-----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, E9cjTpagCnU07172Jj2N/VfNqk8jCbEOtbGYLxq1lS7sl4kNpe487tED9Ewx02Q6 g9wVrvBw27N+Ac6KOzdWLQ== 0000950144-02-004217.txt : 20020423 0000950144-02-004217.hdr.sgml : 20020423 ACCESSION NUMBER: 0000950144-02-004217 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 20 FILED AS OF DATE: 20020423 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KIRKLANDS INC CENTRAL INDEX KEY: 0001056285 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-RETAIL STORES, NEC [5990] IRS NUMBER: 621287151 FILING VALUES: FORM TYPE: S-1 SEC ACT: 1933 Act SEC FILE NUMBER: 333-86746 FILM NUMBER: 02617741 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 g75423s-1.txt KIRKLAND'S INC. AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 23, 2002 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 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 (Primary Standard Industrial (I.R.S. Employer of incorporation or organization) Classification Code Number) Identification No.)
--------------------- 805 N. PARKWAY JACKSON, TENNESSEE 38305 (731) 668-2444 (Address, including zip code, and telephone number, including area code, of Registrant's principal executive offices) --------------------- ROBERT E. ALDERSON PRESIDENT AND CHIEF EXECUTIVE OFFICER 805 N. PARKWAY JACKSON, TENNESSEE 38305 (731) 668-2444 (Name, address, including zip code, and telephone number, including area code, or agent for service) --------------------- COPIES TO: BARRY M. ABELSON, ESQ. VALERIE FORD JACOB, ESQ. ROBERT A. FRIEDEL, ESQ. FRIED, FRANK, HARRIS, SHRIVER & JACOBSON PEPPER HAMILTON LLP ONE NEW YORK PLAZA 3000 TWO LOGAN SQUARE NEW YORK, NY 10004 18TH AND ARCH STREETS (212) 859-8000 PHILADELPHIA, PA 19103-2799 (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 of 1933, 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 of 1933, 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
- ------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------- TITLE OF EACH CLASS OF PROPOSED MAXIMUM AMOUNT OF SECURITIES TO BE REGISTERED AGGREGATE OFFERING PRICE(1) REGISTRATION FEE(2) - ------------------------------------------------------------------------------------------------------------- Common stock, no par value.................................. $143,750,000 $13,225 - ------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------
(1) Estimated solely for purposes of determining the registration fee in accordance with Rule 457(o) under the Securities Act of 1933. Includes shares that the underwriters will have the right to purchase to cover overallotments, if any. (2) The Registrant previously paid a fee to the Commission of $18,658.75 in connection with the filing of its Registration Statement on Form S-1 (No. 333-51517), initially filed on May 1, 1998. That Registration Statement was withdrawn on October 12, 1999. Pursuant to Rule 457(p), $13,225 of the filing fee previously paid by the Registrant is to be offset against the currently due registration fee. ---------------------- 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. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. SUBJECT TO COMPLETION PRELIMINARY PROSPECTUS DATED APRIL 23, 2002 PROSPECTUS SHARES KIRLAND'S, INC. LOGO COMMON STOCK ---------------------- This is Kirkland's, Inc.'s initial public offering. We are selling shares and the selling shareholders are selling shares. The underwriters are offering all of the shares in the U.S. and Canada. We expect the public offering price to be between $ and $ per share. Currently, no public market exists for the shares. After pricing of the offering, we expect that the shares will be quoted on the Nasdaq National Market under the symbol "KIRK." INVESTING IN THE COMMON STOCK INVOLVES RISKS THAT ARE DESCRIBED IN THE "RISK FACTORS" SECTION BEGINNING ON PAGE 9 OF THIS PROSPECTUS. ----------------------
PER SHARE TOTAL --------- ----- Public offering price....................................... $ $ Underwriting discount....................................... $ $ Proceeds, before expenses, to Kirkland's, Inc............... $ $ Proceeds, before expenses, to the selling shareholders...... $ $
Approximately $ million of Kirkland's net proceeds from this offering will be used to redeem shares of preferred stock held by affiliates of Kirkland's. See the "Use of Proceeds" section beginning on page 19 of this prospectus. The underwriters may also purchase up to an additional shares from the selling shareholders at the public offering price, less the underwriting discount, within 30 days from the date of this prospectus to cover overallotments. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. The shares will be ready for delivery on or about , 2002. ---------------------- MERRILL LYNCH & CO. CIBC WORLD MARKETS SUNTRUST ROBINSON HUMPHREY U.S. BANCORP PIPER JAFFRAY ---------------------- The date of this prospectus is , 2002. KIRKLAND'S, INC. STORE LOCATIONS [A map of the United States indicating the number of stores in each state] TABLE OF CONTENTS
PAGE ---- Prospectus Summary.......................................... 1 Risk Factors................................................ 9 Disclosure Regarding Forward-Looking Statements............. 18 About This Prospectus....................................... 18 Use of Proceeds............................................. 19 Dividend Policy............................................. 20 Dilution.................................................... 21 Capitalization.............................................. 23 Selected Consolidated Financial Data........................ 24 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 27 Business.................................................... 39 Management.................................................. 51 Certain Transactions........................................ 63 Principal and Selling Shareholders.......................... 68 Description of Capital Stock................................ 72 Shares Eligible for Future Sale............................. 77 United States Tax Consequences to Non-United States Holders................................................... 79 Underwriting................................................ 83 Legal Matters............................................... 86 Experts..................................................... 86 Where You Can Find More Information......................... 87 Index to Financial Statements............................... F-1 Unaudited Pro Forma Consolidated Condensed Financial Statements................................................ P-1
---------------------- You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized any other person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer and sale is not permitted. You should assume that the information appearing in this prospectus is accurate only as of the date on the front cover of this prospectus. Our business, financial condition, results of operations and prospects may have changed since that date. i PROSPECTUS SUMMARY The following summary highlights information contained elsewhere in this prospectus. We urge you to read this entire prospectus carefully, including the "risk factors" section. In this prospectus, "Kirkland's," "we," "our" and "us" refer to Kirkland's, Inc. and its subsidiaries, unless the context requires otherwise. On January 1, 2001, we changed our fiscal reporting year from a calendar year to a 52/53-week basis ending on the Saturday closest to January 31. As used herein, the term "fiscal 2001" refers to the 52 weeks ended February 2, 2002 and any reference to any fiscal year prior to fiscal 2001 refers to the 12 months ended December 31 of that fiscal year. Adjusted EBITDA is defined in "Summary Consolidated Financial and Other Data." KIRKLAND'S We are a leading specialty retailer of home decor in the United States, operating 236 stores in 28 states. Our stores present a broad selection of distinctive merchandise, including framed art, mirrors, candles, lamps, picture frames, accent rugs, garden accessories and artificial floral products. Our stores also offer an extensive assortment of holiday merchandise, as well as items carried throughout the year suitable for giving as gifts. In addition, we use innovative design and packaging to market home decor items as gifts. We provide our predominantly female customers an engaging shopping experience characterized by a diverse, ever-changing merchandise selection at surprisingly attractive prices. Our stores offer a unique combination of style and value that has led to our emergence as a leader in home decor and has enabled us to develop a strong customer franchise. As a result, we have achieved substantial growth over the last five fiscal years. Since the beginning of 1997, our sales have grown at a compounded annual growth rate of 19%. For the fiscal year ended February 2, 2002, we recorded net sales of $307.2 million and Adjusted EBITDA of $35.5 million, or 11.6% of net sales. Kirkland's was co-founded in 1966 by our current Chairman, Carl Kirkland. We opened our first store in Jackson, Tennessee and have grown steadily thereafter. Although originally focused in enclosed malls in the Southeast, we have expanded beyond that region and also have begun to open stores in selected non-mall venues. Currently, over 40% of our stores are located outside the Southeast, including 60 of the 100 new stores opened since the beginning of fiscal 1997. We currently operate in major metropolitan markets like Houston, Texas and Atlanta, Georgia, middle markets such as Birmingham, Alabama and Buffalo, New York and smaller markets such as Appleton, Wisconsin and Panama City, Florida. As we more than doubled our store base from 104 stores at the end of fiscal 1995 to 226 stores at the end of fiscal 1999, we realized the need to strengthen our infrastructure and enhance several aspects of our operations in order to execute a rapid national expansion. Beginning in late 1999, we undertook a series of initiatives that enabled us to make faster and smarter inventory buying and distribution decisions, to manage the flow of merchandise to our stores more efficiently and to improve overall financial performance. These initiatives included: COMPLETING KEY INVESTMENTS IN INFORMATION TECHNOLOGY. Since late 1999, we have invested $6.5 million in several key information systems projects that provide our decision makers with better tools to increase sales, improve operational efficiency, control and distribute inventory and monitor critical performance indicators on a daily basis. DEVELOPING A MORE SCALABLE DISTRIBUTION INFRASTRUCTURE. In March 2001, we consolidated our central distribution operations into one 303,000-square-foot, leased facility in Jackson, Tennessee, which allowed us to increase our dollar volume of centrally distributed merchandise by 24% from fiscal 2000 to fiscal 2001. This modern facility, together with other improvements to our supply chain, has helped us to keep our stores stocked with fresh merchandise and to reduce significantly the cost of managing inventories at the store level. STRENGTHENING EXECUTIVE MANAGEMENT. Since the second half of 1999, we have added six senior managers, including key hires in merchandising, store operations and information technology. These 1 additions, along with several other key hires and promotions, have broadened the abilities of our management team and have provided leadership to key areas of our business. We believe our management team has valuable experience both from Kirkland's and from other national retailers. IMPROVING STORE-LEVEL OPERATING PERFORMANCE. In January 2001, we instituted a plan to improve sales, increase cash flow and return our stores to higher levels of profitability. The cornerstone of this plan was to reduce store-level inventories and improve inventory turnover. We also intensified our efforts to control and lower store operating expenses and close under-performing stores. We believe the convergence of these operational initiatives led to the significant improvement in our fiscal 2001 operating results as compared to fiscal 2000. For fiscal 2001, our comparable store net sales increased 13.3% over the 53-week period ended February 3, 2001 and our Adjusted EBITDA margin expanded to 11.6% from 7.5% in fiscal 2000. Net cash provided by operating activities increased to $37.5 million as compared to $1.3 million in fiscal 2000, and inventory turnover in fiscal 2001 increased to 3.48x as compared to 2.45x in fiscal 2000. As evidenced by the improvement in our operating results, we believe these initiatives have positioned us to expand our proven retail concept and strengthen our position as a leading specialty retailer of home decor in the United States. KEY OPERATING STRENGTHS Our goal is to be the leading specialty retailer of home decor in each of our markets. We believe the following elements of our business strategy differentiate us from our competitors and position us for profitable growth: ITEM-FOCUSED MERCHANDISING. While our stores contain items covering a broad range of complementary product categories, we emphasize key items within our targeted categories rather than merchandising complete product classifications. Although we do not attempt to be a fashion leader, our experienced buyers work closely with our vendors to identify and develop stylish merchandise reflecting the latest trends. We estimate that over 60% of our merchandise is designed or packaged exclusively for Kirkland's, which distinguishes us in the marketplace and enhances our margins. EVER-CHANGING MERCHANDISE MIX. We believe our ever-changing merchandise mix of over 5,000 stock keeping units, or "SKUs," creates an exciting "treasure hunt" environment, encouraging strong customer loyalty and frequent return visits to our stores. The merchandise in our stores typically is traditionally styled for broad market appeal, yet it reflects an understanding of our customer's desire for newness and freshness. STIMULATING VISUAL PRESENTATION. Our stores have a distinctive, "interior design" look that helps customers visualize the merchandise in their own homes and inspires decorating and gift-giving ideas. Using multiple merchandise arrangements to simulate home settings, we group complementary merchandise creatively throughout the store, rather than displaying products strictly by category or product type. We believe this cross-category merchandising strategy encourages customers to browse for longer periods of time, promoting add-on sales. STRONG VALUE PROPOSITION. Our customers regularly experience the satisfaction of paying noticeably less for items similar or identical to those sold by other retail stores or through catalogs. This strategy of providing a unique combination of style and value is an important element in making Kirkland's a destination store. While we carry items in our stores that sell for several hundred dollars, most items sell for under $50 and are perceived by our customers as affordable luxuries. FLEXIBLE APPROACH TO REAL ESTATE. Our stores operate successfully across a wide spectrum of different regions, market sizes and real estate venues. The flexibility of our concept enables us to select the most promising real estate opportunities that meet requisite economic and demographic criteria within our target markets. 2 GROWTH STRATEGY Key elements of our growth strategy are outlined below: OPENING NEW STORES USING OUR PROVEN STORE MODEL. Over the past five years, we have more than doubled our store base, principally through new store openings. We intend to continue opening new stores both in existing and new markets. We believe there are currently more than 800 additional locations in the United States that could support a Kirkland's store. We expect to open approximately 15 new stores during fiscal 2002 and approximately 35 new stores during fiscal 2003. We believe our proven store model produces strong store-level cash flow and provides an attractive store-level return on investment. In fiscal 2001, our average store generated net sales of approximately $1.3 million and store-level EBITDA of approximately $227,000, or 17.4% of net sales. The average first full year cash return on investment for the 93 stores opened from 1997 through 2000 was approximately 47%. INCREASING STORE PRODUCTIVITY. We plan to increase our sales per square foot and store profitability by leveraging our recent investments in information systems and central distribution, which together contributed to our 18.5% increase in net sales and our 15.1% increase in average net sales per square foot in fiscal 2001. We also believe that our store productivity will benefit from our strong customer franchise, our continuing efforts to enhance the Kirkland's brand, and favorable consumer and demographic trends. ---------------------- We are incorporated in Tennessee, our principal executive offices are located at 805 N. Parkway, Jackson, Tennessee 38305, and our telephone number is (731) 668-2444. Our Internet web site address is www.kirklands.com. The information contained or incorporated in our web site is not a part of this prospectus. 3 THE OFFERING Common stock offered: By us.......................... By the selling shareholders.... Total....................... Shares outstanding after the offering......................... Use of proceeds.................. We estimate that our net proceeds from this offering will be approximately $ million. We intend to use these net proceeds to: - repay certain indebtedness, including all of our outstanding subordinated debt and mandatorily redeemable Class C Preferred Stock and a portion of our new revolving credit facility; and - redeem a portion of the outstanding shares of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock. We will not receive any proceeds from the sale of shares of common stock by the selling shareholders. Risk factors..................... See "Risk Factors" and other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in shares of the common stock. Proposed Nasdaq symbol........... "KIRK" The number of shares outstanding after the offering is based on an assumed initial public offering price of $ per share. The number of shares of common stock to be issued to existing shareholders upon conversion of their preferred stock will be determined by reference to the actual initial public offering price. See "Certain Transactions - Pre-Offering Transactions." The number of shares outstanding after the offering excludes an aggregate of shares of common stock reserved for issuance under our 1996 Executive Incentive and Non-Qualified Stock Option Plan, 2002 Incentive Plan and Employee Stock Purchase Plan. Options to purchase 15,570 shares of common stock will be outstanding under our 1996 Executive Incentive and Non-Qualified Stock Option Plan upon completion of this offering, of which options to purchase 6,370 shares will be exercisable upon completion of this offering. Unless the context otherwise requires, all information in this prospectus (i) gives retroactive effect to a -for-one stock split of the common stock which will occur immediately prior to the completion of this offering, and (ii) assumes that this offering is consummated at an initial public offering price of $ per share (the midpoint of the range on the front cover of this prospectus) on , 2002. See "Use of Proceeds" and "Certain Transactions - Pre-Offering Transactions." 4 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) an amendment and restatement of our charter, which will provide for an authorized capitalization of 100 million shares of common stock and 10 million shares of preferred stock, (iii) the exercise of all of our outstanding warrants and the resulting purchase of an aggregate of 38,124 shares of common stock at an exercise price of $0.01 per share and (iv) the conversion of $ million of the aggregate stated value and accrued dividends of the outstanding shares of our Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock into shares of common stock. The number of shares of common stock to be issued with respect to the preferred stock will equal the aggregate stated value of $ million plus accrued dividends on the preferred stock to be converted, divided by the actual initial public offering price. Assuming an initial public offering price of $ (the midpoint of the range on the front cover of this prospectus) and a consummation of this offering on , shares of common stock will be issued to existing shareholders for their preferred stock. 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 SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA The following summary consolidated financial data for the fiscal years ended December 31, 1997, 1998, 1999 and 2000 and as of and for the fiscal year ended February 2, 2002 presented below under the captions "Statement of Operations Data," "Other Financial Data" and "Balance Sheet Data" have been derived from our audited consolidated financial statements as of those dates and for those periods. The following summary consolidated financial data for the fiscal years ended December 31, 1997, 1998, 1999 and 2000 and the fiscal year ended February 2, 2002 presented below under the caption "Store Data" have been derived from internal records of our operations. You should read the information set forth below in conjunction with other sections of this prospectus, including "Selected Consolidated Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and related notes.
YEAR ENDED DECEMBER 31, YEAR ENDED ----------------------------------------- FEBRUARY 2, 1997 1998 1999 2000 2002(1) -------- -------- -------- -------- ----------- (IN THOUSANDS, EXCEPT SHARE, PER SHARE AND STORE DATA) STATEMENT OF OPERATIONS DATA: Net sales........................................ $153,584 $192,250 $236,622 $259,240 $307,213 Gross profit..................................... 56,586 70,314 82,344 86,864 107,150 Non-cash stock compensation charge(2)............ -- -- -- -- 712 Depreciation and amortization.................... 4,142 5,410 7,276 7,827 7,678 Operating income................................. 16,684 19,084 17,174 11,636 27,138 Interest expense: Senior, subordinated and other notes payable... 7,990 9,254 10,232 11,221 9,759 Class C Preferred Stock........................ 1,800 1,541 1,647 1,850 2,007 Accretion of common stock warrants(3).......... 389 -- (879) -- 7,759 Net income (loss)................................ 3,922 6,427 4,639 (1,315) 4,298 PRO FORMA DATA: Pro forma as adjusted net income(4).............. $ ----------- Pro forma as adjusted earnings per common share(4)....................................... $ =========== Pro forma as adjusted shares outstanding(4)...... =========== OTHER FINANCIAL DATA: Gross profit margin(5)........................... 36.8% 36.6% 34.8% 33.5% 34.9% Adjusted EBITDA(6)............................... $ 20,826 $ 24,494 $ 24,450 $ 19,463 $ 35,528 Adjusted EBITDA margin(7)........................ 13.6% 12.7% 10.3% 7.5% 11.6% Net cash provided by operating activities........ $ 8,669 $ 4,326 $ 12,945 $ 1,336 $ 37,530 Net cash (used in) investing activities.......... (5,479) (14,669) (10,825) (5,981) (4,744) Net cash (used in) provided by financing activities..................................... (3,537) 13,658 (3,370) 19,855 (29,949) STORE DATA: Comparable store net sales increase(8)........... 5.2% 1.0% 3.7% 0.6% 13.3% Number of stores at the end of period(9)......... 138 198 226 240 234 Average net sales per store (in thousands)(10)... $ 1,178 $ 1,169 $ 1,111 $ 1,112 $ 1,307 Average gross square footage per store(11)....... 4,186 4,392 4,364 4,437 4,528 Average net sales per square foot(10)(11)........ $ 281 $ 266 $ 255 $ 251 $ 289
6
AS OF FEBRUARY 2, 2002 ------------------------------------------- PRO FORMA ACTUAL PRO FORMA(12) AS ADJUSTED(13) --------- ------------- --------------- (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents................................... $ 29,751 $ $ Working capital(14)......................................... 1,020 Total assets................................................ 95,818 Total debt, including mandatorily redeemable preferred stock (Class C)................................................. 75,239 Common stock warrants....................................... 7,759 Redeemable convertible preferred stock (Class A, Class B, and Class D)(15).......................................... 86,812 Common stock................................................ 229 Accumulated (deficit) equity(16)............................ (111,439)
- ------------------------------ (1) Effective January 1, 2001, we changed our fiscal reporting year from a calendar year to a 52/53-week basis ending on the Saturday closest to January 31. Our 2001 fiscal year began on February 4, 2001 and ended on February 2, 2002. (2) Reflects a non-cash stock compensation charge related to certain outstanding stock options. (3) Reflects the accretion to fair value of detachable put warrants to purchase common stock, issued by us in connection with our issuance of subordinated debt. The put rights associated with these warrants were terminated as of January 1, 1998, were restored as of December 31, 1999, and were terminated again as of February 3, 2002. (4) Assumes the following transactions were effected as of February 4, 2001: (i) the Pre-Offering Transactions, (ii) the termination of the put rights associated with the put warrants discussed in note (3) above, (iii) the refinancing of our existing senior credit facility with a new senior credit facility, as discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" and (iv) the sale by us of shares in this offering at an assumed initial public offering price of $ per share and the application of the estimated net proceeds from the sale after deducting estimated offering expenses and underwriting discounts and commissions. Pro forma as adjusted net income and pro forma as adjusted earnings per common share exclude the $0.7 million non-cash stock compensation charge in fiscal 2001 related to certain outstanding stock options. (5) Defined as gross profit as a percentage of net sales. Gross profit represents net sales less cost of product sold, freight, store occupancy and central distribution expenses. (6) The term Adjusted EBITDA as used herein represents operating income before depreciation and amortization expense and a non-cash stock compensation charge related to certain outstanding stock options. While Adjusted 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, Adjusted EBITDA has been presented because we believe 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 our ability to meet our future debt service, capital expenditure and working capital requirements. Adjusted EBITDA may differ in method of calculation from similarly titled measures used by other companies. This information should be read in conjunction with our consolidated statements of cash flows contained in our consolidated financial statements and notes thereto included elsewhere in this prospectus. (7) Defined as Adjusted EBITDA as a percentage of net sales. (8) We include new stores in comparable store net sales calculations after the store has been in operation one full fiscal year. We exclude from comparable store net sales calculations each store that was expanded, remodeled or relocated during the applicable period. Each expanded, remodeled or relocated store is returned to the comparable store base after it has been excluded from the comparable store base for one full fiscal year. The comparable store net sales increase for fiscal 2001 reflects the increase in comparable store net sales for the 52-week period ended February 2, 2002 compared to the 53-week period ended February 3, 2001. 7 (9) Our store count excludes our warehouse outlet store located adjacent to our central distribution facility in Jackson, Tennessee. (10) Calculated using net sales of all stores open at both the beginning and the end of the period. (11) 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. (12) Assumes the following transactions were effected as of February 2, 2002: (i) the Pre-Offering Transactions and (ii) the refinancing of our existing senior credit facility with a new senior credit facility, as discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." (13) Gives effect to the transactions described in note (12) as well as the sale by us of shares in this offering at an assumed initial public offering price of $ per share and the application of the estimated net proceeds from the sale after deducting estimated offering expenses and underwriting discounts and commissions. (14) Defined as current assets excluding cash and cash equivalents, less current liabilities excluding current maturities of long-term debt. (15) As of February 2, 2002, the liquidation value of our Class A, Class B and Class D Preferred Stock including $26.9 million of accrued dividends, was $88.4 million. The book value of this preferred stock has been adjusted from the liquidation value in connection with the reduction of the dividend rate on a portion of our Class B Preferred Stock. See Note 6 of the Notes to our consolidated financial statements. (16) In connection with our 1996 recapitalization, distributions of cash and securities to our pre-recapitalization shareholders were recorded as reductions in retained earnings, creating an accumulated deficit balance of $116 million at June 13, 1996. See "Certain Transactions - Recapitalization." 8 RISK FACTORS You should consider carefully the risks and uncertainties described below and other information included in this prospectus before you decide to buy our common stock. If any of the risks described below occur, our business, financial condition or results of operations could be adversely affected in a material way. This could cause the value of our common stock to decline, perhaps significantly, and you may lose all or part of your investment. RISKS RELATED TO OUR BUSINESS IF WE ARE UNABLE TO PROFITABLY OPEN AND OPERATE NEW STORES AND MAINTAIN THE PROFITABILITY OF OUR EXISTING STORES, OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS MAY BE HARMED. One of our strategies is to open new stores by focusing on both existing markets and by targeting new geographic markets. We have opened 100 new stores since the beginning of fiscal 1997. We intend to open approximately 15 new stores in fiscal 2002 and approximately 35 new stores in fiscal 2003, and our future operating results will depend to a substantial extent upon our ability to open and operate new stores successfully. To date we have signed leases for five new stores in fiscal 2002, two of which have already opened. We have not yet identified sites or signed leases for any new stores that we intend to open in fiscal 2003. We also have an ongoing expansion, remodeling and relocation program, and intend to expand, remodel or relocate four stores in fiscal 2002. There can be no assurance that we will be able to open, expand, remodel and relocate stores at this rate, or at all. Our ability to open new stores and to expand, remodel and relocate existing stores depends on a number of factors, including our ability to: - obtain adequate capital resources for leasehold improvements, fixtures and inventory on acceptable terms, or at all; - locate and obtain favorable store sites and negotiate acceptable lease terms; - construct or refurbish store sites; - obtain and distribute adequate product supplies to our stores; - maintain adequate warehousing and distribution capability at acceptable costs; - hire, train and retain skilled managers and personnel; and - continue to upgrade our information and other operating systems to control the anticipated growth and expanded operations. The rate of our expansion will also depend on the availability of adequate capital, which in turn will depend in large part on cash flow generated by our business and the availability of equity and debt capital. There can be no assurance that we will be able to obtain equity or debt capital on acceptable terms or at all. Moreover, our new senior credit facility will contain provisions that restrict the amount of debt we may incur in the future. In addition, the cost of opening, expanding, remodeling and relocating new or existing stores may increase in the future compared to historical costs. The increased cost could be material. If we are not successful in obtaining sufficient capital, we may be unable to open additional stores or expand, remodel and relocate existing stores as planned, which may adversely affect our results of operations. As a result, there can be no assurances that we will be able to achieve our current plans for the opening of new stores and the expansion, remodeling or relocation of existing stores. There also can be no assurance that our existing stores will maintain their current levels of sales and profitability or that new stores will generate sales levels necessary to achieve store-level profitability, much less profitability comparable to that of existing stores. New stores that we open in our existing markets may draw customers from our existing stores and may have lower sales growth relative to stores opened in new markets. New stores also may face greater competition and have lower anticipated sales 9 volumes relative to previously opened stores during their comparable years of operations. New stores opened in new markets, where we are less familiar with the target customer and less well known, may face different or additional risks and increased costs compared to stores operated in existing markets. Also, stores opened in non-mall locations may require greater marketing costs in order to attract customer traffic. These factors, together with increased pre-opening expenses at our new stores, may reduce our average store contribution and operating margins. If we are unable to profitably open and operate new stores and maintain the profitability of our existing stores, our business, financial condition and results of operations may be harmed. The success of our growth plan will be dependent on our ability to promote and/or recruit enough qualified district managers, store managers and sales associates to support the expected growth in the number of our stores, and the time and effort required to train and supervise a large number of new managers and associates may divert resources from our existing stores and adversely affect our operating and financial performance. Our operating results would also be adversely affected by any increase in the minimum wage or other factors that required increases in the compensation paid to our employees. THE AGREEMENTS GOVERNING OUR DEBT IMPOSE RESTRICTIONS ON OUR BUSINESS. We expect to enter into a new senior credit facility in May 2002. This new senior credit facility will contain a number of covenants imposing significant restrictions on our business. These restrictions may affect our ability to operate our business and consummate our business strategy and growth strategy, and may limit our ability to take advantage of potential business opportunities as they arise. These covenants place restrictions on our ability to, among other things: - incur additional indebtedness; - create liens; - pay dividends or make other distributions; - make investments; - sell assets; - make capital expenditures; and - enter into certain mergers and consolidations. The new credit facility is expected to have two financial covenants. One covenant will require us to maintain cash flow, net of capital expenditures, at specified levels. The other covenant will require us to keep our senior debt within a specified ratio of our cash flow. Any failure to comply with these or other financial covenants would allow the lenders to accelerate repayment of their debt, prohibit further borrowing under the revolving portion of the credit facility, declare an event of default, take possession of their collateral, or take other actions available to a secured senior creditor. If compliance with our debt obligations materially hinders our ability to operate our business and adapt to changing industry conditions, we may lose market share, our revenue may decline and our operating results may suffer. This would have a material adverse effect on the market value and marketability of our common stock. There is no assurance that the new senior credit facility will be successfully negotiated or that the indicated terms will be obtained. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." WE MAY NOT BE ABLE TO SUCCESSFULLY ANTICIPATE CONSUMER TRENDS AND OUR FAILURE TO DO SO MAY LEAD TO LOSS OF NET SALES AND SIGNIFICANTLY HARM OUR OPERATING RESULTS. Our success depends on our ability to anticipate and respond to changing merchandise trends and consumer demands in a timely manner. If we fail to identify and respond to emerging trends, consumer 10 acceptance of the merchandise in our stores and our image with our customers may be harmed, which could materially adversely affect our results of operations. Additionally, if we misjudge market trends, we may significantly overstock unpopular products and be forced to take significant inventory markdowns, which would have a negative impact on our operating results and cash flow. Conversely, shortages of items that prove popular could have a material adverse effect on our operating results. In addition, a major shift in consumer demand away from home decor could also have a material adverse effect on our business, results of operations and financial condition. WE DEPEND ON A NUMBER OF VENDORS TO SUPPLY OUR MERCHANDISE, AND ANY DELAY IN MERCHANDISE DELIVERIES FROM CERTAIN VENDORS MAY LEAD TO A DECLINE IN INVENTORY WHICH COULD RESULT IN A LOSS OF NET SALES AND SIGNIFICANTLY HARM OUR OPERATING RESULTS. We purchase our products from approximately 200 vendors with which we have no long-term purchase commitments or exclusive contracts. None of our vendors supplied more than 13% of our merchandise purchases during the 12 months ended April 7, 2002. Historically, we have retained our vendors and we have generally not experienced difficulty in obtaining desired merchandise from vendors on acceptable terms. However, our arrangements with these vendors do not guarantee the availability of merchandise, establish guaranteed prices or provide for the continuation of particular pricing practices. Our current vendors may not continue to sell products to us on current terms or at all, and we may not be able to establish relationships with new vendors to ensure delivery of products in a timely manner or on terms acceptable to us. We may not be able to acquire desired merchandise in sufficient quantities on terms acceptable to us in the future. Also, our business would be adversely affected if there were delays in product shipments to us due to freight difficulties, strikes or other difficulties at our principal transport providers or otherwise. We have from time to time experienced delays of this nature. We are also dependent on vendors for assuring the quality of merchandise supplied to us. Our inability to acquire suitable merchandise in the future or the loss of one or more of our vendors and our failure to replace any one or more of them may have a material adverse effect on our business, results of operations and financial condition. WE ARE DEPENDENT ON FOREIGN IMPORTS FOR A SIGNIFICANT PORTION OF OUR MERCHANDISE, WHICH LEADS TO RISKS ARISING FROM POSSIBLE CHANGES IN THE TRADING RELATIONS AND CONDITIONS BETWEEN THE UNITED STATES AND THE RELEVANT FOREIGN COUNTRIES. Many of our vendors are importers of merchandise manufactured in the Far East and India. While we believe that buying from vendors instead of directly from manufacturers reduces or eliminates the risks involved with relying on products manufactured abroad, our vendors are subject to those risks, and we remain subject to those risks to the extent that their effects are passed through to us by our vendors or cause disruptions in supply. These risks include changes in import duties, quotas, loss of "most favored nation" ("MFN") trading status with the United States for a particular foreign country, work stoppages, delays in shipments, freight cost increases, economic uncertainties (including inflation, foreign government regulations, and political unrest) and trade restrictions (including the United States imposing antidumping or countervailing duty orders, safeguards, remedies or compensation and retaliation due to illegal foreign trade practices). If any of these or other factors were to cause a disruption of trade from the countries in which the suppliers of our vendors are located, our financial condition and results of operations could be materially adversely affected. We currently purchase a majority of our merchandise from importers of goods manufactured in China. China has been granted permanent normal trade relations by the United States effective January 1, 2002, based on its entry into the World Trade Organization ("WTO"), and now enjoys MFN trading status. China's recent entry into the WTO potentially stabilizes the trading relationship between it and the United States, but the possibility of trade disputes concerning merchandise currently imported from China continues to create risks. These risks could result in sanctions against China, and the imposition of new duties on certain imports from China, including products supplied to us. Any significant increase in duties 11 or any other increase in the cost of the products imported for us from China could have a material adverse effect on our results of operations and financial condition. Historically, instability in the political and economic environments of the countries in which our vendors obtain our products has not had a material adverse effect on our operations. However, we cannot predict the effect that future changes in economic or political conditions in such foreign countries may have on our operations. Although we believe that we could access alternative sources in the event of disruptions or delays in supply due to economic or political conditions in foreign countries on our vendors, such disruptions or delays may adversely affect our 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 the merchandise we currently purchase abroad. Countries from which our 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, quotas and other restrictions on imported products. This could disrupt the supply of such products to us and adversely affect our operations. The United States Congress periodically considers other restrictions on the importation of products obtained for us by vendors. The cost of such products may increase for us if applicable duties are raised, or import quotas with respect to such products are imposed or made more restrictive. We are also subject to the risk that the manufacturers abroad who ultimately manufacture our products may employ labor practices that are not consistent with acceptable practices in the United States. In any such event we could be hurt by negative publicity with respect to those practices and, in some cases, face liability for those practices. To date we have not experienced any difficulties of this nature. OUR SUCCESS IS HIGHLY DEPENDENT ON OUR PLANNING AND CONTROL PROCESSES AND OUR SUPPLY CHAIN. An important part of our efforts to achieve efficiencies, cost reductions and sales growth is the continued identification and implementation of improvements to our planning, logistical and distribution infrastructure and our supply chain, including merchandise ordering, transportation and receipt processing. We also need to ensure that our distribution infrastructure and supply chain keep pace with our anticipated growth and increased number of stores. In particular, we may need to expand our existing infrastructure to the extent we open new stores in regions of the United States where we presently do not have stores. The cost of this enhanced infrastructure could be significant. In addition, a significant portion of the distribution to our stores is coordinated through our distribution facility in Jackson, Tennessee. Any significant disruption in the operations of this facility would have a material adverse effect on our operations. WE FACE AN EXTREMELY COMPETITIVE SPECIALTY RETAIL BUSINESS MARKET. The retail market is highly competitive. We compete against a diverse group of retailers, including specialty stores, department stores, discount stores and catalog retailers, which carry merchandise in one or more categories also carried by us. Our product offerings also compete with a variety of national, regional and local retailers, including such specialty retailers as Bed, Bath & Beyond, Cost Plus, Linens 'n Things, Michaels Stores, Pier 1 Imports and Williams-Sonoma. We also compete with these and other retailers for suitable retail locations, suppliers, qualified employees and management personnel. One or more of our competitors are present in substantially all of the malls in which we have stores. Many of our competitors are larger and have significantly greater financial, marketing and other resources than we do. This competition could result in the reduction of our prices and a loss of our market share. Our sales are also impacted by store liquidations of our competitors. We believe that our 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 we will continue to be able to compete successfully against existing or future competition. Our expansion into the markets served by our competitors, and the entry of new competitors or expansion of existing competitors into our markets, may have a material adverse effect on our business, financial condition and results of operations. 12 OUR BUSINESS IS HIGHLY SEASONAL AND OUR FOURTH QUARTER CONTRIBUTES A DISPROPORTIONATE AMOUNT OF OUR OPERATING INCOME AND NET INCOME. We have experienced, and expect to continue to experience, substantial seasonal fluctuations in our 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 last quarter of our fiscal year has historically contributed, and is expected to continue to contribute, a disproportionate amount of our operating income and net income for the entire fiscal year. We expect this pattern to continue during the current fiscal year and anticipate that in subsequent fiscal years the last quarter of our fiscal year will continue to contribute disproportionately to our operating results. Any factors negatively affecting us during the last quarter of our fiscal year, including unfavorable economic conditions, could have a material adverse effect on our financial condition and results of operations, reducing our cash flow, leaving us with excess inventory and making it more difficult for us to finance our capital requirements. WE MAY EXPERIENCE SIGNIFICANT VARIATIONS IN OUR QUARTERLY RESULTS. Our quarterly results of operations may also fluctuate significantly based upon such factors as 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, the timing and level of markdowns, changes in fuel and other shipping costs, changes in our product mix and actions taken by our competitors. A PROLONGED ECONOMIC DOWNTURN COULD RESULT IN REDUCED NET SALES AND PROFITABILITY. Our sales are also subject to a number of factors relating to consumer spending, including general economic conditions affecting disposable consumer income such as unemployment rates, business conditions, interest rates, levels of consumer confidence, energy prices, mortgage rates, the level of consumer debt and taxation. A weak retail environment could also adversely affect our sales. Purchases of home decor items may decline during recessionary periods or a prolonged recession may have a material adverse effect on our business, financial condition and results of operations. In addition, economic downturns during the last quarter of our fiscal year could adversely affect us to a greater extent than if such downturns occurred at other times of the year. There is also no assurance that consumers will continue to focus on their homes or on home-oriented products or that trends in favor of "cocooning" and new home purchases will continue. OUR COMPARABLE STORE NET SALES FLUCTUATE DUE TO A VARIETY OF FACTORS AND MAY NOT BE A MEANINGFUL INDICATOR OF FUTURE PERFORMANCE. Numerous factors affect our comparable store net sales results, including among others, weather conditions, retail trends, the retail sales environment, economic conditions, the impact of competition and our ability to execute our business strategy efficiently. Our comparable store net sales results have experienced fluctuations in the past. Our comparable store net sales increased 3.7% in fiscal 1999 over fiscal 1998, increased 0.6% in fiscal 2000 over fiscal 1999 and increased 13.3% in fiscal 2001 over the 53-week period ended February 3, 2001. In addition, we anticipate that opening new stores in existing markets may result in decreases in comparable store net sales for existing stores in such markets. Past comparable store net sales results may not be indicative of future results. Our comparable store net sales may not increase from quarter to quarter and may decline. As a result, the unpredictability of our comparable store net sales may cause our revenues and operating results to vary quarter to quarter, and an unanticipated decline in revenues or comparable store net sales may cause the price of our common stock to fluctuate significantly. 13 REDUCED CONSUMER SPENDING IN THE SOUTHEASTERN PART OF THE UNITED STATES WHERE A MAJORITY OF OUR STORES ARE CONCENTRATED COULD HARM US. Approximately 55% of our stores are located in the southeastern region of the United States. Consequently, economic conditions, weather conditions, demographic and population changes and other factors specific to this region may have a greater impact on our results of operations than on the operations of our more geographically diversified competitors. In addition, changes in regional factors that reduce the appeal of our stores and merchandise to local consumers could have a material adverse effect on our business, results of operations and financial condition. WE ARE HIGHLY DEPENDENT ON CUSTOMER TRAFFIC IN MALLS. Substantially all of our existing stores are located in enclosed malls. As a result, we largely rely on the ability of mall anchor tenants and other tenants to generate customer traffic in the vicinity of our stores. Historically, we have not relied on extensive media advertising and promotion in order to attract customers to our stores. Our future operating results will also depend on many other factors that are beyond our control, including the overall level of mall traffic and general economic conditions affecting consumer confidence and spending. OUR HARDWARE AND SOFTWARE SYSTEMS ARE VULNERABLE TO DAMAGE THAT COULD HARM OUR BUSINESS. We rely upon our existing management information systems for operating and monitoring all major aspects of our business, including sales, warehousing, distribution, purchasing, inventory control, merchandise planning and replenishment, as well as various financial functions. These systems and our operations are vulnerable to damage or interruption from: - fire, flood and other natural disasters; - power loss, computer systems failures, internet and telecommunications or data network failure, operator negligence, improper operation by or supervision of employees, physical and electronic loss of data or security breaches, misappropriation and similar events; and - computer viruses. Any disruption in the operation of our management information systems, the loss of employees knowledgeable about such systems or our failure to continue to effectively modify such systems could interrupt our operations or interfere with our ability to monitor inventory, which could result in reduced net sales and affect our operations and financial performance. We also need to ensure that our systems are consistently adequate to handle our anticipated store growth and are upgraded as necessary to meet our needs. The cost of any such system upgrades or enhancements would be significant. WE DEPEND ON KEY PERSONNEL, AND IF WE LOSE THE SERVICES OF ANY OF OUR PRINCIPAL EXECUTIVE OFFICERS, INCLUDING CARL KIRKLAND, OUR CHAIRMAN, AND ROBERT E. ALDERSON, OUR CHIEF EXECUTIVE OFFICER, WE MAY NOT BE ABLE TO RUN OUR BUSINESS EFFECTIVELY. We have benefited substantially from the leadership and performance of our senior management, especially Carl Kirkland, our Chairman, and Robert E. Alderson, our President and Chief Executive Officer. Our success will depend on our ability to retain our current management and to attract and retain qualified personnel in the future. Competition for senior management personnel is intense and there can be no assurances that we will be able to retain our personnel. Although we maintain 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 our business, financial condition and results of operations. In addition, the loss of certain of our other principal executive officers could affect our ability to run our business effectively. We have employment agreements with Mr. Kirkland and Mr. Alderson and other members of senior management. The employment agreements with Messrs. Kirkland and Alderson have been extended through June 12, 2002, and negotiations have commenced concerning the terms on which the agreements will be further extended. The loss of a member 14 of senior management would require the remaining executive officers to divert immediate and substantial attention to seeking a replacement. TERRORISM AND THE UNCERTAINTY OF WAR MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATING RESULTS. Terrorist attacks and other acts of violence or war may affect the market on which our common stock will trade, the markets in which we operate, our operations and profitability and your investment. The potential near-term and long-term effects any terrorist or other attacks on the United States or U.S. businesses may have for our customers, the market for our common stock, the demand for merchandise sold by our stores and the U.S. economy are uncertain. The consequences of any terrorist attacks, or any armed conflicts which may result, are unpredictable, and we may not be able to foresee events that could have an adverse effect on our business or your investment. OUR CHARTER AND BYLAW PROVISIONS AND CERTAIN PROVISIONS OF TENNESSEE LAW MAY MAKE IT DIFFICULT IN SOME RESPECTS TO CAUSE A CHANGE IN CONTROL OF KIRKLAND'S AND REPLACE INCUMBENT MANAGEMENT. Our charter authorizes the issuance of "blank check" preferred stock with such designations, rights and preferences as may be determined from time to time by our Board of Directors. Accordingly, the Board of Directors is empowered, without shareholder approval, to issue preferred stock with dividend, liquidation, conversion, voting or other rights that could materially adversely affect the voting power or other rights of the holders of our common stock (including purchasers in this offering). Holders of the common stock will not have preemptive rights to subscribe for a pro rata portion of any capital stock which may be issued by us. 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 Kirkland's. Although we have no present intention to issue any new shares of preferred stock, we may do so in the future. Our charter and bylaws contain certain corporate governance provisions that may deter and inhibit unsolicited changes in control of Kirkland's. 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 2003, 2004 and 2005) 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 entitled to vote (the "Voting Power"). Second, our charter and bylaws do not generally permit shareholders to call, or 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 the shareholders. 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 amendment or repeal of any of the foregoing provisions of the charter mentioned previously in this paragraph requires the affirmative vote of at least 80% of the Voting Power. In addition, the bylaws provide that the amendment or repeal by shareholders of any bylaws made by our Board of Directors requires the affirmative vote of at least 80% of the Voting Power. Furthermore, Kirkland's is subject to certain provisions of Tennessee law, including certain Tennessee corporate takeover acts that are, or may be, applicable to us. These acts include 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 charter, bylaws and Tennessee law provisions may have an anti-takeover effect, including possibly discouraging takeover attempts that might result in a premium over the market price for our common stock. See "Description of Capital Stock - Anti-Takeover Effect of Charter and Bylaw Provisions and Tennessee Laws." 15 RISKS ASSOCIATED WITH THIS OFFERING AN ACTIVE PUBLIC MARKET FOR OUR COMMON STOCK MAY NOT DEVELOP OR BE SUSTAINED, AND THE MARKET PRICE OF OUR COMMON STOCK MAY FALL BELOW THE INITIAL PUBLIC OFFERING PRICE. Prior to this offering, you could not buy or sell our common stock publicly. An active public market for our common stock may not develop or be sustained after this offering, and the market price might fall below the initial public offering price. The initial public offering price may bear no relationship to, and may be higher than, the price at which our common stock will trade upon completion of this offering. The initial public offering price will be determined by negotiations between us and the representatives of the underwriters based on factors that may not be indicative of future performance. THE MARKET PRICE FOR OUR COMMON STOCK MIGHT BE VOLATILE AND COULD RESULT IN A DECLINE IN THE VALUE OF YOUR INVESTMENT. Following this offering, the price at which our common stock will trade may be volatile. The market price of our common stock could be subject to significant fluctuations in response to our operating results, general trends in prospects for the retail industry, announcements by our competitors, analyst recommendations, our ability to meet or exceed analysts' or investors' expectations, the condition of the financial markets 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 our common stock notwithstanding our actual operating performance. FUTURE SALES OF SHARES OF OUR COMMON STOCK IN THE PUBLIC MARKET, OR THE PERCEPTION THAT SUCH SALES MAY OCCUR, MAY DEPRESS OUR STOCK PRICE AND MAKE IT DIFFICULT FOR YOU TO RECOVER THE FULL VALUE OF YOUR INVESTMENT IN OUR SHARES. If our existing shareholders sell substantial amounts of our common stock in the public market following this offering or if there is a perception that these sales may occur, the market price of our common stock could decline. Upon completion of this offering we will have outstanding approximately shares of common stock. Of these shares, only the shares of common stock (plus any of the shares purchased pursuant to the exercise of the underwriters' overallotment option) sold in this offering will be freely tradable, without restriction, in the public market. After the lockup agreements pertaining to this offering expire 180 days from the date of this prospectus, unless waived, an additional shares will be eligible for sale in the public market at various times, subject to volume limitations under Rule 144 of the Securities Act of 1933, as amended (the "Securities Act"). Holders of all of such shares of common stock have the right to require us to register the shares for sale under the Securities Act in certain circumstances and also have the right to include those shares in a registration initiated by us. If we are required to include the shares of common stock of these shareholders pursuant to these registration rights in a registration initiated by us, sales made by such shareholders may adversely affect the price of the common stock and our ability to raise needed capital. In addition, if these shareholders exercise their demand registration rights and cause a large number of shares to be registered and sold in the public market or demand that we register their shares on a shelf registration statement, such sales or shelf registration may have an adverse effect on the market price of the common stock. Following this offering, we also intend to file registration statements with the Securities and Exchange Commission covering shares of common stock issued or reserved for issuance under our 1996 Executive Incentive and Non-Qualified Stock Option Plan, 2002 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 public market, except to the extent that they are restricted by the lock-up agreements referred to above and subject to compliance with Rule 144 in the case of our affiliates. Sales of a large number of shares of common stock issued under these plans in the public market 16 may have an adverse effect on the market price of the common stock. For more information regarding the sale of shares subsequently issued under such plans and the permissible sale of common stock by existing shareholders after the closing of this offering, see "Shares Eligible for Future Sale." CONCENTRATION OF OWNERSHIP AMONG OUR EXISTING DIRECTORS, EXECUTIVE OFFICERS, AND SHAREHOLDERS MAY PREVENT NEW INVESTORS FROM INFLUENCING SIGNIFICANT CORPORATE DECISIONS. Upon completion of this offering, our current directors, executive officers, existing shareholders and their affiliates will, in the aggregate, beneficially own approximately % of our outstanding common stock, assuming no exercise of the underwriters' overallotment option. As a result, these shareholders will be able to exercise a controlling influence over matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions, and will have significant control over our management and policies. These shareholders may support proposals and actions with which you may disagree or which are not in your interests. YOU WILL INCUR IMMEDIATE AND SUBSTANTIAL DILUTION AS A RESULT OF THIS OFFERING. The initial public offering price is substantially higher than the book value per share of the common stock. As a result, purchasers in this offering will experience immediate and substantial dilution of $ per share in the tangible book value of the common stock from the initial public offering price. In addition, to the extent that currently outstanding options to purchase common stock are exercised, there will be further dilution. See "Dilution." 17 DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS This prospectus contains forward-looking statements relating to future events or our future financial performance. Such statements may relate to, 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. Except as required by applicable law, including the securities laws of the United States, and the rules and regulations of the Securities and Exchange Commission, we do not plan to publicly update or revise any forward-looking statements after we distribute this prospectus, whether as a result of any new information, future events or otherwise. ABOUT THIS PROSPECTUS Market data used throughout this prospectus, including information relating to our relative position in the specialty retailing industry, is based on the good faith estimates of management, which estimates are based upon their review of internal surveys, independent industry publications and other publicly available information. Although we believe that these sources are reliable, we do not guarantee the accuracy or completeness of this information, and we have not independently verified this information. The Kirkland's logo, the Kirkland Collection(R) and Cedar Creek(R) private label brand are registered trademarks and/or service marks of Kirkland's. We also claim common law trademark rights in Briar Patch(TM), Kirkland's Outlet(TM), Kirkland's Home(TM) and other marks. We are exploring the possibility of federal registration of several of these marks. All other trademarks or service marks appearing in this prospectus are trademarks or service marks of the companies that utilize them. 18 USE OF PROCEEDS We estimate that our net proceeds from the sale of the shares of common stock offered by us will be approximately $ million, at an assumed initial public offering price of $ , after deducting underwriting discounts and commissions and estimated offering expenses. We will not receive any proceeds from the sale of shares by the selling shareholders. We expect to use the net proceeds from this offering as follows: - $ million to repay outstanding indebtedness under a new revolving credit facility; - $ million to repay all of our outstanding subordinated debt, including accrued and unpaid interest; - $ million to redeem all of the outstanding shares of mandatorily redeemable Class C Preferred Stock (including approximately $ of amounts classified as interest associated with the Class C Preferred Stock) (all of the shares of Class C Preferred Stock are held by affiliates of Kirkland's); and - $ million to redeem $ million of aggregate stated value and accrued and unpaid dividends of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock (substantially all of the shares of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock are held by affiliates of Kirkland's). We expect to enter into a new three-year revolving credit facility in May 2002 that will include a $45 million revolving credit facility ($30 million for the first six months of each calendar year) bearing interest at a floating rate equal to the prime rate or 2.25% above LIBOR, at our election. We expect the amount outstanding under the revolving credit facility to be between $ million and $ million as of the consummation of this offering. The borrowing under our new revolving credit facility will be used to repay our prior credit facility. Our subordinated debt consists of $20.0 million subordinated notes bearing interest at 15.5% per year and maturing on June 30, 2003. Effective upon entering into our new credit facility and repaying accrued interest under the subordinated notes, the interest rate on the subordinated notes will be reduced to 12.5%. As of February 2, 2002, accrued and unpaid interest on the subordinated notes amounted to $3.8 million. By their terms, the subordinated notes are required to be repaid in full with the proceeds of this offering. We issued our Class C Preferred Stock in connection with our 1996 recapitalization and the Class C Preferred Stock has an aggregate stated value of $17.1 million at February 2, 2002. See "Management's Discussion & Analysis of Financial Condition and Results of Operations" and "Certain Transactions - Recapitalization." We accrue an annual amount equal to 9% of the outstanding stated value of the Class C Preferred Stock, which has been reflected as interest expense in our consolidated financial statements. As of February 2, 2002, the aggregate unpaid accrual with respect to the Class C Preferred Stock amounted to $7.2 million. The Class C Preferred Stock is required to be redeemed with the proceeds of this offering. We issued our Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock in connection with various financings between 1996 and 2000. At February 2, 2002, the outstanding Class A, B and D Preferred Stock had an aggregate liquidation value of $88.4 million, including $26.9 million of accrued dividends. The Class A, B and D Preferred Stock currently accrue cumulative dividends at rates varying from 4% to 10% per year compounded quarterly. All outstanding shares of Class A, B and D Preferred Stock that are not being redeemed will be converted immediately into common stock prior to the completion of this offering. See "Prospectus Summary - Pre-Offering Transactions," "Management's Discussion & Analysis of Financial Condition and Results of Operations" and "Certain Transactions." 19 DIVIDEND POLICY We intend to retain all future earnings to finance the continued growth and development of our business, and do not, therefore, anticipate paying any cash dividends on our common stock in the foreseeable future. In addition, our new senior credit facility will likely include restrictions on the payment of cash dividends. No dividends have been paid on our common stock subsequent to 1995. Future cash dividends, if any, will be determined by our Board of Directors, and will be based upon our earnings, capital requirements, financial condition, debt covenants and other factors deemed relevant by our Board of Directors. 20 DILUTION If you invest in our common stock, your interest will be diluted to the extent of the difference between the public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock after this offering. Our pro forma net negative tangible book value as of February 2, 2002, after giving effect to the Pre-Offering Transactions, was $ million, or $ per share of outstanding common stock. Pro forma net negative tangible book value per share is determined by dividing our pro forma net negative tangible book value (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 February 2, 2002, other than to give effect to the sale by us of the shares of common stock offered by us in this offering and the application of the estimated net proceeds therefrom (after deducting estimated offering expenses and the underwriting discounts and commissions), our as adjusted pro forma net negative tangible book value as of February 2, 2002 would have been $ 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 this offering. The following table illustrates this per share dilution: Assumed initial public offering price per share........ $ Net negative tangible book value per share at February 2, 2002.................................. $ ( ) Adjustment for Pre-Offering Transactions............. -------- 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................. $
The following table sets forth, on a pro forma basis as of February 2, 2002, giving effect to the Pre-Offering Transactions, the number of shares of common stock purchased from us, the total consideration paid to us, the average price per share paid by existing shareholders, and the average price per share to be paid by purchasers of common stock in this offering:
SHARES PURCHASED TOTAL CONSIDERATION ------------------- ---------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE --------- ------- ------------ ------- ------------- Existing shareholders(1)........ % $ % $ New investors............ $ --------- ----- ------------ ----- Total............... 100.0% 100.0% ========= ===== ============ =====
21 - ------------------------------ (1) With respect to our executive officers, directors and greater-than-10% shareholders, and assuming the exercise of all outstanding stock options, the number of shares of common stock purchased from us, the total consideration paid to us, and the average price per share paid by such persons, are as follows:
SHARES PURCHASED TOTAL CONSIDERATION ------------------- ---------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE --------- ------- ------------ ------- ------------- % %
Except as otherwise indicated, the foregoing tables do not include (i) 15,570 shares of common stock issuable upon exercise of options that will be outstanding upon completion of this offering at exercise prices ranging from $0.01 to $95.00 per share, of which 6,370 shares are subject to options which will be exercisable upon completion of this offering, and (ii) shares of common stock reserved for future issuance under our 1996 Executive Incentive and Non-Qualified Stock Option Plan, 2002 Incentive Plan and Employee Stock Purchase Plan. See "Management - Employee Benefit Plans." 22 CAPITALIZATION The following table describes our capitalization as of February 2, 2002. Our capitalization is presented: - on an actual basis; - on a pro forma basis to give effect to (i) the Pre-Offering Transactions and (ii) the refinancing of our existing senior credit facility with a new senior credit facility, as discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources;" and - on a pro forma as adjusted basis to give effect to (i) the transactions discussed in the preceding paragraph and (ii) the sale by us of shares in this offering at an assumed initial offering price of $ per share and the application of the estimated net proceeds from the sale (after deducting estimated offering expenses and underwriting discounts and commissions). This presentation should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this prospectus.
