9,800 have been designated as Non-Voting Class B Preferred Stock ("Non-Voting Class B Preferred Stock"); and WHEREAS, the 31,600 shares of authorized Class B Preferred Stock of each Group A Company and Group B Company have been designated simply as Class B Preferred Stock and do not carry voting rights; and WHEREAS, on the date hereof, Holdings owns a 68.4% interest and each of the Individual Investors owns a 7.9% interest in the outstanding Common Stock of each Company (whether voting or non-voting); and WHEREAS, on the date hereof, the Class A Preferred Stock of each Company is owned by Holdings; the Class B Preferred Stock of each Company is owned by the Individual Investors according to the following percentages: Robert Alderson, 25%; Carl Kirkland, 25%; Robert Kirkland, 25% and Bruce Moore, 25%; and the Class C Preferred Stock is owned by the Individual Investors in the following percentages: Robert Alderson, 8.3033%; Carl Kirkland, 39.5839%; Robert Kirkland, 37.7225%; and Bruce Moore, 14.3903%; and WHEREAS, in connection with the Company's execution of the Senior Subordinated Note and Warrant Purchase Agreement dated on or about the date hereof (the "Mezzanine Purchase Agreement"), pursuant to which the Mezzanine Warrant Holders have loaned a total of $20,000,000 in subordinated debt to the Companies, the Mezzanine Warrant Holders have received (i) warrants to purchase up to 11,905 shares of Common Stock, subject to adjustment in accordance with the terms of such warrants ("Mezzanine Warrants" and the shares subject to the Mezzanine Warrants, the "Warrant -2- 6 Shares") and (ii) warrants to purchase up to an additional 4,817 shares of Common Stock, subject to adjustment in accordance with the terms of such warrants, the exercisability of which is contingent upon the timing of certain events and the valuation of the Companies as evidenced by such event (the "Mezzanine Contingent Warrants" and the shares subject to the Mezzanine Contingent Warrants, the "Contingent Warrant Shares"); and WHEREAS, options to purchase 7,143 shares of Common Stock, subject to adjustment in accordance with the terms of the Option Agreements governing such options (the "Option Agreements"), have been granted to the Management Investors, each having the option under the Option Agreements to purchase one-third of such shares (the "Option Shares"); and WHEREAS, as an inducement to completion of the transactions contemplated by the Recapitalization Agreement and the mezzanine financing discussed above, Holdings, the Companies, the Mezzanine Warrant Holders and the Individual Investors have agreed to provide for certain restrictions with respect to the ownership and transfer of the shares of Stock owned by them and certain rights incident to the ownership of shares of Stock pursuant to this Agreement. NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and undertakings of the Companies set forth below, the parties hereto, intending to be legally bound hereby, agree with each other as follows: 1. Certain Defined Terms. Capitalized terms used in this Agreement have the meanings set forth in this Section 1, or are defined in the provisions of this Agreement identified in this Section 1. (a) "Adjusted Common Equity Percentage" shall mean, with respect to a Shareholder, such Shareholder's Common Equity Percentage calculated without taking Offered Shares into account. (b) "Advent" shall mean Advent International Corporation, a Delaware corporation, and any Affiliate of Advent International Corporation. (c) "Affiliate" of a Person shall mean any Person which, directly or indirectly, controls, is controlled by, is under common control with, or under a common management agreement with, such Person. For purposes hereof (i) each Mezzanine Investor shall be deemed to be an Affiliate of each other Mezzanine Investor, (ii) the partners or shareholders of a Mezzanine Investor shall be deemed to be Affiliates of that Mezzanine Investor (but only to the extent of their pro rata interest therein), (iii) the members of Holdings shall be -3- 7 considered to be Affiliates of Holdings (but only to the extent of their pro rata interest therein). (d) "Agreement" means this Shareholders Agreement, as the same may be amended from time to time in accordance herewith. (e) "Board Expansion Right" shall mean the right granted to the holders of the Class A Preferred Stock pursuant to Section 5.4(c) of the Recapitalization Agreement to elect two (2) additional directors to the Boards of Directors of the Companies. (f) "Bona Fide Offer" shall mean a bona fide written offer from any Person other than any of the Companies to purchase any Securities owned by a Shareholder; provided, that if such offer includes an offer to purchase any Preferred Stock, the offer must set forth the aggregate stated value of Preferred Stock which the offeror desires to purchase, which may be accepted through the sale of shares of either Class A Preferred Stock, Class B Preferred Stock or Class C Preferred Stock having an aggregate stated value equal to the amount set forth. (g) "Class A Preferred Amendment" shall mean the amendment to the Companies' Articles or Certificates of Incorporation and Bylaws effected pursuant to Section 5.4(b) of the Recapitalization Agreement and pursuant to which the special voting rights and restrictions of the Class A Preferred Stock, Class B Preferred Stock and Class C Preferred Stock are eliminated, the Non-Voting Common Stock becomes voting stock, and after which no Preferred Stock and all Common Stock will have voting rights, except as required by law. (h) "Closing" shall mean the closing of the transactions contemplated by the Recapitalization Agreement. (i) "Common Equity Percentage" shall mean, as to any Shareholder, the percentage that (i) the outstanding shares of Common Stock then owned by such Shareholder and any shares of Common Stock issuable upon exercise of any warrants (including any Mezzanine Warrants or Mezzanine Contingent Warrants) or Options, in each case which are fully vested and then owned by such Shareholder, is of (ii) the aggregate outstanding number of shares of Common Stock then owned by all of the Shareholders plus all shares of Common Stock issuable upon exercise of any warrants (including any Mezzanine Warrants or Mezzanine Contingent Warrants) or Options, in each case which are fully vested and then owned by any Shareholder. (j) "Common Shares" shall mean issued and outstanding shares of Common Stock. -4- 8 (k) "Common Stock" shall mean the common stock, par value $.01 per share, of each of the Companies. (l) "Consulting Agreement" shall mean the Consulting Agreement by and between Robert Kirkland and the Companies and dated on or about the date hereof. (m) "Counterpart" shall mean a counterpart to this Agreement in the form of Exhibit A hereto, pursuant to the execution of which a Person shall become bound by all of the terms and conditions to this Agreement. (n) "Equity" means all initial capital contributed to all of the Companies by the Shareholders as of the date hereof, including in the form of continuing ownership as well as subsequent capital contributions by the Shareholders. For all purposes hereof (i) the Equity shall be considered to have a value of Forty-five Million Dollars ($45,000,000) as of the date hereof and shall be deemed to have been contributed to the Company on the date hereof; (ii) shares of capital stock shall be valued without regard to voting rights, and (iii) the Class C Preferred Stock shall not be considered Equity. (o) "Excluded Securities" shall mean, collectively: (i) the Option Shares, Warrant Shares and Contingent Warrant Shares; (ii) Common Stock to be issued as a stock dividend; (iii) Shares of any class of a Company's capital stock to be issued upon any subdivision, combination, stock split or reverse stock split of all the outstanding shares of such class of capital stock of a Company; (iv) Any securities to be issued by a Company pursuant to the acquisition by a Company of any Person by means of merger, stock purchase, reorganization, purchase of substantially all the assets or otherwise in which such Company, or its shareholders of record immediately prior to the effective date of such transaction, directly or indirectly, own at least a majority of the voting power of the acquired or resulting entity after such transaction; provided, that such recipient(s) of shares of Stock execute(s) a Counterpart and agree(s) to be bound by the terms and conditions hereof; and (v) Any securities to be issued pursuant to a Public Offering. -5- 9 (p) "Fully Diluted Common Stock" means the number of Common Shares plus the number of shares of Common Stock issuable upon conversion or exercise of other outstanding securities of the Companies. (q) "Group A Companies" shall mean Company Nos. 100, 123, 125, 126 and 128 through 204, such Companies being those which commenced business prior to May 1, 1995 in which Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson owned 37.5%, 37.5%, 15% and 10%, respectively, of the issued and outstanding common stock (measured prior to giving effect to any of the transactions contemplated by the Recapitalization Agreement). (r) "Group B Companies" shall mean Company Nos. 205 through 214, such Companies being those which commenced business after April 30, 1995 but before January 1, 1996 in which Carl Kirkland, Robert Kirkland, Bruce Moore and Robert Alderson owned 37.5%, 37.5%, 15% and 10%, respectively, of the issued and outstanding common stock (measured prior to giving effect to any of the transactions contemplated by the Recapitalization Agreement). (s) "Group C Companies" shall mean Company Nos. 101 through 104, 107, 109 through 111, 115 through 120, 122 and 127, which are all of the Companies other than Group A, B or D Companies. Group C Companies are the Companies in which the shares of the Individual Investors were not owned in the same percentages as the shares of the Group A, B or D Companies prior to the Recapitalization. (t) "Group D Companies" shall mean Company Nos. 215 through 224, such Companies being those commencing business in 1996. (u) "Management Investors" shall mean Kirkland, Bruce Moore and Robert Alderson. (v) "Mezzanine Investor" shall mean any Mezzanine Warrant Holder or any other Person who holds, from time to time, any Mezzanine Warrants, Mezzanine Contingent Warrants, Warrant Shares or Contingent Warrant Shares, and who is or who becomes a party to this Agreement pursuant to the terms hereof. (w) "Management Agreements" shall mean those letter agreements providing for employment of the Management Investors with the Companies and dated on or about the date hereof. (x) "Management Pledge Agreement" shall mean the Management Pledge Agreement executed by the Individual Investors -6- 10 in favor of the First National Bank of Boston, as Administrative Agent, on the date hereof. (y) "Options" shall mean incentive stock or non- qualified options granted pursuant to the Stock Option Plan as in effect on the date hereof, including without limitation the Options granted to the Management Investors to purchase the Option Shares. (z) "Parent Pledge Agreement" shall mean the Parent Pledge Agreement executed by Holdings in favor of The First National Bank of Boston, as Administrative Agent, on the date hereof. (aa) "Permitted Transferee" shall mean, with respect to any Individual Investor (i) such Person's spouse, (ii) any lineal descendant of such Person, (iii) spouses of such lineal descendants, (iv) trusts for the benefit of any such spouse, lineal descendant or spouse of a lineal descendant, or (v) organizations exempt from federal income taxation under Section 501(c)(3) of the Internal Revenue Code of 1986, as amended, provided that such 501(c)(3) organizations shall only constitute Permitted Transferees where the Individual Investor Transfers Stock to such organization for purposes of permitting such organization either to (x) register and sell such Stock in a Public Offering, or (y) sell such Stock to either a Non-Selling Shareholder or a Third Party Offeror pursuant to Section 4 hereof. (ab) "Person" shall mean an individual, a sole proprietorship, a corporation, a partnership, limited liability company, limited liability partnership, a joint venture, an association, a trust, or any other entity or organization, including a government or a political subdivision, agency or instrumentality thereof. (ac) "Preferred Stock" shall mean the Class A Preferred Stock, the Class B Preferred Stock and, where applicable, the Class C Preferred Stock, of each of the Companies. (ad) "Public Offering" shall mean the sale of shares of Common Stock in a registered underwritten public offering resulting in gross proceeds to the Companies of at least Thirty Million Dollars ($30,000,000), if Holdings and the Individual Investors realize a Rate of Return of at least thirty-five percent (35%) on their Equity, after taking into account the amount and timing of all capital contributions (and distributions) to (from) the Companies by (to) Holdings and the Individual Investors. -7- 11 (ae) "Recapitalization" shall mean the Recapitalization as defined in the Recapitalization Agreement. (af) "Recapitalization Agreement" shall mean the Recapitalization Agreement, dated April 26, 1996, among Holdings, the Companies and the Individual Investors. (ag) "Rate of Return" shall mean the internal rate of return for the investment by the Shareholders in the Equity. In the context of a Public Offering, Rate of Return shall be calculated based on the amount that would be realized by the Shareholders if all Shareholders then sold their Common Stock and Class A Preferred Stock and Class B Preferred Stock and realized (A) for their Common Stock the price per share at which Common Stock is sold in the Public Offering (before commissions but after other transaction expenses) and (B) for their Class A Preferred Stock or Class B Preferred Stock, its aggregate stated value plus all accrued and unpaid dividends. (ah) "Securities" shall mean all shares of capital stock, options, warrants, notes, bonds or other equity or debt securities offered or sold by the Companies from time to time on or after the date hereof. (ai) "Shareholder" shall mean any Person who holds, from time to time, any Shares, Mezzanine Warrants or Contingent Mezzanine Warrants, and who or which is or becomes a party to this Agreement pursuant to the terms hereof. (aj) "Shares" shall mean and include all issued and outstanding shares of Common Stock or Preferred Stock now owned or hereafter acquired by the Shareholders. (ak) "Stock" shall mean and include all shares of Common Stock and Preferred Stock of each of the Companies, including without limitation, shares of Common Stock issued, issuable or transferable on the exercise of Options, Mezzanine Warrants, Contingent Mezzanine Warrants, or other rights to acquire shares of Common Stock or on the conversion or exchange of securities convertible into or exchangeable for Common Stock, and all other securities of any of the Companies which may be issued in exchange for or in respect of shares of Common Stock or Preferred Stock (whether by way of stock split, stock dividend, combination, reclassification, reorganization or any other means). (al) "Stock Option Plan" shall mean any Stock Option Plan adopted by the Companies on the date hereof providing for the issuance of the shares of Common Stock to certain employees of the Companies or such Companies' subsidiaries. -8- 12 (am) "Transfer" shall mean any transfer of Stock, whether by sale, assignment, gift, will, devise, bequest, operation of the laws of descent and distribution, or in trust, pledge, hypothecation, mortgage, encumbrance or other disposition. The verb to "Transfer" shall mean to sell, assign, give, transfer (including by gift, will, devise, bequest, or operation of laws of descent and distribution, or in trust), pledge, hypothecate, mortgage, encumber or dispose of. Other capitalized terms used in this Agreement have the definitions set forth in the following sections: Capitalized Term Section ---------------- ------- 10-Day Period 3(d) 30-Day Exercise Period 4(c) 30-Day Period 3(b) 90-Day Period 3(f) Accepting Shareholders 3(d) Allied Preamble Class A Preferred Stock Preamble Class B Preferred Stock Preamble Class C Preferred Stock Preamble Companies Preamble Company Notice 4(b) Company Option Period 4(b) Contingent Warrant Shares Preamble CRL Preamble CT Preamble Exercise Notice 4(c) Fair Market Value 6(d) Final Purchase Notice 4(f) Final Remaining Shares 4(g)(iv) First Option 4(c) First Refusal Notice 4(a) Holdings Preamble Initiating Holders 6(a) Kirkland's Preamble Individual Investors Preamble Marlborough Preamble Mezzanine Contingent Warrants Preamble Mezzanine Purchase Agreement Preamble Mezzanine Warrant Holders Preamble Mezzanine Warrants Preamble Non-Selling Shareholders 4(a) Non-Voting Class B Preferred Stock Preamble Notice of Acceptance 3(c) Notice of Refused Securities 3(c) Offer 3(b) Offered A/B Preferred Shares 4(g)(ii)(B) Offered C Preferred Shares 4(g)(ii)(C) Offered Common Shares 4(g)(ii)(A) -9- 13 Offered Shares 4(a) Option Agreements Preamble Option Shares Preamble Outside Offer 3(f) Participating Shareholder 4(g)(i) Participation Right 4(g)(ii) Preemptive Offer 3(a) Preferred A/B Value 4(g)(ii)(B) Preferred C Value 4(g)(ii)(C) Preferred Initiating Holders 6(b) Preferred Purchase Percentage 6(b) Preferred Stock Preamble Purchase Percentage 6(a) Purchasers 4(g)(i) Recapitalization Agreement Preamble Refused Securities 3(c) Remaining Offered Shares 4(b) Representative Preamble Second Option 4(c) Selling Shareholder 4(a) Third Party Offer Terms 4(b) Third Party Offeror 4(f) Transferred Companies 7 Transferring Shareholder 7 Unpurchased Remaining Offered Shares 4(c) Unpurchased Remaining Shares Notice 4(c) Voting Class B Preferred Stock Preamble Voting Common Stock Preamble Voting Preferred Stock 11(a)(ii) Voting Stock Preamble Warrant Shares Preamble 2. Prohibited Transfers. (a) Each Shareholder hereby agrees that it shall not Transfer all or any of his or its Stock except to the Companies which originally issued the Stock or as expressly provided in this Agreement. No Transfer shall be effective and the Companies shall not, and shall not be compelled to, recognize any Transfer or record any Transfer on their books made other than in accordance with the terms of this Agreement, or issue any certificate representing any Stock to any Person who has received such Stock in a Transfer made other than in accordance with the terms of this Agreement or to any Person who has not delivered to it an executed Counterpart. (b) Each Shareholder shall be permitted to Transfer its Stock to any Affiliate of such Shareholder without compliance with Section 4 hereof, provided that any such transferee shall, as a condition to such Transfer, execute a Counterpart and thereafter the transferee shall be treated as a Shareholder for all purposes under this Agreement; and provided -10- 14 further that if the Notes (as defined in the Mezzanine Agreement) shall be bearing interest at thirteen and one-half percent (13.5%) pursuant to Section 2.06(b) of the Mezzanine Agreement, then, until such Notes shall be redeemed, Holdings shall not be permitted to transfer any of its Common Stock except to its members and then only if the members agree in writing to be bound by the terms of Section 2.06(b) of the Mezzanine Agreement (imposing transfer restrictions). (c) Each Individual Investor shall be permitted to Transfer all or any of his Stock to such Individual Investor's Permitted Transferees without compliance with Section 4 hereof, provided that such Permitted Transferee executes a Counterpart, and, except in the case of a Transfer occasioned as a result of the death of an Individual Investor: (i) notwithstanding such Transfer, the Individual Investor making such Transfer shall remain jointly and severally liable for any breach by the Permitted Transferee of the provisions of this Agreement; and (ii) any Individual Investor who Transfers any or all of his Voting Stock to a Permitted Transferee shall, except with the consent of the holders of a majority of the Shares other than the Shares of the Transferring Individual Investor, retain the right to vote the transferred Stock on any matter on which such Stock is entitled to vote under the provisions of the applicable Company's Certificate of Incorporation. (d) Nothing in this Section 2, shall be construed to restrict the merger of any two or more Companies with each other, notwithstanding that such a merger may be deemed to cause a Transfer of Stock, provided such merger does not cause any material change in the aggregate ownership of Stock. (e) Notwithstanding this Section 2, the Individual Investors and Holdings shall be permitted to pledge their shares in favor of The First National Bank of Boston, as Administrative Agent, pursuant to the Management Pledge Agreement and the Parent Pledge Agreement, both dated the date hereof. (f) Notwithstanding this Section 2, any Individual Investor shall be permitted to pledge his shares of Class C Preferred Stock to a lender to the pledging Individual Investor provided that (i) prior to completing the pledge, the lender undertakes in a writing (in form and substance acceptable to the lender and the Companies) delivered to the Companies that (A) such lender is prohibited from selling or syndicating all, or any portion of the debt obligation secured by the pledge, and (B) in the event of any default on the debt secured by such pledge, all or any portion of the pledged shares (as determined by the -11- 15 Companies) may be purchased by the Companies for a price equal to the lowest of (1) the aggregate Stated Value of the shares being purchased, (2) the Fair Market Value (as determined under procedures comparable to those set forth in Section 6(d) hereof with decisions as to choice of the valuation determiner being made by the Representative and the lender) of the shares being purchased, or (3) the unpaid principal, plus accrued interest, plus all other amounts accrued and owing to the lender in respect of such indebtedness, secured by the pledge, (ii) if Robert Kirkland is the borrower and pledgor, the Consulting Agreement will terminate in the event the Companies exercise their right to purchase, as set forth in section (i)(B) of this section (f), and the pledged shares are not delivered to the Companies concurrently with the purchase, (iii) if any other Individual Investor is the borrower and pledgor, the Management Agreement of such Individual Investor will terminate in the event the Companies exercise their right to purchase, as set forth in section (i)(B) of this section (f), and the pledged shares are not delivered to the Companies concurrently with the purchase, and (iv) the lender is an institution normally engaged in the business of making commercial loans. 3. Preemptive Rights. (a) Except in the case of Excluded Securities, no Company shall issue, sell or exchange, agree to issue, sell or exchange, or reserve or set aside for issuance, sale or exchange, any Securities unless (i) such Company shall have first offered (the "Preemptive Offer") to sell such Securities to the Company's Shareholders on the terms set forth herein and (ii) all other Companies simultaneously undertake identical action (except, if applicable, as to the amount of Securities proposed to be sold by such other Company) and make identical Preemptive Offers. Each Shareholder shall have a preemptive right to purchase up to such Shareholder's Common Equity Percentage of such Securities. Each Shareholder may assign all or any part of its rights and responsibilities with respect to such Offer (as defined below) to an Affiliate. Such Affiliate or Affiliates which are such assignees shall thereafter be deemed to be such assigning Shareholder (to the extent of such assignment) for purposes of applying this Section 3 to such Preemptive Offer. Each such Affiliate shall agree in writing, as a condition to such assignment, to execute a Counterpart in the event of a purchase of Securities pursuant to such assignment. (b) The Companies shall deliver to each Shareholder written notice of the Preemptive Offer, specifying the price and terms and conditions of the offer, including without limitation, the minimum and maximum limits on the amount of Securities proposed to be sold by the Companies pursuant to the offer (the "Offer"), and the Common Equity Percentage applicable to the Shareholder receiving such notice. The -12- 16 Preemptive Offer by its terms shall remain open and irrevocable for a period of thirty (30) days from the date such notice is given (the "30-Day Period"). (c) If a Shareholder desires to purchase Securities pursuant to the Preemptive Offer, such Shareholder shall evidence his or its intention to accept the Preemptive Offer by delivering a written notice to the Representative, signed by the Shareholder, setting forth the percentage of the Securities (not exceeding such Shareholder's Common Equity Percentage of such Securities) that the Shareholder elects to purchase (the "Notice of Acceptance"). Provided the minimum number of Securities set forth in the Preemptive Offer has been sold after conclusion of all procedures set forth in this Section 3, then, upon closing of the Preemptive Offer, each Shareholder shall be obligated to buy the percentage set forth in such Shareholder's Notice of Acceptance times the number of Securities being sold at such closing. No Company shall be permitted to sell at such closing (or any subsequent closing with respect to which the procedures set forth in this Section 3 have not again been followed, except as provided in this Section 3) more than the maximum number of Securities set forth in the Preemptive Offer. The Notice of Acceptance must be given, if at all, prior to the end of the 30-Day Period. Within five (5) days following the end of the 30-Day Period, the