AS OF FEBRUARY 2, 2002 ----------------------------------- PRO FORMA ACTUAL PRO FORMA AS ADJUSTED --------- --------- ----------- (IN THOUSANDS) Cash and cash equivalents.................... $ 29,751 $ $ ========= ==== ==== Long-term debt, including current portion: Existing senior credit facility(1)......... 39,497 New senior credit facility................. -- Subordinated debt(2)....................... 23,744 Mandatorily redeemable preferred stock (Class C)(3)............................ 24,319 --------- ---- ---- Total long-term debt, including current portion.................................... 87,560 --------- ---- ---- Common stock warrants........................ 7,759 Redeemable convertible preferred stock (Class A, Class B and Class D)(4)................. 86,812 Shareholders' equity (deficit): Common stock, at stated value: shares authorized, shares issued and outstanding, actual; shares authorized, shares issued and outstanding, pro forma; and 100,000,000 shares authorized, shares issued and outstanding, pro forma as adjusted(5)... 229 Additional paid-in capital................... -- Accumulated deficit.......................... (111,439) --------- ---- ---- Total shareholders' equity (deficit)......... (111,210) --------- ---- ---- Total capitalization......................... $ 70,921 $ $ ========= ==== ====
- ------------------------------ (1) Includes $1.3 million in the aggregate of accrued and unpaid interest on our senior term loan. (2) Includes $3.8 million in the aggregate of accrued and unpaid interest on our subordinated debt. (3) Includes $7.2 million in the aggregate of accrued and unpaid interest on our Class C Preferred Stock. (4) Includes $26.9 million in the aggregate of accrued and unpaid dividends on our Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock. As of February 2, 2002, the liquidation value of our Class A, Class B and Class D Preferred Stock including $26.9 million of accrued dividends, was $88.4 million. The book value of this preferred stock has been adjusted from the liquidation value in connection with the reduction of the dividend rate on a portion of our Class B Preferred Stock. See Note 6 of the Notes to our consolidated financial statements. (5) Excludes approximately 23,470 shares of common stock reserved for issuance upon the exercise of options outstanding at February 2, 2002 (15,570 shares upon completion of this offering) at exercise prices ranging from $0.01 to $95.00 per share, of which 6,370 shares were subject to options which will be exercisable upon completion of this offering. 23 SELECTED CONSOLIDATED FINANCIAL DATA The selected "Statement of Operations Data" and the "Other Financial Data" for the fiscal years ended December 31, 1999 and December 31, 2000, the 34-day period ended February 3, 2001 and the fiscal year ended February 2, 2002 and the selected "Balance Sheet Data" as of December 31, 2000 and February 2, 2002 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The selected "Balance Sheet Data" as of December 31, 1997, 1998 and 1999 and the selected "Statement of Operations Data" and the "Other Financial Data" for the years ended December 31, 1997 and 1998 have been derived from our audited consolidated financial statements not included in this prospectus. The "Store Data" for all periods presented below have been derived from internal records of our operations. The selected consolidated financial data should be read in conjunction with our consolidated financial statements and notes thereto, and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this prospectus.
34-DAY YEAR ENDED DECEMBER 31, PERIOD ENDED YEAR ENDED ----------------------------------------- FEBRUARY 3, FEBRUARY 2, 1997 1998 1999 2000 2001(1) 2002(2) -------- -------- -------- -------- ------------ ----------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Net sales...................... $153,584 $192,250 $236,622 $259,240 $23,875 $307,213 Cost of sales(3)............... 96,998 121,936 154,278 172,376 18,998 200,063 -------- -------- -------- -------- ------- -------- Gross profit................... 56,586 70,314 82,344 86,864 4,877 107,150 Operating expenses: Other operating expenses..... 35,760 45,820 57,894 67,401 7,388 71,622 Non-cash stock compensation charge(4).................. -- -- -- -- -- 712 Depreciation and amortization................. 4,142 5,410 7,276 7,827 601 7,678 -------- -------- -------- -------- ------- -------- Operating income (loss)........ 16,684 19,084 17,174 11,636 (3,112) 27,138 Interest expense: Senior, subordinated and other notes payable........ 7,990 9,254 10,232 11,221 1,043 9,759 Class C Preferred Stock...... 1,800 1,541 1,647 1,850 154 2,007 Accretion of common stock warrants(5)................ 389 -- (879) -- -- 7,759 Interest income................ (80) (113) (27) (1) -- (278) Offering and financing costs(6)..................... -- -- 852 782 -- -- Other expense (income), net.... (154) (245) (396) (328) (34) 262 Income tax provision (benefit).................... 2,817 2,220 1,106 (573) (1,806) 3,331 -------- -------- -------- -------- ------- -------- Net income (loss).............. 3,922 6,427 4,639 (1,315) (2,469) 4,298 Accretion of redeemable preferred stock and dividends accrued(7)................... (3,755) (3,832) (5,053) (6,555) (778) (6,352) -------- -------- -------- -------- ------- -------- Net income (loss) allocable to common stock................. $ 167 $ 2,595 $ (414) $ (7,870) $(3,247) $ (2,054) ======== ======== ======== ======== ======= ======== Income (loss) per common share Basic........................ $ 1.67 $ 28.13 $ (4.50) $ (71.49) $(23.74) $ (1.50) Diluted...................... $ 1.35 $ 21.99 $ (4.50) $ (71.49) $(23.74) $ (1.50) Weighted average number of common shares outstanding Basic........................ 100,000 92,252 92,101 110,084 136,751 136,752 Diluted...................... 123,549 292,305 92,101 110,084 136,751 136,752
24
YEAR ENDED DECEMBER 31, YEAR ENDED --------------------------------------------- FEBRUARY 2, 1997 1998 1999 2000 2002(2) --------- --------- --------- --------- ----------- (IN THOUSANDS, EXCEPT SHARE DATA) PRO FORMA DATA: Pro forma as adjusted net income(8)......................... $ -------- Pro forma as adjusted earnings per common share(8)................... $ ======== Pro forma as adjusted shares outstanding(8).................... $ ======== OTHER FINANCIAL DATA: Gross profit margin................. 36.8% 36.6% 34.8% 33.5% 34.9% Adjusted EBITDA(9).................. $ 20,826 $ 24,494 $ 24,450 $ 19,463 $ 35,528 Adjusted EBITDA margin(10).......... 13.6% 12.7% 10.3% 7.5% 11.6% Net cash provided by operating activities........................ $ 8,669 $ 4,326 $ 12,945 $ 1,336 $ 37,530 Net cash (used in) investing activities........................ (5,479) (14,669) (10,825) (5,981) (4,744) Net cash (used in) provided by financing activities.............. (3,537) 13,658 (3,370) 19,855 (29,949) STORE DATA: Comparable store net sales increase(11)...................... 5.2% 1.0% 3.7% 0.6% 13.3% Number of stores at the end of period(12)........................ 138 198 226 240 234 Average net sales per store (in thousands)(13).................... $ 1,178 $ 1,169 $ 1,111 $ 1,112 $ 1,307 Average gross square footage per store(14)......................... 4,186 4,392 4,364 4,437 4,528 Average net sales per square foot(13)(14)...................... $ 281 $ 266 $ 255 $ 251 $ 289
AS OF DECEMBER 31, AS OF --------------------------------------------- FEBRUARY 2, 1997 1998 1999 2000 2002(2) --------- --------- --------- --------- ----------- (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents.......... $ 10,881 $ 14,196 $ 12,946 $ 28,156 $ 29,751 Working capital(15)................ 9,332 14,368 11,417 18,418 1,020 Total assets....................... 49,884 82,474 92,600 113,382 95,818 Total debt, including mandatorily redeemable preferred stock (Class C)............................... 88,597 106,241 103,466 104,360 75,239 Common stock warrants.............. 879 879 -- -- 7,759 Redeemable convertible preferred stock (Class A, Class B and Class D)(16)........................... 50,591 50,418 55,471 81,909 86,812 Common stock....................... 210 229 229 229 229 Accumulated (deficit) equity(17)... (104,991) (100,103) (101,517) (108,387) (111,439)
- ------------------------------ (1) Effective January 1, 2001, we changed our fiscal reporting year from a calendar year to a 52/53-week basis ending on the Saturday closest to January 31 resulting in a 34-day stub period as presented. At the beginning of 2001, we instituted a plan to improve sales, increase cash flow and return our stores to higher levels of profitability. The cornerstone of our plan was a strategy to reduce store-level inventories during January and February 2001. This strategy necessitated significant markdown activity that resulted in a reduced gross margin for January and February 2001. However, markdowns were offset by increased net sales, and, as a result, we believe our operating loss for the 34-day period ended February 3, 2001 of $3.1 million was substantially consistent with our operating loss for the 31-day period ended January 31, 2000 of $2.6 million. For the period 25 from February 1, 2000 through February 3, 2001, our net sales were $266.3 million, our gross profit was $87.8 million and our Adjusted EBITDA was $19.0 million. This approximately 53-week period is derived from our internal records and was not audited or reviewed by our auditors. (2) Effective January 1, 2001, we changed our fiscal reporting year from a calendar year to a 52/53-week basis ending on the Saturday closest to January 31. Our 2001 fiscal year began on February 4, 2001 and ended on February 2, 2002. (3) Cost of sales includes cost of product sold, freight, store occupancy and central distribution costs. (4) Reflects a non-cash stock compensation charge related to certain outstanding stock options. (5) Reflects the accretion to the fair value of detachable put warrants to purchase common stock, issued by us in connection with our issuance of subordinated debt. The put rights associated with these warrants were terminated as of January 1, 1998, were restored as of December 31, 1999 and were terminated again as of February 3, 2002. (6) Represents the write down of certain costs associated with a withdrawn equity offering in fiscal 1999 and an unsuccessful refinancing effort in fiscal 2000. (7) Reflects the accretion of the Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock to its redemption value and the accrual of dividends on such preferred stock. (8) Assumes the following transactions were effected as of February 4, 2001: (i) the Pre-Offering Transactions, (ii) the termination of the put rights associated with the put warrants discussed in note (5) above, (iii) the refinancing of our existing senior credit facility with a new senior credit facility, as discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" and (iv) the sale by us of shares in this offering at an assumed initial public offering price of $ per share and the application of the estimated net proceeds from the sale after deducting estimated offering expenses and underwriting discounts and commissions. Pro forma as adjusted net income and pro forma as adjusted earnings per common share exclude the $0.7 million non-cash stock compensation charge in fiscal 2001 related to certain outstanding stock options. (9) The term Adjusted EBITDA as used herein represents operating income before depreciation and amortization expense and a non-cash stock compensation charge related to certain outstanding stock options. While Adjusted 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, Adjusted EBITDA has been presented because we believe 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 our ability to meet our future debt service, capital expenditure and working capital requirements. Adjusted EBITDA may differ in method of calculation from similarly titled measures used by other companies. This information should be read in conjunction with our consolidated statements of cash flows contained in our consolidated financial statements and notes thereto included elsewhere in this prospectus. (10) Defined as Adjusted EBITDA as a percentage of net sales. (11) We include new stores in comparable store net sales calculations after the store has been in operation one full fiscal year. We exclude from comparable store net sales calculations each store that was expanded, remodeled or relocated during the applicable period. Each expanded, remodeled or relocated store is returned to the comparable store base after it has been excluded from the comparable store base for one full fiscal year. The comparable store net sales increase for fiscal 2001 reflects the increase in comparable store net sales for the 52-week period ended February 2, 2002 compared to the 53-week period ended February 3, 2001. (12) Our store count excludes our warehouse outlet store located adjacent to our central distribution facility in Jackson, Tennessee. (13) Calculated using net sales of all stores open at both the beginning and the end of the period. (14) 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. (15) Defined as current assets excluding cash and cash equivalents, less current liabilities excluding current maturities of long-term debt and revolving line of credit. (16) As of February 2, 2002, the liquidation value of our Class A, Class B and Class D Preferred Stock including $26.9 million of accrued dividends, was $88.4 million. The book value of this preferred stock has been adjusted from the liquidation value in connection with the reduction of the dividend rate on a portion of our Class B Preferred Stock. See Note 6 of the Notes to our Consolidated Financial Statements. (17) In connection with our 1996 recapitalization, distributions of cash and securities to our pre-recapitalization shareholders were recorded as reductions in retained earnings, creating an accumulated deficit balance of $116 million at June 13, 1996. See "Certain Transactions - Recapitalization." 26 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." You 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 We are a leading specialty retailer of home decor in the United States, operating 236 stores in 28 states. Our stores present a broad selection of distinctive merchandise, including framed art, mirrors, candles, lamps, picture frames, accent rugs, garden accessories and artificial floral products. Our stores also offer an extensive assortment of holiday merchandise, as well as items carried throughout the year suitable for giving as gifts. In addition, we use innovative design and packaging to market home decor as gifts. We provide our predominantly female customers an engaging shopping experience characterized by a diverse, ever-changing merchandise selection at surprisingly attractive prices. Our stores offer a unique combination of style and value that has led to our emergence as a leader in home decor and has enabled us to develop a strong customer franchise. As a result, we have achieved substantial growth over the last five fiscal years. Since the beginning of 1997, our sales have grown at a compounded annual growth rate of 19%. For the fiscal year ended February 2, 2002, we recorded net sales of $307.2 million and Adjusted EBITDA of $35.5 million, or 11.6% of net sales. Kirkland's was co-founded in 1966 by our current Chairman, Carl Kirkland. In 1996, we completed a recapitalization through which Advent International Group (through affiliated entities) became the largest beneficial owner of our equity. The 1996 recapitalization permitted the then-existing shareholders, consisting of Carl Kirkland, Robert E. Alderson, our current President and Chief Executive Officer, and two other shareholders, to realize a portion of the value of their interest in Kirkland's. As we more than doubled our store base from 104 stores at the end of fiscal 1995 to 226 stores at the end of fiscal 1999, we realized the need to strengthen our infrastructure and enhance several aspects of our operations in order to execute a rapid national expansion. Beginning in late 1999, we undertook a series of initiatives that enabled us to make faster and smarter inventory buying and distribution decisions, to manage the flow of merchandise to our stores more efficiently and to improve overall financial performance. These initiatives included: Completing Key Investments in Information Technology. Since late 1999, we have invested $6.5 million in several key information systems projects that provide our decision makers with better tools to increase sales, improve operational efficiency, control and distribute inventory and monitor critical performance indicators on a daily basis. Developing a More Scalable Distribution Infrastructure. Prior to 2000, we distributed our products primarily through direct shipments from our vendors to each of our individual stores. In March 2001, we consolidated our central distribution operations into one 303,000-square-foot, leased facility in Jackson, Tennessee, which allowed us to increase our dollar volume of centrally distributed merchandise by 24% from fiscal 2000 to fiscal 2001. This modern facility, together with other improvements to our distribution operations, have helped us to keep our stores stocked with fresh merchandise and to reduce significantly the cost of managing inventories at the store level. Strengthening Executive Management. Since the second half of 1999, we have added six senior managers, including key hires in merchandising, store operations and information technology. These additions, along with several other key hires and promotions, have broadened the abilities of our management team and have provided leadership to key areas of our business. We believe our management team has valuable experience both from Kirkland's and from other national retailers. 27 Improving Store-Level Operating Performance. In January 2001, we instituted a plan to improve sales, increase cash flow and return our stores to higher levels of profitability. The cornerstone of this plan was to reduce store-level inventories and improve inventory turnover. We also intensified our efforts to control and lower store operating expenses and close under-performing stores. We believe the convergence of these operational initiatives led to the significant improvement in our fiscal 2001 operating results as compared to fiscal 2000. For fiscal 2001, our comparable store net sales increased 13.3% over the 53-week period ended February 3, 2001 and our Adjusted EBITDA margin expanded to 11.6% from 7.5% in fiscal 2000. Net cash provided by operating activities increased to $37.5 million as compared to $1.3 million in fiscal 2000, and inventory turnover in fiscal 2001 increased to 3.48x as compared to 2.45x in fiscal 2000. As evidenced by the improvement in our operating results, we believe these initiatives have positioned us to expand our proven retail concept and strengthen our position as a leading specialty retailer of home decor in the United States. RESULTS OF OPERATIONS On January 1, 2001, we elected to change our fiscal reporting year from a calendar year basis to a 52/53-week year ending on the Saturday closest to January 31. Consequently, the results of operations table and discussion below compare the fifty-two weeks ended February 2, 2002 and the twelve months ended December 31, 2000. The results for the 34-day "stub period" ended February 3, 2001 are included separately in our consolidated financial statements. In January 2001, we implemented a plan to improve sales, increase cash flow and return our stores to higher levels of productivity. The cornerstone of our plan was a strategy to reduce store-level inventories during January and February 2001. This strategy necessitated significant markdown activity that resulted in a reduced gross margin for January and February 2001. However, markdowns were offset by increased net sales, and, as a result, we believe our operating loss for the 34-day period ended February 3, 2001 of $3.1 million was substantially consistent with our operating loss for the 31-day period ended January 31, 2000 of $2.6 million. For the period from February 1, 2000 through February 3, 2001, our net sales were $266.3 million, our gross profit was $87.8 million and our Adjusted EBITDA was $19.0 million. This approximately 53-week period is derived from our internal records and was not audited or reviewed by our auditors. 28 The table below sets forth selected results of our operations expressed as a percentage of net sales for the periods indicated.
FISCAL YEAR ENDED ----------------------------------------- DECEMBER 31, DECEMBER 31, FEBRUARY 2, 1999 2000 2002(1) ------------ ------------ ----------- Net sales.................................... 100.0% 100.0% 100.0% Cost of sales(2)............................. 65.2 66.5 65.1 ----- ----- ----- Gross profit................................. 34.8 33.5 34.9 Operating expenses: Other operating expenses................... 24.5 26.0 23.3 Non-cash stock compensation charge......... -- -- 0.2 Depreciation and amortization................ 3.1 3.0 2.5 ----- ----- ----- Operating income............................. 7.2 4.5 8.9 Interest expense: Senior, subordinated and other notes payable................................. 4.3 4.3 3.2 Class C Preferred Stock.................... 0.7 0.7 0.7 Accretion of common stock warrants......... (0.4) -- 2.5 Interest income.............................. 0.0 0.0 (0.1) Offering and financing costs(3).............. 0.4 0.3 -- Other expense (income), net.................. (0.2) (0.1) 0.1 ----- ----- ----- Income (loss) before income taxes............ 2.4 (0.7) 2.5 Income tax provision (benefit)............... 0.4 (0.2) 1.1 ----- ----- ----- Net income (loss)............................ 2.0% (0.5)% 1.4% ===== ===== =====
- ------------------------------ (1) Effective January 1, 2001, we changed our fiscal year from a calendar year basis to a 52/53-week year ending on the Saturday closest to January 31. Accordingly, the fiscal year ended February 2, 2002 encompasses the 52-week period beginning on February 4, 2001 and ending on February 2, 2002. (2) Cost of sales includes cost of product sold, freight, store occupancy and central distribution costs. (3) During the year ended December 31, 2000, we recorded an impairment of deferred financing costs that were connected with a refinancing effort that was not consummated. Additionally, during the year ended December 31, 1999, we indefinitely postponed plans for an initial public offering that resulted in the impairment of previously deferred offering costs. FISCAL YEAR ENDED FEBRUARY 2, 2002 COMPARED TO FISCAL YEAR ENDED DECEMBER 31, 2000 Net Sales. Net sales increased by 18.5% to $307.2 million for fiscal 2001 from $259.2 million for fiscal 2000. The net sales increase in fiscal 2001 resulted primarily from an increase in comparable store net sales. Also, the addition of five new stores in fiscal 2001 and the full year impact of the 17 new stores added in fiscal 2000 offset by the closure of 11 stores after fiscal 2000 and three stores in fiscal 2000 contributed to the overall net sales increase. The increase in comparable store net sales accounted for approximately $36.8 million of the total net sales increase, or 76.7%, and the net increase in the store base over the last two fiscal years accounted for approximately $11.2 million, or 23.3%, of the total net sales increase. One of our key operating initiatives during 2001 was a concerted effort to reduce inventory levels and SKU counts to offer a better, sharper array of merchandise without changing the core categories of merchandise that we offer. Much of this inventory reduction was accomplished from January through April 2001 through markdowns and promotional activities. As a result of this effort, merchandise flow improved during the balance of the year, allowing our customers to experience a steady flow of fresh product. In addition, the installation of a fully integrated retail information management system at our home office in April 2001 significantly increased our ability to maintain a fresh merchandise mix and appropriate 29 inventory levels in our stores. The comparable store net sales increase was primarily the result of increased unit sales and customer traffic, although we did experience favorable trends in our average retail price per item sold. Gross Profit. Gross profit, defined as net sales less the cost of sales including cost of product sold, freight, store occupancy and central distribution costs, increased $20.2 million, or 23.2%, to $107.1 million for fiscal 2001 from $86.9 million for fiscal 2000. Gross profit expressed as a percentage of net sales increased to 34.9% for fiscal 2001, from 33.5% for fiscal 2000. The increase in gross profit as a percentage of net sales resulted primarily from the leveraging of store occupancy costs through higher net sales. Additionally, as a result of our aggressive inventory reduction in the first quarter of fiscal 2001, product cost of sales, including freight expenses, declined as a percentage of net sales particularly in the second half of fiscal 2001, due to the strong sell-through and fresher merchandise mix. These factors were partially offset by an increase in central distribution costs as a percentage of net sales as we leased additional distribution center space and increased staffing levels during fiscal 2001. Other Operating Expenses. Other operating expenses, including both store and corporate costs, were $71.6 million, or 23.3% of net sales, for fiscal 2001 as compared to $67.4 million, or 26.0% of net sales, for fiscal 2000. The decline in these operating expenses as a percentage of net sales was primarily the result of strong sales that leveraged the fixed component of operating expenses. The percentage decrease in operating expenses also benefited from several expense control initiatives at the store and corporate levels. Two of the most significant initiatives were directly related to our fiscal 2001 plan to improve store-level operating performance. First, we initiated a concerted effort to restrain growth in store payroll expense. By operating stores with lower inventory levels and improving merchandise distribution and allocation, we were able to reduce store payroll expense to 12.2% of net sales for fiscal 2001 as compared to 13.6% of net sales for fiscal 2000. This improvement is partially the result of our completion of a planned reduction in the number of store assistant manager positions. Second, we were able to save over $1 million by reducing our stores' use of local storage facilities and related truck rentals. During fiscal 2002, we will seek to further reduce the costs associated with these local storage facilities as we continue to increase the volume of our centrally distributed merchandise. Non-Cash Stock Compensation Charge. In fiscal 2001, we incurred a non-cash stock compensation charge related to certain outstanding stock options of $0.7 million, or 0.2% of net sales. No such charge was incurred in fiscal 2000. See Notes 8 and 12 of the Notes to our consolidated financial statements. Depreciation and Amortization. Depreciation and amortization expense was $7.7 million, or 2.5% of net sales, for fiscal 2001 as compared to $7.8 million, or 3.0% of net sales, for fiscal 2000. The decline as a percentage of net sales was the result of the strong sales performance as well as a decline in capital expenditures over the last two fiscal years in relation to previous fiscal years. Interest Expense. Interest expense on senior, subordinated and other notes payable was $9.8 million, or 3.2% of net sales, for fiscal 2001 as compared to $11.2 million, or 4.3% of net sales, for fiscal 2000. The decrease was the result of significantly improved operating cash flow which led to lower average debt balances in fiscal 2001 in comparison to fiscal 2000 combined with lower interest rates. Interest expense associated with the mandatorily redeemable Class C Preferred Stock was $2.0 million, or 0.7% of net sales, for fiscal 2001 as compared to $1.9 million, or 0.7% of net sales, for fiscal 2000. The accretion of common stock warrants of $7.8 million, or 2.5% of net sales, reflects the accretion to fair value of detachable put warrants issued by us in connection with our issuance of subordinated debt in 1996. No such charge was recorded in fiscal 2000. Income Taxes. Income tax expense was $3.3 million, or 43.7% of pre-tax income, for fiscal 2001 as compared to a benefit of $0.6 million, or 30.3% of pre-tax loss, for fiscal 2000. Net Income. As a result of the foregoing, net income was $4.3 million, or 1.4% of net sales, for fiscal 2001 compared to a net loss of $1.3 million, or 0.5% of net sales for fiscal 2000. 30 FISCAL YEAR ENDED DECEMBER 31, 2000 COMPARED TO FISCAL YEAR ENDED DECEMBER 31, 1999 Net Sales. Net sales increased by 9.6% to $259.2 million for fiscal 2000 from $236.6 million for fiscal 1999. The net sales increase in fiscal 2000 resulted primarily from the addition of 17 new stores in fiscal 2000 and the full year impact of the 29 new stores added in fiscal 1999 offset by the closure of three stores in fiscal 2000 and one store in fiscal 1999. Comparable store net sales increased 0.6% in fiscal 2000. The increase in comparable store net sales accounted for $1.1 million, or 4.9%, of the increase in net sales and the net increase in the number of stores over the last two fiscal years accounted for $21.5 million, or 95.1% of the increase. During the first two quarters of fiscal 2000, comparable store net sales increased 7.7% due to successful promotions in select categories. Comparable store net sales decreased 3.9% for the last two quarters of fiscal 2000 and were down 5.4% in the fourth quarter of fiscal 2000. We believe that many factors contributed to the weak second half net sales performance including supply chain inefficiencies, an overall lackluster retail holiday season and a build-up of inventory at the store level as holiday sales did not materialize. Gross Profit. Gross profit increased $4.6 million, or 5.6%, to $86.9 million for fiscal 2000 from $82.3 million for fiscal 1999. Gross profit expressed as a percentage of net sales decreased to 33.5% for fiscal 2000, from 34.8% for fiscal 1999. The decline in gross profit as a percentage of net sales was primarily the result of increases in store occupancy and central distribution costs outpacing the relatively small comparable store net sales growth experienced in fiscal 2000. Expense increases in central distribution resulting from additional throughput volume contributed to the decline in gross profit as a percentage of net sales. Additionally, product cost of sales, including freight expenses, increased as a percentage of net sales due to fourth quarter markdowns taken in an effort to generate sales momentum. Operating Expenses. Operating expenses were $67.4 million, or 26.0% of net sales, for fiscal 2000 as compared to $57.9 million, or 24.5% of net sales, for fiscal 1999. The increase as a percentage of net sales was primarily the result of increases in store payroll and occupancy costs outpacing the modest increase in comparable store net sales. Store payroll expense increased to 13.6% of net sales for fiscal 2000 as compared to 12.8% of net sales for fiscal 1999. The increase in store payroll expense was primarily the result of an increase in the average compensation for store managers along with an increase in the average hourly wage. We also experienced increases in certain corporate operating expenses, including payroll expense in information technology and store operations management. Depreciation and Amortization. Depreciation and amortization expense was $7.8 million, or 3.0% of net sales, for fiscal 2000 as compared to $7.3 million, or 3.1% of net sales, for fiscal 1999. The increase in depreciation expense was the result of relatively high capital expenditures in the years prior to fiscal 2000. As a percentage of net sales, the expense ratio declined as net sales growth generated by new stores outpaced the increase in depreciation and amortization. Interest Expense. Interest expense on senior, subordinated and other notes payable was $11.2 million, or 4.3% of net sales, for fiscal 2000 as compared to $10.2 million, or 4.3% of net sales, for fiscal 1999. The increase was the result of higher average debt balances in comparison to the prior year combined with higher interest rates. Interest expense associated with the mandatorily redeemable Class C Preferred Stock was $1.9 million, or 0.7% of net sales, for fiscal 2000 as compared to $1.6 million, or 0.7% of net sales, for fiscal 1999. The negative accretion of common stock warrants of $0.9 million during fiscal 1999, or 0.4% of net sales, reflects the reduction in fair value of detachable put warrants issued by us in connection with our issuance of subordinated debt in 1996. No such charge was recorded in fiscal 2000. Income Taxes. For fiscal 2000, we recorded an income tax benefit in the amount of $0.6 million, or 30.3% of pre-tax loss, as compared to an expense of $1.1 million, or 19.2% of pre-tax income, for fiscal 1999. In fiscal 1999, we received a tax benefit from surtax exemptions that lowered the statutory rate by 18.6% of pre-tax income. As a result of our December 31, 1999 reorganization (see "Certain Transactions - Reorganization"), this benefit was not available to us in fiscal 2000, nor will it be available to us in the future due to our consolidated corporate structure. 31 Net Income. As a result of the foregoing, we recorded a net loss of $1.3 million, or 0.5%, of net sales for fiscal 2000, as compared to net income of $4.6 million or 2.0% of net sales for fiscal 1999. LIQUIDITY AND CAPITAL RESOURCES Most of our capital requirements relate to new store openings, existing store expansions, remodelings or relocations, seasonal working capital and payment of interest on our outstanding indebtedness. Our working capital requirements are primarily for merchandise inventories, which typically reach their peak by the end of the third quarter of each fiscal year. Historically, we have funded our store openings, expansions, remodelings and relocations and met our working capital requirements from internally generated funds, borrowings under our credit facilities and proceeds from the sale of equity securities. During fiscal 1999, 2000 and 2001, net cash provided by operating activities was $12.9 million, $1.3 million and $37.5 million, respectively. All of our revenues are realized at the point-of-sale in our stores. Thus, our sales are essentially on a cash basis. The cash flow from operating our stores is a significant source of liquidity. This operating cash flow is used primarily to purchase inventory, make interest payments on our indebtedness and pay income taxes. During fiscal 1999, 2000 and 2001, net cash used in investing activities was $10.8 million, $6.0 million, and $4.7 million, respectively. We use cash in investing activities to build new stores and expand, remodel or relocate existing stores. Furthermore, net cash used in investing activities includes purchases of information technology assets and equipment for our distribution facility and corporate headquarters. During fiscal 1999, 2000 and 2001, we opened 29, 17 and five new stores, respectively, and expanded or remodeled 14, four and two stores, respectively. We expect to open approximately 15 new stores during fiscal 2002, two of which were opened prior to the date of this prospectus. Capital expenditures, including leasehold improvements and furniture and fixtures, for the five new stores opened during fiscal 2001 averaged approximately $148,000 (net of landlord allowances), and initial gross inventory requirements (which were partially financed by trade credit) averaged approximately $142,000 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. We also intend to expand or remodel four stores in fiscal 2002 and perform minor refurbishments on several other stores. The cost of remodeling two stores in fiscal 2001 was approximately $153,000 per store. Our total planned capital expenditures for fiscal 2002 are $8.5 million. In addition to providing for new stores, together with expanded, relocated and remodeled stores, these planned capital expenditures include $0.6 million for equipment in our distribution facility and $2.4 million for various investments in information technology assets. Our principal indebtedness during the past three fiscal years consisted of (i) our principal credit facility, which included a term loan of $57 million and a $20 million revolver, (ii) $20 million of senior subordinated notes due in June 2003, (iii) a $5 million subordinated note payable to our Chairman and (iv) our mandatorily redeemable Class C Preferred Stock, with a stated value of $17.1 million as of February 2, 2002, originally issued in connection with our 1996 recapitalization. See "Certain Transactions - Recapitalization." During fiscal 1999, cash of $3.4 million was used in financing activities. During fiscal 1999, we made $5.8 million of principal payments on our long-term debt and repaid $7 million under our revolving line of credit. In addition, in July 1999 we borrowed an additional $7.5 million, including $3.4 million from certain of our shareholders and $4.1 million from our existing senior lenders. The $4.1 million was collateralized with cash and letters of credit supplied by certain of our shareholders. Our shareholders who participated in this loan financing received warrants to purchase 15,847 shares of our common stock as consideration. During fiscal 1999 we also incurred $2.5 million in additional long-term borrowings. In fiscal 2000, financing activities contributed cash of $19.9 million. During fiscal 2000, we drew $20.0 million under our revolving line of credit and received $7.4 million of net proceeds (net of 32 $0.1 million of transaction expenses) from an equity investment by certain of our shareholders. We also repaid the $5 million note due to our Chairman through his conversion of the loan into additional equity. In addition, the $7.5 million of borrowings from July 1999 was repaid as our lenders drew on the $4.1 million of cash collateral posted by certain shareholders, in consideration of which we issued additional equity to these shareholders, and other shareholders converted $3.4 million of these borrowings into additional equity. See "Certain Transactions - 2000 Equity Transaction." In fiscal 2001, $30.0 million was used in financing activities. In fiscal 2001, the principal uses of cash in financing activities were repayments on the line of credit of $20.0 million and term loan principal payments of $9.2 million. See "Certain Transactions" for a description of various financing transactions from 1996 through 2000 involving related parties. Due to our failure to comply with certain financial covenants in our principal credit agreement during fiscal 2000, our existing senior lenders prevented us from continuing to pay current cash interest to our subordinated lenders. We subsequently entered into negotiations with our existing senior and subordinated lenders to amend our agreements with those respective lenders. Pursuant to these negotiations, in June 2001 we entered into amended credit agreements with our existing senior and subordinated lenders and these lenders waived the events of default under their respective facilities. With respect to the existing senior credit facility, the maturity date remained June 30, 2002 and the covenants were made less restrictive. With respect to the subordinated loan agreement, the maturity date remained June 30, 2003 and the interest rate was increased from 12.5% to 15% effective January 1, 2001 and 15.5% effective January 1, 2002. We also reduced the dividend rate on our Class A and Class D Preferred Stock and most of our Class B Preferred Stock from 10% to 4%. Since June 2001 we have complied with all covenants in our existing senior credit agreement and subordinated loan agreement, and we are currently in compliance with all of our lending agreements. In May 2002, we expect to enter into a new, three-year senior secured credit facility that will include a $45 million revolving credit facility ($30 million for the first six months of each calendar year) and a $15 million term loan. The revolving credit facility is expected to bear interest at a floating rate equal to the prime rate or LIBOR plus 2.25%, at our election. Borrowings under the new revolving credit facility are expected to be subject to certain customary conditions and contain customary events of default. The term loan is expected to bear interest at the prime rate plus 7.25%. We will use the proceeds of the term loan, together with a total of approximately $ million of a combination of available cash and borrowings under the revolving credit facility, (1) to repay all indebtedness (including accrued interest outstanding) outstanding under our existing senior secured credit facility under which $39.5 million was outstanding at February 2, 2002, and (2) to pay all accrued and unpaid interest on institutional subordinated debt, of which there was $3.8 million as of February 2, 2002. As a result, the interest rate on the subordinated notes will be reduced from 15.5% to 12.5% and the dividend rate on the Class A, Class B and Class D Preferred Stock will increase from 4% to 10%. There can be no assurance that the new revolving credit facility and term loan will be successfully negotiated. A portion of the proceeds from this offering will be used to pay down the balance expected to be outstanding on the new revolving credit facility. We issued Class A Preferred Stock, Class B Preferred Stock and Class C Preferred Stock in June 1996 and December 1999 and Class D Preferred Stock in August 2000. As of February 2, 2002, the liquidation value, including accrued dividends, on our Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock was $48.9 million, $17.2 million and $22.3 million, respectively. Dividends accrue at an annual rate of 4% for the Class A Preferred Stock and Class D Preferred Stock and at an annual rate of 4% or 10% for the Class B Preferred Stock. Dividends on the Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock have accrued and have not been paid. The Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock are redeemable at our option or at the option of the holders after the earliest to occur of June 12, 2004 or the closing of a liquidity event (which includes this offering). At the option of 60% of the holders, all of the outstanding Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock, other than any shares being redeemed at our option, will automatically convert into common stock upon the occurrence of this offering 33 at a rate equal to the liquidation value of the preferred stock plus accrued dividends, divided by the initial public offering price. The Class C Preferred Stock is mandatorily redeemable at the earliest to occur of July 2004 or the closing of a liquidity event (including this offering). The Class C Preferred Stock has no conversion privileges. The liquidation value of the Class C Preferred Stock, including accrued interest, was $24.3 million at February 2, 2002. Interest on the Class C Preferred Stock accrues at 9% annually on the outstanding balance of the Class C Preferred Stock plus accrued interest. The payments representing such interest accrued after 1997 have not been made as a result of subordination provisions under our existing senior credit facility. The following table summarizes our material contractual obligations, including both on- and off-balance sheet arrangements in effect at February 2, 2002, and as adjusted to give effect to the sale by us of shares of common stock in this offering at an assumed initial public offering price of $ per share and the application of the net proceeds from the sale (after deducting estimated offering expenses and underwriting discounts and commissions):
CONTRACTUAL OBLIGATIONS FISCAL 2002 FISCAL 2003 FISCAL 2004 THEREAFTER TOTAL AS ADJUSTED - ----------------------- ----------- ----------- ----------- ---------- ------ ----------- (IN MILLIONS) Lease financing: Operating lease obligations (store leases)............ $21.7 $20.2 $ 19.6 $66.1 $127.6 $127.6 Operating lease obligations (other)................... 0.7 0.4 0.2 -- 1.3 1.3 Employment and consulting contracts................... 0.3 -- -- -- 0.3 0.3 Long-term borrowings: Senior credit facility(a)... 39.5 -- -- -- 39.5 15.0 Subordinated debt(b)........ -- 23.8 -- -- 23.8 -- Class C preferred stock(b).................. -- -- 24.3 -- 24.3 -- Redeemable convertible preferred stock: Class D preferred stock(c).................. -- -- 22.3 -- 22.3 -- Class A preferred stock(c).................. -- -- 48.9 -- 48.9 -- Class B preferred stock(c).................. -- -- 17.2 -- 17.2 -- ----- ----- ------ ----- ------ ------ Total obligations....... $62.2 $44.4 $132.5 $66.1 $305.2 $144.2 ===== ===== ====== ===== ====== ======
- ------------------------------ (a) Amounts outstanding under our existing senior credit facility are expected to be refinanced and replaced by a new senior credit facility we expect to enter into in May 2002. (b) Includes accrued and unpaid interest. (c) Represents liquidation value of preferred stock, including accrued and unpaid dividends. We believe that net cash provided by operations and availability under our proposed new credit facility, together with the anticipated proceeds from this offering, will be adequate to carry out our fiscal 2002 growth plans in full and fund our planned capital expenditures, interest payments and working capital requirements for at least the next 12 months. To the extent we seek to accelerate our growth plans, and with respect to periods beyond fiscal 2002, we may need to raise additional capital either through the issuance of debt or equity securities or through additional credit facilities. We cannot assure you that such capital would be available on acceptable terms or at all. SEASONALITY AND QUARTERLY FLUCTUATIONS We have historically experienced and expect to continue to experience substantial seasonal fluctuations in our net sales and operating income. We believe this is the general pattern typical of our segment of the retail industry and, as a result, expect that this pattern will continue in the future. Our 34 quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of new store openings, net sales contributed by new stores, shifts in the timing of certain holidays and competition. Consequently, comparisons between quarters are not necessarily meaningful and the results for any quarter are not necessarily indicative of future results. Our strongest sales period is the winter holiday season. We generally realize a disproportionate amount of our net sales and a substantial majority of our operating and net income during the fourth quarter of our fiscal year. In anticipation of the increased sales activity during the fourth quarter of our fiscal year, we purchase large amounts of inventory and hire temporary staffing help for our stores. Our operating performance could suffer if net sales were below seasonal norms during the fourth quarter of our fiscal year. Our net sales, operating income and net income are typically weakest in the first quarter of our fiscal year. We expect this trend to continue. The following table sets forth certain unaudited financial and operating data for Kirkland's in each fiscal quarter during fiscal 2000 and fiscal 2001. The unaudited quarterly information includes all normal recurring adjustments that we consider necessary for a fair presentation of the information shown.
FISCAL QUARTER ENDED(1) ---------------------------------------------------------------------------------- MAR. 31, JUNE 30, SEP. 30, DEC. 31, MAY 5, AUG. 4, NOV. 3, FEB. 2, 2000 2000 2000 2000 2001 2001 2001 2002 -------- -------- -------- -------- ------- ------- ------- -------- (IN THOUSANDS, EXCEPT STORE AND PERCENTAGE DATA) Net sales................ $50,094 $53,869 $55,291 $99,986 $55,961 $63,614 $66,822 $120,816 Gross profit............. 14,890 16,442 16,539 38,993 15,239 20,820 22,093 48,998 Operating income (loss)................. (3,136) (1,334) (1,510) 17,616 (1,725) 2,303 2,691 23,869 Net income (loss)........ (3,560) (2,796) (3,020) 8,061 (2,725) (1,078) (42) 8,143 Adjusted EBITDA(2)....... (1,104) 703 414 19,450 (101) 4,298 4,743 26,588 Stores open at end of period................. 226 231 233 240 235 233 234 234 Comparable store net sales increase (decrease)(3).......... 6.4% 9.0% (1.1)% (5.4)% 3.9% 11.9% 22.9% 18.8%
FISCAL QUARTER ENDED(1) -------------------------------------------------------------------------------- MAR. 31, JUNE 30, SEP. 30, DEC. 31, MAY 5, AUG. 4, NOV. 3, FEB. 2, 2000 2000 2000 2000 2001 2001 2001 2002 -------- -------- -------- -------- ------ ------- ------- ------- As a percentage of sales: Net sales..................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Gross profit.................. 29.7 30.5 29.9 39.0 27.2 32.7 33.1 40.6 Operating income (loss)....... (6.3) (2.5) (2.7) 17.6 (3.1) 3.6 4.0 19.8 Net income (loss)............. (7.1) (5.2) (5.5) 8.1 (4.9) (1.7) (0.1) 6.7 Adjusted EBITDA(2)............ (2.2) 1.3 0.7 19.5 (0.2) 6.8 7.1 22.0
- ------------------------------ (1) Effective January 1, 2001, we changed our fiscal reporting year to a 52-53 week basis ending on the Saturday closest to January 31. Previously, we had reported our results on a calendar year basis. Consequently, the quarterly data for fiscal 2000 were prepared according to the calendar year. The quarterly results for fiscal 2001 were prepared using the 52-53 week basis. The financial and operating data for the 34-day period ended February 3, 2001 is not presented as this period is not included in any of our fiscal quarters. (2) The term Adjusted EBITDA as used herein represents operating income before depreciation and amortization expense and a non-cash stock compensation charge related to certain outstanding stock options. While Adjusted 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, Adjusted EBITDA has been presented because we believe 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 our ability to meet our future debt service, capital expenditure and working capital requirements. Adjusted EBITDA may differ in method of calculation from similarly titled measures used by other companies. This information should be read in conjunction with our consolidated statement of cash flows contained in our consolidated financial statements and notes thereto included elsewhere in this prospectus. (3) We include new stores in comparable store net sales calculations after the store has been in operation one full fiscal year. We exclude from comparable store net sales calculations each store that was expanded, remodeled or relocated during the applicable period. Each expanded, remodeled or relocated store is returned to the comparable store base after it has been excluded from the comparable store base for one full fiscal year. The comparable store net sales calculations for the fiscal 2001 quarters reflect the results of comparing our net sales for each quarter in fiscal 2001 to the corresponding quarter in the prior year, where the 2000 fiscal quarters are measured on a 35 4/5-week basis ending on the Saturday closest to April 30, 2000, July 31, 2000, October 31, 2000 and January 31, 2001. INFLATION We do not believe that our operating results have been materially affected by inflation during the preceding three fiscal years. There can be no assurance, however, that our operating results will not be adversely affected by inflation in the future. CRITICAL ACCOUNTING POLICIES Our critical accounting policies are discussed in the notes to our consolidated financial statements. Certain judgments and estimates utilized in implementing these accounting policies are likewise discussed in each of the notes to our consolidated financial statements. The following discussion aggregates the various critical accounting policies addressed throughout the financial statements, the judgments and uncertainties affecting the application of these policies and the likelihood that materially different amounts would be reported under varying conditions and assumptions. Revenue Recognition - Sales and the related gross profit are recorded at the time our customers provide a satisfactory form of payment and take ownership of the merchandise. There are minimal accounting judgments and uncertainties affecting the application of this policy. We estimate the amount of merchandise that will be returned for a refund and reduce net sales and gross profit by that amount. Given that the vast majority of returns occur within a matter of days of the selling transaction, the risk of us realizing a materially different amount for net sales and gross profit than reported in the consolidated financial statements is minimal. Cost of Sales and Inventory Valuation - Our inventory is stated at the lower of cost or market with cost determined using the average cost method with average cost approximating current cost. We estimate the amount of shrinkage that has occurred through theft or damage and adjust that to actual at the time of our physical inventory counts which occur near our fiscal year-end. We also evaluate the cost of our inventory in relation to the estimated sales price giving consideration to markdowns that will occur prior to or at the point of sale. This evaluation is performed to ensure that we do not carry inventory at a value in excess of the amount we expect to realize upon the sale of the merchandise. Depreciation and Recoverability of Assets - Approximately 26% of our assets at February 2, 2002 represent investments in property and equipment and goodwill. Determining appropriate depreciable lives and reasonable assumptions in evaluating the carrying value of capital assets requires judgments and estimates. - We utilize the straight-line method of depreciation and a variety of depreciable lives. Land is not depreciated. Buildings are depreciated over 40 years. Furniture, fixtures and equipment are depreciated over 5 to 7 years. Leasehold improvements are amortized over the shorter of the useful lives of the asset or the lease term. Our average lease term is 10 years. - To the extent we replace or dispose of fixtures or equipment prior to the end of its assigned depreciable life, we could realize a loss or gain on the disposition. To the extent our assets are used beyond their assigned depreciable life, no depreciation expense is being realized. We reassess the depreciable lives in an effort to reduce the risk of significant losses or gains arising from either the disposition of our assets or the utilization of assets with no depreciation charges. - Recoverability of the carrying value of store assets is assessed annually and upon the occurrence of certain events such as store closings. The assessment requires judgment and estimates for future store generated cash flows. The underlying estimates for cash flows include estimates for future net sales, gross profit, and store expense increases and decreases. During fiscal 2001 and fiscal 2000, we recorded impairments of $82,000 and $103,000, respectively. 36 Insurance Reserves - Workers' compensation, general liability and employee medical insurance programs are partially self-insured. It is our policy to record a self-insurance liability using estimates of claims incurred but not yet reported or paid, based on historical trends. Actual results can vary from estimates for many reasons, including, among others, inflation rates, claim settlement patterns, litigation trends, and legal interpretations. Offering and Financing Costs - In previous years, we have incurred costs related to refinancing efforts and an offering of our common stock. Costs incurred related to financing activities are typically capitalized and amortized over the life of the debt. Costs incurred related to common stock offerings are deducted from the proceeds of the successful offering. Occasionally, the anticipated financing activity or stock offering is not consummated. When that occurs, we expense the costs related to such activities that had been previously deferred in anticipation of the transaction. Stock Options and Warrants - Certain of our stock options require us to record a non-cash stock compensation charge in our financial statements. The amount of the charge is determined based upon the fair value of our common stock. Other options have been granted to employees with an exercise price that is equal to or greater than the fair value of our common stock on the date of grant. Stock options, which have been granted to non-employees in exchange for services, must be valued using an option-pricing model. Stock warrants have been issued in connection with several of our debt issuances and in some cases the warrants contain a feature allowing the holder to put the warrant to us for fair value. In each of these cases, the fair value of our common stock is a significant element of determining the value of the stock option or warrant, or the amount of the non-cash stock compensation charge to be recorded for our variable stock option awards or for non-employee stock option grants. Since our common stock is not traded on a stock exchange, the market value of our stock is not easily determinable. To determine the value of our common stock we first consider the amount paid to us for our common stock in a recent transaction for the sale of our common stock. Absent a recent sale of our common stock, we obtain a valuation from an independent appraiser. In each case, the determination of the fair value of our common stock requires judgment and the valuation has a direct impact on our financial statements. We believe that reasonable methods and assumptions have been used for determining the fair value of our common stock. IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets", effective for fiscal years beginning after December 15, 2001. SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Under SFAS 142, goodwill (and intangible assets deemed to have indefinite lives) will no longer be amortized but will be subject to annual impairment tests. Other intangible assets will continue to be amortized over their useful lives. As of February 2, 2002, we had goodwill, net of accumulated amortization, in the amount of $1.4 million recorded on our balance sheet. For fiscal 2001, we recorded $83,000 in amortization expense on our consolidated statement of operations. We will apply the new rules of accounting for goodwill and other intangible assets beginning in the first quarter of fiscal 2002. We will cease to amortize goodwill in accordance with SFAS 142 and will perform a test for impairment when events and circumstances indicate that an impairment may have occurred. The application of SFAS 141 and SFAS 142 is not expected to have a significant impact on our financial condition or results of operations. In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, "Accounting for the Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and the accounting and reporting provisions of Accounting Principles Board (APB) Opinion No. 30, "Reporting the Results of Operations" for a disposal of a segment of a business. SFAS 144 is effective for fiscal years beginning December 15, 2001. We do not anticipate that the adoption of this standard will have a significant impact on our financial condition or results of operations. 37 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risks related to our operations result primarily from changes in short-term London Interbank Offered Rates, or LIBOR, as our new senior credit facility will utilizes short-term LIBOR contracts. LIBOR contracts are fixed rate instruments for a period of between one and six months, at our discretion. From time to time, we enter into one or more LIBOR contracts. These LIBOR contracts vary in length and interest rate, such that adverse changes in short-term interest rates could affect our overall borrowing rate when contracts are renewed. As of February 2, 2002, we had no borrowings outstanding under our existing line of credit facility. As of February 2, 2002, we had one LIBOR contract outstanding for $37.2 million for our entire existing term loan facility. Based on this debt level for the existing term loan facility, a hypothetical 10% increase in LIBOR from the applicable rate at February 2, 2002 would increase net interest expense by approximately $75,000 on an annual basis, and likewise would decrease both net income and cash flows for that annual period by a corresponding amount. We cannot predict market fluctuations in interest rates and their impact on debt, nor can there be any assurance that long-term fixed-rate debt will be available at favorable rates, if at all. Consequently, our future results may differ materially from estimated results due to adverse changes in interest rates or debt availability. We did not have any material foreign exchange or other significant market risk as of February 2, 2002. 38 BUSINESS GENERAL We are a leading specialty retailer of home decor in the United States, operating 236 stores in 28 states. Our stores present a broad selection of distinctive merchandise, including framed art, mirrors, candles, lamps, picture frames, accent rugs, garden accessories and artificial floral products. Our stores also offer an extensive assortment of holiday merchandise, as well as items carried throughout the year suitable for giving as gifts. In addition, we use innovative design and packaging to market home decor items as gifts. We provide our predominantly female customers an engaging shopping experience characterized by a diverse, ever-changing merchandise selection at surprisingly attractive prices. Our stores offer a unique combination of style and value that has led to our emergence as a leader in home decor and has enabled us to develop a strong customer franchise. As a result, we have achieved substantial growth over the last five fiscal years. Since the beginning of 1997, our sales have grown at a compounded annual growth rate of 19%. For the fiscal year ended February 2, 2002, we recorded net sales of $307.2 million and Adjusted EBITDA of $35.5 million, or 11.6% of net sales. CORPORATE HISTORY AND RECENT INITIATIVES Kirkland's was co-founded in 1966 by our current Chairman, Carl Kirkland. Although originally focused in enclosed malls in the Southeast, we have grown beyond that region and also have begun to open stores in selected non-mall venues. We accelerated our expansion in fiscal 1995, more than doubling our store base from 104 stores at the end of fiscal 1995 to 226 stores at the beginning of fiscal 2000. We also expanded our geography during this period by opening 66 stores outside our core Southeastern base. We operate in major metropolitan markets such as Houston, Texas and Atlanta, Georgia, middle markets such as Birmingham, Alabama and Buffalo, New York and smaller markets such as Appleton, Wisconsin and Panama City, Florida. Beginning in late 1999, we undertook a series of initiatives with the goals of strengthening our infrastructure and enhancing several aspects of our operations in order to position ourselves for profitable growth. These measures have enabled us to make faster and smarter inventory buying and distribution decisions, to manage the flow of merchandise to our stores more efficiently and to improve overall financial performance. These initiatives included: Completing Key Investments in Information Technology. Since late 1999, we have invested $6.5 million in several key information systems projects that provide our decision makers with better tools to increase sales, improve operational efficiency, control and distribute inventory and monitor critical performance indicators on a daily basis. We installed new, state-of-the-art POS software and servers in all of our stores in November 1999. In April 2001, we installed an integrated retail management system at our home office. This system provides greatly enhanced functionality to our merchandise buyers and planners. For example, although our buyers have had access to basic daily sales data for many years, our new retail management system produces much more detailed information via our nightly polling process. This information includes daily sales, inventory and gross margin analyzed by merchandise category, classification or SKU for every store. Finally, in March 2002, we completed the installation of new cash registers in approximately two-thirds of our stores. Developing a More Scalable Distribution Infrastructure. Prior to 2000, we distributed our products primarily through direct shipments from our vendors to each of our individual stores. As our store base grew, we decided to develop a more scalable central distribution strategy. In March 2001, we consolidated our central distribution operations into one 303,000-square-foot, leased facility in Jackson, Tennessee, which allowed us to increase our dollar volume of centrally distributed merchandise by 24% from fiscal 2000 to fiscal 2001. We plan to continue expanding our proportion of centrally distributed merchandise, from 62% of total inventory purchases in fiscal 2001 to 90% by fiscal 2005. Our modern central distribution facility, together with other improvements to our supply chain, has helped us to keep our stores stocked with fresh merchandise and to reduce significantly the cost of 39 managing inventories at the store level. We believe our distribution facility, which we have the option to expand, provides us with adequate distribution capacity at least until fiscal 2004. Strengthening Executive Management. Since the second half of 1999, we have added six senior managers, including key hires in merchandising, store operations and information technology. These additions, along with several other key hires and promotions, have broadened the abilities of our management team and have provided leadership to key areas of our business. In addition, in March 2001 we elevated Robert Alderson, a 16-year Kirkland's veteran and previously our Chief Operating Officer, to the position of Chief Executive Officer. Carl Kirkland, our co-founder and author of the Kirkland's concept, serves as Chairman of the Board and is a strategic advisor to our Merchandising team. We believe our management team has valuable experience both from Kirkland's and from other national retailers. Improving Store-Level Operating Performance. In January 2001, we instituted a plan to improve sales, increase cash flow and return our stores to higher levels of profitability. Key components of the plan included: - Reducing Store-Level Inventories. We aggressively marked down inventory in January and February 2001 resulting in a significant reduction in store-level inventory. These reduced inventory levels, in conjunction with our central distribution and systems investments, facilitated the flow of fresh inventory to our stores. As a result, store management has been able to spend more of their time focusing on our customers and the appearance of the store and less time on the management of inventory in the stockroom and local storage facilities. - Controlling and Reducing Store Operating Expenses. We intensified our efforts to control and reduce store operating expenses. In particular, significant savings were achieved by slowing the growth of store payroll expenses and reducing the costs associated with local storage facilities and related truck rentals. - Closing Under-Performing Stores. We closely reviewed our store base and, as a result, we closed 11 stores after fiscal 2000. Of our stores that were open during all of fiscal 2001, only nine were not profitable at the store level. We believe the convergence of these operational initiatives led to the significant improvement in our fiscal 2001 operating results as compared to fiscal 2000. Financial highlights included: - A 13.3% increase in comparable store net sales over the 53-week period ended February 3, 2001. - An 18% reduction in average inventory per store from $214,000 to $176,000 and an increase in average inventory turnover to 3.48x from 2.45x. - An 83% increase in Adjusted EBITDA to $35.5 million, or 11.6% of net sales. - An increase in net cash provided by operating activities to $37.5 million from $1.3 million. As evidenced by the improvement in our operating results, we believe these initiatives have positioned us to expand our proven retail concept and strengthen our position as a leading specialty retailer of home decor in the United States. KEY OPERATING STRENGTHS Our goal is to be the leading specialty retailer of home decor in each of our markets. We believe the following elements of our business strategy differentiate us from our competitors and position us for profitable growth: Item-Focused Merchandising. While our stores contain items covering a broad range of complementary product categories, we emphasize key items within our targeted categories rather than merchandising complete product classifications. Although we do not attempt to be a fashion leader, our 40 experienced buyers work closely with our vendors to identify and develop stylish merchandise reflecting the latest trends. We take a disciplined approach to test-marketing products and monitoring individual item sales, which enables us to identify and quickly reorder appropriate items in order to maximize sales of popular products. We also evaluate market trends and merchandise sales data to help us develop additional products to be made by our vendors and marketed in our stores, frequently on an exclusive basis. In most cases, this exclusive merchandise is the result of our buying team's experience in interpreting market and merchandise trends in a way that appeals to our customer. We estimate that over 60% of our merchandise is designed or packaged exclusively for Kirkland's, which distinguishes us in the marketplace and enhances our margins. Ever-Changing Merchandise Mix. We believe our ever-changing merchandise mix of over 5,000 SKUs creates an exciting "treasure hunt" environment, encouraging strong customer loyalty and frequent return visits to our stores. The merchandise in our stores is typically traditionally styled for broad market appeal, yet it reflects an understanding of our customer's desire for newness and freshness. Our information systems permit close tracking of individual item sales, enabling us to react quickly to both fast-selling and slow-moving items. Accordingly, we actively change our merchandise throughout the year in response to market trends, sales results, and changes in seasons. We also strategically increase selling space devoted to gifts and seasonal merchandise in advance of holidays. Stimulating Visual Presentation. Our stores have a distinctive, "interior design" look that helps customers visualize the merchandise in their own homes and inspires decorating and gift-giving ideas. Using multiple merchandise arrangements to simulate home settings, we group complementary merchandise creatively throughout the store, rather than displaying products strictly by category or product type. We believe this cross-category merchandising strategy encourages customers to browse for longer periods of time, promoting add-on sales. Strong Value Proposition. Our customers regularly experience the satisfaction of paying noticeably less for items similar or identical to those sold by other retail stores or through catalogs. This strategy of providing a unique combination of style and value is an important element in making Kirkland's a destination store. While we carry items in our stores that sell for several hundred dollars, most items sell for under $50 and are perceived by our customers as affordable luxuries. Our longstanding relationships with vendors and our ability to place large orders of a single item enhances our ability to attain favorable product pricing from vendors. Flexible Approach to Real Estate. Our stores operate successfully across a wide spectrum of different regions, market sizes and real estate venues. We operate our stores in 28 states, and over 40% of our stores are located outside the Southeast. We operate successfully in major metropolitan markets such as Houston, Texas and Atlanta, Georgia, middle markets such as Birmingham, Alabama and Buffalo, New York and smaller markets such as Appleton, Wisconsin and Panama City, Florida. In addition, although our stores are predominantly located in enclosed malls, we also operate successfully in non-mall venues, including selected outlet centers and strip centers. The flexibility of our concept enables us to select the most promising real estate opportunities that meet requisite economic and demographic criteria within our target markets. GROWTH STRATEGY Our growth strategy is to continue to build on our position as a leading specialty retailer of home decor in the United States by: Opening New Stores Using our Proven Store Model. Over the past five years, we have more than doubled our store base, principally through new store openings. We intend to continue opening new stores both in existing and new markets. We anticipate our growth will include mall and non-mall locations in major metropolitan markets, middle markets and in selected smaller communities. We believe there are currently more than 800 additional locations in the United States that could support a Kirkland's store. We expect to open approximately 15 new stores during fiscal 2002 and approximately 35 new stores during fiscal 2003. As of the date of this prospectus, we have opened two new stores in fiscal 2002. 41 Our proven store model produces strong store-level cash flow and provides an attractive store-level return on investment. In fiscal 2001, our average store generated net sales of approximately $1.3 million and store-level Adjusted EBITDA of approximately $227,000, or 17.4% of net sales. These results were relatively consistent across a wide spectrum of different regions, market sizes and real estate venues. Our stores typically achieve profitability in their first full year of operation. From 1997 to 2000, we opened 93 new stores and all but six produced positive store-level Adjusted EBITDA in their first full fiscal year. The average first full year cash return on investment of these stores was approximately 47%. For the stores we opened in fiscal 2000, our first year cash return on investment was significantly higher than the four-year average, which we believe is due largely to the improvements in management, systems and distribution instituted since late 1999. Increasing Store Productivity. We plan to increase our sales per square foot and store profitability by leveraging our recent investments in information systems and central distribution, which together contributed to our 18.5% increase in net sales and our 15.1% increase in average net sales per square foot in fiscal 2001. In fiscal 2001, we installed an advanced merchandise management system, relocated our central distribution operations to a more modern facility and increased the volume of centrally distributed merchandise. Furthermore, we believe that the sales productivity of our stores will benefit from our strong existing customer franchise and our continuing efforts to enhance the Kirkland's brand. Our distinctive and often proprietary merchandise offering, together with carefully coordinated in-store marketing, visual presentation and product packaging, enables us to establish a distinct brand identity and to solidify our bond with customers, further enhancing our store-level productivity. We also believe our comparable store sales will continue to benefit from the discretionary income available to consumers in their prime earning years as well as other consumer and demographic trends favoring home-oriented purchases. INDUSTRY OVERVIEW We compete in the U.S. home accessories and gifts market, which encompasses such varied product groups as candles, framed art, table top decoration, wall decor, figurines, decorative pillows, accent rugs and holiday merchandise. According to industry research, sales in the U.S. retail market for decorative home accessories and gifts were approximately $55 billion in 2000. Within this market, we estimate that sales in the principal product categories carried by our stores were approximately $29 billion in 2000. We believe that the industry will continue to benefit from the following characteristics and trends: Highly Fragmented Industry. The market for home furnishings is highly fragmented with no single company holding a dominant market position. The market includes numerous smaller specialty retailers, as well as department stores, larger mass merchandisers and home furnishings stores, with department stores commanding a decreasing percentage of the home furnishings industry compared to specialty retailers. Favorable Demographic Trends. The U.S. Census Bureau reports that the percentage of the U.S. population represented by people between the ages of 40 and 64 was approximately 30.9% at July 1, 2001 and is expected to increase to approximately 32.7% by 2005. We believe that our industry will benefit as individuals in this group become homeowners (and second home-owners) and reach their peak earnings potential. New and existing single family home sales have been steadily increasing since 1995 and reached a record 6.15 million homes in 2001. Increased Lifestyle Focus on Home and Family. The "cocooning" trend continues to have a significant impact on our market. More consumers have been retreating to their homes to spend more time with family and friends, new home-related magazines have seen increased circulation and television programming related to the home has been increasing. Value-Focused Retailing. We believe that consumers are increasingly seeking retailers who offer value. For example, between 1995 and 2000, retail sales in discount department stores grew at a compounded annual rate of 8.9% compared to 2.1% for conventional department store chains, according to 42 the U.S. Census Bureau. We believe that this consumer-driven emphasis on value should continue to positively impact our growth opportunity. MERCHANDISING Merchandising Strategy. Our merchandising strategy is to (i) offer distinctive, and often exclusive, high quality home decor at affordable prices, (ii) maintain a breadth of product categories, (iii) provide a carefully edited selection of key items within targeted categories, rather than merchandising complete product classifications, (iv) emphasize new and fresh merchandise by continually updating our merchandise mix and (v) present merchandise in a visually appealing manner to create an inviting atmosphere which inspires decorating and gift-giving ideas. We believe that this strategy creates a shopping experience that appeals to shoppers, both style-conscious and price-conscious. Although we do not attempt to be a fashion leader, we identify and capitalize on existing or emerging trends when identifying or developing merchandise for sale. Our information systems permit close tracking of individual item sales, which enables us to react quickly to market trends and best sellers. As a result, we minimize the accumulation of slow-moving inventory and resulting markdowns. Regional differences in home decor are addressed by tailoring inventories to geographic considerations and store net sales results. We continuously introduce new and often exclusive products to our merchandise assortment in order to (i) maintain customer interest due to the freshness of our product selections, encouraging frequent return visits to our stores, (ii) enhance our reputation as a leader in identifying or developing high quality, fashionable products and (iii) allow merchandise which has peaked in sales to be quickly discontinued and replaced by new items. In addition, we strategically increase selling space devoted to gifts and holiday merchandise during the third and fourth quarters of the calendar year. Our flexible store design and layout allow for selling space changes as needed to capitalize on selling trends. While our stores generally carry over 5,000 SKUs, we are constantly monitoring the sell-through on each item and are typically reordering approximately 2,500 active SKUs at any point in time. The make-up of our active SKUs is likewise constantly changing based on changes in selling trends. New and different SKUs are introduced to our stores on a weekly or more frequent basis, and a substantial portion of the inventory carried in our stores is replaced with new SKUs every few months. We purchase merchandise from approximately 200 vendors, and our buying team works closely with many of these vendors to differentiate Kirkland's merchandise from that of our competitors. We estimate that over 60% of our merchandise assortment is designed or packaged exclusively for Kirkland's, generally based on our buyers' experience in modifying certain merchandise characteristics or interpreting market trends into a product and price point that will appeal to our customer. For products that are not manufactured specifically for Kirkland's, we may create custom packaging as a way to differentiate our merchandise offering and reinforce our brand names. Exclusive or proprietary products distinguish us from our competition, enhance the value of our merchandise, and improve our net sales and gross margin. We market a substantial portion of our exclusive or custom-packaged merchandise assortment under the Cedar Creek private label brand and other proprietary names. Our strategy is to continue to grow our exclusive and proprietary products and custom-packaged products within our merchandise mix. Product Assortment. Our major merchandise categories include wall decor (framed art and mirrors), lamps, candles and various holders, photo frames, textiles, garden accessories, floral products and decorative accessories. Our stores also offer an extensive assortment of holiday merchandise, as well as items carried throughout the year suitable for giving as gifts. Consistent with our item-focused strategy, a vital part of the product mix is a variety of home decor and other assorted merchandise that does not necessarily fit into a specific product category. Decorative accessories consist of such varied products as sconces, vases, and clocks. Other merchandise includes accent furniture, novelty items and housewares. Throughout the year and especially in the fourth quarter of the calendar year, our buying team uses its experience in home decor to develop products that are as appropriate for gift-giving as they are for personal purchase. Innovative product design and packaging are important elements of this effort. 43 The following table presents the percentage of fiscal 2001 net sales contributed by our major merchandise categories:
PERCENTAGE OF FISCAL 2001 MERCHANDISE CATEGORY NET SALES - -------------------- ------------- Wall Decor (including framed art and mirrors)............................... 24% Holiday.................................. 11 Lamps.................................... 11 Decorative Accessories................... 10 Garden................................... 10 Candles.................................. 9 Floral................................... 5 Frames................................... 5 Other.................................... 15 --- Total............................... 100% ===
Value to Customer. Through our distinctive merchandising, together with carefully coordinated in-store marketing, visual presentation and product packaging, we continually strive to increase the perceived value of our products to our customers. Our shoppers regularly experience the satisfaction of paying noticeably less for items similar or identical to those sold by other retail stores or through catalogs. Our stores typically have two semi-annual clearance events, one in January and one in July. We also run category promotions periodically throughout the year. We believe our value-oriented pricing strategy, coupled with an adherence to high quality standards, is an important element in establishing our distinct brand identity and solidifying our connection with our customers. STORE OPERATIONS General. We currently operate 236 stores in 28 states, all of which are open seven days a week. In addition to corporate management, five Regional Managers and 27 District Managers (who generally have responsibility for eight to ten stores within a geographic district) manage store operations. A Store Manager and one or two Assistant Store Managers manage individual stores. The Store Manager is responsible for the day-to-day operation of the store, including sales, merchandise display and control, personnel functions, and store security. A typical store has one full-time sales associate, one full-time stock person and six to 12 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 of the calendar year. Format. The prototype Kirkland's store is between 4,200 and 4,800 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 Merchandising and Store Operations personnel. This procedure ensures uniform display standards throughout the chain. Using multiple types of fixtures, we group complementary merchandise creatively throughout the store, rather than displaying products strictly by category or product type. Visual Merchandising. Because of the nature of our merchandise and our focus on identifying and developing best-selling items, we believe adherence to our visual merchandising standards is an important responsibility of our store and field supervisory management. We emphasize visual merchandising in our training efforts and our dedicated team of visual merchants provides valuable leadership and support to this aspect of Store Operations. 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 Visual Merchandising team also assists 44 Regional Managers and District Managers in opening new stores. We believe effective and consistent visual merchandising enhances a store's ability to reach its full sales potential. Personnel Recruitment and Training. We believe our continued success is dependent in part on our ability to attract, retain and motivate quality employees. In particular, the success of our expansion program depends on our ability to promote and/or recruit qualified District and Store Managers and maintain quality sales associates. To date, the majority of our District Managers previously have been Kirkland's Store Managers. A nine-week training program is provided for new District Managers. Store Managers and Assistant Managers, many of whom begin their Kirkland's career as sales associates, currently complete a formal training program before taking responsibility for a store. This training program includes five to 10 days in a designated "training store," working directly with a qualified Store Manager. District Managers are primarily responsible for recruiting new Store Managers. Store Managers are responsible for the hiring and training of new sales associates, assisted where appropriate by a full-time recruiter. We constantly look for motivated and talented people to promote from within Kirkland's, in addition to recruiting from outside Kirkland's. Compensation and Incentives. We compensate our Regional, District and Store Managers with a base salary plus a quarterly performance bonus based on store sales and store-level profit contribution. Sales associates are compensated on an hourly basis. In addition, we regularly run a variety of contests that reward associates for outstanding sales achievement. BRIAR PATCH In July 1998, we acquired The Briar Patch Management Corporation, a specialty retailer of home accessories and gifts based in Savannah, Georgia. Briar Patch operated 35 stores in six southeastern states primarily in markets that were smaller than Kirkland's markets. We applied our merchandising expertise, management, operational disciplines and financial resources to improve the performance of these stores. Under our management, the average net sales per Briar Patch store increased 34% to $1.1 million for fiscal 2001 from approximately $800,000 in the first 12 full months that we owned the stores (August 1998 through July 1999). Furthermore, the store-level profitability of the Briar Patch stores in fiscal 2001 was approximately the same as the store-level profitability of the other Kirkland's stores. We currently operate the Briar Patch stores under the name "Briar Patch by Kirkland's." These stores are operated and merchandised in the same fashion as our stores operated under the "Kirkland's" name. As these stores are remodeled or relocated, we intend to change the name of these stores to "Kirkland's." As of the date of this prospectus, five of the 35 stores acquired from Briar Patch have been remodeled or relocated and are now operating under the "Kirkland's" name, and two of the 35 stores have been closed. REAL ESTATE Strategy. Our real estate strategy is to identify retail properties that are convenient and attractive to our target female customer. The flexibility and broad appeal of our stores and our merchandise allows us to operate successfully in major metropolitan markets such as Houston, Texas and Atlanta, Georgia middle markets such as Birmingham, Alabama and Buffalo, New York and smaller markets such as Appleton, Wisconsin and Panama City, Florida. Site Selection. We locate our stores in enclosed malls or non-mall venues which are destinations for large numbers of shoppers and which reinforce our quality image and brand. To assess potential new locations, we review financial and demographic criteria and analyze the quality of tenants and competitive factors, square footage availability, frontage space and other relevant criteria to determine the overall acceptability of a property and the optimal locations within it. Until recent years, we preferred to locate stores in regional or super-regional malls with a history of high sales per square foot and multiple national department stores as anchors, and generally we sought approximate store frontage of 35 to 40 feet on average. Today, we operate 217 of our 236 stores in 45 enclosed malls, but our flexible store format has allowed us to successfully operate stores in a variety of venues including outlet centers, "lifestyle" strip centers and community strip centers. We believe we are a desirable tenant to developers because of our long and successful operating history, sales productivity, ability to attract customers and our strong position in the home decor category. The following table provides a history of our store openings and closings since the beginning of fiscal 1997.
FISCAL FISCAL FISCAL FISCAL FISCAL 1997 1998 1999 2000 2001(1) ------ ------ ------ ------ ------- Stores open at beginning of period...... 120 138 198 226 240 New stores opened(2).................... 20 27 29 17 5 Briar Patch stores acquired............. -- 35 -- -- -- Stores closed........................... (2) (2) (1) (3) (11) ----- ----- ----- ----- ----- Stores open at end of period............ 138 198 226 240 234 Average gross square footage per store(3).............................. 4,186 4,392 4,364 4,437 4,528
- ------------------------------ (1) Also includes the period beginning on January 1, 2001 and ending on February 3, 2001. (2) Excludes our warehouse outlet store located adjacent to our central distribution facility in Jackson, Tennessee. (3) 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. PURCHASING AND INVENTORY MANAGEMENT Merchandise Sourcing and Product Development. Our merchandise team purchases inventory on a centralized basis to take advantage of our technology and our consolidated buying power and to closely control the merchandise mix in our stores. Our buying team selects all of our products, negotiates with all of our vendors and works closely with our planning and allocation team to optimize store-level merchandise mix by category, classification and item. The seven members of our buying team have an average of 14 years of retail experience, and four of the seven have tenure with Kirkland's ranging from eight to 33 years. We believe this level of experience gives us a competitive advantage in understanding our customer and identifying or developing merchandise suitable to her tastes and budget. We estimate that over 60% of our merchandise assortment is designed or packaged exclusively for Kirkland's, generally based on our buyers' experience in modifying certain merchandise characteristics or interpreting market trends into a product and price point that will appeal to our customer. The amount of exclusively designed or packaged merchandise continues to grow annually. Non-exclusive merchandise is often boxed or packaged exclusively for Kirkland's utilizing Kirkland's proprietary brands. We purchase merchandise from approximately 200 vendors. Approximately 75% of our total purchases are from importers of merchandise manufactured primarily in the Far East and India, with the balance purchased from domestic manufacturers and wholesalers. For our purchases of merchandise manufactured abroad, we believe buying from importers or U.S.-based representatives of foreign manufacturers rather than directly from foreign manufacturers enables us to maximize flexibility and minimize product liability and credit risks. Further, we believe our 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 our stores. For certain categories and items, the strategic use of domestic manufacturers and wholesalers enables us to reduce the lead times between ordering products and offering them in our stores. Planning and Allocation. Our merchandise planning and allocation team works closely with our buying team, field management and store personnel to meet the requirements of individual stores for appropriate merchandise in sufficient quantities. This team also manages inventory levels, allocates merchandise to stores and replenishes inventory based upon information generated by our management information systems. Our inventory control systems monitor current inventory levels at each store and for our operations as a whole. If necessary, we can shift slow-moving inventory to other stores for sell-through 46 prior to instituting corporate-wide markdowns. We also continually monitor recent selling history within each store by category, classification and item to properly allocate further purchases to maximize sales and gross margin. Each of our stores is internally classified for merchandising purposes based on certain criteria including store sales, size, location and historical performance. Although all of our 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. In April 2001, we installed a state-of-the-art merchandise management system improving the efficiency of our planning and allocation process. This system provides our buyers and planners with daily information on sales, gross margin and inventory by category, classification and item. This information is available for each store, permitting our planners to assess merchandise trends and manage inventory levels and flow at the individual store level. DISTRIBUTION Prior to fiscal 2000, we distributed our products primarily through direct shipments from our vendors to each of our individual stores. Inventory backstock was held both in the store's stockroom and in local storage facilities managed by each Store Manager. We maintained a modest central distribution capability in Jackson, Tennessee through a collection of low-cost warehouses to process certain merchandise shipments and to hold inventory for new store openings. As our store base grew, this legacy distribution system became cumbersome and inefficient, and we recognized the need to develop a more scalable central distribution strategy to permit greater inventory control and to reduce freight costs. During fiscal 2000, we began working with Kurt Salmon & Associates, a leading supply chain consulting firm, to improve our distribution practices and to formulate a long-term distribution strategy. In March 2001, we consolidated our central distribution operations into one modern, 303,000-square-foot facility in Jackson, Tennessee, which allowed us to increase our dollar volume of centrally distributed merchandise by 24% from fiscal 2000 to fiscal 2001. In fiscal 2001, we distributed approximately 62% of our merchandise purchases centrally while the remaining 38% of our purchases were shipped directly from vendors to our stores. Central distribution offers a number of important benefits. In addition to allowing us to reduce freight costs and to manage the flow of merchandise to our stores more efficiently, central distribution allows us to increase the percentage of our purchases that are pre-ticketed by vendors (approximately 90% as of April 2002). Increased use of central distribution has enabled us to significantly reduce the use of costly local storage facilities, which our stores traditionally have used to store surplus inventory, and has also resulted in reduced truck rental costs. Our overall distribution expense decreased as a percentage of net sales from 6.5% in fiscal 2000 to 5.7% in fiscal 2001. We will seek to expand our proportion of centrally distributed merchandise to 90% by fiscal 2005, which we believe will facilitate further reductions in our use of local storage facilities during fiscal 2002 and fiscal 2003. We believe that our existing distribution facilities provide us with adequate distribution capacity at least until fiscal 2004. As we continue to capitalize on the benefits of central distribution, we will continue to take advantage of the benefits that direct shipment capability offers, such as maximizing sales during the late fall season. E-COMMERCE We believe the Internet offers opportunities to complement our "brick-and-mortar" stores and to increase our retail commerce and consumer brand awareness of our products. We maintain a web site at www.kirklands.com, which provides our customers with a resource to locate a store, preview our merchandise and purchase products online. We sell a modest amount of merchandise through our web site and we have a small customer service department to handle e-mail and phone inquiries from our store and 47 e-commerce customers. The information contained or incorporated in our web site is not a part of this prospectus. MANAGEMENT INFORMATION SYSTEMS We have invested significant resources developing an information systems infrastructure to support our business. These investments included $6.5 million of software and hardware replacements or upgrades since late 1999. Recent projects included new point-of-sale (POS) software and servers in all stores (fiscal 1999), integrated retail management software at our home office (fiscal 2001) and an upgrade of POS hardware in approximately two-thirds of our stores (fiscal 2001/fiscal 2002). We believe these newly enhanced systems provide our key decision makers, both in stores and at our home office, with the timely information needed to drive our sales and profitability. Our store information systems include a server in each store that runs our automated POS application on multiple POS registers. The server provides managers with convenient access to detailed sales and inventory information for the store. Our POS registers provide price look-up (all merchandise is bar-coded), time and attendance and automated check and credit card processing. Through automated nightly two-way electronic communication with each store, we upload SKU-level sales, gross margin information and payroll hours to our home office system and download new merchandise pricing, price changes for existing merchandise, purchase orders and system maintenance tasks to the store server. Based upon the evaluation of information obtained through daily polling, our planning and allocation team implements merchandising decisions regarding inventory levels, reorders, price changes and allocation of merchandise to our stores. The core of our home office information system is the integrated GERS retail management software installed in April 2001. This system integrates all merchandising and financial applications, including category, classification and SKU inventory tracking, purchase order management, automated ticket making, general ledger, sales audit, accounts payable and fixed asset management. Our distribution center also uses certain elements of the GERS software package. We utilize a Lawson Software package for our payroll and human resource functions. MARKETING Our marketing efforts emphasize in-store signage, store and window banners and displays and other techniques to attract customers and provide an exciting shopping experience. Historically, we have not engaged in extensive media advertising because we believe that we have benefited from our strategic locations in high-traffic shopping malls and valuable "word-of-mouth" advertising by our customers. Many shopping mall leases historically required 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. We supplement our in-store marketing efforts with periodic local newspaper advertisements to promote specific events in our stores, including our semi-annual clearance events. TRADEMARKS All of our stores operate under the name "Kirkland's" other than 28 stores which operate under the name "Briar Patch by Kirkland's." We acquired these stores in 1998. As these stores are remodeled or relocated, we intend to change the name of these stores to the "Kirkland's" name. We registered our "Kirkland's" logo with the United States Patent and Trademark Office on the Principal Register. In addition, we hold several trademark registrations in connection with our Cedar Creek private label brand as well as a registration of "the Kirkland Collection." We believe the "Kirkland's" logo, "the Kirkland Collection" and the Cedar Creek private label brand have become important components in our merchandising and marketing strategy. We also claim common law trademark rights in Briar Patch, Kirkland's Outlet, Kirkland's Home and other marks. We are exploring the possibility of 48 federal registration of several of these marks. We are not aware of any claims of infringement or other challenges to our right to use our marks in the United States. COMPETITION The retail market for home decor is highly competitive. Accordingly, we compete with a variety of specialty stores, department stores, discount stores and catalog retailers that carry merchandise in one or more categories also carried by our stores. Our product offerings also compete with a variety of national, regional and local retailers, including such specialty retailers as Bed, Bath & Beyond, Cost Plus, Linens 'n Things, Michaels Stores, Pier 1 Imports and Williams-Sonoma. We believe that the principal competitive factors influencing our business are merchandise quality and selection, price, visual appeal of the merchandise and the store and the convenience of location. Although we face competition from a broad range of retailers, we believe that few competitors focus exclusively on home decor, primarily in a mall environment. Specialty retailers tend to have higher prices and a narrower assortment of products than our stores. Department stores typically have higher prices than our stores for similar merchandise. Wholesale clubs may have lower prices than our stores, but the product assortment is generally considerably more limited. The number of companies offering a selection of home decor products that overlaps generally with our product assortment has increased over the last five years. However, we believe that our stores still occupy a distinct niche in the marketplace: traditionally styled merchandise, reflective of current market trends typically offered at a discount to catalog and department store prices. We believe we compete effectively with other retailers due to our experience in identifying a broad collection of distinctive merchandise, pricing it to be attractive to the target Kirkland's customer and presenting it in a visually appealing manner. In addition to competing for customers, we compete with other retailers for suitable store locations and qualified management personnel. Many of our competitors are larger and have substantially greater financial, marketing and other resources than we do. See "Risk Factors - We face an extremely competitive specialty retail business market." PROPERTIES We lease all of our store locations and expect to continue our policy of leasing rather than owning. Our leases typically provide for 10-year terms, many with the ability for Kirkland's (or the landlord) 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 key ancillary charges is generally capped. As current leases expire, we believe we 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, we have not experienced unusual difficulty in either renewing leases for existing locations or securing leases for suitable locations for new stores. A majority of our store leases contain provisions permitting the landlord to terminate the lease upon a change in control of Kirkland's. We own our corporate headquarters in Jackson, Tennessee, which currently consists of approximately 40,000 square feet of office space. We lease our 303,000-square-foot distribution center, also located in Jackson, Tennessee. 49 The following table indicates the states and cities where our stores are located and the number of stores within each state: ALABAMA(14) Auburn Birmingham Decatur Dothan Florence Gadsden Hoover Huntsville Mobile Montgomery(2) Oxford Prattville Tuscaloosa ARKANSAS(3) Fayetteville Little Rock North Little Rock FLORIDA(31) Altamonte Springs Boynton Beach Bradenton Brandon Clearwater Coral Springs Daytona Beach Destin Ft. Myers Gainesville Jacksonville(2) Lake Wales Mary Esther Naples Ocoee Orange Park Oviedo Panama City Pembroke Pines Pensacola Sanford Sarasota Sebring St. Petersburg Sunrise Tallahassee Tampa(3) Vero Beach GEORGIA(21) Albany Alpharetta Athens Atlanta(2) Augusta Buford Columbus Commerce Douglasville Duluth Kennesaw Lithonia Macon(2) Morrow Peachtree City Rome Savannah(2) Valdosta ILLINOIS(6) Aurora Bloomington Fairview Heights Gurnee Moline Orland Park INDIANA(7) Evansville Ft. Wayne Greenwood Indianapolis Lafayette Mishawaka Terre Haute IOWA(4) Cedar Rapids Coralville Davenport West Des Moines KANSAS(4) Leawood Overland Park Topeka Wichita KENTUCKY(7) Bowling Green Florence Lexington Louisville(2) Owensboro Paducah LOUISIANA(10) Baton Rouge(2) Gretna Houma Kenner Lafayette Lake Charles Monroe Shreveport Slidell MARYLAND(5) Baltimore Frederick Glen Burnie Hanover Waldorf MICHIGAN(3) Auburn Hills Grandville Okemos MISSISSIPPI(10) Biloxi Columbus Flowood Greenville Hattiesburg Jackson McComb Meridian Ridgeland Tupelo MISSOURI(3) Joplin Springfield St. Louis NEBRASKA(1) Lincoln NEW JERSEY(1) Elizabeth NEW MEXICO(2) Albuquerque(2) NEW YORK(2) Buffalo West Nyack NORTH CAROLINA(16) Asheville Cary Charlotte Concord Durham(2) Fayetteville Greensboro(2) Hickory High Point Pineville Raleigh Rocky Mt. Wilmington Winston-Salem OHIO(10) Akron Beaver Creek Canton Cincinnati(2) Dublin Niles Parma St. Clairsville Youngstown OKLAHOMA(2) Oklahoma City Tulsa PENNSYLVANIA(6) Altoona Camp Hill Erie Exton Lancaster Pittsburgh SOUTH CAROLINA(11) Anderson Bluffton Charleston(2) Columbia(3) Florence Greenville Myrtle Beach Spartanburg TENNESSEE(14) Chattanooga Clarksville Franklin Goodlettsville Jackson Johnson City Knoxville(2) Memphis(3) Nashville(2) Sevierville TEXAS(27) Amarillo Arlington Austin Cedar Park Corpus Christi El Paso Friendswood Frisco Grapevine Houston(4) Humble Hurst Katy Lubbock McAllen Mesquite Midland Plano San Antonio San Marcos Sugar Land The Woodlands Tyler Waco VIRGINIA(11) Charlottesville Chesapeake Colonial Heights Dulles Glen Allen Lynchburg Newport News Norfolk Richmond Roanoke Winchester WEST VIRGINIA(3) Barboursville Bridgeport Charleston WISCONSIN(2) Appleton Eau Claire EMPLOYEES We employed approximately 1,600 full-time and approximately 2,200 part-time employees at December 1, 2001. Of these, approximately 200 were corporate and warehouse center personnel and 3,600 were store employees. The number of part-time employees fluctuates with seasonal needs. None of our employees is covered by a collective bargaining agreement. We believe our employee relations are good. LEGAL PROCEEDINGS We are involved in various routine legal proceedings incidental to the conduct of our business. We believe any resulting liability from existing legal proceedings, individually or in the aggregate, will not have a material adverse effect on our operations or financial condition. 50 MANAGEMENT DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES Our directors, executive officers and key employees and their respective ages as of February 2, 2002, are as follows:
NAME AGE POSITION ---- --- -------- DIRECTORS AND EXECUTIVE OFFICERS: Carl Kirkland(a)............. 61 Chairman of the Board Robert E. Alderson........... 55 President, Chief Executive Officer and Director Reynolds C. Faulkner......... 38 Executive Vice President, Chief Financial Officer and Director H.R. Harvey.................. 44 Senior Vice President of Merchandising C. Edmond Wise, Jr........... 51 Senior Vice President of Store Operations Alexander S. McGrath......... 40 Director David M. Mussafer(a)......... 38 Director R. Wilson Orr, III(a,b)...... 39 Director John P. Oswald(b)............ 42 Director Murray Spain(b).............. 58 Director KEY EMPLOYEES: Chris T. LaFont.............. 41 Vice President of Merchandising - Product Development Grey W. Satterfield.......... 39 Vice President of Merchandising - Planning Toni F. Warren............... 46 Vice President of Merchandising - Replenishment James W. Harris.............. 55 Vice President of Operations and Personnel Deborah A. McDonald.......... 35 Vice President of Visual Merchandising Connie L. Scoggins........... 47 Vice President of Finance and Treasurer/ Controller Lowell E. Pugh, II........... 45 Vice President and General Counsel
- --------------- (a) Member of Compensation Committee (b) Member of Audit Committee DIRECTORS AND EXECUTIVE OFFICERS Carl Kirkland has been Chairman of the Board since June 1996. Mr. Kirkland co-founded Kirkland's in 1966 and served as Chief Executive Officer from 1966 through March 2001 and President from 1966 through November 1997. 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 a Director of Kirkland's since September 1986, President of Kirkland's since November 1997 and Chief Executive Officer of Kirkland's since March 2001. He served as Chief Operating Officer of Kirkland's from November 1997 through March 2001 and as Senior Vice President of Kirkland's since joining in 1986 through November 1997. He also served as Chief Administrative Officer of Kirkland's from 1986 to 1997. Prior to joining Kirkland's, he was a senior partner at the law firm of Menzies, Rainey, Kizer & Alderson. Reynolds C. Faulkner has been a Director of Kirkland's since September 1996 and joined Kirkland's as Senior Vice President and Chief Financial Officer in February 1998. He was promoted to Executive Vice President in February 2002. Prior to joining Kirkland's, from July 1989 to January 1998, 51 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. H.R. Harvey has been Senior Vice President of Merchandising since joining Kirkland's in June 2001. Prior to joining Kirkland's, Mr. Harvey was Vice President of Merchandising at Homeplace of America from July 2000 to June 2001 and Senior Vice President of Merchandising at Saks Incorporated from February 1996 to July 2000. Prior to that, he was with Federated Department Stores for over 16 years, most recently as Merchandising Vice President. C. Edmond Wise, Jr. has been Senior Vice President of Store Operations since joining Kirkland's in December 2000. Prior to joining Kirkland's, Mr. Wise was a Director of Retail Operations for Payless ShoeSource from October 1998 to November 2000. Prior to that, Mr. Wise had 26 years of retail operations experience, including eight years with Edison Brothers Stores from October 1990 to October 1998. Alexander S. McGrath has been a director of Kirkland's 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 Kirkland's. 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 and Selling Shareholders." David M. Mussafer has been a Director of Kirkland's since June 1996. Mr. Mussafer is currently a Managing Director of Advent International Corporation and is responsible for Advent's North American private equity operations. Advent is a private equity investment firm which beneficially owns common stock of Kirkland's through its interests in certain members of Kirkland Holdings L.L.C., one of Kirkland's principal shareholders. Mr. Mussafer joined Advent in 1991 and has been a principal of the firm since 1993. Prior to joining Advent, Mr. Mussafer worked as a Vice President in corporate lending at Chemical Bank from 1985 to 1988. See "Principal and Selling Shareholders." R. Wilson Orr, III has been a Director of Kirkland's since June 1996. Since 1993, Mr. Orr has been a principal of SSM Corporation, a private equity investment firm and an affiliate of SSM Venture Partners, L.P. which is a member of Kirkland Holdings L.L.C., one of Kirkland'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 and Selling Shareholders." John P. Oswald has been a Director of Kirkland's 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 Kirkland's principal shareholders. Mr. Oswald is a beneficial owner of Capital Trust Investments, Ltd., a warrantholder of and subordinated lender to Kirkland's. He is also President and Chief Executive Officer of Bridge East Capital, a private equity investment partnership, which is an affiliate of the Capital Trust Group. Prior to joining Capital Trust Group 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 and Selling Shareholders." Murray Spain has been a Director of Kirkland's since September 2001. In September 2000, Mr. Spain co-founded World Wide Basics, an importer of general merchandise, and has served as its President since inception. Prior to this, he was the co-founder of Dollar Express, Inc. and acted as Dollar Express's President and Chief Operating Officer from its inception in 1961 until May 2000, when Dollar Express merged with Dollar Tree Stores, Inc. At that time, Dollar Express was a chain of 126 retail stores in 5 states. Mr. Spain was not working from May to September 2000. 52 KEY EMPLOYEES Chris T. LaFont has been Vice President of Merchandising since September 1997. Mr. LaFont is responsible for all merchandise buying decisions for Kirkland's. From 1988 to September 1997, he served as Vice President of Visual Merchandising for Kirkland's. Mr. LaFont started his career with Kirkland's in 1981 as a management trainee. Grey W. Satterfield has been Vice President of Merchandising since joining Kirkland's in January 2000. Mr. Satterfield is responsible for merchandise planning and inventory management efforts, including receipt flow management and the maintenance of all open-to-buy reports. Prior to joining Kirkland's, Mr. Satterfield was with Saks Incorporated from October 1996 to December 1999, most recently as Vice President of Product Development. Prior to that, Mr. Satterfield had nine years of buying experience with the Macy's and Federated Stores organizations. Toni F. Warren has been Vice President of Merchandising since January 2000. Ms. Warren is responsible for merchandise allocation and replenishment. Ms. Warren has been with Kirkland's for over 30 years and her experience includes 16 years in store operations and 14 years in purchasing, allocation and merchandise information systems. 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 Kirkland's, Mr. Harris was with Goldsmith's, a division of Federated Department Stores, from 1972 to 1987, where he held various positions in store operations. Deborah A. McDonald has been Vice President of Visual Merchandising since August 2000 and has been with Kirkland's since 1984. She has served as Store Manager, Corporate Specialist and most recently as Director of Visual Merchandising. Ms. McDonald is responsible for creation and implementation of all visual merchandising plans for new and existing stores. Connie L. Scoggins has been Vice President of Finance since January 2000. Ms. Scoggins has been with Kirkland's since 1986 serving as Treasurer and Controller. Prior to joining Kirkland's, Ms. Scoggins was employed by Owens Corning Fiberglass as Accounting Manager. Lowell E. Pugh, II, has been a Vice President since January 2000. He has also served as Secretary since November 1997. Mr. Pugh joined Kirkland's in August 1996 and has served since that time as Assistant Vice President and General Counsel. Prior to that Mr. Pugh served as General Counsel to United Foods, Inc., and prior to that he was a partner with Johnson & Gibbs, a Dallas, Texas law firm. CLASSIFIED BOARD OF DIRECTORS Upon completion of this offering, our Board of Directors 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 our shareholders. The terms of Messrs. McGrath, Orr and Oswald will expire in 2003, the terms of Messrs. Faulkner and Spain will expire in 2004 and the terms of Messrs. Kirkland, Alderson and Mussafer will expire in 2005. A classified board of directors may have the effect of deterring or delaying any attempt by any person or group to obtain control of us 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 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 - Our charter and bylaw provisions and certain provisions of Tennessee law may make it difficult in some respects to cause a change in control of Kirkland's and replace incumbent management." 53 DIRECTOR COMPENSATION To date, directors who are affiliated with us or any of our shareholders have not received separate compensation for their services in that capacity. In the future, we intend to compensate our non-employee directors. The amount of such compensation has not been determined but will be consistent with amounts paid by comparable public companies. COMMITTEES OF THE BOARD The audit committee of the Board of Directors is composed of Messrs. Orr, Oswald and Spain. The principal functions of the audit committee include: - making recommendations to the Board of Directors regarding the selection of our independent public accountants to audit annually our books and records; - reviewing the proposed scope of each audit; - meeting periodically with the independent public accountants and our Chief Financial Officer to review matters relating to our financial statements, our accounting principles and our system of internal accounting controls; and - reporting its recommendations as to the approval of our financial statements to the Board of Directors. The compensation committee of the Board of Directors is composed of Messrs. Kirkland, Mussafer and Orr. The compensation committee is responsible for establishing the salaries of our executive officers, incentives and other forms of compensation and for administering our employee benefit plans. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Other than Carl Kirkland, the members of the compensation committee of the Board of Directors, Messrs. Mussafer and Orr, have not at any time served as officers or employees of Kirkland's, but are affiliated with entities that participated in our 1996 recapitalization, in subsequent equity financings and in the Pre-Offering Transactions. We rent aircraft for business travel from a company owned by Carl Kirkland. We spent $23,000 for the rental of aircraft from this company for fiscal 2001, $92,000 in fiscal 2000 and $63,000 in fiscal 1999. See "Certain Transactions." None of our executive officers presently serves, or in the past has served, on the board of directors or compensation committee of any other entity that has an executive officer who is serving, or who in the past has served, as a member of our Board of Directors or our compensation committee. 54 EXECUTIVE COMPENSATION The following table sets forth certain compensation information with respect to our Chief Executive Officer and our other executive officers whose salary and bonus exceeded $100,000 for our fiscal year ended February 2, 2002 (the "Named Executive Officers"): SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION ------------ AWARDS ANNUAL COMPENSATION ------------ ------------------------------------------------------- SECURITIES ALL OTHER OTHER ANNUAL UNDERLYING COMPENSATION NAME AND PRINCIPAL POSITION FISCAL YEAR SALARY($) BONUS($) COMPENSATION($)(4) OPTIONS(#) ($)(5) - --------------------------- ----------- --------- -------- ------------------ ------------ ------------ Carl Kirkland............. 2001 103,125 -- -- -- 867 Chairman of the Board(1) Robert E. Alderson........ 2001 275,000 40,000 -- 2,500 867 President and Chief Executive Officer(2) Reynolds C. Faulkner...... 2001 226,250 40,000 -- 1,000 867 Executive Vice President and Chief Financial Officer H.R. Harvey............... 2001 140,625 30,000 -- 550 -- Senior Vice President of Merchandising(3) C. Edmond Wise, Jr........ 2001 176,250 30,000 37,855 550 -- Senior Vice President of Store Operations
- ------------------------------ (1) Mr. Kirkland also served as our Chief Executive Officer until March 2001. (2) Mr. Alderson became our Chief Executive Officer in March 2001. Mr. Alderson also served as our Chief Operating Officer until March 2001. (3) Mr. Harvey became our Senior Vice President of Merchandising in June 2001. (4) Amounts for Mr. Wise consists of $30,655 in relocation expenses and $7,200 in automobile allowance. (5) Represents amounts contributed under our 401(k) plan for the benefit of Messrs. Kirkland, Alderson and Faulkner. STOCK OPTIONS GRANTED TO CERTAIN EXECUTIVE OFFICERS DURING FISCAL YEAR 2001 The following table sets forth certain information regarding options for the purchase of common stock that were awarded to our Named Executive Officers during the fiscal year ended February 2, 2002: OPTION GRANTS IN FISCAL 2001
POTENTIAL REALIZABLE VALUE AT ASSUMED PERCENT OF ANNUAL RATES OF STOCK NUMBER OF TOTAL PRICE SECURITIES OPTIONS APPRECIATION FOR UNDERLYING GRANTED EXERCISE OR OPTION TERM($)(2) OPTIONS TO EMPLOYEES BASE PRICE EXPIRATION --------------------- NAME GRANTED(#)(1) IN FISCAL 2001 ($/SH) DATE 5% 10% - ---- ------------- -------------- ----------- ---------- --------- --------- Carl Kirkland............ -- -- -- -- Robert E. Alderson....... 2,500 27% $71.00 11/29/2011 $111,629 $282,889 Reynolds C. Faulkner..... 1,000 11% $71.00 11/29/2011 $ 44,652 $113,156 H.R. Harvey.............. 550 6% $71.00 11/29/2011 $ 24,558 $ 62,236 C. Edmond Wise, Jr....... 550 6% $71.00 11/29/2011 $ 24,558 $ 62,236
55 - ------------------------------ (1) These options will become exercisable as to 33% of such shares on the first anniversary of the option grant date and then will become exercisable for an additional 8.33% on each of our next eight quarter ends. (2) These amounts represent assumed rates of appreciation in the price of our common stock during the terms of the options in accordance with rates specified in applicable federal securities regulations. Actual gains, if any, on stock option exercises will depend on the future price of our common stock and overall stock market conditions. There is no representation that the rates of appreciation reflected in this table will be achieved. STOCK OPTIONS EXERCISED BY CERTAIN EXECUTIVE OFFICERS DURING FISCAL 2001 AND YEAR-END OPTION VALUES. The following table sets forth certain information regarding options for the purchase of common stock that were held by our Named Executive Officers during the fiscal year ended February 2, 2002. None of the Named Executive Officers exercised stock options during the fiscal year ended February 2, 2002. AGGREGATED OPTION EXERCISES IN FISCAL YEAR ENDED FEBRUARY 2, 2002 AND YEAR-END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT OPTIONS AT SHARES FEBRUARY 2, 2002(#) FEBRUARY 2, 2002($) ACQUIRED ON VALUE --------------------------- ------------------------------- NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE (1) - ---- ----------- ----------- ----------- ------------- ----------- ----------------- Carl Kirkland(2)....... -- -- 0 3,950 0 1,372,823 Robert E. Alderson(2).......... -- -- 0 6,450 0 2,065,323 Reynolds C. Faulkner... -- -- 2,283 1,000 577,599 277,000 H.R. Harvey............ -- -- 0 550 0 152,350 C. Edmond Wise, Jr..... -- -- 0 550 0 152,350
- ------------------------------ (1) There was no public trading market for our common stock as of February 2, 2002. Accordingly, these values have been calculated based on our board of directors' determination of the fair market values of the underlying shares as of February 2, 2002 of $348 per share, less the applicable exercise price per share, multiplied by the underlying shares. (2) Upon completion of this offering, the options held by each of Messrs. Kirkland and Alderson to purchase 3,950 shares of common stock, with a value of $1,372,823 as of February 2, 2002, will automatically terminate. EMPLOYEE BENEFIT PLANS 1996 EXECUTIVE INCENTIVE AND NON-QUALIFIED STOCK OPTION PLAN We maintain the Kirkland's, Inc. 1996 Executive Incentive and Non-Qualified Stock Option Plan (as amended, the "1996 Plan"). We believe the 1996 Plan promotes our long-term growth and profitability by providing key employees with incentives to improve shareholder value and to contribute to our growth and financial success. Moreover, we believe the 1996 Plan helps us attract, retain and reward quality employees. The Board of Directors or a committee of the Board of Directors administers the 1996 Plan. Under the terms of the 1996 Plan, the committee will be composed of three directors. The Board of Directors or the committee interprets the 1996 Plan, selects option recipients and determines the number of shares subject to each option and establishes the price, vesting and other terms of each option. While there are no predetermined performance formulas or measures or other specific criteria used to determine recipients of options under the 1996 Plan, grants are based generally upon consideration of the grantee's position and responsibilities, the nature of services provided, the value of the services to us, the present and potential contribution of the grantee to our success, the anticipated number of years of service remaining and other factors which the Board of Directors or the committee deems relevant. Participation in the 1996 Plan is limited to our employees or any of our subsidiaries' employees. Awards under the 1996 Plan may be in the form of incentive stock options or non-qualified stock options. 56 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 1996 Plan and the number, kind and price of shares covered by outstanding options. Stock options may not be exercised more than 10 years after the date of grant. Shares subject to forfeited, cancelled or expired stock options become available for grant again under the 1996 Plan. Stock options grants under the 1996 Plan are not transferable by the participants, except upon death. The exercise price of an incentive stock option must be not less than the fair market value of the common stock on the date the option is granted. Although the 1996 Plan permits the exercise price of a non-qualified stock option to be less than the fair market value of the common stock on the date the option is granted, the exercise price of all non-qualified stock options granted under the 1996 Plan to date have been equal to the fair market value of the common stock on the date of grant. The exercise price of stock options granted under the 1996 Plan may be paid in cash or by tender of previously acquired shares of our common stock. As of the date of this prospectus, options to purchase 15,570 shares of common stock are outstanding under the 1996 Plan at exercise prices ranging from $.01 to $95.00 per share, and no additional options may be granted under the 1996 Plan. Of these options, 6,370 have vested as of the date of the prospectus. No additional shares of common stock are available for issuance in connection with future grants under the 1996 Plan. 2002 INCENTIVE PLAN Prior to the completion of this offering, we intend to adopt the Kirkland's, Inc. 2002 Incentive Plan (the "Incentive Plan"). The Incentive Plan provides for the award of restricted shares of common stock, and incentive stock options, non-qualified stock options and stock appreciation rights with respect to shares of common stock, to our employees, directors, consultants and other individuals who perform services for us. The maximum number of shares of common stock with respect to which awards may be made under the Incentive Plan is . No Participant will receive an award of stock options or stock appreciation rights under the Incentive Plan with respect to more than shares of common stock in any calendar year. In the event of any stock split, reverse stock split, stock dividend, recapitalization, reclassification or other similar event, adjustments may be made at the Board of Directors' discretion to the number of shares reserved for issuance under the Incentive Plan, to the limit on the number of shares that may be subject to stock options or stock appreciation rights granted to a single person in any calendar year and to the number, kind and price of shares covered by outstanding awards. Shares subject to forfeited, cancelled or expired awards become available for grant again under the Incentive Plan. In addition, shares surrendered in payment of any exercise price or in satisfaction of any withholding obligation arising in connection with an award granted under the Incentive Plan become available for grant again under the Incentive Plan. The Board of Directors or the compensation committee of the Board of Directors administers the Incentive Plan. Under the terms of the Incentive Plan, the compensation committee must consist of two or more directors. The Board of Directors or the compensation committee interprets the Incentive Plan, selects award recipients, determines the number of shares subject to each award and establishes the price, vesting and other terms of each award. While there are no predetermined performance formulas or measures or other specific criteria used to determine recipients of awards under the Incentive Plan, awards are based generally upon consideration of the grantee's position and responsibilities, the nature of services provided, the value of the services to us, the present and potential contribution of the grantee to our success, the anticipated number of years of service remaining and other factors which the Board of Directors or the compensation committee deems relevant. The Incentive Plan has no specified term, although incentive stock options will not be granted more than 10 years after the adoption of the Incentive Plan. 57 Stock Options. The Incentive Plan permits the grant of incentive stock options to our employees and the employees of our subsidiaries. The Incentive Plan also provides for the grant of non-qualified stock options to our employees, directors, and consultants and other individuals who perform services for us (as well as to employees, directors, consultants and service providers of our subsidiaries). The exercise price of any incentive stock options granted under the Incentive Plan may not be less than 100% of the fair market value of our common stock on the date of grant. There is no restriction applicable to the exercise price of non-qualified options granted under the Incentive Plan. Options granted under the Incentive Plan may be exercised for cash or in exchange for shares of common stock owned by the option holder for more than six months having a fair market value on the date of exercise equal to the option exercise price. Under the Incentive Plan, each option is exercisable at such time and to such extent as specified in the pertinent option agreement between the option recipient and us. 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 Board of Directors or the compensation committee with respect to a particular option, all options are non-transferable, except upon death. Upon or in anticipation of a change of control in Kirkland's, the Board of Directors or the compensation committee may: (i) cause outstanding options to become immediately exercisable, (ii) provide for the cancellation of options in exchange for comparable options to purchase shares in a successor corporation, or (iii) provide for the cancellation of options in exchange for a cash and/or other substitute consideration. Stock Appreciation Rights. The Incentive Plan also provides for the grant of stock appreciation rights, either alone or in tandem with a stock option. A stock appreciation right entitles its holder to a cash payment of the excess of the fair market value of our common stock on the date of exercise, over the fair market value of our common stock on the date of grant. No stock appreciation right issued under the Incentive Plan will have a term of more than ten years. Upon or in anticipation of a change of control in Kirkland's, the Board of Directors or the compensation committee may: (i) cause outstanding stock appreciation rights to become immediately exercisable or (ii) provide for the cancellation of stock appreciation rights in exchange for a cash and/or other substitute consideration. Restricted Stock. Restricted stock consists of shares of our common stock issued to an employee that will be forfeited to us if certain vesting conditions established by the Board of Directors or the compensation committee at the time of grant (such as a specified period of continued employment or the fulfillment of specified individual or corporate performance goals) are not met. Restricted stock may be sold under the Incentive Plan (at its full value or at a discount) or may be granted solely in consideration for services. Upon or in anticipation of an event of a change of control in Kirkland's, the Board of Directors or the compensation committee may: (i) cause restrictions on shares of restricted stock to lapse, (ii) cancel restricted stock in exchange for shares of restricted stock of a successor corporation or (iii) redeem restricted stock for cash or other substitute consideration. EMPLOYEE STOCK PURCHASE PLAN Prior to the completion of this offering, we intend to adopt an Employee Stock Purchase Plan (the "Stock Purchase Plan"), which allows substantially all of our full-time employees who have been employees for 12 consecutive months, subject to certain limitations, to purchase shares of our common stock at a discount from the prevailing market price at the time of purchase. These shares are either issued by us from our authorized and unissued common stock or purchased by us on the open market. Any employee owning (or having a right to acquire) five percent or more of our voting power or value will not be eligible to participate in the Stock Purchase Plan. shares of our common stock will be available for purchase under the Stock Purchase Plan (subject to adjustment in the event of a stock dividend, split, reverse split or distribution, or other similar change in our common stock). Any future increase in the 58 number of shares of our common stock subject to the Stock Purchase Plan will require shareholder approval. An eligible employee will be eligible to participate in offerings under the Stock Purchase Plan. Offerings under the Stock Purchase Plan will begin upon the completion of this offering and on each subsequent February 1st and August 1st. Each offering will be 24 months long (except for the first offering, which will begin upon completion of this offering and will end on July 31, 2004), so that offerings under the Stock Purchase Plan will overlap. Each offering will include four six-month purchase periods, ending on each July 31st and January 31st (except for the first offering, which will have five purchase periods, the first of which will begin upon completion of this offering and end on July 31, 2002). Once enrolled in a specific offering, an eligible employee will be able to specify an amount (not greater than 15% of pay) to be withheld from his or her paycheck and credited to a bookkeeping account established for him or her (the "Participation Account"). Amounts in the Participation Account will be applied to the purchase of shares of our common stock on the last day of each purchase period. The price of such shares will be equal to 85% of the lesser of: (i) the price of our shares on the last day of the purchase period and (ii) the price of our shares on the first day of the offering (or, for purposes of the first offering, the public offering price). No employee may purchase more than $25,000 worth of common stock (determined based on the price on the first day of the offering) in any calendar year under the Stock Purchase Plan (and any other employee stock purchase plans later established by us or our subsidiaries), with amounts not used in any one year transferable to the following year. In addition, no employee may purchase more than shares of our common stock under the Stock Purchase Plan in any purchase period. Once enrolled in a specific offering, that offering will continue to apply to an eligible employee until he or she withdraws from the offering or terminates from employment, unless the price of our common stock is lower at the end of any purchase period than at the start of the offering. If the price of our common stock is lower at the end of any purchase period than at the start of the offering, then, after the completion of that purchase period, each eligible employee's participation in that offering will terminate and those employees will be enrolled automatically in the offering beginning immediately after that purchase period. Only whole shares of common stock may be purchased under the Stock Purchase Plan. Amounts withheld from an employee's paycheck and that are insufficient to purchase a whole share of common stock will remain credited to the employee's Participation Account. A participating employee may change the rate of his or her payroll withholding under the Stock Purchase Plan from time to time, and may cease participation in any offering altogether by requesting a withdrawal of his or her Participation Account. However, once an employee has withdrawn from an offering, he or she may not resume participation in the Stock Purchase Plan until the start of the next offering. Upon termination of an employee's employment, all amounts credited to his or her Participation Account will be returned to him or her (without interest). If we merge or consolidate with another company, if we sell substantially all our assets, or if we liquidate or dissolve, the end of the then-current purchase period will be accelerated and shares will be purchased under the Stock Purchase Plan immediately before the merger, consolidation, asset sale, liquidation or dissolution (unless the Stock Purchase Plan is assumed by a successor entity). The compensation committee of the Board of Directors will administer the Stock Purchase Plan. The Board of Directors may amend or terminate the Stock Purchase Plan. The Stock Purchase Plan is intended to comply with the requirements of Section 423 of the Internal Revenue of 1986, as amended (the "Code"). The Board of Directors may terminate the Plan at any time. 401(K) PLAN We maintain the Kirkland's, Inc. Retirement Plan ("401(k) Plan") for the benefit of our eligible employees. The 401(k) Plan is intended to be qualified under Code section 401(a) and consists of a 59 401(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 the age of 21. Under the 401(k) component, participants may elect to defer up to the maximum permitted by the Code per year to the 401(k) Plan. Under the 401(m) matching component, we may match each participant's elective deferrals, up to 6% of compensation. Currently, we match 50% of each participant's elective deferrals. Under the profit-sharing component, we may make additional contributions in amounts to be determined by us in our sole discretion. Our profit-sharing contributions are allocated among eligible participants in proportion to each 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 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 ING Aetna Financial Services. 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 upon termination of employment (including by reason of retirement, death or disability). SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN Following the completion of this offering, we intend 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 401(k) Plan, but for the application of certain legal restrictions, we will also credit a matching contribution amount to the SERP equal to what would have been contributed to the 401(k) Plan, in the absence of those restrictions. EMPLOYMENT AGREEMENTS CARL KIRKLAND AND ROBERT E. ALDERSON In connection with our 1996 recapitalization, we entered into employment agreements with Carl Kirkland and Robert E. Alderson. Under the terms of these employment agreements, Mr. Kirkland and Mr. Alderson were employed as officers of Kirkland's. The employment agreements with Messrs. Kirkland and Alderson have been extended through June 12, 2002 and negotiations have commenced concerning the terms on which the agreements will be further extended. Mr. Kirkland's current salary is $137,500, and he is also entitled to receive $712,500 which represents interest on his shares of Class C Preferred Stock. Mr. Alderson's current salary is $275,000, and he is also entitled to receive $149,500 which represents interest on his shares of Class C Preferred Stock. The payments representing interest on the Class C Preferred Stock is payable every February 1 in arrears. The payments representing such interest accrued after 1997 have not been made as a result of subordination provisions under our existing senior credit facility. A portion of the proceeds of this offering will be used to pay the stated value of the Class C Preferred Stock and all accrued and unpaid interest amounts associated with the Class C Preferred Stock, after which no further interest payments associated with the Class C Preferred Stock will be paid. The employment agreements with Messrs. Kirkland and Alderson also 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 our achievement of projected Adjusted EBITDA targets established by the Board of Directors, as well as a discretionary component of up to $75,000. Each executive is entitled to receive the full $175,000 performance-based component of the bonus if we achieve at least 95% of our projected Adjusted EBITDA target for a particular fiscal year, none of 60 the bonus for achievement of the target for the year at a level of 85% or less, and a pro rata portion of $175,000 for achievement of the target for the year at a level of between 85% and 95%. There are no limits on the projected Adjusted EBITDA target to be established by the Board of Directors. The Board of Directors may consider performance measures such as team leadership, new store openings and customer satisfaction in determining the discretionary bonus component. Each of Messrs. Kirkland and Alderson received an option currently representing the right to purchase 3,950 shares of common stock at a per share exercise price of $0.45 in connection with our 1996 recapitalization. The vesting of these options requires that the investors in our 1996 recapitalization achieve a specified internal rate of return on their invested funds upon an initial public offering or sale of Kirkland's. Because this offering will not result in the specified internal rate of return, these options will automatically terminate upon completion of this offering. Each of the employment agreements described above also contains non-competition provisions prohibiting the executive from competing against us during the term of the employment agreement and for three years thereafter without our prior written consent. Messrs. Kirkland and Alderson are also entitled to certain additional benefits (beyond those generally available to our employees) including an automobile allowance and additional life insurance. REYNOLDS C. FAULKNER In February 1998, we entered into an employment agreement with Reynolds C. Faulkner. Mr. Faulkner currently serves as our Executive Vice President and Chief Financial Officer. Mr. Faulkner currently receives an annual salary of $240,000 and is eligible to receive an annual bonus of up to $100,000 at the discretion of the Board of Directors. In addition, Mr. Faulkner received a signing bonus of $100,000 upon commencement of his employment. The term of Mr. Faulkner's agreement has been extended through June 12, 2002, and negotiations have commenced concerning the terms on which the agreement will be further extended. If Mr. Faulkner's employment is terminated prior to June 12, 2002 by us without cause or by Mr. Faulkner under specified circumstances, Mr. Faulkner is entitled to a severance payment equal to the discounted present value of 12 months' salary and benefits, together with a pro-rated annual bonus. On February 2, 1998, Mr. Faulkner received a fully vested option for 2,283 shares of our common stock under the 1996 Plan, which is currently exercisable at a per share exercise price of $95.00. A portion of the shares purchased upon the exercise of Mr. Faulkner's option will be subject to transfer restrictions and repurchase rights at our option at the fair market value of the shares until February 1, 2004. All or part of the transfer restrictions and repurchase rights will lapse following this offering upon the occurrence of certain events, such as our sale or a change of control or the termination of Mr. Faulkner's employment with us by reason of death, disability, termination without cause or termination by Mr. Faulkner under specified circumstances. Mr. Faulkner's employment agreement also contains a non-competition provision prohibiting him from competing against us during the term of the employment agreement and for three years thereafter without our prior written consent. Mr. Faulkner is also entitled to certain additional benefits (beyond those generally available to our employees) including an automobile allowance and additional life insurance. C. EDMOND WISE, JR. AND H.R. HARVEY In December 2000, we entered into an employment agreement with C. Edmond Wise, Jr. Under the terms of that agreement, Mr. Wise serves as our Senior Vice President of Store Operations. Mr. Wise currently receives an annual salary of $190,000, and will be eligible to receive an annual bonus dependent upon the achievement of budgeted Adjusted EBITDA and other financial performance criteria. In addition, Mr. Wise received a signing bonus of $20,000. The term of Mr. Wise's agreement extends until termination by either party at any time with or without cause. 61 In June 2001, we entered into an employment agreement with H.R. Harvey. Under the terms of that agreement, Mr. Harvey serves as our Senior Vice President of Merchandising at an annual salary of $225,000, and will be eligible to receive an annual bonus dependent upon the achievement of budgeted Adjusted EBITDA and other financial performance criteria. In addition, Mr. Harvey received a signing bonus of $20,000. The term of Mr. Harvey's agreement extends until termination by either party at any time with or without cause. The employment agreements for Mr. Wise and Mr. Harvey also contain non-competition provisions prohibiting the executive from being, for a period of two years following termination, connected with management or control of any business similar to ours involving national or regional chain retail operations specializing in or having a substantial inventory mix involving home decor. These non-competition provisions do not restrict the ability of these executives from working in management positions for department stores. 62 CERTAIN TRANSACTIONS RECAPITALIZATION On June 12, 1996, we completed a recapitalization whereby Advent International Group (through affiliated entities (the "Advent Funds")) became the largest beneficial owner of our equity. The 1996 recapitalization permitted certain founding and management shareholders, consisting of Carl Kirkland, Robert E. Alderson and two other shareholders (collectively, the "Principal Shareholders"), to realize a portion of the value of their interest in Kirkland's. In connection with our 1996 recapitalization: - The Advent Funds together with other investors purchased a majority of our common stock and all of our Class A Preferred Stock; - We redeemed a portion of our common stock held by the Principal Shareholders and all of our common stock held by all of our other shareholders; and - We reclassified certain shares of our common stock held by the Principal Shareholders into shares of our Class B Preferred Stock and our Class C Preferred Stock. Concurrent with the consummation of our 1996 recapitalization, we issued an aggregate of $20 million of subordinated notes to a group of institutional lenders. As of February 2, 2002, the aggregate balance of such subordinated notes, including accrued and unpaid interest, was $23.8 million. These notes mature in June 2003 and will be redeemed with a portion of the proceeds of this offering. We also issued to these institutional lenders warrants to purchase 16,722 shares of our common stock at an exercise price of $0.01 per share. The lender of $9.5 million of the outstanding subordinated debt is a mezzanine and private equity firm with which a member of our Board of Directors, Alexander S. McGrath, is affiliated. In fiscal 2001, interest in the amount of $1.5 million was paid to or accrued in favor of the lender affiliated with Mr. McGrath. In connection with the issuance of the subordinated note to the lender affiliated with Mr. McGrath, we issued 6,689 warrants to purchase common stock. These and other warrants held by such lender will be exercised at a price per share of $0.01 immediately prior to the completion of this offering. The lender of $2.1 million of the outstanding subordinated debt is a private equity investment firm with which another member of our Board of Directors, John P. Oswald, is affiliated. In fiscal 2001, interest in the amount of $0.3 million was paid to or accrued in favor of the lender affiliated with Mr. Oswald. In connection with the issuance of the subordinated note to the lender affiliated with Mr. Oswald, we issued 1,505 warrants to purchase common stock. These and other warrants held by such lender will be exercised at a price per share of $0.01 immediately prior to the completion of this offering. INDEBTEDNESS TO OFFICER On October 15, 1998, we borrowed $5 million from Carl Kirkland, our current Chairman, pursuant to an unsecured promissory note that was subordinated to all of our senior indebtedness. The note was originally due as soon as we would have sufficient cash following the pay down of our existing senior revolving line of credit, and originally bore interest at the same rate as our existing senior revolving line of credit. The note was amended and restated on July 7, 1999 to change the maturity date to June 30, 2001 and the timing of the interest payments. The note was again amended and restated on December 31, 1999 to change the maturity date to June 30, 2003, to change the interest rate to 12.5% and to provide that, in the event the note was not repaid in full on or before June 30, 2000, Carl Kirkland would receive warrants to purchase 3,200 shares of our common stock. In August 2000, the loan, together with accrued interest in the amount of approximately $754,000, was discharged through our issuance to Mr. Kirkland of 11,111 shares of common stock, 11,111 shares of Class D Preferred Stock and warrants to purchase 1,389 shares of common stock at a per share purchase price of $.01. At that time, Mr. Kirkland also 63 purchased additional securities for cash. See "- 2000 Equity Transaction." In connection with this transaction, Mr. Kirkland agreed to forego receipt of the warrants to purchase 3,200 shares provided for under the note. 1999 DEBT/EQUITY TRANSACTION On July 7, 1999, we borrowed an aggregate of $7.5 million, of which $3.4 million was borrowed from the Advent Funds and $4.1 million was borrowed from our existing senior lenders. The $4.1 million borrowed from our existing senior lenders was collateralized by cash and letters of credit supplied by certain of our shareholders. In connection with this transaction, we issued warrants to purchase 15,847 shares of common stock to certain of our shareholders as consideration for their loan (in the case of the Advent Funds) or for posting cash or a letter of credit as collateral to secure the loan from the senior lenders. In connection with this borrowing, the following shareholders who are or were affiliated with members of our Board of Directors or who are or were holders of at least five percent of our common stock received the following number of warrants to purchase shares of common stock at a price per share of $0.01:
DOLLAR AMOUNT OF LOAN OR COLLATERAL SHAREHOLDER WARRANTS PROVIDED - ----------- -------- ------------------ Carl Kirkland........................................ 1,287 $ 608,940 Robert Kirkland...................................... 1,287 $ 608,940 Global Private Equity II Limited Partnership......... 5,018 $2,375,373 Advent Direct Investment Program Limited Partnership........................................ 1,962 $ 926,992 Advent Partners Limited Partnership.................. 179 $ 85,642 CT/Kirkland Equity Partners, L.P..................... 1,448 $ 685,434 SSM/Kirkland Equity Partners, L.P.................... 1,738 $ 822,485 Capital Resource Lenders II, L.P..................... 1,089 $ 515,580 Capital Trust Investments, Ltd....................... 245 $ 115,975
REORGANIZATION Prior to December 31, 1999, we operated our stores through separate corporations (ranging as high as 206 corporations) under common ownership and through a wholly-owned subsidiary. On December 31, 1999, we reorganized by merging each of the separate corporations that operated our stores and a wholly-owned subsidiary into a newly formed subsidiary of Kirkland's. In conjunction with the reorganization, we issued 206 additional shares of our common stock, 2,939,230 additional shares of our Class A Preferred Stock, 1,019,535 additional shares of our Class B Preferred Stock and 541,771 additional shares of our Class C Preferred Stock to all of our then-existing shareholders in the same proportion as their ownership interests in each such class prior to the merger. 2000 EQUITY TRANSACTION On August 8, 2000, we issued $20 million of our Class D Preferred Stock and common stock to certain of our then-existing shareholders. In this transaction, (1) we received $7.5 million in cash, including $3.8 million from the Advent Funds and $3.7 million from Carl Kirkland, and issued 16,667 shares of common stock and 16,667 shares of Class D Preferred Stock, (2) Carl Kirkland's $5 million note originally issued on October 15, 1998 was cancelled and we issued to him 11,111 shares of common stock and 11,111 shares of Class D Preferred Stock and (3) the $7.5 million loan from July 7, 1999 was repaid through our existing senior lenders drawing on the $4.1 million of cash collateral posted by certain of our shareholders in exchange for our issuance of securities to the shareholders, and the Advent Funds converting their $3.4 million loan into newly issued securities. In these transactions, we issued 16,667 shares of common stock and 16,667 shares of Class D Preferred Stock to our shareholders at a purchase price of $0.01 per share for the 44,445 shares of common stock and $449.99 per share for the 64 44,445 shares of Class D Preferred Stock. In consideration for the purchase of these shares, we also issued 5,555 warrants to purchase common stock at a price per share of $0.01. The following table lists the number of shares of common stock, shares of Class D Preferred Stock and warrants issued to shareholders who are or were affiliated with members of our Board of Directors or who are or were holders of at least five percent of our common stock:
COMMON CLASS D PURCHASE SHAREHOLDER STOCK PREFERRED STOCK WARRANTS PRICE PAID - ----------- ------ --------------- -------- ---------- Carl Kirkland(1)........................ 20,686 20,686 2,586 $9,308,940 Robert Kirkland......................... 1,353 1,353 169 $ 608,940 Global Private Equity II Limited Partnership .......................... 13,510 13,510 1,688 $6,079,317 Advent Direct Investment Program Limited Partnership........................... 2,060 2,060 51 $1,023,048 Advent Partners Limited Partnership..... 403 403 257 $ 85,642 CT/Kirkland Equity Partners, L.P. ...... 1,781 1,781 223 $ 801,409 SSM/Kirkland Equity Partners, L.P. ..... 1,828 1,828 228 $ 822,485 Capital Resource Lenders II, L.P. ...... 1,146 1,146 143 $ 515,580
- ------------------------------ (1) $5 million of the purchase price for Carl Kirkland was paid through the cancellation of $5 million of subordinated indebtedness owed by Kirkland's to Mr. Kirkland. See " - Indebtedness to Officer." 2001 DIVIDEND AGREEMENT In connection with the June 2001 amendment to our senior subordinated notes, we amended our charter in order to reduce the dividend rate on our Class A Preferred Stock and Class D Preferred Stock from 10% to 4%. We also agreed to use our best efforts to obtain the necessary shareholder consent to amend the charter to similarly reduce the dividend on our Class B Preferred Stock. Although we could not get the requisite shareholder consent, in October 2001 we entered into a Dividend Rate Agreement with Carl Kirkland and Robert E. Alderson in which these two shareholders agreed to reduce the dividend on their Class B Preferred Stock to 4%. PRE-OFFERING TRANSACTIONS Preferred Stock. As of the date of this prospectus, we have four classes of preferred stock. The Class A Preferred Stock, the Class B Preferred Stock and the Class D Preferred Stock currently accrue dividends at rates varying from 4% to 10% per year compounded quarterly. Interest associated with the Class C Preferred Stock currently accrues at a rate of 9% per year, compounded semi-annually. No dividends have been paid on the Class A Preferred Stock, the Class B Preferred Stock or the Class D Preferred Stock. The interest associated with the outstanding Class C Preferred Stock that has accrued after 1997 has not been paid as a result of subordination provisions under our existing senior credit facility. Upon completion of this offering, the Class A Preferred Stock, the Class B Preferred Stock and the Class D Preferred Stock become convertible into common stock at the election of the holders and redeemable at our election, and the Class C Preferred Stock becomes mandatorily redeemable. Kirkland Holdings LLC owns all of the Class A Preferred Stock. Carl Kirkland, Robert E. Alderson and Robert Kirkland own all of the Class B Preferred Stock and Class C Preferred Stock. Carl Kirkland, Robert Kirkland, the Advent Funds, certain other shareholders and certain of our subordinated lenders own the Class D Preferred Stock. Conversion and Redemption of Preferred Stock. Pursuant to the terms of our charter, immediately prior to completion of this offering and as a part of the Pre-Offering Transactions, $ million of the aggregate stated value and accrued dividends of the outstanding shares of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock will be converted into shares of common stock. In addition, immediately prior to the completion of this offering, our warrantholders will exercise all outstanding warrants to purchase 38,124 shares of common stock at a 65 nominal exercise price. Also pursuant to our charter, although not part of the Pre-Offering Transactions, we will redeem from our current shareholders all of the outstanding shares of Class C Preferred Stock for an aggregate of $ million (including approximately $ of amounts classified as interest associated with the Class C Preferred Stock), to be paid from the net proceeds of this offering. See "Use of Proceeds." The number of shares of common stock issuable upon conversion of $ million of the aggregate stated value and accrued dividends of the Class A Preferred Stock, the Class B Preferred Stock and the Class D Preferred Stock will equal the aggregate stated value of $ million plus accrued dividends ($ million at February 2, 2002) on the preferred stock, divided by the actual initial public offering price. Assuming an initial public offering price of $ and a consummation of this offering on , shares of common stock will be issued to our current shareholders for their Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock. If the initial public offering price is $ (i.e., the top of the estimated initial public offering price range), the number of shares of common stock issuable upon such conversion will be , and if the initial public offering price is $ (i.e., the bottom of the estimated initial public offering price range), the number of shares of common stock issuable upon such conversion will be . Charter Amendment and Stock Split. In order to implement the above transactions, we will affect a -for-one stock split of our common stock prior to the consummation of this offering and we will amend and restate our charter to provide for an authorized capitalization of 100,000,000 shares of common stock and 10,000,000 shares of preferred stock. Following the consummation of this offering and the redemption of the Class C Preferred Stock, there will be shares of common stock outstanding and no shares of preferred stock outstanding. USE OF PROCEEDS Carl Kirkland, Robert E. Alderson and Robert Kirkland own all of the shares of the Class C Preferred Stock. A portion of the proceeds to Kirkland's from this offering will be used to redeem all of the Class C Preferred Stock. As a result, Carl Kirkland will receive $ , Robert E. Alderson will receive $ and Robert Kirkland will receive $ . A portion of the proceeds to Kirkland's from this offering will be used to redeem a portion of the outstanding shares of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock. The following table lists the number of shares of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock being redeemed, as well as the amount of proceeds from this offering being received, from shareholders who are affiliated with members of our Board of Directors or who are holders of at least five percent of our common stock:
CLASS A PREFERRED CLASS B PREFERRED CLASS D PREFERRED SHAREHOLDER STOCK STOCK STOCK PROCEEDS - ----------- ----------------- ----------------- ----------------- -------- Carl Kirkland............... $ Robert E. Alderson.......... $ Robert Kirkland............. $ Global Private Equity II Limited Partnership ...... $ Advent Direct Investment Program Limited Partnership............... $ Advent Partners Limited Partnership............... $ CT/Kirkland Equity Partners, L.P. ..................... $ SSM Venture Partners, L.P. ..................... $ Capital Resource Lenders II, L.P. ..................... $
66 SHAREHOLDERS AGREEMENT We have entered into a shareholders agreement with our shareholders. Pursuant to this agreement, certain seats on our Board of Directors have historically been reserved for nominees of certain shareholders. We have agreed to take all necessary actions to cause the Board of Directors to be comprised of, subject to certain conditions, (1) two representatives nominated by Advent International Group and (2) one nominee of each of Capital Trust Investments, Ltd., Carl Kirkland, Robert E. Alderson, SSM Venture Partners, L.P. and Capital Resource Lenders II, L.P. The agreement will terminate upon consummation of this offering. CONSULTING AGREEMENT In connection with our 1996 recapitalization, we entered into a consulting agreement with Robert Kirkland, a shareholder of Kirkland's and a cousin of our Chairman. 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. The agreement provides for an annual consulting fee of $679,000 and a term expiring in June 2003. The consulting fee is classified as interest associated with the Class C Preferred Stock held by Mr. Kirkland. The consulting agreement automatically terminates upon the occurrence of certain events, including our sale, a change of control or a Qualified Public Offering. This offering will constitute a Qualified Public Offering, and, accordingly, Mr. Kirkland's consulting agreement will automatically terminate upon the completion of this offering. We do not intend to renew the consulting arrangement with Mr. Kirkland following this offering. INVENTORY PURCHASES FROM SIGNIFICANT SHAREHOLDER We purchase inventory from a wholesaler previously owned by Robert Kirkland, a shareholder of Kirkland's and a cousin of our Chairman. See "Principal and Selling Shareholders." These purchases aggregated approximately $332,000 during fiscal 2001, $128,000 during fiscal 2000 and $237,000 during fiscal 1999. INVENTORY PURCHASES FROM A FORMER AFFILIATE In past years we purchased inventory from a manufacturer of which Advent International Group was a significant shareholder until November 1999. These purchases aggregated approximately $5,000 during fiscal 2000 and $292,000 during fiscal 1999. We purchased no inventory from such manufacturer in fiscal 2001 and no longer purchase inventory from them. Advent International Group, which (through the Advent Funds) is a member in Kirkland Holdings L.L.C., one of our principal shareholders, used to be a significant shareholder of such manufacturer. Two of our directors, David M. Mussafer and John P. Oswald, were members of the Board of Directors of such manufacturer until November 1999. Mr. Mussafer and Mr. Oswald are also affiliated with members of Kirkland Holdings L.L.C. See "Principal and Selling Shareholders." CHARTER OF AIRPLANES We rent aircraft for business travel from a company owned by Carl Kirkland. We spent $23,000 for the rental of aircraft from this company in fiscal 2001, $92,000 in fiscal 2000 and $63,000 in fiscal 1999. RELATIONSHIP WITH SUNTRUST ROBINSON HUMPHREY SunTrust Robinson Humphrey, a division of SunTrust Capital Markets, Inc., is one of the underwriters in this offering and it or its predecessor firm, The Robinson-Humphrey Company, LLC, has from time to time provided us investment banking services, including services rendered in connection with our 1996 recapitalization, and may continue to provide such services in the future. We consider the terms of our transactions described in the preceding four paragraphs to be at arms length and reasonably equivalent to terms we could obtain through negotiations with an unaffiliated third party under similar economic conditions. 67 PRINCIPAL AND SELLING SHAREHOLDERS The following table sets forth certain information regarding the beneficial ownership of our common stock at February 2, 2002 (assuming that the Pre-Offering Transactions had occurred as of February 2, 2002) by (i) each director and Named Executive Officer, (ii) each person known by us to beneficially own more than 5% of our common stock, (iii) each selling shareholder and (iv) all directors and executive officers as a group, both before and after giving effect to the sale of common stock in this offering. As of such date, and based on the foregoing assumption, there were shares of common stock outstanding before giving effect to the sale of common stock in this offering and shares outstanding after giving effect to the sale of common stock in this offering and the redemption of certain shares with a portion of the proceeds of this offering.