Representative shall give written notice (the "Notice of Refused Securities") to the Shareholders setting forth the percentage of Securities for which a Notice of Acceptance was not received (the "Refused Securities"). (d) If the Shareholders give Notices of Acceptance to the Representative prior to the end of the 30-Day Period indicating their intention to purchase, in the aggregate, less than the maximum amount of Securities set forth in the Preemptive Offer, each Shareholder giving a Notice of Acceptance ("Accepting Shareholders") shall be entitled to purchase by an additional Notice of Acceptance given to the Representative within ten (10) days after the date the Notice of Refused Securities is given (the "10-Day Period"), that proportion of the Refused Securities which the Common Equity Percentage of such Accepting Shareholder (prior to the Offer) bears to the Common Equity Percentage of all Accepting Shareholders. (e) If the Shareholders give Notices of Acceptance prior to the end of the 30-Day Period or 10-Day Period, as applicable, indicating their intention to purchase, in the aggregate, at least the minimum amount of Securities set forth in the Preemptive Offer, the Representative shall schedule a closing of the sale of the Securities to occur on a date not more than sixty (60) days nor less than twenty (20) days after the termination of the 30-Day Period or 10-Day Period, as applicable. Upon the closing of the sale of the Securities, each -13- 17 Accepting Shareholder shall purchase those Securities for which it tendered a Notice of Acceptance upon the terms specified in the Offer. (f) Regardless of whether the Shareholders tender Notices of Acceptance pursuant to subsection (c) and (d) of this Section 3 for at least the minimum amount of Securities set forth in the Offer within the 30-Day Period or the 10-Day Period, as applicable, any remaining Refused Securities may be sold for a period of ninety (90) days after the expiration of the 30-Day Period or 10-Day Period, as applicable (the "90-Day Period"), to any other Person or Persons (including without limitation, executive officers of any Company), upon terms and conditions which are in all material respects (including without limitation, price, form of consideration, payment period and interest rates) the same as those set forth in the Preemptive Offer. The closing of the sale of such Refused Securities (which shall include full payment to the Companies in cash or notes in accordance with the terms of such offer (the "Outside Offer")) shall take place not more than thirty (30) days after the expiration of such 90-Day Period and not less than twenty (20) days after notice of said closing shall have been given by the Representative to each Accepting Shareholder. In the event Accepting Shareholders gave Notices of Acceptance for less than the minimum number of Securities set forth in the Preemptive Offer, provided the Refused Securities agreed to be purchased plus the Securities for which Accepting Shareholders gave Notices of Acceptance exceeds such minimum, then at the same time as the closing of the sale of Refused Securities, each Accepting Shareholder shall purchase those Securities for which it tendered a Notice of Acceptance upon the terms specified in the Preemptive Offer. (g) (i) If at least the minimum amount of the Securities set forth in the Preemptive Offer and the Outside Offer are not agreed to be purchased within the 90-Day Period, the Representative may rescind all Notices of Acceptance tendered by Shareholders by providing written notice of such rescission to each Accepting Shareholder and the Companies shall not sell any Securities pursuant to the Outside Offer. (ii) Any Securities as to which Notices of Acceptance are rescinded, and any Refused Securities not purchased in the Outside Offer may not be sold or otherwise disposed of until they are again offered to the Shareholders under the procedures specified in subsections (a) through (g) hereof. (h) The transferability of Securities purchased by any Shareholder or other Person pursuant to this Section 3 shall be subject to the terms and conditions set forth in this Agreement and any Person who is not then a Shareholder and who purchases Securities shall execute a Counterpart as a condition -14- 18 precedent to such purchase. The obligation of any Shareholder to purchase such Securities is further conditioned upon the preparation of a purchase agreement embodying the terms of the Preemptive Offer or Outside Offer which shall be reasonably satisfactory in form and substance to the Representative and its counsel, and such Shareholder or other purchaser and such Shareholder's or other purchaser's counsel. 4. Third Party Offers to Shareholders; Participation Rights. (a) If any Shareholder (a "Selling Shareholder") receives a Bona Fide Offer to purchase part or all of the Selling Shareholder's Stock in all (and not less than all) of the Companies ("Offered Shares") which it desires to accept, it must give written notice ("First Refusal Notice") to the Representative and comply with this Section 4 before accepting such Bona Fide Offer. Any Bona Fide Offer offering to purchase less than all a Shareholder's Stock shall either be rejected or be an offer to purchase the same percentage of Stock of each Company. The First Refusal Notice shall identify the third party purchaser and the terms of the Bona Fide Offer to purchase the Offered Shares. The Representative shall, within five (5) days of receipt of the First Refusal Notice, provide copies thereof to all other Shareholders (the "Non-Selling Shareholders") and shall simultaneously notify each Non-Selling Shareholder of such Non-Selling Shareholder's Adjusted Common Equity Percentage. The Companies and the Non-Selling Shareholders shall have the options and rights set forth in this Section 4. Each Shareholder may assign all or any part of its rights and obligations with respect to such Bona Fide Offer to an Affiliate. Such Affiliate or Affiliates who are such assignees shall thereafter be deemed to be such assigning Shareholder (to the extent of such assignment) for purposes of applying this Section 4 to such Bona Fide Offer. Each Affiliate shall agree in writing, as a condition to such assignment, to execute a Counterpart, in the event of a purchase of Offered Shares pursuant to such assignment. (b) For a period of up to thirty (30) days after receipt of the First Refusal Notice ("Company Option Period") each of the Companies shall have the right to purchase up to all of the Offered Shares which it has issued at the price and on the other terms and conditions contained in the Bona Fide Offer (the "Third Party Offer Terms"). Unless all of the Companies exercise such right, none of the Companies shall exercise such right. The Representative shall notify the Selling Shareholder within the Company Option Period whether the Companies will exercise such right, such notice (the "Company Notice") specifying the amount of Offered Shares to be purchased by the Companies, if any (any remaining amount being the "Remaining Offered Shares"). A notice by the Companies that they will purchase Offered Shares is herein referred to as a "Company Purchase Notice.") The Company Option -15- 19 Period shall expire on the thirtieth day after the First Refusal Notice or the date the Representative gives a Company Notice indicating that the Companies will not purchase any Offered Shares. (c) Each Non-Selling Shareholder shall have the option (the "First Option") to purchase up to such Non-Selling Shareholder's Adjusted Common Equity Percentage of the Remaining Offered Shares (provided it is the same percentage in each of the Companies), on the Third Party Offer Terms. The First Option may be exercised by giving written notice (an "Exercise Notice") to the Selling Shareholder within thirty (30) days after the expiration of the Company Option Period (the "30-Day Exercise Period"). The Exercise Notice given by a Non-Selling Shareholder shall state the number of Offered Shares (up to such Non-Selling Shareholder's Adjusted Common Equity Percentage of the Remaining Offered Shares) which such Non-Selling Shareholder is willing to purchase. Within five (5) days following expiration of the 30-Day Exercise Period, the Selling Shareholder shall give a written notice ("Unpurchased Remaining Shares Notice") to the Non-Selling Shareholders setting forth the number of Remaining Offered Shares for which an Exercise Notice was not received ("Unpurchased Remaining Offered Shares"). Any Non-Selling Shareholder who exercised its option under this Section 4(b) to purchase such Non-Selling Shareholders' entire Adjusted Common Equity Percentage of the Remaining Offered Shares, shall have an option ("Second Option") to purchase such amount of the Unpurchased Remaining Offered Shares as such Non-Selling Shareholders shall agree upon or, failing such agreement, that proportion of the Unpurchased Remaining Offered Shares which such Non-Selling Shareholder's Common Equity Percentage bears to the aggregate Common Equity Percentage of all such Non-Selling Shareholders. A Non-Selling Shareholder shall exercise the Second Option, if at all, by giving a written second Exercise Notice to the Selling Shareholder within fifteen (15) days after the Selling Shareholder shall have given the Unpurchased Remaining Shares Notice relating to the Unpurchased Remaining Offered Shares. (d) Unless otherwise agreed to by the Selling Shareholder, all Company Purchase Notices and Exercise Notices given by the Companies and Non-Selling Shareholders shall be deemed rescinded if all of the Offered Shares are not to be purchased pursuant thereto. (e) If the Companies or Non-Selling Shareholders shall have given Company Purchase Notices or Exercise Notices as to all of the Offered Shares, all certificates for the Offered Shares shall be delivered to the purchaser(s) thereof, duly endorsed for transfer, at a closing held within not more than thirty (30) days nor less than twenty (20) days after the last such Exercise Notice is given at the then principal office of the Representative or such other place as the Selling Shareholder and -16- 20 the Companies (if the Companies are purchasers) and Non-Selling Shareholders who are purchasers of such Offered Shares shall agree. (f) If all of the Offered Shares are not agreed to be purchased by the Companies and Non-Selling Shareholders, then, within ten (10) days after the earlier of (i) the expiration of the applicable periods in which Non-Selling Shareholders could have exercised the First Option or, if applicable, the Second Option, or (ii) the date on which the Non-Selling Shareholders shall have declined in writing to purchase all of the Offered Shares, the Selling Shareholder shall give notice to all Non-Selling Shareholders and the Representative of the Offered Shares not intended to be purchased pursuant to the operation of Section 4(b) (c) and (d) (the "Final Purchase Notice"). For a period of thirty (30) days after the date the Final Purchase Notice is given, the Selling Shareholder may, subject to Section 4(g) and 4(h) below, sell the Offered Shares to the Person who made the Bona Fide Offer ("Third Party Offeror"); provided, however, that such Offered Shares are sold to the Third Party Offeror upon the Third Party Offer Terms, and that such Third Party Offeror executes a Counterpart. If the Selling Shareholder elects not to rescind Company Purchase Notices and Exercise Notices pursuant to Section 4(d) hereof, the sale of Offered Shares to the Companies and the purchasing Non-Selling Shareholders shall take place at the closing of the sale of the balance of the Offered Shares to the Third Party Offeror and, unless such Non-Selling Shareholders otherwise agree, shall be conditioned on the occurrence of said closing. If the Selling Shareholder wishes to sell all or any part of the Offered Shares on terms other than the Third Party Offer Terms or does not sell such Offered Shares on the Third Party Offer Terms within the aforementioned thirty (30) day period, the Selling Shareholder shall be obligated to make new offers and re-offers to the Companies and the Non-Selling Shareholders, in accordance with this Section 4, before it shall be permitted to Transfer its Shares, or any part thereof, to any Person. (g) (i) If a Non-Selling Shareholder does not exercise its First Option or if such exercise is rescinded pursuant to Section 4(d) above, such Non-Selling Shareholder may elect to participate (each Shareholder so electing being herein a "Participating Shareholder") in the Selling Shareholder's sale of Remaining Offered Shares to the Companies and the Non-Selling Shareholders whose Company Purchase Notices and Exercise Notices have not been rescinded (if any) and the Third Party Offeror (collectively, the "Purchasers"), in accordance with this subsection (g); (ii) Each such Participating Shareholder shall have the right ("Participation Right") to Transfer to the Purchasers on the Third Party