SHARES BENEFICIALLY OWNED AFTER THE NUMBER OF SHARES OFFERING BENEFICIALLY OWNED SHARES TO BE SOLD -------------------- NAME PRIOR TO THE OFFERING IN THE OFFERING NUMBER PERCENTAGE - ---- --------------------- ----------------- ------- ---------- Carl Kirkland(1)........................ 5,877 805 N. Parkway Jackson, TN 38305 Robert E. Alderson(2)................... 34,518 805 N. Parkway Jackson, TN 38305 Reynolds C. Faulkner(3)................. 2,283 H.R. Harvey............................. -- -- * C. Edmond Wise, Jr...................... -- -- * David M. Mussafer(4).................... 69,181 75 State Street Boston, MA 02109 R. Wilson Orr, III(5)................... 9,660 845 Crossover Lane, Suite 140 Memphis, TN 38117 John P. Oswald(6)....................... 14,114 757 Fifth Avenue, 22nd Floor New York, NY 10017 Alexander S. McGrath(7)................. 9,067 Murray Spain............................ -- -- * Kirkland Holdings L.L.C.(8)............. 68,553 75 State Street Boston, MA 02109 Advent International Group(9)(10)(11)... 69,181 75 State Street Boston, MA 02109 Capital Trust Investments, Ltd.(12)..... 1,750 CT/Kirkland Equity Partners, L.P.(13)... 12,364 757 Fifth Avenue, 22nd Floor New York, NY 10017 R-H Capital Partners, L.P.(14).......... 4,524 SSM Venture Partners, L.P.(15).......... 9,660 845 Crossover Lane, Suite 140 Memphis, TN 38117 TCW/Kirkland Equity Partners, L.P.(16).............................. 1,505
68
SHARES BENEFICIALLY OWNED AFTER THE NUMBER OF SHARES OFFERING BENEFICIALLY OWNED SHARES TO BE SOLD -------------------- NAME PRIOR TO THE OFFERING IN THE OFFERING NUMBER PERCENTAGE - ---- --------------------- ----------------- ------- ---------- The Marlborough Capital Investment Fund, L.P.(17).............................. 3,177 Robert E. Kirkland(18).................. 10,727 c/o Kirkland's, Inc. 805 N. Parkway Jackson, TN 38305 Capital Resource Lenders II, L.P.(19)... 9,067 Allied Capital Corporation(20).......... 7,254 All executive officers and directors as a group (10 persons)(21).............. 144,700
- ------------------------------ * Represents less than 1% of the outstanding shares of common stock. (1) Includes warrants to purchase 3,873 shares of common stock and shares of common stock to be issued upon conversion of Class B Preferred Stock and Class D Preferred Stock. Also includes 2,004 shares of common stock held by Mr. Kirkland as Trustee for the benefit of the children of Robert E. Alderson. (2) Includes 5,914 shares of common stock and shares of common stock to be issued upon conversion of Class B Preferred Stock. Also includes 28,604 shares of common stock held by Mr. Alderson as Trustee for the benefit of the children of Carl Kirkland. (3) All of the shares of common stock beneficially owned by Mr. Faulkner are issuable upon exercise of stock options granted by Kirkland's. (4) In its capacity as the manager of funds affiliated with Advent International Group, Advent International Corporation exercises sole voting and investment power with respect to the 60,026 shares of common stock, warrants to purchase 9,155 shares of common stock and shares of common stock issuable upon the conversion of Class A Preferred Stock and Class D Preferred Stock beneficially owned by the Advent Funds and, accordingly, Advent International Group may be deemed to beneficially own such shares. As a result, Mr. Mussafer, one of our directors and a Managing Director of Advent International Corporation, may be deemed to beneficially own these shares. See also note (8) below. If the underwriters' overallotment option is exercised in full, of the shares which may be deemed to be beneficially owned by Advent International Group 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 this offering. Mr. Mussafer disclaims beneficial ownership of all shares held by the Advent Funds other than the 148 shares that are indirectly beneficially owned by Mr. Mussafer. (5) Mr. Orr may be deemed to beneficially own 1,219 shares of common stock, warrants to purchase 1,311 shares of common stock and shares of common stock issuable upon conversion of Class D Preferred Stock held by SSM Venture Partners, L.P. and 7,130 shares of common stock and shares of common stock issuable upon conversion of Class A Preferred Stock which SSM Venture Partners, L.P. beneficially owns as a member of Kirkland Holdings L.L.C. Mr. Orr, one of our directors, is a partner of SSM Corporation which is an affiliate of SSM Venture Partners, L.P. If the underwriters' overallotment option is exercised in full, of the shares owned by SSM Venture 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 this offering. (6) Mr. Oswald may be deemed to beneficially own warrants to purchase 1,750 shares of common stock held by Capital Trust Investments, Ltd., 1,781 shares of common stock, warrants to purchase 1,671 shares of common stock and shares of common stock issuable upon conversion of Class D Preferred Stock held by CT/Kirkland Equity Partners, L.P. and 8,912 shares of common stock and shares of common stock issuable upon conversion of Class A Preferred Stock which CT/Kirkland Equity Partners, L.P. beneficially owns as a member of Kirkland Holdings L.L.C. Mr. Oswald, one of our directors, 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' overallotment 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 this offering. 69 (7) Mr. McGrath may be deemed to beneficially own 1,146 shares of common stock, warrants to purchase 7,921 shares of common stock and shares of common stock issuable upon the conversion of Class D Preferred Stock held by Capital Resource Lenders II, L.P. Mr. McGrath, one of our directors, is a general partner of Capital Resource Partners II, L.P., the general partner of Capital Resource Lenders II, L.P. If the underwriters' overallotment option is exercised in full of the shares owned by Capital Resource Lenders II, L.P. will be sold, as a result of which Mr. McGrath may be deemed to beneficially own shares of common stock, or % of the common stock then outstanding, following this offering. (8) Includes 68,553 shares of common stock and shares of common stock issuable upon conversion of Class A Preferred Stock. The members of Kirkland Holdings L.L.C. which are affiliated with us, 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 Venture Partners, L.P. (10.40052%) and CT/Kirkland Equity Partners, L.P. (13.00%). Kirkland Holdings L.L.C. will be dissolved immediately prior to completion of this offering and all of our shares that are owned by Kirkland Holdings L.L.C. will be distributed to its members. (9) Includes 13,510 shares of common stock, shares of common stock issuable upon exercise of Class D Preferred Stock and warrants to purchase 6,706 shares of common stock and 30,890 shares of common stock and shares of common stock issuable upon the conversion of Class A Preferred Stock which Global Private Equity II Limited Partnership beneficially owns as a member of Kirkland Holdings L.L.C. David Mussafer, one of our directors, is an affiliate of Global Private Equity II Limited Partnership. See Note 4. If the underwriters' overallotment option is exercised in full, of the shares beneficially owned by Global Private Equity II Limited Partnership will be sold, as a result of which it will beneficially own shares of common stock, or % of the common stock then outstanding, following this offering. (10) Includes 2,060 shares of common stock, shares of common stock issuable upon exercise of Class D Preferred Stock and warrants to purchase 2,013 shares of common stock and 12,052 shares of common stock and shares of common stock issuable upon the conversion of Class A Preferred Stock which Advent Direct Investment Program Limited Partnership beneficially owns as a member of Kirkland Holdings L.L.C. David Mussafer, one of our directors, is an affiliate of Advent Direct Investment Program Limited Partnership. See Note 4. If the underwriters' overallotment option is exercised in full, of the shares beneficially owned by Advent Direct Investment Program Limited Partnership will be sold, as a result of which it will beneficially own shares of common stock, or % of the common stock then outstanding, following this offering. (11) Includes 403 shares of common stock, shares of common stock issuable upon exercise of Class D Preferred Stock and warrants to purchase 436 shares of common stock and 1,111 shares of common stock and shares of common stock issuable upon the conversion of Class A Preferred Stock which Advent Partners Limited Partnership beneficially owns as a member of Kirkland Holdings L.L.C. David Mussafer, one of our directors, is an affiliate of Advent Partners Limited Partnership. See Note 4. If the underwriters' overallotment option is exercised in full, of the shares beneficially owned by Advent Partners Limited Partnership will be sold, as a result of which it will beneficially own shares of common stock, or % of the common stock then outstanding, following this offering. (12) Consists of warrants to purchase 1,750 shares of common stock. John Oswald, one of our directors, is an affiliate of Capital Trust Investments, Ltd. See Note 6. If the underwriters' overallotment option is exercised in full, of the shares owned by Capital Trust Investments, Ltd. will be sold, as a result of which it will own shares of common stock, or % of the common stock then outstanding. (13) Includes 1,781 shares of common stock, shares of common stock issuable upon exercise of Class D Preferred Stock and warrants to purchase 1,671 shares of common stock and 8,912 shares of common stock and shares of common stock issuable upon the conversion of Class A Preferred Stock which CT/Kirkland Equity Partners, L.P. beneficially owns as a member of Kirkland Holdings L.L.C. John Oswald, one of our directors, is an affiliate of CT/Kirkland Equity Partners, L.P. See Note 6. If the underwriters' overallotment option is exercised in full, of the shares beneficially owned by CT/Kirkland Equity Partners, L.P. will be sold, as a result of which it will beneficially own shares of common stock, or % of the common stock then outstanding, following this offering. (14) Includes 571 shares of common stock, shares of common stock issuable upon exercise of Class D Preferred Stock and warrants to purchase 614 shares of common stock and 3,339 shares of common stock and shares of common stock issuable upon the conversion of Class A Preferred Stock which 70 R-H Capital Partners, L.P. beneficially owns as a member of Kirkland Holdings L.L.C. If the underwriters' overallotment option is exercised in full, of the shares beneficially owned by R-H Capital Partners, L.P. will be sold, as a result of which it will beneficially own shares of common stock, or % of the common stock then outstanding, following this offering. (15) Includes 1,219 shares of common stock, shares of common stock issuable upon exercise of Class D Preferred Stock and warrants to purchase 1,311 shares of common stock and 7,130 shares of common stock and shares of common stock issuable upon the conversion of Class A Preferred Stock which SSM Venture Partners, L.P. beneficially owns as a member of Kirkland Holdings L.L.C. R. Wilson Orr III, one of our directors, is an affiliate of SSM Venture Partners, L.P. See Note 5. If the underwriters' overallotment option is exercised in full, of the shares beneficially owned by SSM Venture Partners, L.P. will be sold, as a result of which it will beneficially own shares of common stock, or % of the common stock then outstanding, following this offering. (16) Includes 190 shares of common stock, shares of common stock issuable upon exercise of Class D Preferred Stock and warrants to purchase 204 shares of common stock and 1,111 shares of common stock and shares of common stock issuable upon the conversion of Class A Preferred Stock which TCW/Kirkland Equity Partners, L.P. beneficially owns as a member of Kirkland Holdings L.L.C. If the underwriters' overallotment option is exercised in full, of the shares beneficially owned by TCW/Kirkland Equity Partners, L.P. will be sold, as a result of which it will beneficially own shares of common stock, or % of the common stock then outstanding, following this offering. (17) Consists of warrants to purchase 3,177 shares of common stock. If the underwriters' overallotment option is exercised in full, of the shares owned by The Marlborough Capital Investment Fund, L.P. will be sold, as a result of which it will own shares of common stock, or % of the common stock then outstanding, following this offering. (18) Includes 9,271 shares of common stock, 1,456 shares of common stock issuable upon the exercise of warrants and shares of common stock upon the conversion of Class B Preferred Stock and Class D Preferred Stock. If the underwriters' overallotment option is exercised in full, of the shares owned by Mr. Kirkland will be sold, as a result of which he will own shares of common stock, or % of the common stock then outstanding, following this offering. (19) Includes 1,146 shares of common stock, 7,921 shares of common stock issuable upon the exercise of warrants and shares of common stock upon the conversion of Class D Preferred Stock. Alexander McGrath, one of our directors, is an affiliate of Capital Resource Lenders II, L.P. See Note 7. If the underwriters' overallotment option is exercised in full, of the shares owned by Capital Resource Lenders II, L.P. will be sold, as a result of which it will own shares of common stock, or % of the common stock then outstanding, following this offering. (20) Includes 917 shares of common stock, shares of common stock issuable upon exercise of Class D Preferred Stock and warrants to purchase 6,337 shares of common stock. If the underwriters' overallotment option is exercised in full, of the shares owned by Allied Capital Corporation will be sold, as a result of which it will own shares of common stock, or % of the common stock then outstanding, following this offering. (21) Includes 125,891 shares of common stock, 2,283 shares of common stock issuable upon the exercise of stock options, 16,526 shares of common stock issuable upon the exercise of warrants and shares of common stock issuable upon the conversion of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock beneficially owned in the aggregate by our executive officers and our directors. If the underwriters' overallotment option is exercised in full, of the shares subject thereto beneficially owned by our directors and our executive officers will be sold, as a result of which they will beneficially own shares of common stock, or % of the common stock then outstanding, following this offering. 71 DESCRIPTION OF CAPITAL STOCK GENERAL Upon completion of this offering, our authorized capital stock will consist of 100,000,000 shares of common stock, no par value, and 10,000,000 shares of preferred stock, no par value. Upon completion of this 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 this offering. See "Use of Proceeds" and "Certain Transactions - Pre-Offering Transactions." Upon the completion of this offering, there will be shares of common stock issued and outstanding and shares of common stock reserved for issuance under our employee benefits plans, including 15,570 shares issuable upon the exercise of options that will be outstanding upon the completion of this offering. As of the date of this prospectus, we have 136,981 shares of common stock, 38,124 warrants to purchase common stock, 3,007,630 shares of Class A Preferred Stock, 1,043,235 shares of Class B Preferred Stock, 558,893 shares of Class C Preferred Stock and 44,445 shares of Class D Preferred Stock issued and outstanding. Pursuant to the Pre-Offering Transactions which will take place immediately prior to completion of this offering, $ million of the aggregate stated value and accrued dividends of the outstanding shares of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock will be converted into shares of common stock. All of our outstanding warrants will be exercised for common stock and then all outstanding shares of common stock will be split on a -for-one basis into shares of common stock. All of the outstanding shares of the Class C Preferred Stock will be redeemed with a portion of our net proceeds of this 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 our 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 Kirkland's, 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. We and the selling shareholders are selling common stock in this offering. All currently outstanding shares of common stock are, and upon issuance, the shares of common stock being sold by us in this offering 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 that we may designate and issue in the future. See "Risk Factors - Our charter and bylaw provisions and certain provisions of Tennessee law may make it difficult in some respects to cause a change in control of Kirkland's and replace incumbent management." PREFERRED STOCK Pursuant to our amended and restated charter to be filed prior to the completion of this 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 Board of Directors without shareholder action may fix the terms of the preferred stock, the preferred stock could be issued quickly with terms designed to defeat a proposed takeover of Kirkland's, or to make the removal of our management more difficult. The authority to issue preferred stock or rights to purchase preferred stock 72 could be used to discourage a change in control of Kirkland's. Our management is not aware of any such threatened transaction to obtain control of Kirkland's, and the Board of Directors has no current plans to designate and issue any shares of preferred stock. WARRANTS There are currently an aggregate of 38,124 warrants to purchase shares of common stock outstanding. All of these warrants are currently exercisable and their exercise price is $0.01 per share, subject to certain anti-dilution adjustment provisions. Prior to the consummation of this offering, all of our warrantholders will exercise all of their warrants. This offering will not trigger any of the anti-dilution adjustment provisions in the warrants. "See Certain Transactions -- Pre-Offering Transactions." LIMITATION OF DIRECTORS' LIABILITY The charter provides that none of our directors will be personally liable to us or any of our 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 us or our 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. We believe this provision will assist us in securing and maintaining the services of qualified non-employee directors. REGISTRATION RIGHTS Pursuant to a registration rights agreement, by and among us and our shareholders, the holders of shares of our common stock will be entitled to register these shares under the Securities Act. Under the registration rights agreement, holders may demand that we file a registration statement under the Securities Act covering some or all of the holders' registrable securities. The registration rights agreement limits the number of demand registrations that we are required to make on behalf of the holders, and also requires a minimum anticipated price to the public of $5 million. In an underwritten offering, the managing underwriter has the right, subject to specified conditions, to limit the number of registrable securities if it is believed such registrations will exceed the number that can be sold at the desired price. In such a case, mezzanine warrantholders have priority in registration over other holders of registrable securities. In addition, holders have "piggyback" registration rights. If we propose to register any of our equity securities under the Securities Act other than pursuant to demand registration rights noted above or specified excluded registrations, holders may require us to include all or a portion of their registrable securities in the registration and in any related underwriting. In an underwritten offering, the managing underwriter, if any, has the right, subject to specified conditions, to limit the number of registrable securities. Additionally, such piggyback registrations are subject to delay or termination of the registration. Holders have requested that of their shares of common stock be registered for sale in this offering. The holders also have unlimited rights to require us to register their shares on Form S-3 once we are eligible to use such form. In general, we will bear all fees, costs and expenses of registrations, other than underwriting discounts and commissions. ANTI-TAKEOVER EFFECT OF CHARTER AND BYLAW PROVISIONS AND TENNESSEE LAWS Our charter and bylaws as well as Tennessee law contain various provisions intended to (i) promote stability of our shareholder base and (ii) render more difficult certain unsolicited or hostile attempts to take us over which could disrupt us, divert the attention of our directors, officers and employees and adversely affect the independence and integrity of our business. A summary of these provisions of the charter, bylaws and Tennessee law is set forth below. 73 Classified Board; Removal of Directors. Pursuant to the charter, our Board of Directors may consist of between three and 15 members, as determined from time to time by the 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 2003, 2004 and 2005. 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 our Board of Directors 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 of Directors, or by a sole remaining director. Any director elected in accordance with the preceding sentence will hold office until the next annual meeting of shareholders and until such director's successor is elected and qualified. At such next annual meeting, the shareholders shall elect a director to serve the remaining term of the newly created or vacated directorship and until such director's successor shall have been duly elected and qualified. No decrease in the number of directors constituting our Board of Directors 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 and only after a finding of cause by a majority of the Board of Directors (excluding the director subject to removal) followed by the affirmative vote of the holders of at least 80% of the voting power of all of our outstanding capital stock entitled to vote generally in the election of directors, voting together as a single class. These provisions of the charter preclude a third party from removing incumbent directors and simultaneously gaining control of our Board of Directors 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 our Board of Directors. Accordingly, these provisions could discourage a third party from initiating a proxy contest, making a tender offer or otherwise attempting to gain control of Kirkland's. 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 our Chairman or our President or upon a resolution adopted by a majority of the entire Board of Directors. 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. Only persons nominated in accordance with our shareholder notice procedure are eligible to serve as directors, and only business brought before the annual meeting in accordance with our 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 our Secretary, subject to certain exceptions, not in less than 60 days nor more than 90 days prior to the first anniversary of the previous year's annual meeting; provided, however that in the event the date of the annual meeting is more than 30 days before or more than 60 days after such anniversary date, notice by the shareholder must be received not earlier than the 90th day prior to the annual meeting and not later than the 60th day prior to the annual meeting or the 15th day following public announcement of such meeting. For nominations and proposals for any special 74 meetings, the bylaws require notice not more than 90 days nor less than 60 days before the special meeting, or the 15th day following the day on which public announcement is first made of the special meeting and of the nominees proposed by the Board of Directors to be elected at such meeting. The bylaws provide that notice to our Secretary 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 has the power to determine whether a shareholder nomination or proposal was brought in accordance with our shareholder notice procedure. By requiring advance notice of nominations by shareholders, our shareholder notice procedure affords 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, our shareholder notice procedure provides a more orderly procedure for conducting annual meetings of shareholders and, to the extent deemed necessary or desirable by the Board of Directors, provides 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 has the power to determine compliance with our 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 all of our outstanding capital stock entitled to vote generally in the election of directors ("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. With the previous approval of the Board of Directors, a majority of the Voting Power is required to amend these charter provisions. 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 all of our outstanding capital stock entitled to vote generally in the election of directors, voting together as a single class. 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 we are) 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 75 the vote. It may not take effect for at least two years after the vote. We have not adopted a charter or bylaw amendment removing us 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. We satisfy 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 that 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 Securities Exchange Act of 1934, as amended (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 StockTrans, Inc. 76 SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering, there has been no public market for our securities. 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 this offering or the perception that such sales may occur could have an adverse effect on the market price of the common stock. SALE OF RESTRICTED SHARES Upon completion of this offering, we will have shares of common stock outstanding. Of these shares, the shares of common stock offered in this offering will be freely tradeable without restriction or further registration, except for shares purchased by our "affiliates" or our "underwriters" (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 outstanding shares of common stock ( shares if the underwriters' overallotment option is exercised in full) will be 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 the lock-up agreements, of the Restricted Shares will be eligible for sale immediately in the public market without restriction pursuant to Rule 144(k), and 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 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 us to register the shares for sale under the Securities Act in certain circumstances and have the right to include those shares in a Kirkland's initiated registration. See "Description of Capital Stock - Registration Rights." RULE 144 In general, Rule 144 allows a person who has beneficially owned Restricted Shares for at least one year, including persons who may be deemed our affiliates, to sell, within any three-month period, up to the number of Restricted Shares that does not exceed the greater of: - 1% of the then outstanding shares of common stock and - our average weekly trading volume during the four calendar weeks preceding the date on which notice of the sale is filed with the Securities and Exchange Commission. A person who is not deemed to have been our affiliate at any time during the three months preceding a sale and who has beneficially owned his or 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. LOCK-UP AGREEMENTS We and our executive officers, directors and all of the holders of our common stock before this offering (who will hold, in the aggregate, % of our common stock after this offering) have agreed, except in limited circumstances, not to sell or transfer any shares of our common stock for 180 days after the date of this prospectus without first obtaining the written consent of Merrill Lynch. See "Underwriting - No Sales of Similar Securities." RULE 701 Under Rule 701, any of our employees, officers or directors or consultants who purchased shares pursuant to a written compensatory plan or contract, including our 1996 Plan and our Incentive Plan, who is not our affiliate, is entitled to sell such shares without having to comply with the public information, 77 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 of our affiliates 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. OPTION GRANTS/S-8 REGISTRATION STATEMENT The shares underlying certain options which will be exercisable upon completion of this 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 will become eligible for sale subject to compliance with Rule 144. In addition, we may issue up to additional shares of common stock pursuant to our 1996 Plan, the Incentive Plan and the Stock Purchase Plan. See "Management - Employee Benefit Plans." We intend 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 our "affiliates" or our "underwriters." 78 UNITED STATES TAX CONSEQUENCES TO NON-UNITED STATES HOLDERS The following is a general discussion of the material United States federal income and estate tax consequences of the acquisition, ownership and disposition of our common stock by a non-U.S. holder. As used in this discussion, the term "non-U.S. holder" means a beneficial owner of our common stock that is not, for United States federal income tax purposes: - an individual who is a citizen or resident of the United States; - a corporation or partnership (or entity classified as a corporation or partnership for such purposes) created or organized in or under the laws of the United States or of any political subdivision of the United States; - an estate whose income is includible in gross income for U.S. federal income tax purposes regardless of its source; or - a trust, if a U.S. court is able to exercise primary supervision over the administration of the trust and one or more U.S. persons have authority to control all substantial decisions of the trust or if the trust has a valid election in effect under applicable U.S. Treasury regulations to be treated as a "United States person" for such purposes. This discussion does not consider: - U.S. state and local or non-U.S. tax consequences; - specific facts and circumstances that may be relevant to a particular non-U.S. holder's tax position, including, if the non-U.S. holder is a partnership or trust that the United States federal income tax consequences of holding and disposing of our common stock may be affected by certain determinations made at the partner or beneficiary level; - the United States federal income tax consequences for the shareholders, partners or beneficiaries of a non-U.S. holder; - special United States federal income tax rules that may apply to particular non-U.S. holders, such as financial institutions, insurance companies, tax-exempt organizations, U.S. expatriates, broker-dealers, and traders in securities; and - special United States federal income tax rules that may apply to a non-U.S. holder that holds our common stock as part of a "straddle," "hedge," "conversion transaction," "synthetic security" or other integrated investment. The following discussion is based on provisions of the U.S. Internal Revenue Code of 1986, as amended, applicable U.S. Treasury regulations and administrative and judicial interpretations, all as in effect on the date of this prospectus, and all of which are subject to change, retroactively or prospectively. The following summary assumes that a non-U.S. holder holds our common stock as a capital asset. Each non-U.S. holder should consult a tax advisor regarding the United States federal, state, local and non-U.S. income and other tax consequences of acquiring, holding and disposing of shares of our common stock. DIVIDENDS We do not anticipate paying cash dividends on our common stock in the foreseeable future. See "Dividend Policy." In the event, however, that we pay dividends on our common stock, we will have to withhold a United States federal withholding tax at a rate of 30%, or a lower rate under an applicable income tax treaty, from the gross amount of the dividends paid to a non-U.S. holder. Non-U.S. holders should consult their own tax advisors regarding their entitlement to benefits under a relevant income tax treaty. 79 Dividends that are effectively connected with a non-U.S. holder's conduct of a trade or business in the United States and, if an income tax treaty applies, that are attributable to a permanent establishment in the United States, will be taxed on a net income basis at the regular graduated rates and in the manner applicable to United States persons. In that case, we will not have to withhold U.S. federal withholding tax if the non-U.S. holder complies with applicable certification and disclosure requirements. In addition, a "branch profits tax" may be imposed at a 30% rate, or a lower rate under an applicable income tax treaty, on dividends received by a foreign corporation that are effectively connected with the conduct of a trade or business in the United States. In order to claim the benefit of an applicable income tax treaty to either reduce the withholding tax, or eliminate it because the dividend is attributable to a US permanent establishment, a non-U.S. holder will be required to satisfy applicable certification and other requirements. However, - in the case of our common stock held by a foreign partnership, the certification requirement will generally be applied to the partners of the partnership and the partnership will be required to provide us certain information; - if you hold our common stock through an intermediary (as defined in the Treasury regulations, the certification requirement may be applied to you, and not to the intermediary, and the intermediary may be obligated to provide us certain information; - in the case of our common stock held by a foreign trust, the certification requirement will generally be applied to the trust or the beneficial owners of the trust depending on whether the trust is a "foreign complex trust," "foreign simple trust," or "foreign grantor trust" as defined in the applicable U.S. Treasury regulations; and - look-through rules will apply for tiered partnerships, foreign simple trusts and foreign grantor trusts. A non-U.S. holder that is a foreign partnership or a foreign trust is urged to consult its own tax advisor regarding its status under these U.S. Treasury regulations and the certification requirements applicable to it. If we withhold tax on dividends at 30%, but you are a non-U.S. holder that is eligible for a reduced rate of U.S. federal withholding tax under an income tax treaty, you may obtain a refund or credit of any excess amounts withheld by filing an appropriate claim for a refund with the U.S. Internal Revenue Service. GAIN ON DISPOSITION OF COMMON STOCK A non-U.S. holder generally will not be taxed on gain recognized on a disposition of our common stock unless: - the gain is effectively connected with the non-U.S. holder's conduct of a trade or business in the United States and, if an income tax treaty applies, is attributable to a permanent establishment maintained by the non-U.S. holder in the United States; in these cases, the gain will be taxed on a net income basis at the regular graduated rates and in the manner applicable to United States persons (unless an applicable income tax treaty provides otherwise) and, if the non-U.S. holder is a foreign corporation, the "branch profits tax" described above may also apply; - the non-U.S. holder is an individual who holds our common stock as a capital asset, is present in the United States for more than 182 days in the taxable year of the disposition and meets other requirements; or - we are or have been a "U.S. real property holding corporation" for U.S. federal income tax purposes at any time during the shorter of the five-year period ending on the date of disposition or the period that the non-U.S. holder held our common stock. 80 Generally, a corporation is a "U.S. real property holding corporation" if the fair market value of its "U.S. real property interests" equals or exceeds 50% of the sum of the fair market value of its worldwide real property interests plus its other assets used or held for use in a trade or business. We believe that we are not currently, and we do not anticipate becoming in the future, a U.S. real property holding corporation. However, even if we are or have been a U.S. real property holding corporation, a non-U.S. holder which did not beneficially own, directly or indirectly, more than 5% of the total fair market value of our common stock at any time during the shorter of the five-year period ending on the date of disposition or the period that our common stock was held by the non-U.S. holder (a "non-5% holder") and which is not otherwise taxed under any other circumstances described above, generally will not be taxed on any gain realized on the disposition of our common stock if, at any time during the calendar year of the disposition, our common stock was regularly traded on an established securities market within the meaning of the applicable U.S. Treasury regulations. FEDERAL ESTATE TAX Our common stock that is owned or treated as owned by an individual who is a non-U.S. holder (as specially defined for U.S. federal estate tax purposes) at the time of death will be included in the individual's gross estate for U.S. federal estate tax purposes, unless an applicable estate tax or other treaty provides otherwise and, therefore, may be subject to U.S. federal estate tax. INFORMATION REPORTING AND BACKUP WITHHOLDING TAX Dividends paid to you may be subject to information reporting and United States backup withholding tax. If you are a non-U.S. holder, you will be exempt from such backup withholding tax if you provide a Form W-8BEN or otherwise meet documentary evidence requirements for establishing that you are a non-U.S. holder or otherwise establish an exemption. If you are a U.S. Holder, you will be exempt from back up withholding if you provide a completed and executed form W-9 and the IRS has not advised us that you are subject to back up withholding, or you meet certain other exemptions from back up withholding. The gross proceeds from the disposition of our common stock may be subject to information reporting and backup withholding tax. If you sell your common stock outside the United States through a non-U.S. office of a non-U.S. broker and the sales proceeds are paid to you outside the United States, then the United States backup withholding and information reporting requirements generally will not apply to that payment. However, U.S. information reporting, but not backup withholding, will apply to a payment of sales proceeds, even if that payment is made outside the United States, if you sell your common stock through a non-U.S. office of a broker that: - is a United States person; - derives 50% or more of its gross income in specific periods from the conduct of a trade or business in the United States; - is a "controlled foreign corporation" for United States federal income tax purposes; or - is a foreign partnership, if at any time during its tax year: - one or more of its partners are United States persons who in the aggregate hold more than 50% of the income or capital interests in the partnership; or - the foreign partnership is engaged in a United States trade or business, unless the broker has documentary evidence in its files that you are a non-U.S. person and certain other conditions are met or you otherwise establish an exemption. 81 If you receive payments of the proceeds of a sale of our common stock to or through a United States office of a broker, the payment is subject to both United States backup withholding and information reporting unless you are a non-US person and provide a Form W-8BEN certifying that you are a non-U.S. person or you are a US person and you provide a completed and executed Form W-9, and the IRS has not advised us that you are subject to back up withholding, or you otherwise establish an exemption. You generally may obtain a refund of any amounts withheld under the backup withholding rules that exceed your income tax liability by filing a refund claim with the U.S. Internal Revenue Service. 82 UNDERWRITING We intend to offer the shares in the U.S. and Canada through the underwriters. Merrill Lynch, Pierce, Fenner & Smith Incorporated, CIBC World Markets Corp., SunTrust Capital Markets, Inc. and U.S. Bancorp Piper Jaffray Inc. are acting as representatives of the underwriters named below. Subject to the terms and conditions described in a purchase agreement among us, the selling shareholders and the underwriters, we and the selling shareholders have agreed to sell to the underwriters, and the underwriters severally have agreed to purchase from us and the selling shareholders, the number of shares listed opposite their names below.
NUMBER UNDERWRITERS OF SHARES ------------ --------- Merrill Lynch, Pierce, Fenner & Smith Incorporated................................... CIBC World Markets Corp. ................................... SunTrust Capital Markets, Inc. ............................. U.S. Bancorp Piper Jaffray Inc. ............................ -------- Total.......................................... ========
The underwriters have agreed to purchase all of the shares sold under the purchase agreement if any of these shares are purchased. If an underwriter defaults, the purchase agreement provides that the purchase commitments of the nondefaulting underwriters may be increased or the purchase agreement may be terminated. We and the selling shareholders have agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act, or to contribute to payments the underwriters may be required to make in respect of those liabilities. The underwriters are offering the shares, subject to prior sale, when, as and if issued to and accepted by them, subject to approval of legal matters by their counsel, including the validity of the shares, and other conditions contained in the purchase agreement, such as the receipt by the underwriters of officer's certificates and legal opinions. The underwriters reserve the right to withdraw, cancel or modify offers to the public and to reject orders in whole or in part. COMMISSIONS AND DISCOUNTS The representatives have advised us and the selling shareholders that the underwriters propose initially to offer the shares to the public at the initial public offering price on the cover page of this prospectus and to dealers at that price less a concession not in excess of $ per share. The underwriters may allow, and the dealers may reallow, a discount not in excess of $ per share to other dealers. After the initial public offering, the public offering price, concession and discount may be changed. The following table shows the public offering price, underwriting discount and proceeds before expenses to Kirkland's and the selling shareholders. The information assumes either no exercise or full exercise by the underwriters of their overallotment option.
PER SHARE WITHOUT OPTION WITH OPTION --------- -------------- ----------- Public offering price...................... Underwriting discount...................... Proceeds, before expenses, to Kirkland's... Proceeds, before expenses, to the selling shareholders.............................
The expenses of the offering, not including the underwriting discount, are estimated at $ and are payable by Kirkland's. 83 OVERALLOTMENT OPTION The selling shareholders have granted an option to the underwriters to purchase up to additional shares at the public offering price less the underwriting discount. The underwriters may exercise this option for 30 days from the date of this prospectus solely to cover any overallotments. If the underwriters exercise this option, each will be obligated, subject to conditions contained in the purchase agreement, to purchase a number of additional shares proportionate to that underwriter's initial amount reflected in the above table. RESERVED SHARES At our request, the underwriters have reserved for sale, at the initial public offering price, up to shares offered by this prospectus for sale to some of our directors, officers, employees and related persons. If these persons purchase reserved shares, this will reduce the number of shares available for sale to the general public. Any reserved shares that are not orally confirmed for purchase within one day of the pricing of this offering will be offered by the underwriters to the general public on the same terms as the other shares offered by this prospectus. NO SALES OF SIMILAR SECURITIES We, our executive officers and directors and all of our existing shareholders have agreed, with exceptions, not to sell or transfer any common stock for 180 days after the date of this prospectus without first obtaining the written consent of Merrill Lynch. Specifically, we and these other individuals have agreed not to directly or indirectly - offer, pledge, sell or contract to sell any common stock, - sell any option or contract to purchase any common stock, - purchase any option or contract to sell any common stock, - grant any option, right or warrant for the sale of any common stock, - lend or otherwise dispose of or transfer any common stock, - request or demand that we file a registration statement related to the common stock, or - enter into any swap or other agreement that transfers, in whole or in part, the economic consequence of ownership of any common stock whether any such swap or transaction is to be settled by delivery of shares or other securities, in cash or otherwise. This lockup provision applies to common stock and to securities convertible into or exchangeable or exercisable for or repayable with common stock. It also applies to common stock owned now or acquired later by the person executing the agreement or for which the person executing the agreement later acquires the power of disposition. QUOTATION ON THE NASDAQ NATIONAL MARKET We expect the shares to be approved for quotation on the Nasdaq National Market, subject to notice of issuance, under the symbol "KIRK." Before this offering, there has been no public market for our common stock. The initial public offering price will be determined through negotiations among us, the selling shareholders and the representatives. In addition to prevailing market conditions, the factors to be considered in determining the initial public offering price are - the valuation multiples of publicly traded companies that the representatives believe to be comparable to us, - our financial information, 84 - the history of, and the prospects for, our company and the industry in which we compete, - an assessment of our management, its past and present operations, and the prospects for, and timing of, our future revenues, - the present state of our development, and - the above factors in relation to market values and various valuation measures of other companies engaged in activities similar to ours. An active trading market for the shares may not develop. It is also possible that after this offering the shares will not trade in the public market at or above the initial public offering price. The underwriters do not expect to sell more than 5% of the shares in the aggregate to accounts over which they exercise discretionary authority. PRICE STABILIZATION, SHORT POSITIONS AND PENALTY BIDS Until the distribution of the shares is completed, Securities and Exchange Commission rules may limit underwriters and selling group members from bidding for and purchasing our common stock. However, the representatives may engage in transactions that stabilize the price of the common stock, such as bids or purchases to peg, fix or maintain that price. If the underwriters create a short position in the common stock in connection with this offering, i.e., if they sell more shares than are listed on the cover of this prospectus, the representatives may reduce that short position by purchasing shares in the open market. The representatives may also elect to reduce any short position by exercising all of part of the overallotment option described above. Purchases of the common stock to stabilize its price or to reduce a short position may cause the price of the common stock to be higher that it might be in the absence of such purchases. The representatives may also impose a penalty bid on underwriters and selling group members. This means that if the representatives purchase shares in the open market to reduce the underwriter's short position or to stabilize the price of such shares, they may reclaim the amount of the selling concession from the underwriters and selling group members who sold those shares. The imposition of a penalty bid may also affect the price of the shares in that it discourages resales of those shares. Neither we 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 we nor any of the underwriters makes any representation that the representatives will engage in these transactions or that these transactions, once commenced, will not be discontinued without notice. INTERNET DISTRIBUTION Merrill Lynch will be facilitating Internet distribution for this offering to certain of its Internet subscription customers. Merrill Lynch intends to allocate a limited number of shares for sale to its online brokerage customers. An electronic prospectus is available on the Internet Web site maintained by Merrill Lynch. Other than the prospectus in electronic format, the information on the Merrill Lynch Web site is not part of this prospectus. OTHER RELATIONSHIPS SunTrust Robinson Humphrey, a division of SunTrust Capital Markets, Inc., or its predecessor firm, The Robinson-Humphrey Company, LLC, has from time to time provided us with investment banking services, including services rendered in connection with our 1996 recapitalization, and may continue to provide such services in the future. 85 LEGAL MATTERS The validity of the shares of common stock offered hereby is being passed upon for us by Pepper Hamilton LLP and the underwriters are being represented by Fried, Frank, Harris, Shriver & Jacobson (a partnership including professional corporations). Pepper Hamilton LLP and Fried, Frank, Harris, Shriver & Jacobson will rely upon Baker, Donelson, Bearman & Caldwell with respect to matters governed by Tennessee law. EXPERTS The consolidated balance sheets of Kirkland's as of February 2, 2002, February 3, 2001 and December 31, 2000, and the related consolidated statements of operations, changes in shareholders' deficit and cash flows for the year ended February 2, 2002, the 34 days ended February 3, 2001 and each of the two years in the period ended December 31, 2000, included in this prospectus and elsewhere in the registration statement have been so included in reliance upon the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. 86 WHERE YOU CAN FIND MORE INFORMATION We filed with the Securities and Exchange Commission a registration statement on Form S-1 under the Securities Act for the shares of common stock to be sold in this offering. This prospectus does not contain all of the information in the registration statement and the exhibits and schedule that were filed with the registration statement. For further information with respect to us and our common stock, we refer you to the registration statement and the exhibits and schedules that were filed with the registration statement. Statements contained in this prospectus about the contents of any contract or any other document that is filed as an exhibit to the registration statement are not necessarily complete, and we refer you to the full text of the contract or other document filed as an exhibit to the registration statement. A copy of the registration statement and the exhibits and schedules that were filed with the registration statement may be inspected without charge at the public reference facilities maintained by the Securities and Exchange Commission in Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and copies of all or any part of the registration statement may be obtained from the Securities and Exchange Commission upon payment of the prescribed fee. Information on the operation of the public reference facilities may be obtained by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission maintains a World Wide Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Securities and Exchange Commission. The address of the site is http://www.sec.gov. You may also request copies of these filings, at no cost, by telephone at (731) 668-2444 or by mail to: Kirkland's, Inc., 805 N. Parkway, Jackson, TN 38305, Attention: General Counsel. Upon completion of this offering, we will become subject to the information and periodic reporting requirements of the Exchange Act, and, in accordance with such requirements, will file periodic reports, proxy statements and other information with the Securities and Exchange Commission. These periodic reports, proxy statements and other information will be available for inspection and copying at the regional offices, public reference facilities and web site of the Securities and Exchange Commission referred to above. We intend to furnish our shareholders with annual reports containing financial statements audited by our independent accountants. 87 INDEX TO FINANCIAL STATEMENTS INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Report of the Independent Accountants....................... F-2 Consolidated Statements of Operations for the years ended December 31, 1999 and 2000, 34 days ended February 3, 2001 and year ended February 2, 2002........................... F-3 Consolidated Balance Sheets as of December 31, 2000, February 3, 2001 and February 2, 2002..................... F-4 Consolidated Statements of Changes in Shareholders' Deficit for the years ended December 31, 1999 and 2000, 34 days ended February 3, 2001 and year ended February 2, 2002.... F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1999 and 2000, 34 days ended February 3, 2001 and year ended February 2, 2002........................... F-6 Notes to Consolidated Financial Statements.................. F-7
F-1 REPORT OF THE INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Kirkland's, Inc. The stock split described in Note 13 to the consolidated financial statements has not been consummated at April 22, 2002. When it has been consummated, we will be in a position to furnish the following report: "In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of changes in shareholders' deficit and of cash flows present fairly, in all material respects, the financial position of Kirkland's, Inc. at December 31, 2000, February 3, 2001, and February 2, 2002, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2000, the 34 days ended February 3, 2001, and the year ended February 2, 2002 in conformity with accounting principles generally accepted in the United States of America. 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 consolidated financial statements in accordance with auditing standards generally accepted in the United States of America, 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 our opinion." PricewaterhouseCoopers LLP Memphis, TN April 19, 2002, except for Note 13 as to which the date is , 2002 F-2 KIRKLAND'S, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
YEAR ENDED --------------------------- 34 DAYS ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, FEBRUARY 3, FEBRUARY 2, 1999 2000 2001 2002 ------------ ------------ ------------- ----------- Net sales.................................. $236,622 $259,240 $ 23,875 $307,213 Cost of sales.............................. 154,278 172,376 18,998 200,063 -------- -------- -------- -------- Gross profit............................. 82,344 86,864 4,877 107,150 Operating expenses: Other operating expenses................. 57,894 67,401 7,388 71,622 Non-cash stock compensation charge....... -- -- -- 712 -------- -------- -------- -------- Total operating expenses.............. 57,894 67,401 7,388 72,334 Depreciation and amortization.............. 7,276 7,827 601 7,678 -------- -------- -------- -------- Operating income (loss).................. 17,174 11,636 (3,112) 27,138 Interest expense: Senior, subordinated and other notes payable............................... 10,232 11,221 1,043 9,759 Class C Preferred Stock.................. 1,647 1,850 154 2,007 Accretion of common stock warrants....... (879) -- -- 7,759 -------- -------- -------- -------- Total interest expense................ 11,000 13,071 1,197 19,525 Interest income............................ (27) (1) -- (278) Offering and financing costs (Note 1)...... 852 782 -- -- Other expense (income), net................ (396) (328) (34) 262 -------- -------- -------- -------- Income (loss) before income taxes........ 5,745 (1,888) (4,275) 7,629 Income tax provision (benefit)............. 1,106 (573) (1,806) 3,331 -------- -------- -------- -------- Net income (loss)........................ 4,639 (1,315) (2,469) 4,298 Accretion of redeemable preferred stock and dividends accrued........................ (5,053) (6,555) (778) (6,352) -------- -------- -------- -------- Net loss allocable to common stock......... $ (414) $ (7,870) $ (3,247) $ (2,054) ======== ======== ======== ======== Loss per common share: Basic.................................... $ (4.50) $ (71.49) $ (23.74) $ (1.50) ======== ======== ======== ======== Diluted.................................. $ (4.50) $ (71.49) $ (23.74) $ (1.50) ======== ======== ======== ======== Weighted average number of common shares outstanding: Basic.................................... 92,101 110,084 136,751 136,752 ======== ======== ======== ======== Diluted.................................. 92,101 110,084 136,751 136,752 ======== ======== ======== ======== Pro Forma Earnings Per Share (Note 14): Earnings Per Common Share: Basic................................. ======== Diluted............................... ======== Weighted average number of common shares outstanding: Basic................................. ======== Diluted............................... ========
The accompanying notes are an integral part of these consolidated financial statements. F-3 KIRKLAND'S, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT FOR SHARE AMOUNTS)
PRO FORMA AS OF FEBRUARY 2, 2002 DECEMBER 31, FEBRUARY 3, FEBRUARY 2, (UNAUDITED) 2000 2001 2002 (NOTE 14) ------------ ----------- ----------- ------------- ASSETS Current assets: Cash and cash equivalents.................. $ 28,156 $ 26,914 $ 29,751 $ 29,751 Inventories................................ 47,993 45,330 32,763 32,763 Prepaid expenses and other current assets.................................. 1,999 2,006 1,902 1,902 Deferred income taxes...................... 2,139 1,381 1,375 1,375 -------- -------- --------- -------- Total current assets.................... 80,287 75,631 65,791 65,791 Property and equipment, net.................. 26,047 25,682 23,748 23,748 Noncurrent deferred income taxes............. 4,210 6,774 4,140 4,140 Debt issue costs, net........................ 1,345 1,261 757 757 Goodwill, net................................ 1,472 1,465 1,382 1,382 Other assets................................. 21 14 -- -- -------- -------- --------- -------- Total assets............................ $113,382 $110,827 $ 95,818 $ 95,818 ======== ======== ========= ======== LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' DEFICIT Current liabilities: Current maturities of long-term debt....... $ 9,167 $ 9,167 $ 38,177 $ 38,177 Revolving line of credit................... 20,000 20,000 -- -- Accounts payable........................... 19,072 19,110 12,530 12,530 Income taxes payable....................... 399 413 429 429 Accrued expenses........................... 14,242 14,075 21,349 21,349 Accrued stock compensation................. -- -- 712 712 -------- -------- --------- -------- Total current liabilities............... 62,880 62,765 73,197 73,197 -------- -------- --------- -------- Long-term debt: Senior credit facility..................... 38,177 38,177 -- -- Subordinated debt.......................... 19,894 19,897 19,940 19,940 Mandatorily redeemable preferred stock (Class C)............................... 17,122 17,122 17,122 17,122 Other liabilities............................ 1,558 1,584 2,198 2,198 Common stock warrants........................ -- -- 7,759 -- Commitments and Contingencies, note 10 Redeemable convertible preferred stock, no par value: Class D.................................... 20,680 20,879 22,293 -- Class A.................................... 45,460 45,890 48,901 -- Class B.................................... 15,769 15,918 15,618 -- Shareholders' deficit: Common stock, at stated value; 92,306, 136,751 and 136,981 shares issued and outstanding at December 31, 2000, February 3, 2001 and February 2, 2002, respectively............................ 229 229 229 229 Additional paid-in capital................. -- -- -- 94,571 Accumulated deficit........................ (108,387) (111,634) (111,439) (111,439) -------- -------- --------- -------- Total liabilities, redeemable preferred stock, and shareholders' deficit...... $113,382 $110,827 $ 95,818 $ 95,818 ======== ======== ========= ========
The accompanying notes are an integral part of these consolidated financial statements. F-4 KIRKLAND'S, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' DEFICIT (IN THOUSANDS, EXCEPT FOR SHARE AMOUNTS)
COMMON STOCK ---------------- ADDITIONAL ACCUMULATED SHARES AMOUNT PAID IN CAPITAL DEFICIT ------- ------ --------------- ----------- Balance at December 31, 1998..................... 92,100 $229 $ -- $(100,103) Accretion of redeemable preferred stock and dividends accrued.............................. (5,053) Issuance of common stock......................... 206 Net income....................................... 4,639 ------- ---- ---- --------- Balance at December 31, 1999..................... 92,306 229 -- (101,517) Accretion of redeemable preferred stock and dividends accrued.............................. (6,555) Issuance of common stock (see Note 2)............ 44,445 Net loss......................................... (1,315) ------- ---- ---- --------- Balance at December 31, 2000..................... 136,751 229 -- (108,387) Accretion of redeemable preferred stock and dividends accrued.............................. (778) Net loss......................................... (2,469) ------- ---- ---- --------- Balance at February 3, 2001...................... 136,751 229 -- (111,634) Fair value adjustment for dividend rate change on preferred stock (see Note 6)................... 2,227 Accretion of redeemable preferred stock and dividends accrued.............................. (22) (6,330) Exercise of stock options........................ 230 22 Net income....................................... 4,298 ------- ---- ---- --------- Balance at February 2, 2002...................... 136,981 $229 $ -- $(111,439) ======= ==== ==== =========
The accompanying notes are an integral part of these consolidated financial statements. F-5 KIRKLAND'S, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED --------------------------- 34 DAYS ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, FEBRUARY 3, FEBRUARY 2, 1999 2000 2001 2002 ------------ ------------ ------------- ----------- Cash flows from operating activities: Net income (loss)....................................... $ 4,639 $(1,315) $(2,469) $ 4,298 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation of property and equipment.................. 5,892 6,439 504 6,296 Amortization of debt issue costs, debt discount and goodwill.............................................. 1,384 1,430 94 1,434 Loss on disposal of property and equipment.............. -- 21 7 382 Accretion of common stock warrants...................... (879) -- -- 7,759 Write-off of debt issue costs........................... -- 782 -- -- Write-off of offering costs............................. 852 -- -- -- Deferred tax expense (benefit).......................... (2,385) (1,015) (1,806) 2,640 Changes in assets and liabilities: Inventories........................................... (5,091) (6,146) 2,663 12,567 Prepaid expenses and other current assets............. (593) (179) (7) 104 Other noncurrent assets............................... (15) -- 7 14 Accounts payable...................................... 6,405 1,369 38 (6,580) Income taxes payable.................................. 505 (2,591) 14 16 Accrued expenses and other noncurrent liabilities..... 2,231 2,541 (141) 7,888 Accrued stock compensation............................ -- -- -- 712 -------- ------- ------- -------- Net cash provided by (used in) operating activities........................................ 12,945 1,336 (1,096) 37,530 -------- ------- ------- -------- Cash flows from investing activities: Proceeds from sale of property and equipment............ -- 60 -- -- Capital expenditures.................................... (10,825) (6,041) (146) (4,744) -------- ------- ------- -------- Net cash used in investing activities............... (10,825) (5,981) (146) (4,744) -------- ------- ------- -------- Cash flows from financing activities: Net borrowings (repayments) on revolving line of credit................................................ (7,000) 20,000 -- (20,000) Proceeds from issuance of short-term debt............... 7,500 -- -- -- Proceeds from issuance of long-term debt................ 2,500 -- -- -- Debt issue and offering costs........................... (595) (881) -- (804) Principal payments on long-term debt.................... (5,775) (6,648) -- (9,167) Proceeds from equity contribution, net of issue costs... -- 7,384 -- -- Exercise of options..................................... -- -- -- 22 -------- ------- ------- -------- Net cash (used in) provided by financing activities........................................ (3,370) 19,855 -- (29,949) -------- ------- ------- -------- Cash and cash equivalents Net (decrease) increase............................. (1,250) 15,210 (1,242) 2,837 Beginning of period................................. 14,196 12,946 28,156 26,914 -------- ------- ------- -------- End of period....................................... $ 12,946 $28,156 $26,914 $ 29,751 ======== ======= ======= ======== Supplemental disclosures: Interest paid........................................... $ 10,211 $10,992 $ -- $ 7,298 ======== ======= ======= ======== Income taxes paid....................................... $ 3,132 $ 3,033 $ (16) $ 613 ======== ======= ======= ========
The accompanying notes are an integral part of these consolidated financial statements. F-6 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES Kirkland's, Inc. (the "Company") is a leading specialty retailer of home decor with stores in 28 states. The consolidated financial statements of the Company include the accounts of Kirkland's, Inc. and its wholly owned subsidiaries Kirkland's Stores, Inc. and kirklands.com, inc. Significant intercompany accounts and transactions have been eliminated. Fiscal Year - Effective January 1, 2001, the Company elected to change its fiscal year from a calendar basis to a 52/53-week year ending on the Saturday closest to January 31. The 34-day transition period ended February 3, 2001 is presented separately in these consolidated financial statements. Unless specifically indicated otherwise, any reference herein to "1999" and "2000" or "Fiscal 1999" and "Fiscal 2000" relates to as of or for the years ended December 31, 1999 and 2000, respectively. Any reference to "2001" or "Fiscal 2001" relates to as of or for the year ended February 2, 2002. 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 of construction costs incurred in connection with store openings and remodelings 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 using the straight-line method over the life of the debt and are shown net of accumulated amortization of $5,224,000 at December 31, 2000, $4,702,000 at February 3, 2001 and $3,676,000 at February 2, 2002. The Company recorded amortization expense of $1,305,000 at December 31, 2000, $84,000 at February 3, 2001, and $1,308,000 at February 2, 2002. Goodwill - During 1998, the Company purchased 100% of the stock of Briar Patch Management Corporation ("Briar Patch"). In connection with this purchase, the Company recorded goodwill in the amount of the excess of the purchase price over the fair market value of the net assets of Briar Patch. The goodwill is being amortized on a straight-line basis over 20 years. The Company recorded amortization expense of $79,000 for December 31, 1999, $83,000 at both December 31, 2000 and February 2, 2002, and $7,000 for the 34-day period ended February 3, 2001. Long-Lived Assets - The Company periodically reviews the recoverability of property and equipment, goodwill, and other long-lived assets whenever an event or change in circumstances indicates the carrying amount of an asset or group of assets may not be recoverable. The impairment review includes comparison of future cash flows expected to be generated by the asset or group of assets with their associated carrying value. If the carrying value of the asset or group of assets exceeds the expected cash flows (undiscounted and without interest charges), an impairment loss is recognized to the extent the carrying amount of the asset exceeds its fair value. The Company recorded an impairment of $103,000 and $82,000 at December 31, 2000 and February 2, 2002, respectively, relating to the leasehold improvements of stores anticipated to be closed. This charge is included in depreciation and amortization on the consolidated statement of operations. F-7 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Cost of Sales - Cost of sales includes cost of product sold, freight, store occupancy and central distribution costs. Offering and Financing Costs - During 2000, the Company expensed offering and financing costs on the Company's statement of operations of $782,000 for costs related to a refinancing effort that was not consummated. Additionally, during 1999, the Company indefinitely postponed plans for an offering of its common stock resulting in an expense of $852,000 for costs previously anticipated to be deducted from the proceeds of the offering. Preopening Expenses - Preopening expenses, which consist primarily of payroll and occupancy costs, are expensed as incurred. Advertising Expenses - Advertising costs are expensed as incurred. Advertising expense, including lease-required advertising, was $1,553,000, $2,595,000 and $3,743,000 for fiscal years 1999, 2000 and 2001, respectively, and $402,000 for the 34-day period ended February 3, 2001. Income Taxes - 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. Authorized Capital - At February 2, 2002, the authorized capital of Kirkland's, Inc. consisted of 500,000 shares of common stock; 3,100,000 shares of Class A Preferred Stock; 1,100,000 shares of Class B Preferred Stock; 600,000 shares of Class C Preferred Stock; and 75,000 shares of Class D Preferred Stock. See Notes 2 and 6 for a description of the terms of each issue. Stock Options and Warrants - The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for its stock compensation plans. Compensation cost on stock options is measured as the excess, if any, of the fair value of the Company's stock at the date of the grant over 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 8). The fair value of detachable put warrants is initially recorded as a discount to the related debt and is amortized to interest expense, using the straight-line method, over the term of the related debt. The put warrants are adjusted to their current fair value at each balance sheet date. 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. Insurance Reserves - Workers' compensation, general liability and employee medical insurance programs are partially self-insured. It is the Company's policy to record its self-insurance liability using estimates of claims incurred but not yet reported or paid, based on historical trends. Actual results can vary from estimates for many reasons, including, among others, inflation rates, claim settlement patterns, litigation trends and legal interpretations. Fair Value of Financial Instruments - At December 31, 2000, February 3, 2001 and February 2, 2002, 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 for long-term debt, approximate fair value because of their short maturities. Long-term debt approximates fair value based on the short periods of interest rate repricing for F-8 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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. Non-cash Supplemental Disclosure - Accretion and dividends accrued for redeemable Class A Preferred Stock; Class B Preferred Stock; and Class D Preferred Stock of $5,053,000, $6,555,000 and $6,352,000 have been excluded from the Statements of Cash Flows for the years ended December 31, 1999, December 31, 2000 and February 2, 2002, respectively. Accretion and dividends accrued of $778,000 have been excluded from the Statement of Cash Flows for the 34-day period ended February 3, 2001. The effect of the fair value adjustment to the Class B Preferred Stock of $2,227,000, as more fully discussed in Note 6, was excluded from the Statement of Cash Flows for the year ended February 2, 2002. Revenue Recognition - The Company recognizes revenue at the time of sale of merchandise to the Company's customers. Sales include the sale of merchandise, net of returns, and exclusive of sales taxes. Earnings Per Share - Earnings per share is presented on a basic and diluted basis. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. Comprehensive income - Comprehensive income is reported in accordance with SFAS No. 130, Reporting Comprehensive Income. Comprehensive income does not differ from the consolidated net income presented in the consolidated statements of operations. Recent Accounting Pronouncements - In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets", effective for fiscal years beginning after December 15, 2001. SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Under SFAS 142 goodwill (and intangible assets deemed to have indefinite lives) will no longer be amortized but will be subject to annual impairment tests. Other intangible assets will continue to be amortized over their useful lives. As of February 2, 2002, the Company had goodwill, net of accumulated amortization, with a net book value of approximately $1,382,000 and recorded amortization expense of $83,000 for the year then ended. The Company will apply the new rules of accounting for goodwill and other intangible assets beginning in the first quarter of fiscal 2002. The Company will cease to amortize goodwill in accordance with SFAS 142 and will perform a test for impairment when events and circumstances indicate that an impairment may have occurred. The application of SFAS 141 and SFAS 142 is not expected to have a significant impact on the Company's financial condition or results of operations. In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, "Accounting for the Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and the accounting and reporting provisions of Accounting Principles Board (APB) Opinion No. 30, "Reporting the Results of Operations" for a disposal of a segment of a business. SFAS 144 is effective for fiscal years beginning after December 15, 2001. The Company does not anticipate that the adoption of this standard will have a significant impact on its financial condition or results of operations. F-9 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 2 - EQUITY TRANSACTIONS AND CAPITAL STRUCTURE EQUITY TRANSACTIONS Recapitalization On June 12, 1996, the Company completed a leveraged recapitalization (the "Recapitalization") pursuant to which Advent International Group, through affiliated entities, ("Advent"), a private equity investment firm, became the largest beneficial owner of the Company. The Recapitalization permitted the founding shareholders of the Company to realize a portion of their investment in cash. As a result of the Recapitalization, the capital structure of the Company changed to consist of two classes of redeemable convertible preferred stock ("Class A Preferred Stock" and "Class B Preferred Stock"), a class of mandatorily redeemable preferred stock ("Class C Preferred Stock") and common stock. At the time of the Recapitalization, the Company discontinued its subchapter S corporation election and became a C corporation for federal income tax purposes. Since a new capital structure was formed, the existing retained earnings of the Company were transferred to additional paid-in capital so that a new historical accumulation of earnings could begin post-recapitalization. Distributions of cash and securities to the former shareholders of the Company made immediately subsequent to the Recapitalization were recorded to retained earnings, creating a negative retained earnings balance of $116 million at the beginning of the post-recapitalization period. August 2000 Equity Offering On August 8, 2000, the Company and certain of its existing shareholders completed an additional equity offering of $20 million. Investors in the offering received shares of Class D Preferred Stock ("Class D Preferred Stock") and common stock. The new equity offering included the following components: - A contribution of $7.5 million in cash from shareholders affiliated with Advent ($3.8 million) and a management employee of the Company ($3.7 million) in exchange for a total of 16,667 shares of common stock at $0.01 per share and 16,667 shares of Class D Preferred Stock at $449.99 per share. - A conversion of a $5.0 million note held by a management employee of the Company to equity through an exchange of the principal on the note for 11,111 shares of common stock at $0.01 per share and 11,111 shares of Class D Preferred Stock at $449.99 per share. - The repayment of a $7.5 million term note. The term note had been provided to the Company in conjunction with an amendment (see Note 6) to its Senior Debt Agreement and Supplemental Loan Agreement. Of the $7.5 million advanced under the term note, $4.1 million had been collateralized by a pledge from certain shareholders of the Company, and $3.4 million had been loaned to the Company by shareholders affiliated with Advent. The $7.5 million principal on the note was repaid through the surrender of the collateral provided by shareholders in exchange for equity, and conversion into equity of the loan advanced by shareholders affiliated with Advent. Total consideration received by shareholders in connection with the term note repayment was 16,667 shares of common stock at $0.01 per share and 16,667 shares of Class D Preferred Stock at $449.99 per share. In conjunction with the equity offering, the Company also issued warrants to purchase an aggregate of 5,555 shares of the Company's common stock for $0.01 per share. The warrants were issued to the investors in the equity offering on a pro-rata basis in relation to their participation in the total offering. The warrants were considered to have no value at August 8, 2000, based upon the market value received in exchange for common shares in the equity offering. F-10 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Capital Structure - As a result of the aforementioned capital transactions, the charter of Kirkland's, Inc. was amended to establish the following capital structure. Common Stock The authorized capital of Kirkland's, Inc. includes 500,000 shares of voting common stock. The holders of the common stock have one vote per share and are not entitled to cumulative voting in the election of directors. Redeemable Convertible Preferred Stock (Class A, Class B and Class D) The Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock have voting privileges on par with common shareholders and have liquidation values of $30,749,000; $14,206,000; and $20,000,000, respectively, plus accrued dividends. The dividends are cumulative and accrue at 4% compounded quarterly for the Class A Preferred Stock and Class D Preferred Stock, and ranging from 4% to 10% for the Class B Preferred Stock (see Note 6). The Class D Preferred Stock has a redemption preference over all other classes of stock of the Company. 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 D Preferred Stock and Class C Preferred Stock have been redeemed. The Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock are redeemable at our option or at the option of the holders after the earliest to occur of June 12, 2004 or the closing of a liquidity event (as defined). The Class A Preferred Stock and Class B Preferred Stock must be redeemed in equal proportions. Additionally, at the option of 60% of the holders, all of the outstanding the Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock, other than any shares being redeemed at our option, will automatically convert into common stock upon the occurrence of an initial public offering of the Company's common stock at a rate equal to the liquidation value plus accrued dividends, divided by the initial public offering price. NOTE 3 - PROPERTY AND EQUIPMENT Property and equipment is comprised of the following (in thousands):
DECEMBER 31, FEBRUARY 3, FEBRUARY 2, 2000 2001 2002 ------------ ----------- ----------- Land........................................ $ 402 $ 402 $ 402 Buildings................................... 3,460 3,460 3,460 Equipment................................... 10,430 10,438 12,916 Furniture and fixtures...................... 25,889 25,850 23,706 Leasehold improvements...................... 15,791 15,786 12,406 Projects in process......................... 2,088 2,143 623 ------- ------- ------- 58,060 58,079 53,513 Less accumulated depreciation............... 32,013 32,397 29,765 ------- ------- ------- $26,047 $25,682 $23,748 ======= ======= =======
F-11 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4 - ACCRUED EXPENSES Accrued expenses are comprised of the following (in thousands):
DECEMBER 31, FEBRUARY 3, FEBRUARY 2, 2000 2001 2002 ------------ ----------- ----------- Accrued compensation........................ $ 759 $ 891 $ 2,618 Sales taxes payable......................... 3,458 1,678 1,234 Percentage rent accrual..................... 441 460 827 Gift certificates and store credits......... 2,597 2,323 2,992 Accrued interest payable.................... 6,416 7,613 12,352 Other....................................... 571 1,110 1,326 ------- ------- ------- $14,242 $14,075 $21,349 ======= ======= =======
NOTE 5 - INCOME TAXES The provision (benefit) for income taxes consists of the following (in thousands):
YEAR ENDED --------------------------- 34 DAYS ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, FEBRUARY 3, FEBRUARY 2, 1999 2000 2001 2002 ------------ ------------ ------------- ----------- Current Federal.................... $ 2,862 $ 318 $ -- $ 397 State...................... 629 124 -- 293 ------- ------- ------- ------ 3,491 442 -- 690 ------- ------- ------- ------ Deferred Federal.................... (2,008) (1,092) (1,461) 2,388 State...................... (377) 77 (345) 252 ------- ------- ------- ------ (2,385) (1,015) (1,806) 2,640 ------- ------- ------- ------ $ 1,106 $ (573) $(1,806) $3,331 ======= ======= ======= ======
F-12 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Significant components of the Company's deferred tax assets are as follows (in thousands):
DECEMBER 31, FEBRUARY 3, FEBRUARY 2, 2000 2001 2002 ------------ ----------- ----------- Current deferred tax assets Inventory valuation methods............... $ 772 $ 663 $ 502 Accruals.................................. 1,367 718 873 ------ ------ ------ 2,139 1,381 1,375 ------ ------ ------ Noncurrent deferred tax assets Property and equipment.................... 546 601 -- Stock options and warrants valuation...... -- -- 3,215 Other..................................... 630 603 835 Net operating loss and credit carryforwards.......................... 3,234 5,770 2,136 Valuation allowance....................... (200) (200) (200) ------ ------ ------ 4,210 6,774 5,986 ------ ------ ------ Noncurrent deferred tax liability Property and equipment.................... -- -- 1,846 ------ ------ ------ Net noncurrent deferred tax asset........... 4,210 6,774 4,140 ------ ------ ------ Total deferred tax assets................... $6,349 $8,155 $5,515 ====== ====== ======
A reconciliation of the provision for income taxes to the amount computed by applying the federal statutory tax rate of 35.0% to income before income taxes for the periods indicated below, respectively, is as follows:
YEAR ENDED --------------------------- 34 DAYS ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, FEBRUARY 3, FEBRUARY 2, 1999 2000 2001 2002 ------------ ------------ ------------- ----------- Statutory Federal income tax rate....................... 35.0% (35.0)% (35.0)% 35.0% State income taxes, net of Federal income tax effect..................... 3.4 (4.2) (3.9) 4.7 Benefit from surtax exemptions................. (18.6) 1.0 1.0 -- Deferred taxes: impact of merger on state NOL's...... 0.0 4.4 0.0 -- Other........................ (0.6) 3.5 (4.3) 4.0 ----- ----- ----- ----- 19.2% (30.3)% (42.2)% 43.7% ===== ===== ===== =====
At December 31, 2000, February 3, 2001, and February 2, 2002, the Company was in a net operating loss carryforward position for federal taxes and in certain states. These loss carryforwards aggregated approximately $10.8 million and $14.5 million for federal purposes and $6.7 million and $10.0 million for state purposes as of December 31, 2000 and February 3, 2001, respectively. As of February 2, 2002, the Company had $4.7 million in net operating loss carryforwards for federal purposes and $4.3 million in certain states. These carryforwards will expire, if unused, in 2004 through 2021. During the year ended December 31, 2000, certain state loss carryforwards were disallowed. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. F-13 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company has established a valuation allowance, as it is more likely than not that certain net operating loss carryforward items will expire unused. NOTE 6 - INDEBTEDNESS Indebtedness consists of the following (in thousands):
DECEMBER 31, FEBRUARY 3, FEBRUARY 2, 2000 2001 2002 ------------ ----------- ----------- Senior Credit Facility: Senior Debt (Tranche A), principal and interest payable quarterly at varying amounts through June 2002, interest at a floating rate, as defined in the credit agreement (average rate of 9.8% in 2000, 11.9% in the 34-day period ended February 3, 2001 and 5.6% in 2001)...... $ 1,667 $ 1,667 $ -- Senior Debt (Tranche B), principal and interest payable quarterly at varying amounts through June 2002, interest at a floating rate, as defined in the credit agreement (average rate of 10.8% in 2000, 12.4% in the 34-day period ended February 3, 2001 and 8.5% in 2001)...... 45,677 45,677 38,177 Revolving credit facility, interest at a floating rate, as defined in the credit agreement (average rate of 9.2% in 2000, 11.9% in the 34-day period ended February 3, 2001 and 8.2% in 2001)............................. 20,000 20,000 -- -------- -------- ------- 67,344 67,344 38,177 Senior Subordinated Notes, interest payable quarterly, principal due in June 2003 (average rate of 13.5% in 2000, 15.0% in the 34-day period ended February 3, 2001 and 15.0% in 2001)........................................... 20,000 20,000 20,000 Mandatorily redeemable preferred stock, Class C, interest at 9% annually......................... 17,122 17,122 17,122 -------- -------- ------- 104,360 104,363 75,239 Less: Unamortized debt discount....................... 106 103 60 Current portion................................. 29,167 29,167 38,177 -------- -------- ------- Total long-term indebtedness.................... $ 75,193 $ 75,196 $37,062 ======== ======== =======
Senior Credit Facility - The senior credit facility as amended (the "Senior Debt Agreement") entered into in connection with the Recapitalization (see Note 2), with a syndicate bank group provides for $65 million in senior term debt (Tranche A $20 million and Tranche B $45 million) and a $20 million revolving line of credit ("Line of Credit"). The Line of Credit requires a 30-day consecutive zero balance between January 1 and March 1 of each year. The Company is required to pay a commitment fee to the bank at a rate per annum equal to .5% of the unused portion of the Line of Credit. Borrowings under the Tranche A term loan and the Line of Credit bear interest at 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 Tranche B term loan bear interest at a floating rate (the higher of the federal funds rate plus .5% or the prime rate) plus 2.95% or a Eurodollar Rate, as defined, plus 3.95%. F-14 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) On July 7, 1999, the Company entered an amendment to its Senior Debt Agreement and Supplemental Loan Agreement. The amendment provided an additional $2.5 million in borrowings under the Tranche B term loan and a term note (the "Term Note") for $7.5 million due June 2000. Of the $7.5 million advanced under the Term Note, $3.4 million was loaned by shareholders affiliated with Advent and $4.1 million was collaterized by cash and letters of credit supplied by other shareholders of the Company. In conjunction with the amendment, the Company issued warrants to purchase an aggregate of 15,847 shares of common stock of the Company for $0.01 per share. The warrants were issued to certain shareholders of the Company in consideration for collateralizing the principal on the Term Note or advancing a portion of the borrowings represented by the Term Note. The warrants were considered to have no value at July 7, 1999, based upon a fair value analysis of the Company's common stock at July 7, 1999. On August 8, 2000, the Term Note was repaid through the surrender of the collateral provided by shareholders in exchange for equity and conversion into equity of the loan advanced by shareholders affiliated with Advent (see Note 2). Effective June 19, 2001, the Company completed an amendment to its Senior Debt Agreement with its senior bank syndicate, whereby all previous financial covenant violations were waived and new financial covenant requirements were established for the duration of the amended agreement. As of February 2, 2002, the Company was in compliance with all financial covenants. Subordinated Note Agreement - Concurrent with the Senior Debt Agreement, the Company entered into a Senior Subordinated Note and Warrant Purchase Agreement (the "Subordinated Note Agreement") with a group of preferred shareholders providing for $20 million in subordinated notes. The notes have a maturity date of June 30, 2003 and bear interest at the rate of 12.50% per annum. 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") were reserved for the holders of the notes, entitling them to purchase, for $0.01 per share, an additional 4,817 shares of common stock of the Company if a liquidity event achieving certain valuation targets had not occurred prior to December 31, 1999. This condition not having been met, the Incentive Warrants became exercisable to the holders of the notes effective January 1, 2000. Under the original provisions of this agreement, all of 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. An initial value of $300,000 was allocated to the 16,722 warrants and recorded as a discount on the related debt. This discount is being amortized over the life of the notes. Prior to January 1, 1998, at which time the holders of the warrants agreed to terminate their put option, the warrants were marked to market based upon the fair value of the underlying common stock as of each period end. Upon termination of the put option the recorded liability of $879,000 was reclassified as temporary equity. The put option was reinstated on December 31, 1999. The 16,722 warrants were determined to have no value based upon a fair value analysis of the Company's common stock, and the $879,000 previously recorded as temporary equity was adjusted through the statement of operations. At December 31, 2000 and February 2, 2002, the warrants were marked to market resulting in accretion of $0 and $7,759,000, respectively, based upon the fair value of the underlying common stock. The put option was terminated again on February 3, 2002. Concurrent with the June 19, 2001 amendment to the senior credit facilities, the Company also entered into an amendment of its Subordinated Note Agreement (the "Subordinated Amendment"). Pursuant to the Subordinated Amendment, all previous events of default were waived and new financial covenant requirements were established for the duration of the facility. Effective January 1, 2001, the interest rate on the subordinated notes, plus accrued interest, was increased to 15.0% per annum compounded quarterly. Effective January 1, 2002, the interest rate on the subordinated notes, plus accrued interest, was increased to 15.5% per annum. Additionally, as a condition of the Subordinated Amendment, F-15 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) the Company agreed to amend its charter to reduce the dividend rate on the Class A Preferred Stock and Class D Preferred Stock to 4% effective June 30, 2001. Further, the Company agreed to use its best efforts to file an amendment to the same effect with respect to the Class B Preferred Stock on or before June 30, 2001. Although the Company could not get the requisite shareholder consent, in October 2001 the Company entered into an agreement with two of the shareholders of the Class B Preferred Stock whereby the dividend rate for these two shareholders was reduced to 4% effective June 30, 2001. The Company recorded a $2,227,000 writedown of the Class B Preferred Stock to reflect the fair value adjustment for the reduction in the dividend rate from 10% to 4% at July 1, 2001. Under the Company's amended credit agreements (both senior and subordinated), the Company is required to maintain stated levels of net worth as well as comply with certain coverage ratios and limits on capital expenditures. The borrowings are collateralized by substantially all of the Company's assets. Mandatorily Redeemable Preferred Stock - The Class C Preferred Stock issued in conjunction with the recapitalization (see Note 2) has a liquidation preference to the Class A Preferred Stock and the Class B Preferred Stock and had a liquidation value of $17,122,000 at December 31, 2000, February 3, 2001 and February 2, 2002. 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 provided that all of the Class D Preferred Stock has been redeemed, and is mandatorily redeemable in whole at the earliest to occur of July 2004 or the closing of a liquidity event, as defined. In connection with the Class C Preferred Stock, the Company incurs interest expense equal to 9% per annum of the outstanding balance, including accrued interest compounded semi-annually. This has been reflected in interest expense in the accompanying consolidated statements of operations. At December 31, 2000, February 3, 2001 and February 2, 2002, accrued interest expense related to the Class C Preferred Stock was $5,036,000, $5,190,000, and $7,197,000, respectively. Other Indebtedness - On October 15, 1998, the Company entered into a Subordinated Promissory Note Agreement (the "Promissory Note Agreement") with a management employee of the Company. Under the Promissory Note Agreement, the Company was permitted to borrow up to $5 million from this employee at an interest rate equal to the rate specified in the Company's Line of Credit. After May 1, 1999, the rate increased to 2.0% higher than the rate specified in the Line of Credit. On August 8, 2000, the management employee exchanged the principal of this note for equity in the Company (see Note 2). The principal maturities of long-term debt outstanding at February 2, 2002 including unamortized discounts in years subsequent to 2001 are as follows: $38,177,000 in 2002; $20,000,000 in 2003; and $17,122,000 in 2004. NOTE 7 - LONG-TERM LEASES The Company leases retail store facilities and certain equipment under operating leases with terms ranging up to ten years and expiring at various dates through 2013. Most of the retail store lease 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 $19,570,000, $22,371,000 and $24,344,000 in fiscal years 1999, 2000 and 2001, respectively, and $1,936,000 for the 34 days ended February 3, 2001. Contingent rental expense was $435,000, $199,000 and $752,000 for fiscal years 1999, 2000 and 2001, respectively, and $57,000 for the 34-day period ended February 3, 2001. Future minimum lease payments under all operating leases with initial terms of one year or more are as follows: $22,392,000 in 2002; $20,636,000 in 2003; $19,778,000 in 2004; $18,520,000 in 2005; $15,767,000 in 2006; and $31,797,000 thereafter. F-16 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 8 - EMPLOYEE BENEFIT PLANS Stock Options - On June 12, 1996, the Company adopted the "1996 Executive Incentive and Non-Qualified Stock Option Plan" (the "Plan") which provides employees and officers with opportunities to purchase shares of the Company's common stock. The Plan authorizes the grant of incentive and non-qualified stock options and requires that the exercise price of incentive stock options be at least 100% of the fair market value of the stock at the date of the grant. In connection with the 1996 recapitalization, the Company entered into agreements to grant options to two management employees. The agreements provide that each of the two management employees will receive option grants representing 2% of the fully diluted shares. The agreements further provide that future issuances of common stock shall not dilute the management employees' position and that additional grants will be awarded upon each issuance of common stock. These options become 100% vested 24 hours prior to an asset sale, public offering, or stock sale, in which the investors in the 1996 recapitalization achieve a specified internal rate of return on their invested funds. If the specified internal rate of return targets are not met upon a liquidity event, the options automatically terminate and are forfeited. Options outstanding under these agreements were 4,762, 4,762, and 7,900 at December 31, 2000, February 3, 2001, and February 2, 2002, respectively. No compensation expense has been recognized since the options have not vested and management believes the likelihood of exercise is remote. On September 28, 1999, the Company's Board of Directors re-priced certain options granted in 1998 to $95.00 per share, which was not less than the fair value of the Company's stock at the date of the re-pricing, as determined by the Company's Board of Directors. These options to purchase 2,283 shares remained outstanding at February 2, 2002. The repricing resulted in variable accounting under the provisions of APB 25 and FIN 44. Accordingly, the Company has recognized a non-cash stock compensation charge of approximately $578,000 in the consolidated financial statements in connection with these options. Transactions under the Company's stock option plans in each of the periods indicated are as follows:
WEIGHTED AVERAGE NUMBER EXERCISE OF SHARES PRICE --------- -------- Outstanding at December 31, 1999........................... 9,800 $49.06 Granted.................................................. -- -- Exercised................................................ -- -- Forfeited................................................ (258) 95.00 ------ ------ Outstanding at December 31, 2000........................... 9,542 $47.81 Granted.................................................. -- -- Exercised................................................ -- -- Forfeited................................................ -- -- ------ ------
F-17 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
WEIGHTED AVERAGE NUMBER EXERCISE OF SHARES PRICE --------- -------- Outstanding at February 3, 2001............................ 9,542 $47.81 Granted.................................................. 14,226 46.02 Exercised................................................ (230) 95.00 Forfeited................................................ (68) 95.00 ------ ------ Outstanding at February 2, 2002............................ 23,470 $46.13 ====== ======
Options to purchase 4,780, 4,780, and 6,370 shares of common stock were exercisable at December 31, 2000, February 3, 2001, and February 2, 2002, respectively. The weighted average exercise price of these options was $95 per share. 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 fiscal years 1999, 2000 and 2001, the Company's pro forma net income (loss) would have been approximately $3,999,000, $(1,325,000) and $4,293,000, respectively. Net loss for the 34-day period ended February 3, 2001, on a pro forma basis would have been approximately $(2,469,000). The earnings per share would have been:
YEAR ENDED 34 DAYS --------------------------- ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, FEBRUARY 3, FEBRUARY 2, 1999 2000 2001 2002 ------------ ------------ ------------- ----------- Basic............................... $(5.15) $(71.58) $(23.74) $(1.50) ====== ======= ======= ====== Diluted............................. $(5.15) $(71.58) $(23.74) $(1.50) ====== ======= ======= ======
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%; risk-free interest rates of 5.5%; expected lives of 5 years, and no expected dividend payments. The weighted average remaining contractual life of the options was 7.2 years, 6.2 years, and 7.9 years for the fiscal years ended 1999, 2000 and 2001, respectively. The weighted average contractual life of the options was 6.1 years at February 3, 2001. 401(k) Savings Plan - The Company maintains a defined contribution 401(k) employee benefit plan, which covers all employees meeting certain age and service requirements. Up to 6% of the employee's compensation may be matched at the Company's discretion. This discretionary percentage was 50% of an employee's contribution subject to Plan maximums in 2001. The Company's matching contributions were approximately $82,000, $102,000 and $249,000 in 1999, 2000 and 2001, 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 1999, 2000 or 2001. NOTE 9 - EARNINGS PER SHARE Basic earnings per share are based upon the weighted average number of shares outstanding. Diluted earnings per share are based upon the weighted average number of shares outstanding plus the shares that would be outstanding assuming exercise of dilutive stock options and warrants. F-18 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The computations for basic and diluted earnings per share are as follows (in thousands, except for per share amounts):
YEAR ENDED --------------------------- 34-DAY PERIOD YEAR ENDED DECEMBER 31, DECEMBER 31, ENDED FEBRUARY 3, FEBRUARY 2, 1999 2000 2001 2002 ------------ ------------ ----------------- ----------- Numerator: Net loss allocable to common stock.......... $ (414) $ (7,870) $ (3,247) $ (2,054) ======= ======== ======== ======== Denominator for basic earnings per share: Average number of common shares outstanding.... 92,101 110,084 136,751 136,752 ======= ======== ======== ======== Denominator for diluted earnings per share: Average number of common shares outstanding.... 92,101 110,084 136,751 136,752 ------- -------- -------- -------- 92,101 110,084 136,751 136,752 ======= ======== ======== ======== Basic earnings per share................. $ (4.50) $ (71.49) $ (23.74) $ (1.50) ======= ======== ======== ======== Diluted earnings per share................. $ (4.50) $ (71.49) $ (23.74) $ (1.50) ======= ======== ======== ========
The calculation of fully diluted earnings per share for December 31, 1999, December 31, 2000, and February 3, 2001 and February 2, 2002 excludes stock options outstanding of 9,800, 9,542, 9,542 and 23,470 respectively and outstanding warrants of 38,124 as their effect would be anti-dilutive. NOTE 10 - RELATED PARTIES Inventory is purchased in the ordinary course of business from an entity formerly owned by a substantial shareholder of the Company. Purchases approximated $237,000, $128,000 and $332,000 in 1999, 2000 and 2001, respectively. The Company purchases inventory from a manufacturer in which one of the shareholders had a significant ownership interest. Purchases from this manufacturer totaled $292,000 and $5,000 in 1999 and 2000, respectively. The Company purchased no inventory from this manufacturer in 2001. The Company rents aircraft from an entity owned by a substantial shareholder. Rental expense approximated $63,000, $92,000 and $23,000 in 1999, 2000 and 2001, respectively. NOTE 11 - COMMITMENTS AND CONTINGENCIES 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. The Company has employment agreements with two key management employees and a consulting agreement with another individual, all of whom were shareholders of the Company prior to the Recapitalization. The employment agreements expire on June 12, 2002 and require annual aggregate salary payments of $550,000. These three individuals own all of the outstanding Class C Preferred Stock. These agreements also require the Company to pay an annual interest amount equal to 9% of the outstanding F-19 KIRKLAND'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) balance of this preferred stock (see Note 6). Payments representing such interest accrued after 1997 have not been made as a result of subordination provisions under the Company's senior credit facility. The consulting agreement expires June 12, 2003. 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, operating results or cash flows of the Company. NOTE 12 - CONSULTING CONTRACT In July 2001, the Company entered into an agreement with a consultant to provide services to the Company. Under the terms of the agreement, the consultant was granted the option to purchase 1,888 shares of common stock at $.01. As the options were granted to a non-employee, the Company has recorded a non-cash stock compensation charge of $134,000 in the consolidated financial statements, equal to the fair market value of the options determined using the Black-Scholes option pricing model on the date of grant. NOTE 13 - PRE-OFFERING STOCK SPLIT Prior to the completion of the Company's planned public offering, the Company intends to effect a split of its common stock. All share and per share information in the consolidated financial statements will be retroactively restated to reflect the stock split for all periods presented. NOTE 14 - UNAUDITED PRO FORMA BALANCE SHEET AND EARNINGS PER SHARE INFORMATION The unaudited pro forma balance sheet information as of February 2, 2002 gives effect to the conversion or redemption of the Class A, Class B, and Class D redeemable convertible preferred stock, the redemption of the Class C redeemable preferred stock, and the exercise of all outstanding common stock warrants that is expected to occur upon the consummation of the initial public offering of the Company's common stock. The unaudited pro forma earnings per share information for the year ended February 2, 2002 gives effect to the conversion of the Class A, Class B, and Class D redeemable convertible preferred stock and the exercise of all outstanding common stock warrants that is expected to occur upon the consummation of the initial public offering of the Company's common stock, as if they had occurred as of February 4, 2001. The unaudited pro forma balance sheet and pro forma earnings information does not give effect to the sale of shares by the Company in its planned public offering. F-20 UNAUDITED PRO FORMA CONSOLIDATED CONDENSED FINANCIAL STATEMENTS Immediately prior to completion of this offering as a part of the Pre-Offering Transactions, $ million of aggregate stated value and accrued dividends on the outstanding shares of our Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock will be converted into an aggregate of shares of common stock (at an assumed initial public offering price of $ per share). Additionally, prior to completion of this offering, our warrantholders will exercise all of our outstanding warrants to purchase 38,124 shares of common stock. See "Certain Transactions - Pre-Offering Transactions." Using a portion of the net proceeds of this offering we will purchase or redeem from current shareholders all of the outstanding shares of our Class C Preferred Stock and $ million of aggregate stated value and accrued dividends on the outstanding shares of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock. The pro forma consolidated condensed balance sheet as of February 2, 2002 and the pro forma consolidated condensed statements of operations for the year ended February 2, 2002 which follow give effect to: (i) the Pre-Offering Transactions, and (ii) this offering and the application of the estimated net proceeds therefrom as if such transactions had occurred as of the beginning of the period. In our opinion all adjustments necessary to present fairly such pro forma consolidated condensed statements of operations have been made. These unaudited pro forma consolidated 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 our future operations. These unaudited pro forma financial statements should be read in conjunction with the accompanying notes. P-1 UNAUDITED PRO FORMA CONSOLIDATED CONDENSED STATEMENT OF INCOME FOR THE YEAR ENDED FEBRUARY 2, 2002
PRE-OFFERING OFFERING PRO FORMA HISTORICAL ADJUSTMENTS SUBTOTAL ADJUSTMENTS AS ADJUSTED ---------- ------------ -------- ----------- ----------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Net sales.................................... $307,213 $307,213 $307,213 Cost of sales................................ 200,063 200,063 200,063 -------- -------- -------- Gross profit............................... 107,150 107,150 107,150 Operating expenses: Other operating expenses................... 71,622 71,622 71,622 Non-cash stock compensation charge......... 712 712 712 Depreciation and amortization................ 7,678 7,678 7,678 -------- -------- -------- Operating income........................... 27,138 27,138 27,138 Interest expense: Senior credit facility and other indebtedness............................. 5,835 5,835 5,835 Subordinated debt.......................... 3,924 3,924 (3,924)(e) -- Class C Preferred Stock.................... 2,007 2,007 (2,007)(f) -- Accretion of common stock warrants......... 7,759 (7,759)(b) -- -- Interest income.............................. (278) (278) (278) Other income, net............................ 262 262 262 -------- -------- -------- Income before income taxes............... 7,629 15,388 21,319 Income tax provision......................... 3,331 3,390(c) 6,721 2,581(c) 9,302 -------- -------- -------- Net income............................... 4,298 8,667 12,017 Accretion of redeemable preferred stock and dividends accrued.......................... (6,352) 6,352(d) -- -- -------- -------- -------- Net income allocable to common stock(a)...... (2,054) 8,667 12,017 -------- -------- -------- Income per common share(a): Basic...................................... $ (1.50) $ $ -------- -------- -------- Diluted.................................... $ (1.50) $ $ -------- -------- -------- Weighted average number of common shares outstanding(a): Basic...................................... 136,752 -------- -------- -------- Diluted.................................... 136,752 -------- -------- --------
- ------------------------------ (a) Assumes the Pre-Offering Transactions (as defined on page 5) were effected as of the beginning of the period, at an assumed initial public offering price of $ per share. At a different initial public offering price, the pro forma number of shares outstanding and pro forma net income per share would be different. See "Certain Transactions - Pre-Offering Transactions." (b) Represents the reduction in accretion of common stock warrants of $7.8 million resulting from the exercise of warrants as part of the Pre-Offering Transactions. (c) Represents the tax effect of the foregoing adjustments, resulting in an effective statutory tax rate of approximately 43.7%, excluding the accretion of common stock warrants for 2001. (d) Represents the reduction in accretion and dividends accrued of $6.4 million resulting from the issuance of shares of Common Stock upon the conversion and/or redemption of all $88.4 million of aggregate stated value and accrued dividends on our outstanding Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock (at an assumed initial public offering price of $ per share). (e) Represents the interest and amortization expense reduction of $3.9 million resulting from repayment of approximately $20.0 million of subordinated debt from the estimated net proceeds of this Offering. See "Use of Proceeds." (f) Represents the interest expense reduction of $2 million 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 this Offering. See "Use of Proceeds." P-2 UNAUDITED PRO FORMA CONSOLIDATED CONDENSED BALANCE SHEET FEBRUARY 2, 2002
PRE-OFFERING OFFERING PRO FORMA HISTORICAL ADJUSTMENTS SUBTOTAL ADJUSTMENTS AS ADJUSTED ---------- ------------ --------- ----------- ----------- (IN THOUSANDS) ASSETS Current assets: Cash and cash equivalents................... $ 29,751 $(28,301)(a) $ 1,450 $ 5,681(d) $ 7,131 Inventories................................. 32,763 32,763 32,763 Other current assets........................ 3,277 3,277 3,277 --------- --------- --------- Total current assets...................... 65,791 37,490 43,171 Property and equipment, net................... 23,748 23,748 23,748 Other noncurrent assets....................... 6,279 6,279 6,279 --------- --------- --------- Total assets.............................. $ 95,818 $ 67,517 $ 73,198 ========= ========= ========= LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' DEFICIT Current liabilities: Current maturities of long-term debt........ 38,177 (38,177)(a) -- -- Accounts payable............................ 12,530 12,530 12,530 Other current liabilities................... 22,490 (3,804)(a) 17,366 (7,197)(d) 10,169 (1,320)(a) Total current liabilities..................... 73,197 29,896 22,699 --------- --------- --------- Senior credit facility........................ -- 15,000 (a) 15,000 15,000 Subordinated debt............................. 19,940 19,940 (20,000)(d) -- 60 (e) Class C Preferred Stock....................... 17,122 17,122 (17,122)(d) -- Other liabilities............................. 2,198 2,198 2,198 Common stock warrants......................... 7,759 (7,759)(b) -- -- --------- --------- --------- Redeemable convertible preferred stock: Class D..................................... 22,293 (22,293)(c) -- -- Class A..................................... 48,901 (48,901)(c) -- -- Class B..................................... 15,618 (15,618)(c) -- -- Shareholders' deficit: Common Stock................................ 229 229 229 Paid-in capital............................. -- 7,759 (b) 94,571 50,000 (d) 144,571 86,812 (c) Accumulated deficit......................... (111,439) (111,439) (60)(e) (111,499) --------- --------- --------- Total liabilities, redeemable preferred stock and shareholders' deficit......... $ 95,818 $ 67,517 $ 73,198 ========= ========= =========
- ------------------------------ (a) Represents the repayment of our existing senior credit facility of $39.5 million (which consists of $38.2 million of current maturities of long-term debt and $1.3 million of other current liabilities) and $3.8 million of accrued interest on subordinated debt with the proceeds from a new credit facility consisting of a $15 million term loan and a revolving line of credit. We anticipate this facility will close in May 2002. If this refinancing transaction had closed on February 2, 2002, then there would have been no borrowings under the new line of credit at closing, but rather a use of $28.3 million from existing cash balances. (b) Assumes the exercise of all common stock warrants. (c) Assumes conversion and/or redemption of all redeemable convertible preferred stock (Class A, Class B and Class D), resulting in an increase to paid-in capital in an amount equal to the stated value and accrued dividends on such stock. (d) Assumes net proceeds from this offering of $50 million, of which $20.0 million is used to retire subordinated debt, $24.3 million is used to retire the mandatorily redeemable Class C Preferred Stock ($17.1 million of stated value of Class C Preferred Stock and $7.2 million of interest associated with the Class C Preferred Stock) and $5.7 million is allocated to cash and cash equivalents. (e) Relates to the accretion of debt discount of $60,000 associated with the early extinguishment of the subordinated debt. P-3 [photographs of stores, customers and merchandise] - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Through and including , 2002 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers' obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. SHARES KIRLAND'S, INC. LOGO COMMON STOCK --------------------- PROSPECTUS --------------------- MERRILL LYNCH & CO. CIBC WORLD MARKETS SUNTRUST ROBINSON HUMPHREY U.S. BANCORP PIPER JAFFRAY , 2002 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 us in connection with the issuance and distribution of the securities being registered:
NATURE OF EXPENSE AMOUNT - ----------------- ------ SEC Registration Fee........................................ $ 13,225 Nasdaq National Market Listing Fee.......................... 95,000 NASD Fee.................................................... 14,875 Printing and engraving fees................................. 150,000 Registrant's counsel fees and expenses...................... * Selling shareholders' counsel fees and expenses............. * Accounting fees and expenses................................ * Officers and Directors Liability Insurance.................. * Blue Sky expenses and counsel fees.......................... 5,000 Transfer agent and registrar fees........................... 10,000 Miscellaneous............................................... * -------- Total..................................................... $ * ========
- --------------- * 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. Our charter and our bylaws will provide that we will indemnify from liability, and advance expenses to, any of our present or former directors or officers to the fullest extent allowed by the TBCA, II-1 as amended from time to time, or any subsequent law, rule, or regulation adopted. Additionally, the charter will provide that none of our directors will be personally liable to us or any of our 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 us or our 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 April 1999, we sold the following securities (giving retroactive effect to a -for-one stock split to be effected in connection with the Pre-Offering Transactions) without registration under the Securities Act: 1. In July 1999, in connection with an additional loan from our then-existing senior lenders, certain of our then-existing shareholders collateralized a portion of the additional loan or loaned funds directly to us. In consideration for this, we issued to such shareholders warrants to purchase an aggregate of 15,847 shares of common stock at $0.01 per share. 2. In December 1999, we reorganized by merging each of the separate corporations that operated our stores and Briar Patch Management Corporation, our wholly-owned subsidiary, into Kirkland's Stores, Inc., a wholly owned subsidiary of Kirkland's. In conjunction with the merger, we issued 206 additional shares of our common stock, 2,939,230 additional shares of our Class A Preferred Stock, 1,019,535 additional shares of our Class B Preferred Stock and 541,771 additional shares of our Class C Preferred Stock to all of our then-existing shareholders in the same proportion as their ownership interests in each such class prior to the merger. 3. In August 2000, we sold to certain then-existing shareholders, including a management shareholder, 44,445 shares of common stock, 44,445 shares of Class D Preferred Stock and warrants to purchase an aggregate of 5,555 shares of common stock for $0.01 per share, for an aggregate of $7.5 million in cash, the surrender of a $5.0 million note held by a management shareholder and the repayment of a $7.5 million note held by our then-existing senior lenders. 4. In July 2001, we granted a stock option to a consultant to purchase 1,888 shares of common stock at an exercise price of $0.01 per share. 5. In November 2001, we granted stock options to 30 of our employees to purchase an aggregate of 9,200 shares of common stock under our 1996 Plan at an exercise price of $71.00 per share. We believe 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 us or our management and to have been purchasing for investment without a view to further distribution. II-2 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 E. 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.) (Incorporated herein by reference to Exhibit 2.1 to the registration statement on Form S-1 of Kirkland's filed on May 5, 1998 Registration No. 333-51517 [the "1998 Form S-1"]) 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 this 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 this offering) *4.1 Form of Specimen Stock Certificate *5.1 Opinion of Pepper Hamilton LLP 10.1 Amended and Restated Credit Agreement dated as of June 19, 2001, 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. 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) (Incorporated herein by reference to Exhibit 10.2 to the 1998 Form S-1) 10.3 Form of Amended and Restated Registration Rights Agreement dated as of April 15, 2002, 2002, by and among Kirkland Holdings L.L.C., Kirkland's, Inc., SSM Venture Partners, L.P., Joseph R. Hyde III, Johnston C. Adams, Jr., John H. Pontius, CT/Kirkland Equity Partners, L.P., R-H Capital Partners, L.P., TCW/Kirkland Equity Partners, L.P., Capital Resource Lenders II, L.P., Allied Capital Corporation, The Marlborough Capital Investment Fund, L.P., Capital Trust Investments, Ltd., Global Private Equity II Limited Partnership, Advent Direct Investment Program Limited Partnership, Advent Partners Limited Partnership, Carl Kirkland, Robert Kirkland, Robert E. Alderson, The Amy Katherine Alderson Trust, The Allison Leigh Alderson Trust, The Carl T. Kirkland Grantor Retained Annuity Trust 2001-1 and Steven Collins 10.4 Consulting Agreement by and between Kirkland's and Robert Kirkland dated June 12, 1996 (Incorporated herein by reference to Exhibit 10.5 to the 1998 Form S-1) 10.5 Employment Agreement by and between Kirkland's and Carl Kirkland dated June 12, 1996, as amended through July 31, 2000 10.6 Employment Agreement by and between Kirkland's and Robert E. Alderson dated June 12, 1996, as amended through July 31, 2000 10.7 Employment Agreement by and between Kirkland's and Reynolds C. Faulkner dated as of February 2, 1998, as amended through July 31, 2000 10.8 Employment Agreement by and between Kirkland's and H.R. Harvey dated June 18, 2001 10.9 Employment Agreement by and between Kirkland's and C. Edmond Wise, Jr. dated December 4, 2000 10.10 1996 Executive Incentive and Non-Qualified Stock Option Plan, as amended through April 17, 2002 10.11 2002 Incentive Plan 10.12 Employee Stock Purchase Plan
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EXHIBIT NO. DESCRIPTION - ------- ----------- 10.13 Form of Amended and Restated Shareholders Agreement dated as of April 15, 2002, by and among Kirkland Holdings L.L.C., Kirkland's, Inc., SSM Venture Partners, L.P., Joseph R. Hyde III, Johnston C. Adams, Jr., John H. Pontius, CT/Kirkland Equity Partners, L.P., R-H Capital Partners, L.P., TCW/Kirkland Equity Partners, L.P., Capital Resource Lenders II, L.P., Allied Capital Corporation, The Marlborough Capital Investment Fund, L.P., Capital Trust Investments, Ltd., Global Private Equity II Limited Partnership, Advent Direct Investment Program Limited Partnership, Advent Partners Limited Partnership, Carl Kirkland, Robert Kirkland, Robert E. Alderson, The Amy Katherine Alderson Trust, The Allison Leigh Alderson Trust, The Carl T. Kirkland Grantor Retained Annuity Trust 2001-1 and Steven Collins 10.14 Stock Option Agreement by and between Kirkland's and Carl Kirkland dated June 11, 1996 as amended through April 17, 2002 10.15 Stock Option Agreement by and between Kirkland's and Reynolds C. Faulkner dated as of February 2, 1998 (Incorporated herein by reference to Exhibit 10.16 to the registration statement on Form S-1/A of Kirkland's filed on July 16, 1998 Registration No. 333-51517 1998 Amendment No. 1 to Form S-1) 10.16 Sublease Agreement by and between Southwind Properties and Kirkland's dated March 5, 2001 21 Subsidiaries of Kirkland's 23.1 Consent of PricewaterhouseCoopers LLP *23.2 Consent of Pepper Hamilton LLP (included in Exhibit 5.1) 24.1 Power of Attorney (included on signature pages)
- --------------- * 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. 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 underwriters to permit prompt delivery to each purchaser. 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 Securities and Exchange 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 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: (i) 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. (ii) 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 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. II-4 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant 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 22nd day of April, 2002. KIRKLAND'S, INC. By: /s/ ROBERT E. ALDERSON ------------------------------------ Robert E. Alderson Chief Executive Officer POWER OF ATTORNEY Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed below by the following persons in the capacities and on the dates indicated. Each person whose signature appears below hereby constitutes and appoints Robert E. Alderson and Reynolds C. Faulkner his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution for him 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, and to file the same, with exhibits thereto and other documents in connection therewith or in connection with the registration of the common stock offered hereby under the Securities Exchange Act of 1934, with the Securities and Exchange Commission, granting unto such attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary in connection with such matters and hereby ratifying and confirming all that such attorney-in-fact and agent or his substitutes may do or cause to be done by virtue hereof.