Offer Terms: -17- 21 (A) if the Offered Shares include Common Stock (the "Offered Common Shares"), a number of shares of Common Stock equal to the product of the number of Offered Common Shares times a fraction, the numerator of which is the Common Equity Percentage of such Participating Shareholder and the denominator of which is the aggregate Common Equity Percentage of all Participating Shareholders and the Selling Shareholder. The number of shares of Common Stock to be sold by the Selling Shareholder to the Purchasers shall be reduced by the number of shares of Common Stock to be sold to the Purchasers by a Participating Shareholder pursuant to the exercise of a Participation Right; and (B) if the Offered Shares include Class A Preferred Stock or Class B Preferred Stock (the "Offered A/B Preferred Shares," and the aggregate stated value of the Offered A/B Preferred Shares being herein referred to as the "Preferred A/B Value"), a number of shares of Class A Preferred Stock or Class B Preferred Stock (without regard to voting rights) having an aggregate stated value equal to the product of the Preferred A/B Value times a fraction, the numerator of which is the aggregate stated value of the shares of Class A Preferred Stock or Class B Preferred Stock owned by such Participating Shareholder and the denominator of which is the sum of the Preferred A/B Value and the aggregate stated value of all shares of Class A Preferred Stock and Class B Preferred Stock owned by all Participating Shareholders and the Selling Shareholder. The number of Offered A/B Preferred Shares to be sold by the Selling Shareholder to the Purchasers shall be reduced by the number of Offered A/B Preferred Shares having an aggregate stated value equal to the aggregate stated value of the shares of Class A Preferred Stock or Class B Preferred Stock to be sold to the Purchasers by Participating Shareholders pursuant to the exercise of Participation Rights; (C) if the Offered Shares include Class C Preferred Stock (the "Offered C Preferred Shares," and the aggregate stated value of the Offered C Preferred Shares being herein referred to as the "Preferred C Value"), a number of shares of Class C Preferred Stock (without regard to voting rights) having an aggregate stated value equal to the product of the Preferred C Value times a fraction, the numerator of which is the aggregate stated value of the shares of Class C Preferred Stock owned by such Participating Shareholder and the denominator of which is the sum of the Preferred C Value and the aggregate stated value of all shares of Class C Preferred Stock owned by all Participating Shareholders and the Selling Shareholder. The number of Offered C Preferred Shares to be sold by the Selling Shareholder to the Purchasers shall be reduced by the number of Offered C Preferred Shares having an aggregate stated value equal to the aggregate stated value of the shares of Class C Preferred -18- 22 Stock to be sold to the Purchasers by Participating Shareholders pursuant to the exercise of Participation Rights; (iii) The Participation Right shall be exercised, if at all, by the Participating Shareholder giving written notice of exercise of the Participation Right to the Selling Shareholder and each of the other Non-Selling Shareholders within fifteen (15) days after the Final Purchase Notice is given pursuant to Section 4(f); (iv) If the Selling Shareholder would retain ownership of Offered Shares by reason of the exercise of Participation Rights (such remaining shares being herein the "Final Remaining Shares"), the Selling Shareholder may either (i) rescind all exercises of Participation Rights, reject the Bona Fide Offer and retain ownership of the Offered Shares, or (ii) negotiate with the Purchasers to purchase the Final Remaining Shares on the Third Party Offer Terms or terms less advantageous to the Selling Shareholder than the Third Party Offer Terms. Any such sale of the Final Remaining Shares to the Purchasers shall not be subject to the provisions of Sections 2 or 4 of this Agreement, except the obligation on the part of the Third Party Offeror to execute a Counterpart. A Transfer of Shares pursuant to the exercise of a Participation Right shall not be subject to the provisions of Sections 2 and 4 of this Agreement. (h) Notwithstanding anything to the contrary contained in this Section 4, (i) any Transfer permitted by Section 2 hereof shall not be restricted by this Section 4, (ii) any sale of Stock in connection with a Public Offering, or pursuant to the provisions of Rule 144 of the Securities Act of 1933, as amended, shall not be restricted by this Section 4. 5. Stock Splits, Etc. If there shall be any change in the Stock of a Company as a result of any merger, consolidation, reorganization, recapitalization, stock dividend, split-up, combination or exchange of Shares, or otherwise, the provisions of this Agreement shall apply with equal force to additional and/or substitute Securities, if any, received by each Shareholder in exchange for or by virtue of its ownership of Shares. 6. Joinder Requirements. (a) If at any time holders (the "Initiating Holders") of a majority of the outstanding shares of Common Stock desire to sell at least a majority of the outstanding shares of Common Stock to a prospective purchaser which is not an Affiliate of any of such holders at a per share price of at least ninety percent (90%) of the Fair Market Value (as defined in Section 6(d) below), and the purchaser of such Shares requires, as a condition of the sale, that the purchaser acquire more than a -19- 23 majority of the outstanding shares of the Common Stock (the percentage of Common Stock sought to be purchased by the purchaser being herein referred to as the "Purchase Percentage"), then (i) all of the holders of Mezzanine Warrants shall be required to exercise the Purchase Percentage of their Mezzanine Warrants and sell such Mezzanine Warrant Shares, and (ii) all Management Investors or other holders of Options shall be required to exercise the Purchase Percentage of their vested Options and sell the Shares purchased pursuant to such exercise, and (iii) all of the Shareholders (including the Initiating Holders) shall be required to sell the Purchase Percentage (and shall not sell more than the Purchase Percentage) of their Stock (as constituted after such exercise of Mezzanine Warrants), to the purchaser on the same price and other terms and conditions as those offered to the Initiating Holders. (b) If at any time holders ("Preferred Initiating Holders") of at least a majority of the outstanding shares of Preferred Stock desire to sell at least a majority of the outstanding Preferred Stock to a prospective purchaser which is not an Affiliate of any of such holders, and the purchaser of such Preferred Stock requires, as a condition of the sale, that the purchaser acquire more than a majority of the outstanding shares of Preferred Stock of all Shareholders (the percentage of Preferred Stock sought to be purchased by the purchaser being herein referred to as the "Preferred Purchase Percentage"), then all of the Shareholders shall be required to sell the Preferred Purchase Percentage of their Preferred Stock to the purchaser on the same price and other terms and conditions as those offered to the Preferred Initiating Holders. (c) For purposes of Section 6(b), the term "Preferred Stock" shall not include the Class C Preferred Stock. Any sale of Common Stock or Preferred Stock pursuant to this Section 6, including the sale by the Initiating Holders or Preferred Initiating Holders, shall not be subject to the provisions of Sections 2 and 4 of this Agreement. (d) For purposes of this Agreement, "Fair Market Value" of a share of Stock shall mean such value as determined by an investment banking firm mutually acceptable to both the Board of Directors of the Company and holders of a majority of Stock being involuntarily required to join in the sale under Section 6 hereof. In the event an investment banking firm cannot be mutually agreed upon, such value shall be a value per share of Stock as determined by a nationally recognized firm engaged in the business of (among other things) valuing privately held businesses, which is not an Affiliate of the Company, any director of the Company, or any of the Shareholders, and which is selected by the mutual agreement of the holders of a majority of the Stock being involuntarily required to join in the sale under Section 6 hereof. If such holders are unable to agree, then -20- 24 holders of the Mezzanine Warrants and the Management Investors shall agree on one appraiser, and if they cannot agree the Mezzanine Warrant holders shall select one appraiser and the Management Investors shall select one appraiser. The appraiser or appraisers so selected shall determine the Fair Market Value. An average of all appraisals shall be the Fair Market Value if more than one appraisal is used. If the Fair Market Value is more than ninety percent (90%) of the sale price, the fees paid to the investment banking firm or appraiser or appraisers for determining the Fair Market Value shall be borne by the holders of Stock who are being required to involuntarily join the sale under Section 6(a). Otherwise, such cost shall be borne by the Initiating Holders. 7. Failure to Deliver Shares. If a Shareholder (the "Transferring Shareholder") becomes obligated to Transfer any Stock to any of the Companies or to another Shareholder pursuant to this Agreement (including a Transfer to another Shareholder for purposes of Transfer to another purchaser pursuant to Section 6 or otherwise) and fails to deliver such Stock in accordance with the terms of this Agreement, the Company or Companies whose Stock the Transferring Shareholder is obligated to transfer (the "Transferred Companies") or such other Shareholder, as the case may be, may, at its or their option, in addition to all other remedies it may have, either (i) send to the Transferring Shareholder the purchase price for such Stock as is herein specified, or (ii) deposit such amount with a trustee or escrow agent for the benefit of the Transferring Shareholder for release upon delivery of such Stock to the trustee or escrow agent in accordance with the terms of this Agreement. Thereupon, the Transferred Companies, upon written notice to the Transferring Shareholder, (a) shall cancel on its books the certificate or certificates representing the Stock so required to be transferred by the Transferring Shareholder and (b) shall issue, in lieu thereof, in the name of the Transferred Companies, such other Shareholder or purchaser, as the case may be, a new certificate or certificates representing such Stock; provided, however, the Transferred Companies shall be under no obligation to so cancel and issue Stock unless the other Shareholder or purchaser, as the case may be, delivers to the Transferred Companies its agreement to indemnify, defend and hold harmless the Transferred Companies, its officers and employees, successors and assigns, from any and all losses, claims, damages or liabilities (or actions in respect thereof) to which the Transferred Companies may become subject as a result of, arising out of, or based upon the Transferred Companies so canceling and issuing Stock, and such other Shareholder or purchaser, as the case may be, shall reimburse the Transferred Companies for any legal or other expenses reasonably incurred by the Transferred Companies in connection therewith. All of the Transferring Shareholder's rights in and to such Stock shall terminate as of the date of such Notice. -21- 25 8. Termination. Except as provided in Section 15 hereof, this Agreement shall terminate upon (i) the consummation of a Public Offering or (ii) the earlier mutual agreement of Shareholders having an aggregate Common Equity Percentage of at least eighty percent (80%). 9. Registration Rights. The Shareholders shall have the registration and other rights set forth in the Registration Rights Agreement dated the date hereof and among the parties hereto. 10. Financial Reports and Information. (a) Within ninety (90) days after the end of each fiscal year of the Companies, for so long as this Agreement shall be in effect, the Companies agree to furnish each of the Shareholders with audited consolidated and consolidating financial statements of the Companies for such fiscal year (showing comparison to the prior fiscal year) which shall include a statement of income and retained earnings for each such fiscal year, a balance sheet as at the last day thereof, and a statement of cash flows prepared in accordance with generally accepted accounting principles consistently applied, and accompanied by the report, without qualification, of the Companies' independent certified public accountants (which shall be of recognized national standing), including such accountant's management letters to the Companies and a breakdown of all the Shareholders of each Company, listing next to each Shareholder's name, the Shareholder's Common Equity Percentage. (b) If for any period any Company shall have any subsidiary or subsidiaries whose accounts are consolidated with those of such Company, then in respect of such period the financial statements delivered pursuant to the foregoing Section 11(a) shall be the consolidated financial statements of such Company and all such consolidated subsidiaries. (c) Promptly upon becoming available, copies of all financial statements, reports, press releases, notices, proxy statements and other documents sent by any of the Companies to their lenders or released to the public and copies of all regular and periodic reports, if any, filed by the Companies with the Securities and Exchange Commission or any securities exchange. (d) Upon request from any Shareholder including any Selling Shareholder to any of the Companies, such Company shall disclose to such Shareholder, in writing, the name and address of such Shareholder (as it then appears on the records of the Company) and such Shareholder's Common Equity Percentage. -22- 26 11. Company Governance Provisions. (a) Unless and until holders of Class A Preferred Stock exercise the Board Expansion Right or effect the Class A Preferred Amendment, each Company's Board of Directors shall have nine (9) seats, at least seven (7) of which shall be filled at all times. The Members of the Board of Directors shall be elected in the following manner: (i) If seven (7) directors of the Company's Board of Directors are appointed, the holders of a majority of the outstanding shares of Voting Common Stock, shall have the special and exclusive right at all times to elect three (3) directors to the Board of Directors of each Company. To the extent all nine (9) of the directors of the Company's Board of Directors are appointed, such holders shall have the special and exclusive right at all times to elect four (4) directors to the Board of Directors of each Company (in either event, the directors appointed under this Section 11(a)(i) shall be referred to herein as the "Holdings Representatives"). A Holdings Representative shall not be subject to removal, other than for cause, unless such removal is approved by a majority of all the votes entitled to be cast in an election for such directors by the holders of the Voting Common Stock. A majority of the Holdings Representatives shall have the right to make all determinations concerning the taking of action by the Companies to enforce the Companies' rights under the Recapitalization Agreement. (ii) If seven (7) directors of the Company's Board of Directors are appointed, the holders of outstanding shares of Voting Class B Preferred Stock and Class C Preferred Stock ("Voting Preferred Stock"), voting as a separate voting group, shall have the special and exclusive right at all times to elect four (4) directors to the Board of Directors of each Company. To the extent all nine (9) directors of the Company's Board of Directors are appointed, such holders shall have the special and exclusive right at all times to elect five (5) directors to the Board of Directors of each Company (in either event, the directors appointed under this Section 11(a)(ii) shall be referred to herein as "Management Representatives"). Any Management Representative shall not be subject to removal, other than for cause, unless such removal is approved by a majority of all the votes entitled to be cast in an election for such directors by the holders of the Voting Preferred Stock. (iii) If only seven (7) directors of a Company's initial Board of Directors are appointed, either the holders of a majority of the outstanding shares of Voting Common Stock or the holders of the Voting Preferred Stock may, at any time, appoint an additional director to the Board of Directors of the Company. If Holdings on the one hand, or the holders of the -23- 27 Voting Preferred Stock on the other hand, appoint an additional director under this Section 11(a)(iii), the other must appoint an additional director to the Board of Directors such that the Board of Directors shall then consist of nine (9) directors. (iv) Unless an individual nominated to serve on the Board of Directors of the Kirkland Companies hereunder expressly agrees in writing otherwise, such nomine shall not be deemed to be the deputy of or otherwise required to discharge his or her duties on such Boards under the direction of, or with special attention to the interests of, the person designating such nominee to serve on the Boards. (b) The initial board of directors shall be comprised of the following individuals and each Shareholder agrees to vote such Shareholder's Shares accordingly: (i) The Holding Representatives shall be: (A) David M. Mussafer (B) John P. Oswald (C) Alexander S. McGrath (ii) The Management Representatives shall be: (A) R. Wilson Orr, III (B) Carl Kirkland, Chairman (C) Robert Alderson (D) Bruce Moore (c) From and after the date hereof, each Shareholder agrees to vote (including by execution of a written consent or in any other manner permitted by law and each of the Companies' certificate or articles of incorporation and by-laws) all of his or its Shares over which he or it has voting control, and will take all other necessary or desirable actions within his or its control, and the Companies will take all necessary or desirable actions within its control, in order to cause: (i) the election to the Board of Directors of each Company of the Holdings Representatives, such directors to be nominated by Holdings, as follows: (A) one (1) (if seven (7) seats are filled on the Board) or two (2) (if all nine (9) seats are filled on the Board) representatives designated by Advent International Corporation, but only for so long as investment funds affiliated -24- 28 with Advent International Corporation have a Common Equity Percentage (directly or indirectly through Holdings) of at least fifteen percent (15%). (B) one representative designated by Capital Trust, but only for so long as Capital Trust (or any of its Affiliates) has (directly or indirectly through Holdings) a Common Equity Percentage of at least two percent (2%), or holds $900,000 aggregate principal amount of Senior Subordinated Notes (as defined in the Mezzanine Agreement); and (C) one representative designated by CRL (or if CRL distributes any of its Warrant Shares to any of its partners, by a majority in interest of the holders of such Warrant Shares, or if CRL transfers its Warrant Shares, by the holder of the highest aggregate principal amount of the Senior Subordinated Notes (as defined in the Mezzanine Agreement) owned by CRL, its successors or assigns), but only for so long as CRL (or any of its partners) has a Common Equity Percentage of at least three percent (3%). (ii) the election to the Board of Directors of each Company of the Management Representatives, such directors to be nominated by the holders of Class B Preferred Stock and Class C Preferred Stock, as follows: (A) One (1) representative designated by Carl Kirkland, so long as he remains an employee (or retired employee) of the Companies and he has a Common Equity Percentage of at least four percent (4%) of the outstanding shares of Common Stock; (B) One (1) representative designated by Bruce Moore, so long as he remains an employee (or retired employee) of the Companies and he has a Common Equity Percentage of at least four percent (4%) of the outstanding shares of Common Stock; (C) One (1) representative designated by Robert Alderson, so long as he remains an employee (or retired employee) of the Companies and he has a Common Equity Percentage of at least four percent (4%) of the outstanding shares of Common Stock; (D) One (1) representative designated by SSM/Kirkland Equity Partners, L.P. but only for so long as such entity (or any of its partners) has a Common Equity Percentage (directly or indirectly through Holdings) of at least two percent (2%); (E) If and only if all nine (9) seats are to be filled on the Board, one (1) individual designated by -25- 29 the majority decision of the Management Investors, which person shall be an individual unrelated to any of the investors in Holdings and any of the Mezzanine Investors. (iii) the removal from the Board of any representative designated as provided in this Section 11(c) upon the express written request of the designator thereof or upon the failure of any of the thresholds specified in Section 11(c) with respect to such particular designator; and (iv) in the event that any representative designated as provided in this Section 11(c) for any reason ceases to serve as a member of the Board of Directors of any of the Companies during his term of office, the resulting vacancy on each Board to be filled by a representative designated by the person who or which designated the ceasing director; provided that if such person ceases to serve as a member of the Board of Directors because the designator thereof ceases to meet the thresholds set forth in Section 11(c), such vacancy shall be filled as required by the bylaws of the Companies, as amended from time to time. (d) Nothing herein shall diminish the rights of the holders of the Class A Preferred Stock set forth in Section 5.4 of the Recapitalization Agreement and all Shareholders agree to vote their Stock to cause compliance with such provisions. (e) The initial director designated in Section 11(b)(i)(A) or his successor elected pursuant to Section 11(c)(i)(A) shall be the director whose approval is required pursuant to Section 14 of Article III of the bylaws of the Companies (as required pursuant to Section 5.7 of the Recapitalization Agreement). (f) If the Company receives a written notice requesting that any action be taken to implement the provisions of this Section 11, the Companies and each Shareholder agree promptly to take such action as may be necessary so to implement such provisions in accordance with this Section, including, without limitation, the calling of a special meeting, the voting of Shares, the execution of written consents or any other necessary action in connection therewith. (g) Absent cause, neither the Company nor the Shareholders will take any action to remove any Board representative designated pursuant to Section 11(c) without the advance written consent of the Person who or which designated that director. (h) The Companies shall cause (i) the number of directors of each Company to be the same at all times and (ii) any person serving as a director or a member of a committee of -26- 30 the Board of Directors of any Company to also serve concurrently as a director of each other Company. Each of Capital Trust and CRL shall, at all times that it has a right to designate directors pursuant to Section 11(c)(i)(B) or (C) hereof, have a representative on each committee of the Board of Directors of each of the Companies unless, and only for so long as, it waives in writing such right with respect to a specific committee. (i) Each Shareholder agrees to vote (including by execution of a written consent or in any other manner permitted by law and each of the Companies' respective certificate or articles of incorporation and by laws) all of his or its Shares over which he or it has voting control, and will take all other necessary or desirable actions within his or its control, and the Companies will take all necessary or desirable action within its control, to cause (i) from and after any exercise of the Board Expansion Right, the Board of Directors of each of the Companies to be comprised of two (2) more directors than it is then comprised of, with the original seven (7) or nine (9), as applicable, elected as provided in Section 11(c) hereof and two (2) additional representatives designated by Advent International Corporation; and (ii) from and after the effectiveness of the Class A Preferred Amendment, the Board of Directors of each of the Companies to be comprised of not less than seven (7) members, provided that at least seven (7) members of the Board after any increase in the number of Board seats shall be representatives of Shareholders (if threshold ownership percentages are met) as contemplated by subsections (A) (for one (1) director), (B) and (C) of Section 11(c)(i), and (A), (B), (C) and (D) of Section 11(c)(ii). (j) The Class A Preferred Amendment shall be effected no later than the date the Companies and each of the Shareholders engage an investment banking firm to undertake an offering of Common Stock or similar affirmative steps are taken by the Companies to cause a public market to exist for the Common Stock. 