SIGNATURE TITLE DATE --------- ----- ---- /s/ ROBERT E. ALDERSON President, Chief Executive Officer April 22, 2002 - --------------------------------------------- and Director (Principal Executive Robert E. Alderson Officer) /s/ REYNOLDS C. FAULKNER Executive Vice President, Chief April 22, 2002 - --------------------------------------------- Financial Officer and Director Reynolds C. Faulkner (Principal Financial Officer) /s/ CONNIE L. SCOGGINS Vice President of Finance and April 22, 2002 - --------------------------------------------- Treasurer/Controller (Principal Connie L. Scoggins Accounting Officer) /s/ CARL KIRKLAND Chairman of the Board April 22, 2002 - --------------------------------------------- Carl Kirkland /s/ ALEXANDER S. MCGRATH Director April 22, 2002 - --------------------------------------------- Alexander S. McGrath /s/ DAVID M. MUSSAFER Director April 22, 2002 - --------------------------------------------- David M. Mussafer
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SIGNATURE TITLE DATE --------- ----- ---- /s/ R. WILSON ORR, III Director April 22, 2002 - --------------------------------------------- R. Wilson Orr, III /s/ JOHN P. OSWALD Director April 22, 2002 - --------------------------------------------- John P. Oswald /s/ MURRAY SPAIN Director April 22, 2002 - --------------------------------------------- Murray Spain
II-6 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION - ------- ----------- 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 this 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 this offering) 10.1 Amended and Restated Credit Agreement dated as of June 19, 2001, 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. 10.3 Form of Amended and Restated Registration Rights Agreement dated as of April 15, 2002, by and among Kirkland Holdings L.L.C., Kirkland's, Inc., SSM Venture Partners, L.P., Joseph R. Hyde III, Johnston C. Adams, Jr., John H. Pontius, CT/Kirkland Equity Partners, L.P., R-H Capital Partners, L.P., TCW/Kirkland Equity Partners, L.P., Capital Resource Lenders II, L.P., Allied Capital Corporation, The Marlborough Capital Investment Fund, L.P., Capital Trust Investments, Ltd., Global Private Equity II Limited Partnership, Advent Direct Investment Program Limited Partnership, Advent Partners Limited Partnership, Carl Kirkland, Robert Kirkland, Robert E. Alderson, The Amy Katherine Alderson Trust, The Allison Leigh Alderson Trust, The Carl T. Kirkland Grantor Retained Annuity Trust 2001-1 and Steven Collins 10.5 Employment Agreement by and between Kirkland's and Carl Kirkland dated June 12, 1996, as amended 10.6 Employment Agreement by and between Kirkland's and Robert E. Alderson dated June 12, 1996, as amended 10.7 Employment Agreement by and between Kirkland's and Reynolds C. Faulkner dated as of February 2, 1998, as amended 10.8 Employment Agreement by and between Kirkland's and H.R. Harvey dated June 18, 2001 10.9 Employment Agreement by and between Kirkland's and C. Edmond Wise, Jr. dated December 4, 2000 10.10 1996 Executive Incentive and Non-Qualified Stock Option Plan, as amended through April 17, 2002 10.11 2002 Incentive Plan 10.12 Employee Stock Purchase Plan 10.13 Form of Amended and Restated Shareholders Agreement dated as of April 15, 2002, by and among Kirkland Holdings L.L.C., Kirkland's, Inc., SSM Venture Partners, L.P., Joseph R. Hyde III, Johnston C. Adams, Jr., John H. Pontius, CT/Kirkland Equity Partners, L.P., R-H Capital Partners, L.P., TCW/Kirkland Equity Partners, L.P., Capital Resource Lenders II, L.P., Allied Capital Corporation, The Marlborough Capital Investment Fund, L.P., Capital Trust Investments, Ltd., Global Private Equity II Limited Partnership, Advent Direct Investment Program Limited Partnership, Advent Partners Limited Partnership, Carl Kirkland, Robert Kirkland, Robert E. Alderson, The Amy Katherine Alderson Trust, The Allison Leigh Alderson Trust, The Carl T. Kirkland Grantor Retained Annuity Trust 2001-1 and Steven Collins 10.14 Stock Option Agreement by and between Kirkland's and Carl Kirkland dated June 11, 1996, as amended through April 17, 2002 10.16 Sublease Agreement by and between Southwind Properties and Kirkland's dated March 5, 2001 21 Subsidiaries of Kirkland's 23.1 Consent of PricewaterhouseCoopers LLP 24.1 Power of Attorney (included on signature pages)
EX-3.1 3 g75423ex3-1.txt AMENDED AND RESTATED CHARTER OF KIRKLAND'S, INC. 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 upon filing with the Tennessee Secretary of State (the "Effective Time"(1)). 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 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 Five Million Three Hundred Seventy-Five Thousand (5,375,000), 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 Four Million Eight Hundred Seventy-Five Thousand (4,875,000) 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) Three Million One Hundred Thousand (3,100,000) 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) One Million One Hundred Thousand (1,100,000) 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) Six Hundred Thousand (600,000) 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"), and (v) Seventy-Five Thousand (75,000) shares designated as a series of Preferred Stock referred to as Class D Preferred Stock, which shall be without par value (the "Class D Preferred Stock"). 5. Certain Definitions. Unless the context otherwise requires, the terms defined in this Section 5 shall have, for all purposes of this Amended and Restated Charter the meanings herein specified (with terms defined in the singular having comparable meanings when used in the plural). "Anticipated Effective Date" has the meaning set forth in Section 7.6. (1) Editor's note: The "Effective Time" was August 8, 2000. "Board of Directors" means the Board of Directors of the Corporation or any authorized committee of the Board of Directors, as the same may be constituted from time to time. "Class A Excess Dividend Amount" has the meaning set forth in Section 7.3.2. "Class A Liquidation Preference" has the meaning set forth in Section 7.3.1. "Class A Preferred Stock" means the Class A Preferred Stock, no par value per share, designated as "Class A Preferred Stock" in the Charter. "Class A Preferred Stock Stated Value" means $13.58859 per share. "Class A Redemption Price" has the meaning set forth in Section 7.5.1. "Class B Excess Dividend Amount" has the meaning set forth in Section 8.3.2. "Class B Liquidation Preference" has the meaning set forth in Section 8.3.1. "Class B Preferred Stock" means the Class B Preferred Stock, no par value per share, designated as "Class B Preferred Stock" in the Charter. "Class B Preferred Stock Stated Value" means $13.58859 per share. "Class B Redemption Price" has the meaning set forth in Section 8.5.1. "Class C Liquidation Preference" has the meaning set forth in Section 9.3.1. "Class C Preferred Stock" means the Class C Preferred Stock, no par value per share, designated as "Class C Preferred Stock" in the Charter. "Class C Preferred Stock Stated Value" means $30.63556 per share. "Class C Redemption Event" has the meaning set forth in Section 9.5.2. "Class C Redemption Price" has the meaning set forth in Section 9.5.3. "Class D Liquidation Preference" has the meaning set forth in Section 10.3.1 hereof. "Class D Preferred Stock" means the Corporation's Class D Preferred Stock, no par value per share, as the same may be amended or modified from time to time. "Class D Preferred Stock Stated Value" means $450.00 per share. "Class D Redemption Price" has the meaning set forth in Section 10.5.1 hereof. -2- "Common Stock" means the Common Stock, no par value per share, of the Corporation. "Conversion Date" has the meaning set forth in Section 7.6. hereof. "Conversion Price" means the offering price per share at which the Common Stock of the Corporation is first offered to the public in the Qualified Public Offering. "Corporation" means Kirkland's, Inc. "Event of Conversion" has the meaning set forth in Section 7.6. "Issue Date" means the first date on which any shares of Class D Preferred Stock are issued by the Corporation. "Liquidation" means any sale, merger, consolidation, dissolution, liquidation or winding up of the Corporation, voluntary or involuntary. "Liquidity Event" means (A) a sale of all or a majority in value of the assets of the Corporation and its consolidated subsidiaries, taken as a whole. (B) the acquisition of more than fifty percent (50%) of the outstanding shares of Common Stock of the Corporation, 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 in effect as of the Effective Time, between the Corporation and the shareholders thereof) if such transfers are permitted without restriction pursuant to the terms of such shareholders agreement; (C) a Qualified Public Offering; or (D) a refinancing after the Effective Time of the indebtedness of the Corporation for borrowed money existing as of the Effective Time, in connection with which the Corporation repurchase or redeem any capital stock for value. "Notes" has the meaning set forth in Section 7.2.1 hereof. "Person" means any individual, corporation, partnership, firm, joint venture, association, limited liability company or partnership, joint-stock company, trust, unincorporated organization or any government, or governmental or regulatory body thereof, or political subdivision thereof, whether federal, state, local or foreign, or any agency or instrumentality thereof, or any court or arbitrator (public or private). "Past Due Interest" has the meaning set forth in Section 7.2.1 hereof. -3- "Qualified Public Offering" means a sale of shares of the Common Stock of the Corporation in a registered underwritten public offering resulting in gross proceeds to the Corporation of at least Thirty Million Dollars ($30,000,000). "Redemption Allowance Date" has the meaning set forth in Section 7.5.1 hereof. 6. Common Stock. The express terms and conditions of the shares classified and designated as Common Stock are as follows: 6.1. 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. 6.2. Liquidation. On 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. 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 3,100,000 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 with respect to payment of dividends, distributions, redemptions and distributions upon Liquidation to all other shares of capital stock of the Corporation except the Class C Preferred Stock and the Class D 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, subject to the rights of the holders of Class D Preferred Stock, 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, that from and after June 12, 1999, dividends shall accrue in an amount equal to ten (10%) of the Class A Preferred Stock Stated Value per share per year, provided further that dividends shall accrue in an amount equal to four percent (4%) per annum of the Class A Preferred Stock Stated Value per share per year from the period from June 30, 2001 until such time as the Company has paid on the promissory notes (the "Notes") issued in connection with that Senior Subordinated Note and Warrant Purchase Agreement dated as of June 12, 1996, as amended, all interest that had accrued and was not paid as of June 19, 2001, in the amount of Three Million Seventy-Two Thousand -4- Five Hundred Nine Dollars ($3,072,509), plus all additional interest accrued under the Notes after June 19, 2001 that is not paid when due (collectively, "Past Due Interest"). 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 the Effective Time which does not expressly provide that it ranks senior to or on a parity with the Class A Preferred Stock as to the payment of dividends, distributions, redemptions and distributions upon Liquidation, 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. 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. Following any Liquidation, no distribution of any of the assets of the Corporation shall be made to the holders of (i) Common Stock, (ii) any class or series of the Corporation's capital stock authorized, created or designated after the Effective Time which does not expressly provide that it ranks senior to or on a parity with the Class A Preferred Stock as to the payment of dividends, distributions, redemptions and distributions upon Liquidation, or (iii) Class B Preferred Stock by reason of their ownership thereof unless and until the holders of Class A Preferred Stock shall have received out of the assets of the Corporation legally available for distributions to its shareholders, 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 -5- 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 any distribution of the Class D Liquidation Preference to the holders of Class D Preferred Stock pursuant to Section 10.3 and distribution of the Class C Liquidation Preference 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 D Liquidation Preference, the Class C Liquidation Preference, 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. 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, Class B Preferred Stock and Class D 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, after the Effective Time, 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; -6- 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 D Preferred Stock pursuant to Section 10.5 and 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, (ii) June 12, 2004, and (iii) the full payment and discharge of the senior subordinated indebtedness of the Corporation in the initial principal amount of Twenty Million Dollars ($20,000,000) (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 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 Redemption Price"). 7.5.2. After (or simultaneously with) the completion of the redemption of all of the outstanding Class D Preferred Stock pursuant to Section 10.5 and 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 8.5.2, the Corporation -7- 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 9.5. 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 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. At any time after notice of redemption pursuant to Section 7.1 or Section 7.2 hereof shall have been mailed and before the redemption date specified therein, the Corporation may deposit for the pro rata benefit of the holders of the shares of Class A Preferred Stock so called for redemption the funds necessary for such redemption with a bank or trust company having a capital and surplus of at least $500,000,000. Any monies so deposited by the Corporation and unclaimed at the end of two years from the date designated for such redemption shall revert to the general funds of the Corporation. After such reversion such bank or trust company shall, upon demand, pay over to the Corporation such unclaimed amounts and thereupon such bank or trust company shall be relieved of all responsibility in respect thereof to such holder and such holder shall look only to the Corporation for the payment of the Class A Redemption Price. Any interest accrued on funds so deposited pursuant to this Section 7.5.5 shall be paid from time to time to the Corporation for its own account. Upon the deposit of funds pursuant to this Section 7.5.5 in respect of shares of Class A Preferred Stock called for -8- redemption, notwithstanding that any certificates for such shares shall not have been surrendered for cancellation, the shares represented thereby shall no longer be deemed outstanding, the rights to receive dividends thereon shall cease to accrue from and after the redemption date, and all rights of the holders of the shares of Class A Preferred Stock called for redemption shall cease and terminate, excepting only the right to receive the Class A Redemption Price therefor, without interest. 7.5.6. When shares are redeemed pursuant to this Section 7, such redemption shall only occur to the extent that (i) there shall be sufficient funds of the Corporation legally available for such redemption, (ii) such redemption would not violate any covenants of the Corporation to any lender to the Corporation or its subsidiaries and (iii) such redemption would not violate the terms of any management or shareholder agreement to which the Corporation is party. 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, Class B Preferred Stock and Class D 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, holders of Class B Preferred Stock and holders of Class D Preferred Stock, together representing at least sixty percent (60%) of the aggregate outstanding shares of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock shall have elected to convert all of the issued and outstanding shares of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock (other than those shares being redeemed pursuant to Section 7.5.1, Section 8.5.1, and Section 10.5.1, 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 (x) the sum of (A) the Class A Preferred Stock Stated Value plus (B) 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") divided by (y) the Conversion Price. 7.6.1. 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 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 -9- 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. 7.6.2. 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. 7.6.3. 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. 7.6.4. The holders of the Class A Preferred Stock, the holders of the Class B Preferred Stock, and the holders of the Class D Preferred Stock by vote of sixty percent (60%) of the aggregate outstanding shares of Class A Preferred Stock, Class B Preferred Stock and Class D 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, and Section 10.6. 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. 7.6.5. 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: 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 1,100,000 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 -10- 8.3 hereof) and senior with respect to payment of dividends, distributions, redemptions and distributions upon Liquidation, to all other shares of the capital stock of the Corporation except the Class C Preferred Stock and the Class D 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 subject to the rights of the holders of Class D Preferred Stock, 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 from and after June 12, 1999, 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 the Effective Time which does not expressly provide that it ranks senior to or on a parity with the Class B Preferred Stock as to the payment of dividends, distributions, redemptions and distributions upon Liquidation, 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 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. -11- 8.3.1. Following any Liquidation, no distribution of any of the assets of the Corporation shall be made to the holders of (i) Common Stock or (ii) any class or series of the Corporation's capital stock authorized, created or designated after the Effective Time which does not expressly provide that it ranks senior to or on a parity with the Class B Preferred Stock as to the payment of dividends, distributions, redemptions and distributions upon Liquidation by reason of their ownership thereof unless and until the holders of Class B Preferred Stock shall have received out of the assets of the Corporation legally available for distributions to its shareholders, 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 distribution of the Class D Liquidation Preference to the holders of Class D Preferred Stock pursuant to Section 10.3, distribution of the Class C Liquidation Preference 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 D Liquidation Preference, the Class C Liquidation Preference, 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. 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, Class A Preferred Stock and Class D 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 -12- outstanding shares of the Class B Preferred Stock as a separate class, the Corporation shall not, after the Effective Time, 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 , Class D 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 the Effective Time 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 D Preferred Stock pursuant to Section 10.5 and 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 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 Redemption Price"). -13- 8.5.2. After (or simultaneously with) the completion of the redemption of all of the outstanding Class D Preferred Stock pursuant to Section 10.5 and 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 9.5.2, 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 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 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. At any time after notice of redemption pursuant to Section 8.1 or Section 8.2 hereof shall have been mailed and before the redemption date specified therein, the Corporation may deposit for the pro rata benefit of the holders of the shares of Class B Preferred Stock so called for redemption the funds necessary for such redemption with a bank or trust company having a capital and surplus of at least $500,000,000. Any monies so deposited by the Corporation and unclaimed at the end of two years from the date designated for such redemption shall revert to the general funds of the Corporation. After such reversion such bank or trust -14- company shall, upon demand, pay over to the Corporation such unclaimed amounts and thereupon such bank or trust company shall be relieved of all responsibility in respect thereof to such holder and such holder shall look only to the Corporation for the payment of the Class B Redemption Price. Any interest accrued on funds so deposited pursuant to this Section 8.5.5 shall be paid from time to time to the Corporation for its own account. Upon the deposit of funds pursuant to this Section 8.5.5 in respect of shares of Class B Preferred Stock called for redemption, notwithstanding that any certificates for such shares shall not have been surrendered for cancellation, the shares represented thereby shall no longer be deemed outstanding, the rights to receive dividends thereon shall cease to accrue from and after the redemption date, and all rights of the holders of the shares of Class B Preferred Stock called for redemption shall cease and terminate, excepting only the right to receive the Class B Redemption Price therefor, without interest. 8.5.6. When shares are redeemed pursuant to this Section 8, such redemption shall only occur to the extent that (i) there shall be sufficient funds of the Corporation legally available for such redemption, (ii) such redemption would not violate any covenants of the Corporation to any lender to the Corporation or its subsidiaries and (iii) such redemption would not violate the terms of any management or shareholder agreement to which the Corporation is party. 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 (x) the sum of (A) the Class B Preferred Stock Stated Value plus (B) accrued but unpaid dividends, if any, payable with respect to such shares of Class B Preferred Stock up to and including the Conversion Date divided by (y) the Conversion Price. 8.6.1. 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. -15- 8.6.2. 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. 8.6.3. 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. 8.6.4. 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 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. 8.6.5. 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 600,000 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 with respect to payment of dividends, distributions, redemptions and distributions upon Liquidation to all other shares of the capital stock of the Corporation except the Class D Preferred Stock. 9.2. Dividends with Respect Class C Preferred 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. -16- 9.3. Liquidation Preference with Respect to Class C Preferred Stock. 9.3.1. Following any Liquidation, no distribution of any of the assets of the Corporation shall be made to the holders of (i) Common Stock (ii) any class or series of the Corporation's capital stock authorized, created or designated after the Effective Time which does not expressly provide that it ranks senior to or on a parity with the Class C Preferred Stock as to the payment of dividends, distributions, redemptions, or distributions upon Liquidation, (iii) Class A Preferred Stock, or (iv) Class B Preferred Stock by reason of their ownership thereof unless and until the holders of Class C Preferred Stock shall have received out of the assets of the Corporation legally available for distributions to its shareholders, an amount per share equal to the sum of the Class C Preferred Stock Stated Value 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 and after any distribution of the Class D Liquidation Preference to holders of Class D Preferred Stock pursuant to Section 10.3. 9.3.2. In the event of any Liquidation, after payment of the Class D Liquidation Preference and 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, after the Effective Time, 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 -17- 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. 9.5. Redemption with Respect to Class C Preferred Stock. 9.5.1. At any time and from time to time after the Effective Time and after (or simultaneously with) the completion of the redemption of all of the outstanding Class D Preferred Stock pursuant to Section 10.5, 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 (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 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 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 -18- 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. 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. At any time after notice of redemption pursuant to Section 9.1 or Section 9.2 hereof shall have been mailed and before the redemption date specified therein, the Corporation may deposit for the pro rata benefit of the holders of the shares of Class C Preferred Stock so called for redemption the funds necessary for such redemption with a bank or trust company having a capital and surplus of at least $500,000,000. Any monies so deposited by the Corporation and unclaimed at the end of two years from the date designated for such redemption shall revert to the general funds of the Corporation. After such reversion such bank or trust company shall, upon demand, pay over to the Corporation such unclaimed amounts and thereupon such bank or trust company shall be relieved of all responsibility in respect thereof to such holder and such holder shall look only to the Corporation for the payment of the Class C Redemption Price. Any interest accrued on funds so deposited pursuant to this Section 9.5.6 shall be paid from time to time to the Corporation for its own account. Upon the deposit of funds pursuant to this Section 9.5.6 in respect of shares of Class C Preferred Stock called for redemption, notwithstanding that any certificates for such shares shall not have been surrendered for cancellation, the shares represented thereby shall no longer be deemed outstanding, the rights to receive dividends thereon shall cease to accrue from and after the redemption date, and all rights of the holders of the shares of Class C Preferred Stock called for redemption shall cease and terminate, excepting only the right to receive the Class C Redemption Price therefor, without interest. 9.5.7. When shares are redeemed pursuant to this Section 9, such redemption shall only occur to the extent that (i) there shall be sufficient funds of the Corporation legally available for such redemption, (ii) such redemption would not violate any covenants of the Corporation to any lender to the Corporation or its Subsidiaries, (iii) such redemption would not violate the terms of any management or shareholder agreement to which the Corporation is party, and (iv) with respect to a redemption pursuant to Section 9.5.2, all shares of Class D Preferred Stock shall have been redeemed or are otherwise no longer outstanding. -19- 10. Class D Preferred Stock. The express terms and conditions of the shares classified and designated as Class D Preferred Stock, no par value, of the Corporation are as follows: 10.1. Designation and Number of Shares of Class D Preferred Stock. The designation of the series of preferred stock in this Section 10 is Class D Preferred Stock and the number of shares of such series is 75,000 shares having a stated value per share equal to $450.00 (the "Class D Preferred Stock Stated Value"). The Class D Preferred Stock shall rank senior with respect to payment of dividends, distributions, redemptions and distributions upon Liquidation to all other shares of capital stock of the Corporation including the Common Stock and the Class A Preferred Stock, Class B Preferred Stock and Class C Preferred Stock. 10.2. Dividends with Respect to Class D Preferred Stock. 10.2.1. The holder of each share of Class D Preferred Stock shall be entitled to receive, when, as and if declared by the Board or Directors, preferential, cumulative, dividends in cash, which dividends shall be cumulative and shall accrue from the Issue Date, in an amount equal to ten percent (10%) of the Class D Preferred Stock Stated Value per share per year, provided that from the period from June 30, 2001 until the Past Due Interest on the Notes is paid, dividends shall accrue in an amount equal to four (4%) of the Class D Preferred Stock Stated Value per share per year. 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. Whenever dividends are payable pursuant to this Section 10, 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. 10.2.2. If, in any dividend period or periods, full dividends (whether past or current) upon the outstanding shares of Class D 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 shares of Class D Preferred Stock through the payment date for such dividends are declared and paid on each share of Class D Preferred Stock, no dividends shall be declared or paid or set apart for payment upon any class or series of the Corporation's capital stock authorized, created or designated after the Effective Time which does not expressly provide that it ranks senior to or on a parity with the Class D Preferred Stock as to the payment of dividends, distributions, redemptions and distributions upon Liquidation 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 shares of Class D Preferred Stock, the aggregate payment to all holders of shares of Class D 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 D Preferred Stock. -20- 10.2.3. Holders of the Class D Preferred Stock shall not, solely as a result of such holders' ownership of such Class D 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. 10.3. Liquidation Preference with Respect to Class D Preferred Stock. 10.3.1. Following any Liquidation, no distribution of any of the assets of the Corporation shall be made to the holders of (i) any other class or series of the Corporation's capital stock or (ii) any class or series of the Corporation's capital stock authorized, created or designated after the Effective Time which does not expressly provide that it ranks senior to or on a parity with the Class D Preferred Stock as to the payment of dividends, distributions, redemptions and distributions upon Liquidation by reason of their ownership thereof unless and until the holders of Class D Preferred Stock shall have received out of the assets of the Corporation legally available for distributions to its shareholders, an amount per share equal to the sum of the Class D Preferred Stock Stated Value plus all accrued and unpaid dividends, if any, to the date of payment, (the "Class D Liquidation Preference") for each share of Class D 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 D Preferred Stock the full amount of the Class D Liquidation Preference, the holders of shares of Class D Preferred Stock shall share ratably in any distribution of assets available for distribution to the Class D Preferred Stock holders. 10.3.2. In the event of any Liquidation, after payment shall have been made to the holders of shares of Class D Preferred Stock of the amounts described in Section 10.3.1 and Section 10.3.2 hereof, the holders of shares of Class D Preferred Stock shall be entitled to no further participation in the distribution of the assets of the Corporation. 10.3.3. 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. 10.4. Voting Rights with Respect to Class D Preferred Stock. The holders of shares of Class D 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 shares of Common Stock, voting together with the holders of shares of Common Stock, Class A Preferred 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 D Preferred Stock as a separate class, the Corporation shall not, 10.4.1. after the Effective Date, 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 a parity with the Class D Preferred Stock (other than such shares of Class D Preferred Stock issued as dividends hereunder) or (B) in any -21- manner adversely affects the holders of the Class D 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 D Preferred Stock; 10.4.2. in any manner alter or change the designations or the powers, preferences or rights, or the qualifications, limitations or restrictions of the Class D Preferred Stock, including without limitation, by increasing or decreasing the number of shares of the Class D Preferred Stock authorized for issuance hereunder, or by increasing or decreasing the par value or Class D Preferred Stock Stated Value of the shares of the Class D Preferred Stock; or 10.4.3. 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 Date or (c) Class A Preferred Stock, Class B Preferred Stock or Class C 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 D Preferred Stock or (B) which in any manner adversely affects the holders of the Class D Preferred Stock. 10.5. Redemptions with Respect to Class D Preferred Stock. 10.5.1. At any time and from time to time 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 D Preferred Stock then outstanding. For each share of Class D Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant to this Section 10.5.1, 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 D Liquidation Preference (for purposes of this Section, the "Class D Redemption Price"). 10.5.2. At any time and from time to time after a Redemption Allowance Date, at the option of a holder of the Class D 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 shares of Class D Preferred Stock held by such holder. For each share of Class D Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant to this Section 10.5.2, 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 D Redemption Price. 10.5.3. If the funds of the Corporation legally available for redemption pursuant to Section 10.5.2 are insufficient to redeem the number of shares which the Corporation is required to redeem pursuant to Section 10.5.2 those funds which are available will be used to -22- 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 D 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 D 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 D 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 D Preferred Stock which the Corporation is then obligated to redeem in proportion to the number of shares of Class D 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 D Preferred Stock shall be paid in full before payments shall be made to holders of Class A Preferred Stock pursuant to Section 7.5 and Class B Preferred Stock pursuant to Section 8.5 and Class C Preferred Stock pursuant to Section 9.5. 10.5.4. Notwithstanding the fact that a written notice of redemption is given, all rights of the redeeming holder with respect to shares of Class D 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 D Redemption Price therefor is paid (such payment being a continuing obligation of the Corporation). 10.5.5. At any time after notice of redemption pursuant to Section 10.2.1 or Section 10.2.2 hereof shall have been mailed and before the redemption date specified therein, the Corporation may deposit for the pro rata benefit of the holders of the shares of Class D Preferred Stock so called for redemption the funds necessary for such redemption with a bank or trust company having a capital and surplus of at least $500,000,000. Any monies so deposited by the Corporation and unclaimed at the end of two years from the date designated for such redemption shall revert to the general funds of the Corporation. After such reversion such bank or trust company shall, upon demand, pay over to the Corporation such unclaimed amounts and thereupon such bank or trust company shall be relieved of all responsibility in respect thereof to such holder and such holder shall look only to the Corporation for the payment of the Class D Redemption Price. Any interest accrued on funds so deposited pursuant to this Section 10.5.5 shall be paid from time to time to the Corporation for its own account. Upon the deposit of funds pursuant to this Section 10.5.5 in respect of shares of Class D Preferred Stock called for redemption, notwithstanding that any certificates for such shares shall not have been surrendered for cancellation, the shares represented thereby shall no longer be deemed outstanding, the rights to receive dividends thereon shall cease to accrue from and after the redemption date, and all rights of the holders of the shares of Class D Preferred Stock called for redemption shall cease and terminate, excepting only the right to receive the Class D Redemption Price therefor, without interest. 10.5.6. When shares are redeemed pursuant to this Section 10, such redemption shall only occur to the extent that (i) there shall be sufficient funds of the -23- Corporation legally available for such redemption, (ii) such redemption would not violate any covenants of the Corporation to any lender to the Corporation or its subsidiaries and (iii) such redemption would not violate the terms of any management or shareholders agreement to which the Corporation is a party. 10.6. Conversion Rights. Upon an Event of Conversion, each and every share of Class D Preferred Stock then outstanding (other than those shares being redeemed), by virtue of, and simultaneously with the occurrence of a Qualified Public Offering 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 (x) the sum of (A) the Class D Preferred Stock Stated Value plus (B) all accrued but unpaid dividends, if any, payable with respect to such shares of Class D Preferred Stock up to and including the Conversion Date divided by (y) the Conversion Price. 10.6.1. Conversion shall be deemed to have been effected with respect to conversion under this Section 10.6 on the Conversion Date. Simultaneous with the conversion being effected, the shares of Class D 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 10.6.3 hereof, payable with respect to the shares of Class D 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. 10.6.2. No fractional shares of Common Stock shall be issued upon conversion of shares of Class D Preferred Stock. Instead of any fractional shares of Common Stock which would otherwise be issuable upon conversion of any shares of Class D 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 D 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. 10.6.3. 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 D 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 D Preferred Stock in respect of which such shares are being issued. -24- 10.6.4. The holders of shares of the Class D Preferred Stock by vote of sixty percent (60%) of the aggregate outstanding shares of Class D 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 10.6. 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. 10.6.5. 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. 11. 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 11 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 11 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. -25- 12. Adoption. This amended and restated charter was adopted by unanimous written consent of the Board of Directors and Shareholders of the Corporation dated August 7, 2000. This charter replaces and supersedes the original charter of the Corporation filed with the Tennessee Secretary of State and all amendments thereto. 13. Corporation for Profit. The Corporation is for profit. Dated: August 8, 2000 By: /s/ Robert E. Alderson ------------------------------------- Title: President -26- EX-3.2 4 g75423ex3-2.txt FORM OF AMENDED AND RESTATED CHARTER OF KIRKLAND'S Exhibit 3.2 [COVER CERTIFICATE FOR PRE-EFFECTIVE CHARTER AMENDMENT] CERTIFICATE OF KIRKLAND'S, INC. KIRKLAND'S, INC., a Tennessee corporation (the "Company"), does hereby certify, pursuant to Section 48-20-107(d) of the Tennessee Business Corporation Act, that: FIRST: The Board of Directors of the Company, by Unanimous Written Consent on April __, 2002, adopted a resolution proposing and declaring advisable that the Charter of the Company be amended and restated to read in full as set forth in the Amended and Restated Charter attached hereto and filed herewith as Appendix A (the "Amended and Restated Charter"). SECOND: The Shareholders of the Company, by Unanimous Written Consent on April __, 2002, adopted the Amended and Restated Charter in accordance with the provisions of Section 48-20-103 of the Tennessee Business Corporation Act. THIRD: Upon the filing of this Certificate and the Amended and Restated Charter with the Tennessee Department of State, and without any other action on the part of the Company or any other person, (a) each share of Common Stock then issued and outstanding shall be converted into _____ shares of Common Stock, (b) any certificate representing a share of Common Stock shall thereafter represent ______ shares of Common Stock, and (c) the Amended and Restated Charter shall become effective, superseding the Company's existing charter and all prior amendments thereto and restatements thereof. IN WITNESS WHEREOF, the Company has caused this Certificate to be signed by _____________, its _____________________, and attested by _________________, its Secretary, this _____ day of ___________, 2002. ATTESTED: KIRKLAND'S, INC. By: By: ------------------------------------ ------------------------------- [NAME] [NAME] Secretary [TITLE] [To become effective immediately prior to effectiveness of the Offering] APPENDIX A AMENDED AND RESTATED CHARTER OF KIRKLAND'S, INC. This Amended and Restated Charter of Kirkland's, Inc. (the "Corporation") shall be effective upon filing with the Tennessee Secretary of State. The undersigned corporation hereby adopts the following amended and restated charter pursuant to ss. 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 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 One Hundred Ten Million (110,000,000), of which One Hundred Million (100,000,000) 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 (10,000,000) shares shall constitute a single class of shares known as Preferred Stock (the "Preferred Stock"). Of the Preferred Stock (i) Three Million One Hundred Thousand (3,100,000) 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) One Million One Hundred Thousand (1,100,000) 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"), (iii) Six Hundred Thousand (600,000) shares shall be designated as a series referred to as Class C Preferred Stock, which shall be without par value (the "Class C Preferred Stock"), and (iv) Seventy-Five Thousand (75,000) shares shall be designated as a series referred to as Class D Preferred Stock, which shall be without par value (the "Class D Preferred Stock"). 5. Certain Definitions. Unless the context otherwise requires, the terms defined in this Section 5 shall have, for all purposes of this Amended and Restated Charter the meanings herein specified (with terms defined in the singular having comparable meanings when used in the plural). "Anticipated Effective Date" has the meaning set forth in Section 8.6. "Board of Directors" means the Board of Directors of the Corporation or any authorized committee of the Board of Directors, as the same may be constituted from time to time. "Class A Excess Dividend Amount" has the meaning set forth in Section 8.3.2. "Class A Liquidation Preference" has the meaning set forth in Section 8.3.1. "Class A Preferred Stock" means the Class A Preferred Stock, no par value per share, designated as "Class A Preferred Stock" in the Charter. "Class A Preferred Stock Stated Value" means $13.58859 per share. "Class A Redemption Price" has the meaning set forth in Section 8.5.1. "Class B Excess Dividend Amount" has the meaning set forth in Section 9.3.2. "Class B Liquidation Preference" has the meaning set forth in Section 9.3.1. "Class B Preferred Stock" means the Class B Preferred Stock, no par value per share, designated as "Class B Preferred Stock" in the Charter. "Class B Preferred Stock Stated Value" means $13.58859 per share. "Class B Redemption Price" has the meaning set forth in Section 9.5.1. "Class C Liquidation Preference" has the meaning set forth in Section 10.3.1. "Class C Preferred Stock" means the Class C Preferred Stock, no par value per share, designated as "Class C Preferred Stock" in the Charter. "Class C Preferred Stock Stated Value" means $30.63556 per share. "Class C Redemption Event" has the meaning set forth in Section 10.5.2. "Class C Redemption Price" has the meaning set forth in Section 10.5.3. "Class D Liquidation Preference" has the meaning set forth in Section 11.3.1 hereof. "Class D Preferred Stock" means the Corporation's Class D Preferred Stock, no par value per share, as the same may be amended or modified from time to time. "Class D Preferred Stock Stated Value" means $450.00 per share. "Class D Redemption Price" has the meaning set forth in Section 11.5.1 hereof. -2- "Common Stock" means the Common Stock, no par value per share, of the Corporation. "Conversion Date" has the meaning set forth in Section 8.6. hereof. "Conversion Price" means the offering price per share at which the Common Stock of the Corporation is first offered to the public in the Qualified Public Offering. "Corporation" means Kirkland's, Inc. "Event of Conversion" has the meaning set forth in Section 8.6. "Issue Date" means the first date on which any shares of Class D Preferred Stock are issued by the Corporation. "Liquidation" means any sale, merger, consolidation, dissolution, liquidation or winding up of the Corporation, voluntary or involuntary. "Liquidity Event" means (A) a sale of all or a majority in value of the assets of the Corporation and its consolidated subsidiaries, taken as a whole. (B) the acquisition of more than fifty percent (50%) of the outstanding shares of Common Stock of the Corporation, by a person or group of persons acting in concert, who are not shareholders of the Corporation as of August 8, 2000, other than transfers to an Affiliate or to a Permitted Transferee (as such terms are defined in the shareholders agreement in effect as of August 8, 2000, between the Corporation and the shareholders thereof) if such transfers are permitted without restriction pursuant to the terms of such shareholders agreement; (C) a Qualified Public Offering; or (D) a refinancing after August 8, 2000 of the indebtedness of the Corporation for borrowed money existing as of August 8, 2000, in connection with which the Corporation repurchase or redeem any capital stock for value. "Notes" has the meaning set forth in Section 8.2.1 hereof. "Person" means any individual, corporation, partnership, firm, joint venture, association, limited liability company or partnership, joint-stock company, trust, unincorporated organization or any government, or governmental or regulatory body thereof, or political subdivision thereof, whether federal, state, local or foreign, or any agency or instrumentality thereof, or any court or arbitrator (public or private). "Past Due Interest" has the meaning set forth in Section 8.2.1 hereof. -3- "Preferred Stock Designation" has the meaning set forth in Section 7 hereof. "Qualified Public Offering" means a sale of shares of the Common Stock of the Corporation in a registered underwritten public offering resulting in gross proceeds to the Corporation of at least Thirty Million Dollars ($30,000,000). "Redemption Allowance Date" has the meaning set forth in Section 8.5.1 hereof. 6. Common Stock. The express terms and conditions of the shares classified and designated as Common Stock are as follows: 6.1. 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. 6.2. Liquidation. On 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. 7. 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; -4- (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; (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. 8. 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: 8.1. Designation and Number of Shares of Class A Preferred Stock. The designation of the series of preferred stock in this Section 8 is Class A Preferred Stock and the number of shares of such series is 3,100,000 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 8.3 and Section 9.3) and senior with respect to payment of dividends, distributions, redemptions and distributions upon Liquidation to all other shares of capital stock of the Corporation except the Class C Preferred Stock and the Class D Preferred Stock. -5- 8.2. Dividends with Respect to Class A Preferred Stock. 8.2.1. In each year, the holder of each share of Class A Preferred Stock shall be entitled to receive, subject to the rights of the holders of Class D Preferred Stock, 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, that from and after June 12, 1999, dividends shall accrue in an amount equal to ten (10%) of the Class A Preferred Stock Stated Value per share per year, provided further that dividends shall accrue in an amount equal to four percent (4%) per annum of the Class A Preferred Stock Stated Value per share per year from the period from June 30, 2001 until such time as the Company has paid on the promissory notes (the "Notes") issued in connection with that Senior Subordinated Note and Warrant Purchase Agreement dated as of June 12, 1996, as amended, all interest that had accrued and was not paid as of June 19, 2001, in the amount of Three Million Seventy-Two Thousand Five Hundred Nine Dollars ($3,072,509), plus all additional interest accrued under the Notes after June 19, 2001 that is not paid when due (collectively, "Past Due Interest"). 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. 8.2.2. 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 August 8, 2000 which does not expressly provide that it ranks senior to or on a parity with the Class A Preferred Stock as to the payment of dividends, distributions, redemptions and distributions upon Liquidation, 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. 8.2.3. 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. -6- 8.2.4. 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. 8.3. Liquidation Preference with Respect to Class A Preferred Stock. 8.3.1. Following any Liquidation, no distribution of any of the assets of the Corporation shall be made to the holders of (i) Common Stock, (ii) any class or series of the Corporation's capital stock authorized, created or designated after August 8, 2000 which does not expressly provide that it ranks senior to or on a parity with the Class A Preferred Stock as to the payment of dividends, distributions, redemptions and distributions upon Liquidation, or (iii) Class B Preferred Stock by reason of their ownership thereof unless and until the holders of Class A Preferred Stock shall have received out of the assets of the Corporation legally available for distributions to its shareholders, 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 any distribution of the Class D Liquidation Preference to the holders of Class D Preferred Stock pursuant to Section 11.3 and distribution of the Class C Liquidation Preference to the holders of the Class C Preferred Stock pursuant to Section 10.3. 8.3.2. In the event of any Liquidation, after payment of the Class D Liquidation Preference, the Class C Liquidation Preference, 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 9.3.2, 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"). 8.3.3. 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 8.3.1 and Section 8.3.2, 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. 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. 8.4. 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 -7- same effect as such holders of the Common Stock, voting together with the holders of Common Stock, Class B Preferred Stock and Class D 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, after August 8, 2000, 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 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; 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 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 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 August 8, 2000 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. 8.5. Redemptions with Respect to Class A 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 D Preferred Stock pursuant to Section 11.5 and after (or simultaneously with) the completion of the redemption of all of the outstanding Class C Preferred Stock pursuant to Section 10.5, and after the earlier to occur of (i) the closing of a Liquidity Event, (ii) June 12, 2004, and (iii) the full payment and discharge of the senior subordinated indebtedness of the Corporation in the initial principal amount of Twenty Million Dollars ($20,000,000) (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 8.5.1 unless a pro rata number (based on aggregate stated values) of Class B Preferred shares shall be redeemed pursuant to Section 9.5.1. 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 -8- 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 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 Redemption Price"). 8.5.2. After (or simultaneously with) the completion of the redemption of all of the outstanding Class D Preferred Stock pursuant to Section 11.5 and after (or simultaneously with) the completion of the redemption of all of the outstanding Class C Preferred Stock pursuant to Section 10.5, 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 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 A 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 9.5.2 are insufficient to redeem the number of shares which the Corporation is required to redeem pursuant to Section 8.5.2 and 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 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 10.5. 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 A Preferred Stock which are the subject of such written notice of redemption shall continue as if the written notice of -9- 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). 8.5.5. At any time after notice of redemption pursuant to Section 8.5.1 or Section 8.5.2 hereof shall have been mailed and before the redemption date specified therein, the Corporation may deposit for the pro rata benefit of the holders of the shares of Class A Preferred Stock so called for redemption the funds necessary for such redemption with a bank or trust company having a capital and surplus of at least $500,000,000. Any monies so deposited by the Corporation and unclaimed at the end of two years from the date designated for such redemption shall revert to the general funds of the Corporation. After such reversion such bank or trust company shall, upon demand, pay over to the Corporation such unclaimed amounts and thereupon such bank or trust company shall be relieved of all responsibility in respect thereof to such holder and such holder shall look only to the Corporation for the payment of the Class A Redemption Price. Any interest accrued on funds so deposited pursuant to this Section 8.5.5 shall be paid from time to time to the Corporation for its own account. Upon the deposit of funds pursuant to this Section 8.5.5 in respect of shares of Class A Preferred Stock called for redemption, notwithstanding that any certificates for such shares shall not have been surrendered for cancellation, the shares represented thereby shall no longer be deemed outstanding, the rights to receive dividends thereon shall cease to accrue from and after the redemption date, and all rights of the holders of the shares of Class A Preferred Stock called for redemption shall cease and terminate, excepting only the right to receive the Class A Redemption Price therefor, without interest. 8.5.6. When shares are redeemed pursuant to this Section 8, such redemption shall only occur to the extent that (i) there shall be sufficient funds of the Corporation legally available for such redemption, (ii) such redemption would not violate any covenants of the Corporation to any lender to the Corporation or its subsidiaries and (iii) such redemption would not violate the terms of any management or shareholder agreement to which the Corporation is party. 8.5.7. Upon payment of the Class A Redemption Price by the Corporation with respect to shares of Class A Preferred Stock being redeemed pursuant to this Section 8.5, 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. 8.6. 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, Class B Preferred Stock and Class D 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, holders of Class B Preferred Stock and holders of Class D Preferred Stock, together representing at least sixty percent (60%) of the aggregate outstanding -10- shares of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock shall have elected to convert all of the issued and outstanding shares of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock (other than those shares being redeemed pursuant to Section 8.5.1, Section 9.5.1, and Section 11.5.1, 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 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 (x) the sum of (A) the Class A Preferred Stock Stated Value plus (B) 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") divided by (y) the Conversion Price. 8.6.1. 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 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 8.6.3, 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. 8.6.2. 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. 8.6.3. 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. 8.6.4. The holders of the Class A Preferred Stock, the holders of the Class B Preferred Stock, and the holders of the Class D Preferred Stock by vote of sixty percent (60%) -11- of the aggregate outstanding shares of Class A Preferred Stock, Class B Preferred Stock and Class D 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 9.6, and Section 11.6. 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. 8.6.5. 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 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: 9.1. Designation and Number of Shares of Class B Preferred Stock. The designation of the series of Preferred Stock set forth in this Section 9 is Class B Preferred Stock and the number of shares of such series is 1,100,000 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 8.3 and Section 9.3 hereof) and senior with respect to payment of dividends, distributions, redemptions and distributions upon Liquidation, to all other shares of the capital stock of the Corporation except the Class C Preferred Stock and the Class D Preferred Stock. 9.2. Dividends with respect to Class B Preferred Stock. 9.2.1. In each year, the holder of each share of Class B Preferred Stock shall be entitled to receive subject to the rights of the holders of Class D Preferred Stock, 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 from and after June 12, 1999, 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. 9.2.2. 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 -12- 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 August 8, 2000 which does not expressly provide that it ranks senior to or on a parity with the Class B Preferred Stock as to the payment of dividends, distributions, redemptions and distributions upon Liquidation, 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. 9.2.3. 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. 9.2.4. 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. 9.3. Liquidation Preference with Respect to Class B Preferred Stock. 9.3.1. Following any Liquidation, no distribution of any of the assets of the Corporation shall be made to the holders of (i) Common Stock or (ii) any class or series of the Corporation's capital stock authorized, created or designated after August 8, 2000 which does not expressly provide that it ranks senior to or on a parity with the Class B Preferred Stock as to the payment of dividends, distributions, redemptions and distributions upon Liquidation by reason of their ownership thereof unless and until the holders of Class B Preferred Stock shall have received out of the assets of the Corporation legally available for distributions to its shareholders, 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 distribution of the Class D Liquidation Preference to the holders of Class D Preferred Stock pursuant to Section 11.3, distribution of the Class C Liquidation Preference to the holders of the Class C Preferred Stock pursuant to Section 10.3, and distribution of the Class A Liquidation Preference to the holders of the Class A Preferred Stock pursuant to Section 8.3. 9.3.2. In the event of any Liquidation, after payment of the Class D Liquidation Preference, the Class C Liquidation Preference, 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 -13- 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 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"). 9.3.3. 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 9.3.1 or Section 9.3.2, 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. 9.3.4. 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. 9.4. 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, Class A Preferred Stock and Class D 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, after August 8, 2000, 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 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 , Class D 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; 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 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 9.4.3. reclassify the shares of any (a) Common Stock, (b) class or series of the Corporation's capital stock authorized, created or designated after August 8, 2000 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. -14- 9.5. Redemptions with Respect to Class B Preferred Stock. 9.5.1. At any time and from time to time after (or simultaneously with) the completion of the redemption of all of the outstanding Class D Preferred Stock pursuant to Section 11.5 and after (or simultaneously with) the completion of the redemption of all of the outstanding Class C Preferred Stock pursuant to Section 10.5 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 9.5.1 unless a pro rata number (based on aggregate stated values) of Class A Preferred Stock shall be redeemed pursuant to Section 8.5.1. 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 9.5.1, 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 Redemption Price"). 9.5.2. After (or simultaneously with) the completion of the redemption of all of the outstanding Class D Preferred Stock pursuant to Section 11.5 and after (or simultaneously with) the completion of the redemption of all of the outstanding Class C Preferred Stock pursuant to Section 10.5, 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 9.5.2, 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. 9.5.3. If the funds of the Corporation legally available for redemption pursuant to Section 9.5.2 and Section 8.5.2 are insufficient to redeem the number of shares which the Corporation is required to redeem pursuant to Section 9.5.2 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 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 -15- (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 9.5. 9.5.4. 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). 