12. Specific Performance. Because of the unique character of the shares of Stock, the Companies will be irreparably damaged if this Agreement is not specifically enforced. Should any dispute arise concerning the Transfer of Stock, an injunction may be issued restraining any Transfer pending the determination of such controversy. In the event of any controversy concerning the right or obligation to Transfer any such Stock, such right or obligation shall be enforceable in a court of equity by a decree of specific performance. Such remedy shall be cumulative and not exclusive, and shall be in addition to any other remedy which the Companies or the other Shareholders of the Companies may have. -27- 31 13. Legend. Each certificate evidencing any of the Shares shall bear a legend substantially as follows: "The shares represented by this certificate are subject to restrictions on transfer and may not be sold, exchanged, transferred, pledged, hypothecated or otherwise disposed of except in accordance with and subject to all the terms and conditions of a certain Shareholders Agreement dated as of June 12, 1996, among the Company, certain affiliates of the Company and their shareholders, a copy of which the Company will furnish to the holder of this certificate upon request and without charge." 14. Notices. All notices and other communications hereunder shall be in writing and shall be given to the person either personally or by sending a copy thereof by first class or express mail, postage prepaid, or by telegram (with messenger service specified), telex or TWX (with answer back received) or courier services, charges prepaid, or by telecopier, to such party's address (or to such party's telex, TWX, telecopier or telephone number). If the notice is sent by mail, it shall be deemed to have been to the person entitled thereto five (5) business days after being deposited in the United States mail, and if the notice is sent by telegraph or courier services, it shall be deemed to have been given to the person entitled thereto one (1) business day after deposited with a telegraph office or courier service for delivery to that person or, in the case of telex, TWX or telecopy when dispatched. If to Holdings, to: Kirkland Holdings L.L.C. 101 Federal Street Boston, MA 02110 Attention: David M. Mussafer Telecopy No.: (617)951-0566 With a copy to: Pepper, Hamilton & Scheetz 3000 Two Logan Square Philadelphia, PA 19103 Attention: Julia D. Corelli, Esq. Telecopy No.: (215)981-4750 -28- 32 If to the Management Investors or any Company (including the Representative), to: Kirkland's, Inc. P.O. Box 7222 Jackson, TN 38303-7222 Attention: Carl Kirkland Telecopy No.: (901)664-9345 With a copy to: Baker, Donelson, Bearman & Caldwell 20th Floor First Tennessee Building 165 Madison Avenue Memphis, TN 38103 Attention: Robert Walker, Esq. Telecopy No.: (901)577-2303 If to Robert Kirkland, to: CBK, Ltd. 600 East Sherwood Union City, Tennessee 38261 Attention: Robert Kirkland Telecopy No.: (901)885-3857 With a copy to: Wyatt, Tarrant & Combs 6075 Poplar Avenue, Suite 650 Memphis, Tennessee 38119 Attention: Nash Neyland, Esquire Telecopy No.: (901)537-1010 If to Mezzanine Warrant Holders, to: Capital Resource Lenders II, L.P. 85 Merrimac Street Suite 200 Boston, MA 02114 Attention: Alexander S. McGrath Telecopy No.: (617)723-9819 -29- 33 Allied Capital Corporation and Allied Capital Corporation II 1666 K Street, N.W. Suite 901 Washington, D.C. 20006 Attention: Susan Gallagher Telecopy No.: (202)659-2053 The Marlborough Capital Investment Fund, L.P. 399 Boylston Street Boston, MA 02116 Attention: Margaret Lanoix Telecopy No.: (617)421-9631 Capital Trust Investments, Ltd. 575 Fifth Avenue, 40th Floor New York, NY 10017 Attention: John P. Oswald Telecopy No.: (212)490-6950 With a copy to: Testa, Hurwitz & Thibeault, LLP High Street Tower 125 High Street Boston, MA 02110 Attention: Andrew E. Taylor, Jr., Esquire Telecopy No.: (617)248-7100 Notice of any change in any such address shall also be given in the manner set forth above. Whenever the giving of notice is required, the giving of such notice may be waived by the party entitled to receive such notice. 15. Entire Agreement and Amendments. This Agreement constitutes the entire agreement of the parties with respect to the subject matter hereof and, except as provided in clause (i) of Section 8 hereof, neither this Agreement nor any provision hereof may be waived, modified, amended or terminated except by a writing duly executed by holders of Stock having an aggregate Common Equity Percentage of at least eighty percent (80%), and, if the waiver, modification, amendment or termination would affect the rights or obligations of a holder of Preferred Stock, by holders of at least eighty percent (80%) of the aggregate stated value of the class of Preferred Stock so affected; provided, that (i) until the termination of this Agreement pursuant to clause (i) of Section 8 hereof, and except as otherwise provided by operation of the terms of Section 11 hereof, the right of any Shareholder to nominate a director in accordance with the provisions of Section 11 hereof may not be -30- 34 modified, amended or terminated without the consent of such Shareholder, (ii) any such waiver, amendment or modification shall affect all Shareholders equally unless the Shareholder affected differently shall have specifically approved the waiver, amendment or modification, and (iii) the terms and provisions of this Section 15 shall not be modified or amended without the prior written consent of each of the Shareholders. To the extent any term or other provision of any other indenture, agreement or instrument by which any party hereto is bound conflicts with this Agreement, this Agreement shall have precedence over such conflicting term or provision. In the event Holdings dissolves, each of the members of Holdings shall execute a Counterpart to this Agreement and shall thereafter be deemed to be a Shareholder hereunder for all purposes of this Agreement. 16. Expenses. The Companies shall reimburse the Shareholders for expenses incurred by them (or by the members of Holdings to the extent such expenses are to be paid by Holdings), including the reasonable expenses of counsel, in connection with (i) the negotiation, preparation, execution and delivery of this Agreement, the Operating Agreement of Holdings, and the Agreements of Limited Partnership of CT/Kirkland Equity Partners, L.P., Marlborough/Kirkland Equity Partners, L.P., TCW/Kirkland Equity Partners, L.P. and SSM/Kirkland Equity Partners, L.P., or (ii) the administration of such entities, including the filing of tax returns and preparation of financial reports provided that the expenses reimbursed under clause (ii) above shall not exceed $5,000 per year. 17. Dividends. Each Company shall not allow the payment of dividends on the Class A Preferred Stock or the Class B Preferred Stock unless and until any and all payments required to be made by the Company under the Management Agreements have been paid to the Management Investors and any and all payments required to be made by the Company under the Consulting Agreement shall have been made to Robert Kirkland. 18. Amendment to Charter. From and after the date hereof, each Shareholder agrees to vote all of his or its shares over which he or it has voting control, and will take all other necessary or desirable actions within his or its control, and the Companies will take all necessary or desirable actions within its control, in order to cause an amendment to the Companies' charter to increase the authorized Common Stock of the Companies upon exercise by holders of Class A Preferred Stock and/or Class B Preferred Stock of their rights to convert such stock into shares of Common Stock. 19. Company Joinders. The Companies and Shareholders shall cause all future companies formed in connection with the expansion of the Companies' operations (i) to be owned either by Kirkland's, Inc. or by the Shareholders in the same manner as -31- 35 Group D Companies, and (ii) if owned by the Shareholders, to become parties to this Agreement and the Registration Rights Agreement. Kirkland's specifically agrees that it shall not transfer any of the capital stock of any such future subsidiaries without either following the provisions of Section 4 hereof or obtaining the prior approval of Shareholders having an aggregate Common Equity Percentage of at least eighty percent (80%). 20. Governing Law; Successors and Assigns. This Agreement shall be construed and enforced in accordance with Delaware law and shall be binding upon the parties hereto and their respective successors and assigns. The parties hereto agree that any action to enforce this Agreement may be properly brought in any court within the State of Delaware or in the United States District Court for the District of Delaware, and the parties hereto agree that the courts of the State of Delaware and the United States District Court for the District of Delaware shall have jurisdiction with respect to the subject matter hereof and the person of the parties hereto. 21. Waivers. The failure of any party to insist upon strict performance of any of the terms or conditions of this Agreement will not constitute a waiver of any of its rights hereunder. 22. Severability. If any provision of this Agreement is held illegal, invalid, or unenforceable, such illegality, invalidity, or unenforceability will not affect any other provision hereof. This Agreement shall, in such circumstances, be deemed modified to the extent necessary to render enforceable the provisions hereof. 23. Captions. Captions are for convenience only and are not deemed to be part of this Agreement. 24. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 25. Attorney's Fees. In the event of litigation of any dispute or controversy arising from, in, under or concerning this Agreement or any amendment hereof, including, without limiting the generality of the foregoing, any claimed breach hereof or thereof, the prevailing party in such action shall be entitled to recover from the other party in such action, such sum -32- 36 as the court shall fix as reasonable attorney's fees incurred by such prevailing party. 26. Parties Benefitted. Nothing in this Agreement, express or implied, is intended to confer upon any third party any rights, remedies, obligations or liabilities. 27. Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective heirs, personal representatives, successors and assigns. [SPACE INTENTIONALLY LEFT BLANK] -33- 37 IN WITNESS WHEREOF, the parties have executed this Shareholders Agreement under seal on the date first above written. CAPITAL RESOURCE LENDERS II, L.P., by CAPITAL RESOURCE PARTNERS II, L.P., its General Partner By: Robert C. Ammerman ----------------------------------- Title: General Partner ALLIED CAPITAL CORPORATION By: Susan Gallagher ----------------------------------- Title: SVP -------------------------------- ALLIED CAPITAL CORPORATION II By: Susan Gallagher ----------------------------------- Title: SVP -------------------------------- THE MARLBOROUGH CAPITAL INVESTMENT FUND, L.P., by MARLBOROUGH CAPITAL MANAGEMENT, L.P., its general partner, By: /s/ Margaret Lanoix ----------------------------------- Name: Margaret Lanoix, its authorized partner [EXECUTIONS CONTINUED] -34- 38 CAPITAL TRUST INVESTMENTS, LTD. By: John P. Oswald ----------------------------------- Title: Attorney-in-Fact -------------------------------- KIRKLAND HOLDINGS L.L.C. By: David Mussafer ----------------------------------- Title: -------------------------------- ATTEST: KIRKLAND'S, INC. By: /s/ Robert E. Alderson By: /s/ Carl Kirkland -------------------------- ----------------------------------- Title: VP/Sec Title: President ----------------------- -------------------------------- [EXECUTIONS CONTINUED] -35- 39 Corporate Name -------------- 101 Kirkland's of Carolina, Inc. 102 Kirkland's of Charlotte, Eastland Mall, Inc. 103 Kirkland's of Tennessee, Inc. 104 K. C. Corp. Inc. 107 Kirkland's of Greensboro, Four Seasons Mall, Inc. 109 Kirkland's of Fayetteville, Cross Creek Mall, Inc. 110 Kirkland's of Wilmington, Independence Mall, Inc. 111 Kirkland's III, Jackson-Metro Center, Inc. 114 Kirkland's of Memphis, Tennessee, Laurelwood Shopping Center, Inc. 115 Kirkland's of Ridgeland, Mississippi, Northpark Mall, Inc. 116 Kirkland's of Knoxville, East Towne Mall, Inc. 117 Kirkland's of Huntsville, Madison Square Mall, Inc. 118 Kirkland's of Valley View Mall, Roanoke, VA, Inc. 119 Kirkland's of Nashville, Hickory Hollow Mall, Inc. 120 Kirkland's of Birmingham, Riverchase Galleria, Inc. 122 Kirkland's of BriarCliffe Mall, Myrtle Beach, South Carolina, Inc. 123 Kirkland's of Pecanland Mall, Monroe, LA, Inc. 125 Kirkland's of Towne Center at Cobb, Atlanta, GA, Inc. 126 Kirkland's of Gwinnett Place, Atlanta, GA, Inc. 127 Kirkland's of Rivergate Mall, Nashville, TN, Inc. 128 Kirkland's of Peachtree Mall, Columbus, GA, Inc. 129 Kirkland's of Cumberland Mall, Atlanta, GA, Inc. 130 Kirkland's of Hamilton Place Mall, Chattanooga, TN, Inc. 131 Kirkland's of Houston Galleria, Houston, TX, Inc. 132 Kirkland's of Mall of Memphis, Memphis, TN, Inc. 134 Kirkland's of Woodland Hills Mall, Tulsa, OK, Inc. 135 Kirkland's of Dayton Mall, Dayton, OH, Inc. 136 Kirkland's of Oxmoor Center, Louisville, KY, Inc. 137 Kirkland's of South Square Mall, Durham, NC, Inc. 138 Kirkland's of Valley View Center, Dallas, TX, Inc. 139 Kirkland's of Chesterfield Towne Center, Richmond, VA, Inc. 140 Kirkland's of Park Plaza, Little Rock, AR, Inc. 141 Kirkland's of Montgomery Mall, Montgomery, AL, Inc. 142 Kirkland's of Southlake Mall, Atlanta, GA, Inc. 143 Kirkland's of Southpark Mall, Richmond, VA, Inc. 144 Kirkland's of Eastland Mall, Evansville, IN, Inc. 145 Kirkland's of Fayette Mall, Lexington, KY, Inc. 146 Kirkland's of Hickory Ridge Mall, Memphis, TN, Inc. 148 Kirkland's of Regency Square Mall, Jacksonville, FL, Inc. 149 Kirkland's of McCain Mall, Little Rock, AR, Inc. 150 Kirkland's of River Ridge Mall, Lynchburg, VA, Inc. 151 Kirkland's of Bel Air Mall, Mobile, AL, Inc. 152 Kirkland's of The Mall at Barnes Crossing, Tupelo, MS, Inc. 153 Kirkland's of Cortana Mall, Baton Rouge, LA, Inc. 154 Kirkland's of Bellevue Center, Nashville, TN, Inc. 155 Kirkland's of Tri-County Mall, Cincinnati, OH, Inc. 156 Kirkland's of The Mall of the Avenues, Jacksonville, FL, Inc. -36- 40 # Corporate Name - - -------------- 157 Kirkland's of Eastwood Mall, Birmingham, AL, Inc. 158 Kirkland's of Lakeside Mall, New Orleans, LA, Inc. 159 Kirkland's of Carolina Place, Charlotte, N.C., Inc. 160 Kirkland's of Cary Village Mall, Raleigh, N.C., Inc. 161 Kirkland's of Cool Springs Galleria, Nashville, TN, Inc. 162 Kirkland's of Kenwood Towne Centre, Cincinnati, OH, Inc. 163 Kirkland's of St. Louis Galleria, St. Louis, MO, Inc. 164 Kirkland's of Wiregrass Commons Mall, Dothan, AL, Inc. 165 Kirkland's of Regency Mall, Richmond, VA, Inc. 166 Kirkland's of Florence, Florence, KY, Inc. 167 Kirkland's of Acadiana Mall, Lafayette, LA, Inc. 168 Kirkland's of Padre Staples Mall, Corpus Christi, TX, Inc. 169 Kirkland's of Belden Village, Canton, OH, Inc. 170 Kirkland's of West Oaks Mall, Houston, TX, Inc. 171 Kirkland's of Charleston Town Center, Charleston, W. VA, Inc. 172 Kirkland's of Crestwood Plaza, St. Louis, MO, Inc. 173 Kirkland's of White Marsh Mall, Baltimore, MD, Inc. 174 Kirkland's of Collin Creek Mall, Dallas, TX, Inc. 175 Kirkland's of Baybrook Mall, Houston, TX, Inc. 176 Kirkland's of Governor's Square Mall, Tallahassee, FL, Inc. 178 Kirkland's of Barton Creek Mall, Austin, TX, Inc. 179 Kirkland's of Highland Mall, Austin, TX, Inc. 180 Kirkland's of Battlefield Mall, Springfield, MO, Inc. 181 Kirkland's of Penn Square Mall, Oklahoma City, OK, Inc. 182 Kirkland's of Oak Park Mall, Kansas City, KS, Inc. 183 Kirkland's of Mall St. Vincent, Shreveport, LA, Inc. 184 Kirkland's of Owings Mills Mall, Baltimore, MD, Inc. 185 Kirkland's of Oakwood Center, New Orleans, LA, Inc. 186 Kirkland's of The Mall at Johnson City, Johnson City, TN, Inc. 187 Kirkland's of Glenbrook Mall, Ft. Wayne, IN, Inc. 188 Kirkland's of North Pointe Mall, Atlanta, GA, Inc. 189 Kirkland's of Northpark Mall, Joplin, MO, Inc. 190 Kirkland's of Orlando Fashion Square, Orlando, FL, Inc. 191 Kirkland's of The Mall at Fairfield Commons, Dayton, OH, Inc. 192 Kirkland's of St. Charles Towne Center, Waldorf, MD Inc. 193 Kirkland's of Regency Mall, Florence, AL, Inc. 194 Kirkland's of South Plains Mall, Lubbock, TX, Inc. 195 Kirkland's of The Parks at Arlington, Ft. Worth, TX, Inc. 196 Kirkland's of Parma Town Mall, Cleveland, OH, Inc. 197 Kirkland's of St. Clair Square, St. Louis, MO, Inc. 198 Kirkland's of Turtle Creek Mall, Hattiesburg, MS, Inc. 199 Kirkland's of The Woodlands, Houston, TX, Inc. 200 Kirkland's of Brandon Town Center, Tampa, FL, Inc. 201 Kirkland's of Memorial City Mall, Houston, TX, Inc. 202 Kirkland's of University Mall, Tuscaloosa, AL, Inc. 203 Kirkland's of Santa Rosa Mall, Fort Walton, FL, Inc. 204 Kirkland's of Panama City Mall, Panama City, FL, Inc. 205 Kirkland's of Town East Mall, Mesquite, TX, Inc. -37- 41 # Corporate Name - - -------------- 206 Kirkland's of Kentucky Oaks Mall, Paducah, KY, Inc. 207 Kirkland's of Crabtree Valley Mall, Raleigh, N.C., Inc. 208 Kirkland's of Oak Hollow Mall, High Point, N.C., Inc. 209 Kirkland's of Fox Valley Mall, Chicago, IL, Inc. 210 Kirkland's of Hawthorne Mall, Chicago, IL, Inc. 211 Kirkland's of Stratford Square, Chicago, IL, Inc. 212 Kirkland's of Orland Square, Chicago, IL, Inc. 214 Kirkland's of Coastland Mall, Naples, FL, Inc. 215 Kirkland's of Edgewater Mall, Biloxi, MS, Inc. 216 Kirkland's of Town Center Plaza, Kansas City, KS, Inc. 217 Kirkland's of Castleton Square, Indianapolis, IN., Inc. 218 Kirkland's of Cordova Mall, Pensacola, FL, Inc. 219 Kirkland's of University Park, South Bend, IN, Inc. 220 Kirkland's of Westgate Mall, Amarillo, TX, Inc. 221 Kirkland's of Westgate Mall, Spartanburg, SC, Inc. 222 Kirkland's of Meridian Mall, Lansing, MI, Inc. 223 Kirkland's of Cottonwood Mall, Albuquerque, NM, Inc. 224 Kirkland's of University Mall, Tampa, FL, Inc. By: /s/ Carl Kirkland ---------------------------- Title: President -------------------------- ATTEST: By: /s/ Robert E. Alderson ---------------------------- Title: VP/Sec -------------------------- -38- 42 /s/ Carl Kirkland ----------------------------- CARL KIRKLAND /s/ Robert E. Kirkland ----------------------------- ROBERT KIRKLAND /s/ Robert E. Alderson ----------------------------- ROBERT ALDERSON /s/ Bruce Moore ----------------------------- BRUCE MOORE [END OF SIGNATURES] -39- 43 EXHIBIT A TO SHAREHOLDERS AGREEMENT COUNTERPART THIS INSTRUMENT forms part of the Shareholders Agreement (the "Agreement") made as of the __th day of June, 1996, among Kirkland Holdings L.L.C., Kirkland's, Inc., affiliates of Kirkland's, Inc., Carl Kirkland, Robert Kirkland, Bruce Moore, Robert Alderson, Capital Resource Lenders II, L.P., Allied Capital Corporation, Allied Capital Corporation II, The Marlborough Capital Investment Fund, L.P. and Capital Trust Investments, Ltd., and any additional Shareholders of the Companies (as defined in the Agreement), from time to time, which Agreement permits execution by counterpart. The undersigned hereby acknowledges having received a copy of the said Agreement (which is annexed hereto as Schedule I) and having read the said Agreement in its entirety, and for good and valuable consideration, receipt and sufficiency of which is hereby acknowledged, hereby agrees that the terms and conditions of the said Agreement shall be binding upon the undersigned as a Shareholder and such terms and conditions shall inure to the benefit of and be binding upon the undersigned and its successors and permitted assigns. IN WITNESS WHEREOF, the undersigned has executed this instrument this ____ day of ___________, 199 . _________________________________ (Signature of Shareholder) _________________________________ (Name in block letters) -40- EX-10.14 21 REDEMPTION AGREEMENT DATED DECEMBER 26, 1997 1 EXHIBIT 10.14 REDEMPTION AGREEMENT THIS REDEMPTION AGREEMENT (the "Agreement") made and entered into this 26th day of December, 1997, by and among BRUCE MOORE, a resident of the state of North Carolina ("Moore"), KIRKLAND'S, INC., a corporation organized and existing under the laws of the State of Tennessee ("Kirkland's") and the other undersigned corporations hereto, each a corporation organized and existing under the laws of the State of Tennessee (Kirkland's and such other corporations hereinafter referred to individually as a "Corporation" and collectively the "Corporations"). RECITALS OF FACT Moore is the owner of the issued and outstanding Stock of the Corporations set forth on Exhibit A attached hereto ("Shares"). Moore has served as an employee, officer and director of the Corporations. On even date herewith, Moore tendered his resignation as an officer and director of the Corporations effective the later of January 7, 1998, or the date of payment in full of the Note referenced in Paragraph 2 hereof. Moore has determined that it is in his best interest to retire from active business with Corporations to allow him to pursue other interests. To accomplish this, Moore desires to realize the value of his investment in the Corporations, and has therefore proposed to tender all of his Shares in the Corporations for redemption at a value and upon certain terms and conditions as hereinafter provided. Moore and the Corporations desire to establish and confirm their understanding with regard to that certain letter agreement dated June 12, 1996, executed by Kirkland's and agreed to and accepted by Moore (the "Employment Agreement"), and the continuing rights and obligations of the parties thereunder. The Employment Agreement is attached hereto for reference as Exhibit B. NOW, THEREFORE, in consideration of the promises and undertaking as herein provided, the parties hereto do covenant and agree as follows: 1. Redemption of Stock. On the date hereof, Moore has tendered and delivered to Kirkland's, as agent for each of the Corporations, as applicable, certificates evidencing his ownership of the Shares, properly endorsed for redemption, which Shares constitute all of the shares of the capital stock of the Corporations owned by Moore. By execution of this Agreement the Corporations acknowledge receipt of such stock certificates. 2. Redemption Price and Payment. On January 7, 1998, the Corporations will pay to Moore the aggregate sum of Six Million Eight Hundred Eighty Eight Thousand Five Hundred Sixty Six Dollars ($6,888,566) (the "Redemption Price"), which obligation is represented by the promissory note of the Corporations, a copy of which is attached hereto as Exhibit C, (the "Note") which Note has been duly executed, approved and authorized by the Corporations and this date 2 delivered to Moore. By execution of this Agreement Moore acknowledges receipt of such Note. It is specifically understood and agreed among all parties hereto that the Redemption Price constitutes the fair market value for the Shares. The parties agree that the Redemption Price shall be allocated among the Shares in accordance with the Purchase Price Allocation Statement attached hereto as Exhibit D. Each Corporation shall be liable to pay the portion of the aggregate Redemption Price set forth on Exhibit "D" as its allocable share. 3. Payment of Redemption Price; Other Payment By Moore. The Redemption Price will be paid via wire transfer to the financial institution designated to the Corporations by Moore, which information Moore will provide in writing at least five business days prior to January 7, 1998. On January 7, 1998, Moore will pay to the Corporations $2,686.00 by check, which amount represents the balance due on capital contributions by Moore to certain of the newer Corporations. 4. Representations and Warranties of Moore. Moore represents and warrants to the Corporations that Moore is the legal owner of the Shares, that he has the full right, title, and interest to such Shares, that he has the right and power to sell and transfer such Shares to the Corporations, and that such Shares are unencumbered, except for a pledge by Moore to BankBoston, N.A., as Agent in connection with the Credit Agreement dated as of June 12, 1996 , as amended, among Kirkland's Holdings L.L.C., the Borrowers named therein (including Kirkland's, Inc.), the Banks named therein, BankBoston, N.A., as Administrative Agent (the "Administrative Agent"), and Lehman Commercial Paper, Inc., as Arranger. The parties will obtain a release of such pledge of stock by the Administrative Agent, as represented by a letter from the Administrative Agent, to be attached hereto as Exhibit E on or before January 7, 1998. Moore further represents and warrants to the Corporations that he has not employed any broker or finder in connection with this transaction, and that no broker or finders fee is due to any person in connection with this transaction. The representations and warranties made by Moore in this paragraph shall survive the execution of this Agreement and the closing of the transactions contemplated herein. 5. Representations and Warranties of the Corporations. The Corporations represent and warrant to Moore that this Agreement and the Note constitute the valid and binding obligation of each of the Corporations, and that this Agreement and the Note have been authorized and approved by all necessary corporate action of each of the Corporations. 6. Rights and Obligations Under Employment Agreement. (a) Kirkland's agrees, notwithstanding Moore's resignation of his employment under the Employment Agreement, (i) to make a one-time compensation payment to Moore of $259,000 on January 7, 1998, and (ii) to continue to pay to Moore only the portion of the "Annual Salary" (as such term is defined and used in the Employment Agreement) represented by the annual amount of $275,000, or $22,917 per month , which is payable through the term ending June 12, 2000, as provided for in the Employment Agreement, and (iii) to pay for the benefit of Moore and his immediate family premiums for the health, medical and hospitalization insurance on the same basis currently provided to Moore and other Company employees, so long as the salary payments to Moore in (ii) above are in effect. Moore acknowledges that, except as provided in the preceding sentence, he will receive, or be -2- 3 entitled to receive, no other compensation or benefits from the Corporations under the Employment Agreement or otherwise. (b) Aside from payment of the portion of the Annual Salary as provided in Section 6(a) above, Moore hereby releases Kirkland's, and each of the other Corporations, from any and all liabilities and obligations of the Corporations under the Employment Agreement. (c) Moore acknowledges and agrees that the restrictive covenants set forth in Section 6.1 of the Employment Agreement, as well as the other provisions of Section 6 of the Employment Agreement, (i) are incorporated herein by reference as fully as if set out verbatim, (ii) are an ongoing and integral element of this Agreement, and (iii) shall continue in full force and effect until June 11, 2003, all as provided in the Employment Agreement. 7. General Release. Except for the matters in the Employment Agreement as set forth in Paragraph 5 hereof, the payment obligation to Moore provided for in Paragraph 2 hereof, and the survival of the representations and warranties made by Moore in Paragraph 4 hereof, the parties hereunder each fully and unconditionally release the other party from any and all claims, liabilities, contracts, actions, debts, chooses in action, and any and all other matters, it being the intent of each of the parties to grant to the other a full and complete general release, as more particularly set forth in the General Release executed by each of the parties and attached hereto as Collective Exhibit F. Each of the parties by execution of this Agreement acknowledges receipt of each of such General Releases. 8. Other Documents. The parties agree to execute and deliver all such other and further documents, instruments and papers as may reasonably be deemed necessary or advisable to carry out the intent and purpose of this Redemption Agreement. 9. Binding Effect. The terms and conditions of this Redemption Agreement are binding upon and shall inure to the benefit of the parties hereto, their heirs, executors, administrators, successors and assigns. 10. Controlling Law. This Agreement shall be construed and enforced in accordance with Tennessee law, without regard to conflicts of laws principles. In the event of any subsequent question or dispute as to the meaning of any provision herein, the laws of the State of Tennessee, shall be relied upon to resolve such question. 11. Entire Agreement. This document contains the entire agreement among the parties, and any amendments or alterations hereof or additions hereto shall be of no force or effect whatsoever unless in writing and signed by all the parties. 12. Exhibits. The Exhibits attached hereto and referenced herein are incorporated into this Agreement by such references. -3- 4 13. Severability. If any provisions of this Agreement is held illegal, invalid, or unenforceable, such illegality, invalidity or unenforceability will not affect any other provisions hereof. IN WITNESS WHEREOF, the parties have signed this Redemption Agreement, or caused this Redemption Agreement to be executed by their duly authorized representative, as of the date first written above. /s/ Bruce Moore ------------------------------------------------------------------ Bruce Moore /s/ Carl Kirkland ------------------------------------------------------------------ Carl Kirkland, President and Chief Executive Officer of each of the companies listed below Kirkland's, Inc. Kirkland's of Pecanland Mall, Monroe, LA, Inc. Kirkland's of Town Center at Cobb, Atlanta, GA, Inc. Kirkland's of Gwinnett Place, Atlanta, GA, Inc. Kirkland's of Peachtree Mall, Columbus, GA, Inc. Kirkland's of Cumberland Mall, Atlanta, GA, Inc. Kirkland's of Hamilton Place Mall, Chattanooga, TN, Inc. Kirkland's of Houston Galleria, Houston, TX, Inc. Kirkland's of Mall of Memphis, Memphis, TN, Inc. Kirkland's of Woodland Hills Mall, Tulsa, OK, Inc. Kirkland's of Dayton Mall, Dayton, OH, Inc. Kirkland's of Oxmoor Center, Louisville, KY, Inc. Kirkland's of South Square Mall, Durham, NC, Inc. Kirkland's of Valley View Center, Dallas, TX, Inc. Kirkland's of Chesterfield Towne Center, Richmond, VA, Inc. Kirkland's of Park Plaza Mall, Little Rock, AR, Inc. Kirkland's of Montgomery Mall, Montgomery, AL, Inc. Kirkland's of Southlake Mall, Atlanta, GA, Inc. Kirkland's of Southpark Mall, Richmond, VA, Inc. Kirkland's of Eastland Mall, Evansville, IN, Inc. Kirkland's of Fayette Mall, Lexington, KY, Inc. Kirkland's of Hickory Ridge Mall, Memphis, TN, Inc. Kirkland's of Regency Square Mall, Jacksonville, FL, Inc. Kirkland's of McCain Mall, Little Rock, AR, Inc. Kirkland's of River Ridge Mall, Lynchburg, VA, Inc. Kirkland's of Bel Air Mall, Mobile, AL, Inc. Kirkland's of The Mall at Barnes Crossing, Tupelo, MS, Inc. Kirkland's of Cortana Mall, Baton Rouge, LA, Inc. Kirkland's of Bellevue Center, Nashville, TN, Inc. Kirkland's of Tri-County Mall, Cincinnati, OH, Inc. Kirkland's of The Mall of the Avenues, Jacksonville, FL, Inc. Kirkland's of Eastwood Mall, Birmingham, AL, Inc. -4- 5 Kirkland's of Lakeside Mall, New Orleans, LA, Inc. Kirkland's of Carolina Place, Charlotte, N.C., Inc. Kirkland's of Cary Village Mall, Raleigh, N.C., Inc. Kirkland's of Cool Springs Galleria, Nashville, TN, Inc. Kirkland's of Kenwood Towne Centre, Cincinnati, OH, Inc. Kirkland's of St. Louis Galleria, St. Louis, MO, Inc. Kirkland's of Wiregrass Commons Mall, Dothan, AL, Inc. Kirkland's of Regency Mall, Richmond, VA, Inc. Kirkland's of Florence Mall, Florence, KY, Inc. Kirkland's of Acadiana Mall, Lafayette, LA., Inc. Kirkland's of Padre Staples Mall, Corpus Christi, TX, Inc. Kirkland's of Belden Village, Canton, OH, Inc. Kirkland's of West Oaks Mall, Houston, TX, Inc. Kirkland's of Charleston Town Center, Charleston, W. VA, Inc. Kirkland's of Crestwood Plaza, St. Louis, MO, Inc. Kirkland's of White Marsh Mall, Baltimore, MD, Inc. Kirkland's of Collin Creek Mall, Dallas, TX, Inc. Kirkland's of Baybrook Mall, Houston, TX, Inc. Kirkland's of Governor's Square Mall, Tallahassee, FL, Inc. Kirkland's of Barton Creek Mall, Austin, TX, Inc. Kirkland's of Highland Mall, Austin, TX, Inc. Kirkland's of Battlefield Mall, Springfield, MO, Inc. Kirkland's of Penn Square Mall, Oklahoma City, OK, Inc. Kirkland's of Oak Park Mall, Kansas City, KS, Inc. Kirkland's of Mall St. Vincent, Shreveport, LA, Inc. Kirkland's of Owings Mills Mall, Baltimore, MD, Inc. Kirkland's of Oakwood Center, New Orleans, LA, Inc. Kirkland's of The Mall at Johnson City, Johnson City, TN, Inc. Kirkland's of Glenbrook Mall, Ft. Wayne, IN, Inc. Kirkland's of North Pointe Mall, Atlanta, GA, Inc. Kirkland's of Northpark Mall, Joplin, MO, Inc. Kirkland's of Orlando Fashion Square, Orlando, FL, Inc. Kirkland's of The Mall at Fairfield Commons, Dayton, OH, Inc. Kirkland's of St. Charles Towne Center, Waldorf, MD, Inc. Kirkland's of Regency Mall, Florence, AL, Inc. Kirkland's of South Plains Mall, Lubbock, TX, Inc. Kirkland's of The Parks at Arlington, Ft. Worth, TX, Inc. Kirkland's of Parma Town Mall, Cleveland, OH, Inc. Kirkland's of St. Clair Square, St. Louis, MO, Inc. Kirkland's of Turtle Creek Mall, Hattiesburg, MS, Inc. Kirkland's of The Woodlands, Houston, TX, Inc. Kirkland's of Brandon Town Center, Tampa, FL, Inc. Kirkland's of Memorial City Mall, Houston, TX, Inc. Kirkland's of University Mall, Tuscaloosa, AL, Inc. Kirkland's of Santa Rosa Mall, Fort Walton, FL, Inc. Kirkland's of Panama City Mall, Panama City, FL, Inc. Kirkland's of Town East Mall, Mesquite, TX, Inc. Kirkland's of Kentucky Oaks Mall, Paducah, Ky, Inc. Kirkland's of Crabtree Valley Mall, Raleigh, N.C., Inc. Kirkland's of Oak Hollow Mall, Highpoint, N. C., Inc. -5- 6 Kirkland's of Fox Valley Mall, Chicago, IL, Inc. Kirkland's of Hawthorne Mall, Chicago, IL, Inc. Kirkland's of Stratford Square, Chicago, IL, Inc. Kirkland's of Orland Square, Chicago, IL, Inc. Kirkland's of Coastland Mall, Naples, FL, Inc. Kirkland's of Carolina, Inc. Kirkland's of Charlotte, Eastland Mall, Inc. Kirkland's of Tennessee, Inc. K. C. Corp., Inc. Kirkland's of Greensboro, Four Seasons Mall, Inc. Kirkland's of Fayetteville, Cross Creek Mall, Inc. Kirkland's of Wilmington, Independence Mall, Inc. Kirkland's III, Jackson-Metro Center, Inc. Kirkland's of Memphis, Tennessee, Laurelwood Shopping Center, Inc. Kirkland's of Ridgeland, Mississippi, Northpark Mall, Inc. Kirkland's of Knoxville, East Towne Mall, Inc. Kirkland's of Huntsville, Madison Square Mall, Inc. Kirkland's of Valley View Mall, Roanoke, VA, Inc. Kirkland's of Nashville, Hickory Hollow Mall, Inc. Kirkland's of Birmingham, Riverchase Galleria, Inc. Kirkland's of Briar Cliffe Mall, Myrtle Beach, South Carolina, Inc. Kirkland's of Rivergate Mall, Nashville, TN, Inc. Kirkland's of Edgewater Mall, Biloxi, MS, Inc. Kirkland's of Town Center Plaza, Kansas City, KS, Inc. Kirkland's of Castleton Square, Indianapolis, IN., Inc. Kirkland's of Cordova Mall, Pensacola, FL, Inc. Kirkland's of University Park, South Bend, IN, Inc. Kirkland's of Westgate Mall, Spartanburg, SC, Inc. Kirkland's of Westgate mall, Amarillo, TX, Inc. Kirkland's of Meridian Mall, Lansing, MI, Inc. Kirkland's of Cottonwood Mall, Albuquerque, NM, Inc. Kirkland's of University Mall, Tampa, FL, Inc. Kirkland's of Northwest Arkansas Mall, Fayetteville, AR, Inc. Kirkland's of Indian River Mall, Vero Beach, FL, Inc. Kirkland's of Tyrone Square, St. Petersburg, FL, Inc. Kirkland's of Northgate Mall, Cincinnati, OH, Inc. Kirkland's of West Oaks Mall, Orlando, FL, Inc. Kirkland's of Park City Center, Lancaster, PA, Inc. Kirkland's of Northpark Mall, Davenport, IA, Inc. Kirkland's of Perimeter Mall, Atlanta, GA, Inc. Kirkland's of Wolfchase Galleria, Memphis, TN, Inc. Kirkland's of Lindale Mall, Cedar Rapids, IA, Inc. Kirkland's of Coronado Mall, Albuquerque, NM, Inc. Kirkland's of Willowbrook Mall, Houston, TX, Inc. -6- 7 Exhibit A Shares of Stock
Corporation Shares Class of Stock Certificate ----------- ------ -------------- ----------- Group A and B 7,250 Common 4 Companies (Voting) 650 Common 1 (Non-Voting) 7,900 Class B 3 Preferred 2,878 Class C 3 Preferred Group C 7,900 Common 1 Companies (Non-Voting) 3,000 Class B 3 Preferred (Voting) 4,900 Class B 1 Preferred (Non-Voting) Group D 7,900 Common 4 Companies (Voting) 7,900 Class B 3 Preferred Group E 79 Common 4 Companies
The listing of Group A, B, C, D, and E Companies begins on the next page (A-2). A-1 EX-23.1 22 CONSENT OF PRICE WATERHOUSE LLP 1 Exhibit 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the use in the Prospectus constituting part of this Registration Statement on Form S-1 of our report dated February 13, 1998 (except for Note 8 which is as of April 27, 1998) relating to the combined financial statements of Kirkland's, Inc. and Affiliates, which appears in such Prospectus. We also consent to the references to us under the headings "Experts" and "Selected Combined Financial Data" in such Prospectus. However, it should be noted that Price Waterhouse LLP has not prepared or certified such "Selected Combined Financial Data." PRICE WATERHOUSE LLP Memphis, Tennessee April 28, 1998 EX-23.2 23 CONSENT OF KPMG PEAT MARWICK LLP 1 Exhibit 23.2 INDEPENDENT AUDITORS' CONSENT The Board of Directors Kirkland's Inc., and Affiliates: We consent to the use of our report included herein and to the reference to our firm under the headings "Experts" and "Selected Combined Financial Data" in the Prospectus. KPMG Peat Marwick LLP Memphis, Tennessee April 28, 1998 EX-27.1 24 FINANCIAL DATA SCHEDULE WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
5 1,000 YEAR DEC-31-1995 JAN-01-1995 DEC-31-1995 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 112,035 112,035 68,835 68,835 40,097 0 1,415 1,688 0 1,688 0 0 0 1,688 16,880 16,880
EX-27.2 25 FINANCIAL DATA SCHEDULE WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
5 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1 11,228 0 0 0 16,985 29,587 25,211 14,598 45,636 12,414 89,041 46,836 0 235 (102,890) 45,636 127,946 127,946 80,438 80,438 31,958 0 6,294 9,256 2,693 6,563 0 0 0 6,563 76.18 67.47
EX-27.3 26 FINANCIAL DATA SCHEDULE WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
5 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1 10,881 0 0 0 20,036 32,518 29,303 16,408 49,884 16,726 85,055 50,591 0 210 (102,698) 49,884 153,584 153,584 96,998 96,998 39,668 0 10,179 6,739 2,817 3,922 0 0 0 3,922 1.67 1.35
EX-27.4 27 FINANCIAL DATA SCHEDULE WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
5 1,000 3-MOS DEC-31-1997 JAN-01-1997 MAR-31-1997 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 26,178 26,178 18,619 18,619 8,338 0 2,508 (3,287) (923) (2,364) 0 0 0 (2,364) (33.03) (33.03)
EX-27.5 28 FINANCIAL DATA SCHEDULE WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
5 1,000 3-MOS DEC-31-1998 JAN-01-1998 MAR-31-1998 1 2,177 0 0 0 22,546 27,483 30,206 17,312 44,596 13,690 88,973 47,584 0 203 (105,854) 44,596 30,615 30,615 21,110 21,110 10,268 0 2,315 (3,078) (920) (2,158) 0 0 0 (2,158) (34.04) (34.04)
-----END PRIVACY-ENHANCED MESSAGE-----