9.5.5. At any time after notice of redemption pursuant to Section 9.5.1 or Section 9.5.2 hereof shall have been mailed and before the redemption date specified therein, the Corporation may deposit for the pro rata benefit of the holders of the shares of Class B Preferred Stock so called for redemption the funds necessary for such redemption with a bank or trust company having a capital and surplus of at least $500,000,000. Any monies so deposited by the Corporation and unclaimed at the end of two years from the date designated for such redemption shall revert to the general funds of the Corporation. After such reversion such bank or trust company shall, upon demand, pay over to the Corporation such unclaimed amounts and thereupon such bank or trust company shall be relieved of all responsibility in respect thereof to such holder and such holder shall look only to the Corporation for the payment of the Class B Redemption Price. Any interest accrued on funds so deposited pursuant to this Section 9.5.5 shall be paid from time to time to the Corporation for its own account. Upon the deposit of funds pursuant to this Section 9.5.5 in respect of shares of Class B Preferred Stock called for redemption, notwithstanding that any certificates for such shares shall not have been surrendered for cancellation, the shares represented thereby shall no longer be deemed outstanding, the rights to receive dividends thereon shall cease to accrue from and after the redemption date, and all rights of the holders of the shares of Class B Preferred Stock called for redemption shall cease and terminate, excepting only the right to receive the Class B Redemption Price therefor, without interest. 9.5.6. When shares are redeemed pursuant to this Section 9, such redemption shall only occur to the extent that (i) there shall be sufficient funds of the Corporation legally available for such redemption, (ii) such redemption would not violate any covenants of the Corporation to any lender to the Corporation or its subsidiaries and (iii) such redemption would not violate the terms of any management or shareholder agreement to which the Corporation is party. 9.5.7. Upon payment of the Class B Redemption Price by the Corporation with respect to shares of Class B Preferred Stock being redeemed pursuant to this Section 9.5, -16- 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. 9.6. 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 9.5.1), 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 (x) the sum of (A) the Class B Preferred Stock Stated Value plus (B) accrued but unpaid dividends, if any, payable with respect to such shares of Class B Preferred Stock up to and including the Conversion Date divided by (y) the Conversion Price. 9.6.1. Conversion shall be deemed to have been effected with respect to conversion under Section 9.6 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 9.6.3, 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. 9.6.2. 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. 9.6.3. 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. 9.6.4. 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, -17- 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 9.6 and Section 8.6, and Section 11.6. 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. 9.6.5. 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. 10. 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: 10.1. Designation and Number Preferred Stock. The designation of the series of preferred stock in this Section 10 is Class C Preferred Stock (hereinafter called "Class C Preferred Stock") and the number of shares of such series is 600,000 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 with respect to payment of dividends, distributions, redemptions and distributions upon Liquidation to all other shares of the capital stock of the Corporation except the Class D Preferred Stock. 10.2. Dividends with Respect Class C Preferred 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. 10.3. Liquidation Preference with Respect to Class C Preferred Stock. 10.3.1. Following any Liquidation, no distribution of any of the assets of the Corporation shall be made to the holders of (i) Common Stock (ii) any class or series of the Corporation's capital stock authorized, created or designated after August 8, 2000 which does not expressly provide that it ranks senior to or on a parity with the Class C Preferred Stock as to the payment of dividends, distributions, redemptions, or distributions upon Liquidation, (iii) Class A Preferred Stock, or (iv) Class B Preferred Stock by reason of their ownership thereof unless and until the holders of Class C Preferred Stock shall have received out of the assets of the Corporation legally available for distributions to its shareholders, an amount per share equal to the sum of the Class C Preferred Stock Stated Value 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 and -18- after any distribution of the Class D Liquidation Preference to holders of Class D Preferred Stock pursuant to Section 11.3. 10.3.2. In the event of any Liquidation, after payment of the Class D Liquidation Preference and after payment shall have been made to the holders of shares of Class C Preferred Stock of the amounts described in Section 10.3.1, 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. 10.3.3. 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. 10.4. 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 10.4. 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, after August 8, 2000, 10.4.1. 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; 10.4.2. 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 10.4.3. 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. 10.5. Redemption with Respect to Class C Preferred Stock. 10.5.1. At any time and from time to time after August 8, 2000 and after (or simultaneously with) the completion of the redemption of all of the outstanding Class D Preferred Stock pursuant to Section 11.5, 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 -19- 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. 10.5.2. 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 10.5.3, until the redemption occurs. 10.5.3. 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 10.5, 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 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 10.5.2, 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. 10.5.4. If the funds of the Corporation legally available for redemption pursuant to Section 10.5.1 or Section 10.5.2 are insufficient to redeem the number of shares which the Corporation is required to redeem pursuant to Section 10.5.1 or Section 10.5.2, 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. 10.5.5. 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 -20- 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). 10.5.6. At any time after notice of redemption pursuant to Section 10.1 or Section 10.2 hereof shall have been mailed and before the redemption date specified therein, the Corporation may deposit for the pro rata benefit of the holders of the shares of Class C Preferred Stock so called for redemption the funds necessary for such redemption with a bank or trust company having a capital and surplus of at least $500,000,000. Any monies so deposited by the Corporation and unclaimed at the end of two years from the date designated for such redemption shall revert to the general funds of the Corporation. After such reversion such bank or trust company shall, upon demand, pay over to the Corporation such unclaimed amounts and thereupon such bank or trust company shall be relieved of all responsibility in respect thereof to such holder and such holder shall look only to the Corporation for the payment of the Class C Redemption Price. Any interest accrued on funds so deposited pursuant to this Section 10.5.6 shall be paid from time to time to the Corporation for its own account. Upon the deposit of funds pursuant to this Section 10.5.6 in respect of shares of Class C Preferred Stock called for redemption, notwithstanding that any certificates for such shares shall not have been surrendered for cancellation, the shares represented thereby shall no longer be deemed outstanding, the rights to receive dividends thereon shall cease to accrue from and after the redemption date, and all rights of the holders of the shares of Class C Preferred Stock called for redemption shall cease and terminate, excepting only the right to receive the Class C Redemption Price therefor, without interest. 10.5.7. When shares are redeemed pursuant to this Section 10, such redemption shall only occur to the extent that (i) there shall be sufficient funds of the Corporation legally available for such redemption, (ii) such redemption would not violate any covenants of the Corporation to any lender to the Corporation or its Subsidiaries, (iii) such redemption would not violate the terms of any management or shareholder agreement to which the Corporation is party, and (iv) with respect to a redemption pursuant to Section 10.5.2, all shares of Class D Preferred Stock shall have been redeemed or are otherwise no longer outstanding. 10.5.8. Once the Class C Redemption Price has been paid by the Corporation with respect to shares of Class C Preferred Stock being redeemed pursuant to this Section 10.5, 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 11. Class D Preferred Stock. The express terms and conditions of the shares classified and designated as Class D Preferred Stock, no par value, of the Corporation are as follows: 11.1. Designation and Number of Shares of Class D Preferred Stock. The designation of the series of preferred stock in this Section 11 is Class D Preferred Stock and the number of shares of such series is 75,000 shares having a stated value per share equal to $450.00 (the "Class D Preferred Stock Stated Value"). The Class D Preferred Stock shall rank senior with respect to payment of dividends, distributions, redemptions and distributions upon -21- Liquidation to all other shares of capital stock of the Corporation including the Common Stock and the Class A Preferred Stock, Class B Preferred Stock and Class C Preferred Stock. 11.2. Dividends with Respect to Class D Preferred Stock. 11.2.1. The holder of each share of Class D Preferred Stock shall be entitled to receive, when, as and if declared by the Board of Directors, preferential, cumulative, dividends in cash, which dividends shall be cumulative and shall accrue from the Issue Date, in an amount equal to ten percent (10%) of the Class D Preferred Stock Stated Value per share per year, provided that from the period from June 30, 2001 until the Past Due Interest on the Notes is paid, dividends shall accrue in an amount equal to four (4%) of the Class D Preferred Stock Stated Value per share per year. 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. Whenever dividends are payable pursuant to this Section 10, 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. 11.2.2. If, in any dividend period or periods, full dividends (whether past or current) upon the outstanding shares of Class D 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 shares of Class D Preferred Stock through the payment date for such dividends are declared and paid on each share of Class D Preferred Stock, no dividends shall be declared or paid or set apart for payment upon any class or series of the Corporation's capital stock authorized, created or designated after August 8, 2000 which does not expressly provide that it ranks senior to or on a parity with the Class D Preferred Stock as to the payment of dividends, distributions, redemptions and distributions upon Liquidation 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 shares of Class D Preferred Stock, the aggregate payment to all holders of shares of Class D 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 D Preferred Stock. 11.2.3. Holders of the Class D Preferred Stock shall not, solely as a result of such holders' ownership of such Class D 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. -22- 11.3. Liquidation Preference with Respect to Class D Preferred Stock. 11.3.1. Following any Liquidation, no distribution of any of the assets of the Corporation shall be made to the holders of (i) any other class or series of the Corporation's capital stock or (ii) any class or series of the Corporation's capital stock authorized, created or designated after August 8, 2000 which does not expressly provide that it ranks senior to or on a parity with the Class D Preferred Stock as to the payment of dividends, distributions, redemptions and distributions upon Liquidation by reason of their ownership thereof unless and until the holders of Class D Preferred Stock shall have received out of the assets of the Corporation legally available for distributions to its shareholders, an amount per share equal to the sum of the Class D Preferred Stock Stated Value plus all accrued and unpaid dividends, if any, to the date of payment, (the "Class D Liquidation Preference") for each share of Class D 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 D Preferred Stock the full amount of the Class D Liquidation Preference, the holders of shares of Class D Preferred Stock shall share ratably in any distribution of assets available for distribution to the Class D Preferred Stock holders. 11.3.2. In the event of any Liquidation, after payment shall have been made to the holders of shares of Class D Preferred Stock of the amounts described in Section 11.3.1 and Section 11.3.2 hereof, the holders of shares of Class D Preferred Stock shall be entitled to no further participation in the distribution of the assets of the Corporation. 11.3.3. 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. 11.4. Voting Rights with Respect to Class D Preferred Stock. The holders of shares of Class D 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 shares of Common Stock, voting together with the holders of shares of Common Stock, Class A Preferred 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 D Preferred Stock as a separate class, the Corporation shall not, 11.4.1. after the Effective Date, 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 a parity with the Class D Preferred Stock (other than such shares of Class D Preferred Stock issued as dividends hereunder) or (B) in any manner adversely affects the holders of the Class D 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 D Preferred Stock; -23- 11.4.2. in any manner alter or change the designations or the powers, preferences or rights, or the qualifications, limitations or restrictions of the Class D Preferred Stock, including without limitation, by increasing or decreasing the number of shares of the Class D Preferred Stock authorized for issuance hereunder, or by increasing or decreasing the par value or Class D Preferred Stock Stated Value of the shares of the Class D Preferred Stock; or 11.4.3. 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 Date or (c) Class A Preferred Stock, Class B Preferred Stock or Class C 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 D Preferred Stock or (B) which in any manner adversely affects the holders of the Class D Preferred Stock. 11.5. Redemptions with Respect to Class D Preferred Stock. 11.5.1. At any time and from time to time 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 D Preferred Stock then outstanding. For each share of Class D Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant to this Section 11.5.1, 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 D Liquidation Preference (for purposes of this Section, the "Class D Redemption Price"). 11.5.2. At any time and from time to time after a Redemption Allowance Date, at the option of a holder of the Class D 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 shares of Class D Preferred Stock held by such holder. For each share of Class D Preferred Stock which is to be redeemed by the Corporation at any time in a redemption pursuant to this Section 11.5.2, 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 D Redemption Price. 11.5.3. If the funds of the Corporation legally available for redemption pursuant to Section 11.5.2 are insufficient to redeem the number of shares which the Corporation is required to redeem pursuant to Section 11.5.2 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 D 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 D Preferred Stock which the Corporation shall be obligated to redeem are so redeemed, when -24- additional funds of the Corporation are legally available for the redemption of any of the shares of Class D 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 D Preferred Stock which the Corporation is then obligated to redeem in proportion to the number of shares of Class D 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 D Preferred Stock shall be paid in full before payments shall be made to holders of Class A Preferred Stock pursuant to Section 8.5 and Class B Preferred Stock pursuant to Section 9.5 and Class C Preferred Stock pursuant to Section 10.5. 11.5.4. Notwithstanding the fact that a written notice of redemption is given, all rights of the redeeming holder with respect to shares of Class D 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 D Redemption Price therefor is paid (such payment being a continuing obligation of the Corporation). 11.5.5. At any time after notice of redemption pursuant to Section 11.2.1 or Section 11.2.2 hereof shall have been mailed and before the redemption date specified therein, the Corporation may deposit for the pro rata benefit of the holders of the shares of Class D Preferred Stock so called for redemption the funds necessary for such redemption with a bank or trust company having a capital and surplus of at least $500,000,000. Any monies so deposited by the Corporation and unclaimed at the end of two years from the date designated for such redemption shall revert to the general funds of the Corporation. After such reversion such bank or trust company shall, upon demand, pay over to the Corporation such unclaimed amounts and thereupon such bank or trust company shall be relieved of all responsibility in respect thereof to such holder and such holder shall look only to the Corporation for the payment of the Class D Redemption Price. Any interest accrued on funds so deposited pursuant to this Section 11.5.5 shall be paid from time to time to the Corporation for its own account. Upon the deposit of funds pursuant to this Section 11.5.5 in respect of shares of Class D Preferred Stock called for redemption, notwithstanding that any certificates for such shares shall not have been surrendered for cancellation, the shares represented thereby shall no longer be deemed outstanding, the rights to receive dividends thereon shall cease to accrue from and after the redemption date, and all rights of the holders of the shares of Class D Preferred Stock called for redemption shall cease and terminate, excepting only the right to receive the Class D Redemption Price therefor, without interest. 11.5.6. When shares are redeemed pursuant to this Section 11, such redemption shall only occur to the extent that (i) there shall be sufficient funds of the Corporation legally available for such redemption, (ii) such redemption would not violate any covenants of the Corporation to any lender to the Corporation or its subsidiaries and (iii) such redemption would not violate the terms of any management or shareholders agreement to which the Corporation is a party. -25- 11.5.7. Once the Class D Redemption Price has been paid by the Corporation with respect to shares of Class D Preferred Stock being redeemed pursuant to this Section 11.5, such shares of Class D Preferred Stock shall no longer be deemed to be outstanding, shall be canceled and shall not be subject to reissuance by the Corporation 11.6. Conversion Rights. Upon an Event of Conversion, each and every share of Class D Preferred Stock then outstanding (other than those shares being redeemed), by virtue of, and simultaneously with the occurrence of a Qualified Public Offering 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 (x) the sum of (A) the Class D Preferred Stock Stated Value plus (B) all accrued but unpaid dividends, if any, payable with respect to such shares of Class D Preferred Stock up to and including the Conversion Date divided by (y) the Conversion Price. 11.6.1. Conversion shall be deemed to have been effected with respect to conversion under this Section 11.6 on the Conversion Date. Simultaneous with the conversion being effected, the shares of Class D 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 11.6.3 hereof, payable with respect to the shares of Class D 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. 11.6.2. No fractional shares of Common Stock shall be issued upon conversion of shares of Class D Preferred Stock. Instead of any fractional shares of Common Stock which would otherwise be issuable upon conversion of any shares of Class D 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 D 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. 11.6.3. 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 D 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 D Preferred Stock in respect of which such shares are being issued. -26- 11.6.4. The holders of shares of the Class D Preferred Stock by vote of sixty percent (60%) of the aggregate outstanding shares of Class D 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 11.6. 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. 11.6.5. 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. 12. 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. 13. Directors. 13.1. 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. 13.2. Classes. 13.2.1. 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. 13.2.2. 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 2003; 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 2004; 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 2005. 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 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 -27- 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. 13.2.3. 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 13.2.1. 13.3. 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. 13.4. 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. 14. 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 14 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 faith or which involve intentional misconduct or a knowing violation of law, (iii) unlawful distributions under Section 48-18-304 of the Tennessee Business Corporation Act, or (iv) receiving any improper personal benefit. If the Tennessee Business Corporation Act is amended or other Tennessee law is enacted to permit further elimination or limitation of the personal -28- 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 14 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. 15. 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. 16. 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 12, 13, 14, 15 and this Section 16 of this Charter may not be repealed, altered, amended or rescinded in any respect nor may provisions be adopted inconsistent with Sections 12, 13, 14, 15 and this Section 16 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. 17. Adoption. This amended and restated charter was adopted by unanimous written consent of the Board of Directors and Shareholders of the Corporation dated April , 2002. This charter replaces and supersedes the original charter of the Corporation filed with the Tennessee Secretary of State and all amendments thereto. 18. Corporation for Profit. The Corporation is for profit. Dated: , 2002. ------------------ KIRKLAND'S, INC. By: ---------------------------------------- Title: ------------------------------------- -29- EX-3.3 5 g75423ex3-3.txt BYLAWS OF KIRKLAND'S, INC. 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 omitted 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. (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 of 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 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 -2- 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. 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 -3- Corporation. The Class A Preferred Stock shall not have any voting tights 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 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 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 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). -4- 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. 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. -5- 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. 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. Meetings of any committee shall be governed by the provisions of this Article III relating to meetings of the Board, except that the notice period for calling a special meeting of a committee shall be determined by the Board in connection with the establishment of such committee or from time to time thereafter. 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 -6- 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 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. 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 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 Alderson 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 Alderson. 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. -7- 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. 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 -8- 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 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; (t) 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 -9- 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 payment 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 like 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. -10- 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 52/53 week year basis ending on the Saturday closest to January 31. 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 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 -11- 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 was 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. 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 -12- the shareholders if the votes cast favoring the amendment exceed the votes cast opposing the amendment. ATTEST: /s/ Robert E. Alderson ---------------------- Secretary -13- EX-3.4 6 g75423ex3-4.txt FORM OF AMENDED AND RESTATED BYLAWS OF KIRKLAND'S EXHIBIT 3.4 [To be adopted effective upon completion of the Offering] 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 "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. (a) 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. For nominations or other business to be properly brought before an annual meeting by a shareholder, the shareholder must have given timely notice thereof in writing to the Secretary of the Corporation and such other business must otherwise be a proper matter for shareholder action. To be timely, a shareholder's notice with respect to any annual meeting must be received by the Secretary at the principal executive offices of the Corporation not later than the 60th day nor earlier than the 90th day prior to the first anniversary of the preceding year's annual meeting; provided, however, that in the event that the date of the annual meeting is more than 30 days before or more than 60 days after such anniversary date, notice by the shareholder must be so received not earlier than the 90th day prior to the annual meeting and not later than the later of the 60th day prior to the annual meeting or the 15th day following the day on which public announcement of the date of the meeting is first made by the Corporation. In no event shall the public announcement of an adjournment or postponement of an annual meeting commence a new time period for the giving of a shareholder's notice as described above. A shareholder's notice shall set forth (A) as to each person whom the shareholder proposes to nominate for election or reelection as a director, all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors in an election contest, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934 ("Exchange Act") and -2- Rule 14a-11 thereunder (including such person's written consent to being named in the proxy statement as a nominee and to serving as a director if elected); (B) as to any other business that the shareholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting, the reasons for conducting such business at the meeting and any material interest in such business of such shareholder and the beneficial owner, if any, on whose behalf the proposal is made; and (C) as to the shareholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made (1) the name and address of such shareholder, as they appear on the Corporation's books, and of such beneficial owner; (2) the class and number of shares of the Corporation which are owned beneficially and of record by such shareholder and such beneficial owner; and (3) a representation that such shareholder and beneficial owner intend to appear in person or by proxy at the meeting. (b) Notwithstanding anything in paragraph (a) of this Section 5.1 to the contrary, in the event that the number of directors to be elected to the Board of Directors of the Corporation at the annual meeting is increased pursuant to an act of the Board of Directors of the Corporation and there is no public announcement by the Corporation naming all of the nominees for director or specifying the size of the increased Board of Directors on or before the date which is 15 days before the latest date by which a shareholder may timely notify the Corporation of nominations or other business to be brought by a shareholder in accordance with paragraph (a) of this Section 5.1, a shareholder's notice required by this Section 5.1 shall also be considered timely, but only with respect to nominees for any new positions created by such increase, if it shall be received by the Secretary at the principal executive offices of the Corporation not later than the 15th day following the day on which such public announcement is first made by the Corporation. 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 15th 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. -3- 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. 5.5. Non-Exclusivity. If the Corporation is required under Rule 14a-8 under the Exchange Act to include a shareholder's proposal in its proxy statement, such shareholder shall be deemed to have given timely notice for purposes of this bylaw with respect to such proposal. Nothing in this bylaw shall be deemed to affect any rights of the holders of any series of Preferred Stock to elect directors. 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 -4- 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, 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 -5- 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 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- 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 confirmation 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 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. 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 -7- 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 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 -8- 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 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 -9- 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. 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. -10- 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 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 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 President 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 Chief Operating Officer, 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. -11- Section 9. Chief Operating Officer. If a Chief Operating Officer is elected, 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. 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 -12- 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 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. -13- 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. 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 52/53 week year basis ending on the Saturday closest to January 31. 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 -14- another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan or other enterprise; (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 (C) in the case of any criminal proceeding, the individual had no reasonable cause to believe the individual's conduct was unlawful; -15- 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. 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: -16- (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. 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, -17- 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 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: -------------------------------- -18- 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 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 A-1 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 (D) 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 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 or Section 7 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 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. A-2 (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 any 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 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. A-3 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 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 A-4 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-10.1 7 g75423ex10-1.txt AMENDED AND RESTATED CREDIT AGREEMENT EXHIBIT 10.1 ================================================================================ AMENDED AND RESTATED CREDIT AGREEMENT AMONG KIRKLAND HOLDINGS L.L.C. THE BORROWERS SPECIFIED HEREIN, THE SEVERAL LENDERS FROM TIME TO TIME PARTIES HERETO, FLEET NATIONAL BANK AS ADMINISTRATIVE AGENT AND LEHMAN COMMERCIAL PAPER INC. AS ADVISOR AND ARRANGER DATED AS OF JUNE 19, 2001 ================================================================================ TABLE OF CONTENTS
Page SECTION 1. DEFINITIONS............................................................. 1 1.1 Defined Terms.................................................... 1 1.2 Other Definitional Provisions.................................... 22 SECTION 2. AMOUNT AND TERMS OF COMMITMENTS......................................... 21 2.1 Tranche A Term Loans............................................. 22 2.2 Intentionally Omitted............................................ 22 2.3 Tranche B Term Loans............................................. 22 2.3A Intentionally Omitted............................................ 22 2.3B Intentionally Omitted............................................ 22 2.4 Intentionally Omitted............................................ 22 2.4A Intentionally Omitted............................................ 22 2.4B Intentionally Omitted............................................ 22 2.5 Revolving Credit Commitments..................................... 22 2.6 Procedure for Revolving Credit Borrowing......................... 23 2.7 Clean-Up......................................................... 23 2.8 Commitment Fees, etc............................................. 24 2.9 Repayment of Loans, Evidence of Debt............................. 24 2.10 Termination or Reduction of Revolving Credit Commitments......... 25 2.11 Optional Prepayments............................................. 25 2.12 Mandatory Prepayments and Commitment Reductions.................. 26 2.13 Conversion and Continuation Options.............................. 27 2.14 Minimum Amounts and Maximum Number of Eurodollar Tranches........ 28 2.15 Interest Rates and Payment Dates................................. 28 2.16 Computation of Interest and Fees................................. 29 2.17 Inability to Determine Interest Rate............................. 29 2.18 Pro Rata Treatment and Payments, Use of Proceeds................. 30 2.19 Illegality....................................................... 31
-ii- 2.20 Requirements of Law.............................................. 31 2.21 Taxes............................................................ 32 2.22 Indemnity........................................................ 33 2.23 Change of Lending Office......................................... 34 2.24 Right of Contribution............................................ 34 2.25 Swing Line Commitment............................................ 34 2.26 Procedure for Swing Line Borrowing............................... 35 2.27 Refunded Swing, Line Loans; Swing, Line Loan Participations...... 35 SECTION 3. LETTERS OF CREDIT....................................................... 36 3.1 L/C Commitment................................................... 36 3.2 Procedure for Issuance of Letter of Credit....................... 37 3.3 Fees, Commissions and Other Charges.............................. 37 3.4 L/C Participations............................................... 38 3.5 Reimbursement Obligation of the Borrowers........................ 39 3.6 Obligations Absolute............................................. 39 3.7 Letter of Credit Payments........................................ 39 3.8 Applications..................................................... 40 SECTION 4. REPRESENTATIONS AND WARRANTIES.......................................... 40 4.1 Financial Condition.............................................. 40 4.2 No Change........................................................ 41 4.3 Corporate Existence, Compliance with Law......................... 41 4.4 Corporate Power; Authorization; Enforceable Obligations.......... 41 4.5 No Legal Bar..................................................... 41 4.6 No Material Litigation........................................... 42 4.7 No Default....................................................... 42 4.8 Ownership of Property, Liens..................................... 42 4.9 Intellectual Property............................................ 42 4.10 No Burdensome Restrictions....................................... 42 4.11 Taxes............................................................ 42 4.12 Federal Regulations.............................................. 43
-iii- 4.13 ERISA............................................................ 43 4.14 Investment Company Act; Other Regulations........................ 43 4.15 Subsidiaries..................................................... 43 4.16 Purpose of Loans; Limitations on Use............................. 44 4.17 Environmental Matters............................................ 44 4.18 Accuracy of Information.......................................... 45 4.19 Security Documents............................................... 45 4.20 Solvency......................................................... 46 4.21 Purchase Agreement Representations and Warranties................ 46 SECTION 5. CONDITIONS PRECEDENT.................................................... 46 5.1 Conditions to Initial Extension of Credit........................ 46 5.2 Conditions to Effectiveness of this Agreement.................... 51 5.3 Conditions to Each Extension of Credit.......................... 53 SECTION 6. AFFIRMATIVE COVENANTS................................................... 53 6.1 Financial Statements............................................. 53 6.2 Certificates, Other Information.................................. 54 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........... 56 6.7 Notices.......................................................... 56 6.8 Environmental Laws............................................... 57 6.9 Interest Rate Protection......................................... 57 6.10 Further Assurances............................................... 57 6.11 Additional Collateral............................................ 58 6.12 Key Man Life Insurance........................................... 58 6.13 Store Locations.................................................. 58 6.14 Intentionally Omitted............................................ 59 6.15 Purchase Agreement Affirmative Covenants......................... 59 6.16 Intentionally Omitted............................................ 59
-iv- SECTION 7. NEGATIVE COVENANTS...................................................... 59 7.1 Financial Condition Covenants.................................... 59 7.2 Limitation on Indebtedness....................................... 60 7.3 Limitation on Liens.............................................. 61 7.4 Limitation on Guarantee Obligations.............................. 62 7.5 Limitation on Fundamental Changes................................ 62 7.6 Limitation on Sale of Assets..................................... 63 7.7 Limitation on Restricted Payments................................ 63 7.8 Limitation on Capital Expenditures............................... 64 7.9 Limitation on Investments, Loans and Advances.................... 64 7.10 Limitation on Optional Payments and Modifications of Debt Instruments and Preferred Stock, etc. ........................... 64 7.11 Limitation on Transactions with Affiliates....................... 65 7.12 Limitation on Sales and Leasebacks............................... 65 7.13 Limitation on Changes in Fiscal Year............................. 65 7.14 Limitation on Negative Pledge Clauses............................ 65 7.15 Limitation on Lines of Business.................................. 65 7.16 Limitation on Activities of the Parent........................... 65 7.17 Purchase Agreement Negative Covenants............................ 66 7.18 Limitations on Stores............................................ 66 SECTION 8. EVENTS OF DEFAULT....................................................... 66 SECTION 9. THE ADMINISTRATIVE AGENT................................................ 70 9.1 Appointment...................................................... 70 9.2 Delegation of Duties............................................. 70 9.3 Exculpatory Provisions........................................... 70 9.4 Reliance by Administrative Agent................................. 71 9.5 Notice of Default................................................ 71 9.6 Non-Reliance on Administrative Agent and Other Lenders........... 71 9.7 Indemnification.................................................. 72 9.8 Administrative Agent in Its Individual Capacity.................. 72 9.9 Successor Administrative Agent................................... 73
-v- SECTION 10. GUARANTEE.............................................................. 73 10.1 Guarantee........................................................ 73 10.2 No Subrogation, Contribution, Reimbursement or Indemnity......... 73 10.3 Amendments, etc. with respect to the Obligations................. 74 10.4 Guarantee Absolute and Unconditional............................. 74 10.5 Reinstatement.................................................... 75 10.6 Payments......................................................... 75 SECTION 11. MISCELLANEOUS.......................................................... 75 11.1 Amendments and Waivers........................................... 75 11.2 Notices.......................................................... 76 11.3 No Waiver; Cumulative Remedies................................... 77 11.4 Survival......................................................... 78 11.5 Payment of Expenses and Taxes.................................... 78 11.6 Successors and Assigns, Participations and Assignments........... 79 11.7 Adjustments; Set-off............................................. 82 11.8 Counterparts..................................................... 82 11.9 Severability..................................................... 82 11.10 Integration...................................................... 82 11.11 GOVERNING LAW.................................................... 83 11.12 Submission To Jurisdiction, Waivers.............................. 83 11.13 Acknowledgments.................................................. 83 11.14 WAIVERS OF JURY TRIAL............................................ 84 11.15 Confidentiality.................................................. 84 11.16 Reliance on Representations and Actions of Designated Borrower... 84 11.17 Amendment and Restatement........................................ 84 11.18 Waiver of Defaults............................................... 85 11.19 Waiver of Default Interest....................................... 85
-vi- 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 K Form of Lender Warrant -vii- AMENDED AND RESTATED CREDIT AGREEMENT, dated as of June 19, 2001, among Kirkland 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"), Fleet National Bank, 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. W I T N E S S E T H WHEREAS, the Parent, the Borrowers, the Lenders and the Administrative Agent, among others, entered into a Credit Agreement dated as of June 12, 1996 (as amended and in effect, the "Existing Agreement"); and WHEREAS, the Parent, the Borrowers, the Lenders and the Administrative Agent have agreed to amend the Existing Agreement; and WHEREAS, in order to implement such amendment, the Parent, the Borrowers, the Lenders and the Administrative Agent desire to amend and restate the Existing Agreement in its entirety, as provided herein. 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: "Additional Interest": an amount equal to $972,594.00, provided that if all Obligations are paid in full, all Letters of Credit cash collateralized and all Commitments terminated (collectively, the "Repayment") by the following dates and no Default shall have occurred, the Additional Interest shall be reduced to the following amount:
Date of Repayment Additional Interest On or before June 30, 2001 $583,556.00 After June 30, 2001 but on or before September 30, 2001 $778,075.00 After September 30, 2001 $972,594.00
"Administrative Agent": Fleet National Bank, 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": Advent International Corporation. "Advent Funds": Funds affiliated with Advent which own 64.26% of the membership interests of the Parent. "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. "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 Amended and Restated 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). "Applicable Margin": for each Type of Loan, the rate per annum set forth under the relevant column heading below:
Base Rate Loans Eurodollar Loans Revolving Credit Loans 2.25% 3.25% Tranche A Term Loans . 2.25% 3.25% Tranche B Term Loans . 2.95% 3.95%
"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. "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 Line Projection Utilization": The amounts set forth below for the periods indicated:
Base Line Projection Utilization (at all times Month during the month, except where indicated) May,. 2001 $14,500,000 June, 2001 $18,000,000 July, 2001 $19,000,000 August, 2001 $20,000,000 September, 2001 $20,000,000* October, 2001 $20,000,000* November, 2001 $20,000,000* December, 2001 $15,000,000** January, 2002 $10,000,000** February, 2002 $12,000,000 March, 2002 $14,500,000 April, 2002 $15,500,000 May, 2002 $16,000,000 June, 2002 $18,000,000
*provided that, (i) the Borrower may increase the Base Line Projection Utilization in the months of September, October, and/or November, 2001 by an amount not to exceed an additional $5,000,000 in the aggregate in any month provided that the Increased Base Line Conditions are satisfied, and **(ii) the Base Line Projection Utilization for the months of December, 2001 and January, 2002 shall be required to be achieved at the end of each such month only and during such months the Base Line Projection Utilization shall not exceed the Base Line Projection Utilization in effect on the last day of the previous month, that is, $20,000,000 (subject to increase as set forth in the first proviso hereto) for December, 2001 and $15,000,000 for January, 2002. "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 3 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 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 date June 12, 1996 executed and delivered by each Borrower, substantially in the form of Exhibit B, as the same has been or may be amended, supplemented or otherwise modified from time to time. "Borrowing Base": at any time of calculation, an amount equal to the lesser of: (a) the Inventory Advance Rate multiplied by the Borrowers' Eligible Inventory at the lesser of cost or market value (determined in accordance with GAAP) minus such reserves as the Administrative Agent may reasonably establish; or (b) the Base Line Projection Utilization for the applicable month at the time of calculation. "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. 4 "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. "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. "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 5.2 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 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 5 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 and paid during such period and (C) Combined Lease Expense minus (ii) the sum of (without duplication) (A) any cash income taxes paid 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 and paid 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. "Combined Interest Coverage Ratio": for any period, the ratio of (a) Combined EBITDA 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 but excluding interest on account of Series C Preferred and the Additional Interest), 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) 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 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. 6 "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 Original 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 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 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. "Eligible Inventory": such of the Borrowers' finished goods inventory as the Administrative Agent in its reasonable discretion deems eligible for inclusion in the calculation of Borrowing Base. Without limiting the foregoing, Eligible Inventory shall not include the following: (a) Inventory which is not merchantable and readily saleable to the public in the ordinary course of business, or which are damaged, defective or to be returned to vendor; 7 (b) Inventory that is not solely owned by the Borrowers or is on consignment to the Borrowers; (c) Inventory that is not located at a property that is owned or leased by the Borrowers other than Inventory in transit between properties owned or leased by the Borrowers; (d) Inventory that is not subject to a perfected first-priority security interest in favor of the Administrative Agent for the benefit of the Lenders; (e) Inventory that consists of samples, labels, bags, packaging and other similar non-merchandise categories. (f) Inventory which has been sold but not yet delivered or as to which any Borrower has accepted a deposit. "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. "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 10:00 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. 8 "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). "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 or prepayments required pursuant to Section 2.12 hereof). "Excess Cash Flow Application Date": as defined in Section 2.12(c). "Existing Agreement": as defined in the Recitals hereto. "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. 9 "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. "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, (1) 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. "Increased Base Line Conditions": The furnishing by all of the Lenders of their prior written consent to an increase in the Base Line Projection Utilization by an amount not to exceed $5,000,000.00 in the aggregate, which consent shall not be unreasonably withheld or delayed. The Lenders' consent shall not be deemed to have been unreasonably withheld or delayed unless each of the following conditions is satisfied on the date of, and at the time the Borrowers request, an increase: (a) No Lender shall be obligated to participate in such increase. (b) No Default or Event of Default shall then exist. (c) The Borrowers shall furnish the Administrative Agent with fifteen (15) days prior written notice of the requested increase in the Base Line Projection Utilization for any month. (d) The Person (which need not necessarily be a Lender) funding the increase in the Baseline Project Utilization (the "Increased Advance") shall agree (i) that any lien on the Parent's and the Borrowers' assets granted to such Person shall either be 10 subordinate to that held by the Administrative Agent and the Lenders or shall be pari passu with the liens of the Administrative Agent and the Lenders, (ii) that the proceeds of the Increased Advance shall be utilized solely for working capital purposes, including the purchase of inventory, but shall not be utilized to pay the Term Loans, (iii) that all payments made by or on behalf of the Borrowers on account of the Obligations due to the Revolving Credit Lenders and the Increased Advance shall be applied pro rata to the Obligations due to the Revolving Credit Lenders and the Increased Advance, based upon the outstanding Revolving Credit Commitments and the commitments under the Increased Advance, (iv) that such Person shall have no voting rights or other ability to direct, limit, or prohibit actions with respect to the administration of the Loan Documents and the Collateral, including without limitation, with respect to waivers, amendments, sale, release and foreclosure of the Collateral or otherwise; (v) that the Person providing the Increased Advance shall enter into a standstill agreement with the Administrative Agent and the Lenders pursuant to which such Person agrees not to exercise any remedies upon default against the Borrowers and Parent until all Obligations have been irrevocably paid in full; (vi) that after the Borrowers comply with the provisions of Section 2.7 of this Agreement (at which point all Increased Advances must also have been repaid in full), such Person shall not make any further loans or advances to the Borrowers (other than as a Revolving Credit Lender) until the Obligations have been irrevocably paid in full; and (vii) to such other intercreditor provisions as the Administrative Agent and the Lenders may reasonably require. (e) The principal payment due in December, 2001 on account of the Tranche B Term Loan shall be increased automatically to an amount equal to $8,000,000. (f) In consideration of the Lenders' consent to the increase in the Base Line Utilization Projection, the Borrowers shall pay the Lenders a fee in such amount as the Lenders may reasonably require. The foregoing list of conditions ((a) through (f)) shall not be deemed to be an exclusive list of the reasons the Lenders may withhold their consent; rather, such list is illustrative only and will not limit or restrict the bases upon which such consent may be withheld. "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, accounts and contract rights) owned by such 11 Person, whether or not such Person has assumed or become liable for the payment of such obligation. "Individual Shareholders": collectively, Carl Kirkland, Robert Alderson, and Robert Kirkland. "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 Management Shareholders in the amount of $3,000,000 per person, on terms satisfactory to the Administrative Agent, (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 month to occur while such Loan is outstanding, (b) as to any Eurodollar Loan, the last day of each month and on 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; (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. 12 "Inventory Advance Rate": The following percentages for the periods indicated:
Period Inventory Advance Rate January 1 through June 30 of each year 62.5% July 1 through December 31 of 2001 72.5%
"Issuing Lender": Fleet National Bank, 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 Administrative Agent and such Lender. "L/C Commitment": $5,000,000. "L/C Fee Payment Date": the last day of each month 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. "Lender Affiliates": (a) with respect to any Lender, (i) an Affiliate of such Lender or (ii) any entity (whether a corporation, partnership, trust or otherwise) that is administered or managed by a Lender that is engaged in making, purchasing, holding or otherwise investing in commercial loans and similar extensions of credit in the ordinary course of its business and (b) with respect to any Lender that is a fund which invests in bank loans and similar extensions of credit, any other fund that invests in bank loans and similar extensions of credit and is managed by the same investment advisor as such Lender or by an Affiliate of such Lender. "Lender Warrants": warrants in favor of the Lenders (in the form of Exhibit K hereto), pursuant to which the Lenders may acquire five percent (5%) of the equity interests of the Parent (on a fully diluted basis) for nominal consideration. "Lender Warrants Alternative": payment in cash to the Administrative Agent for the pro rata benefit of the Lenders of $2,000,000.00 at the option of Parent, in lieu of Lender Warrants. "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). 13 "Loan": any loan made by any Lender pursuant to this Agreement. "Loan Documents": this Agreement, the Notes, the Applications and the Security Documents. "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 executed and delivered by the Management Shareholders dated as of June 12, 1996 substantially in the form of Exhibit E-2, as the same may be amended, supplemented or otherwise modified from time to time. "Management Shareholders": Carl Kirkland and Robert Alderson "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 mortgages or deeds 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 has been granted a Lien pursuant to each Mortgage. "Multiemployer Plan": a Plan which is a multiemployer plan as defined in Section 4001(a)(3) of ERISA. 14 "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, and 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, 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). "Original Closing Date": June 12, 1996. "Parent Pledge Agreement": the Parent Pledge Agreement dated as of June 12, 1996 executed and delivered by the Parent, substantially in the form of Exhibit E-1, 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). 15 "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, the Series C Preferred and the Series D Preferred. "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, as amended and in effect. "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). "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. 16 "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 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.ss.2615. "Required Lenders": at any date shall mean the holders of 66-2/3% or more of 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. 17 "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 Original 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). "Revolving Credit Note": as defined in Section 2.9(c). "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, 2002. "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 A Preferred": the Class A preferred stock, the terms of which are set forth in the Amended and Restated Charter of Kirkland's, Inc. dated as of August 8, 2000 as filed with the Secretary of State of Tennessee. "Series B Preferred": the Class B preferred stock, the terms of which are set forth in the Amended and Restated Charter of Kirkland's, Inc. dated as of August 8, 2000 as filed with the Secretary of State of Tennessee. "Series C Preferred": the Class C preferred stock, the terms of which are set forth in the Amended and Restated Charter of Kirkland's, Inc. dated as of August 8, 2000 as filed with the Secretary of State of Tennessee. 18 "Series D Preferred": the Class D preferred stock, the terms of which are set forth in the Amended and Restated Charter of Kirkland's, Inc. dated as of August 8, 2000 as filed with the Secretary of State of Tennessee. "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. "Standby Letter of Credit": as defined in Section 3.1(a). "Subordinated Debt": the $20,000,000.00 of 12.25% to 12.50% senior subordinated notes issued by the Borrowers to the Subordinated Debt Holders as of June 12, 1996. "Subordinated Debt Holders": collectively, Capital Resource Lenders II, L.P., Allied Capital Corporation, and The Marlborough Capital Investment Fund, L.P. and Capital Trust Investments, Ltd. "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, as amended and in effect. "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. 19 "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 the 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. "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 Original 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 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. 20 "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). "Tranche B Termination Date": June 30, 2002. "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. "U.S. Taxes": as defined in Section 11.6(d). "Warrants": collectively (a) the warrants to purchase shares of the common stock of the Designated Borrower issued pursuant to (i) the Purchase Agreement, (ii) the Capital Investment Commitment and Stock Purchase Agreement dated July 7, 1999, (iii) the Securities Purchase Agreement dated August 8, 2000, and (b) the Lender Warrants "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. 21 SECTION 2. AMOUNT AND TERMS OF COMMITMENTS 2.1 Tranche A Term Loans. Each Tranche A Term Loan Lender made term loans (a "Tranche A Term Loan") to the Borrowers, jointly and severally, on the Original Closing Date. On the date hereof, the outstanding principal balance of the Tranche A Term Loans is $833,333.33. 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 Section 2.13. 2.2 Intentionally Omitted. 2.3 Tranche B Term Loans. Pursuant to the Existing Agreement, certain Tranche B Term Loan Lenders made tranche B term loans, supplemental tranche B term loans and second supplemental tranche B term loans to the Borrowers, jointly and severally. On the date hereof, after giving effect to the payment required pursuant to Section 5.2(k) below, the aggregate outstanding principal balance of such term loans shall be $45,427,272.10. On the Closing Date, such loans will be amended, restated and consolidated into a term loan (a "Tranche B Term Loan") to the Borrowers, jointly and severally in an amount not to exceed the amount of the Tranche B Term Loan Commitment of such Lender. 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. 2.3A Intentionally Omitted. 2.3B Intentionally Omitted. 2.4 Intentionally Omitted. 2.4A Intentionally Omitted. 2.4B Intentionally Omitted. 2.5 Revolving Credit Commitments. (a) The Borrowers acknowledge that as of the Closing Date, immediately prior to the effectiveness of this Agreement, the outstanding principal balance of the Revolving Credit Loans is $20,000,000.00. 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 (A) the L/C Obligations then outstanding and (B) the aggregate principal amount of the Swing Line Loans then outstanding, does not exceed the amount of such Lender's Revolving Credit Commitment, provided, however, that all such Revolving Credit Loans, when added to the sum of (A) the L/C Obligations then outstanding and (B) the aggregate principal amount of the Swing Line Loans then outstanding, shall not exceed the lesser of (x) the Borrowing Base, or (y) the Revolving Credit Commitments of all Revolving Credit Lenders. During the Revolving Credit 22 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 the period from January 1 to March 1, 2002 the aggregate outstanding principal amount of the Revolving Credit Loans and Swing Line Loans shall be reduced to zero, provided that notwithstanding the foregoing, such clean up may commence at any time after December 1, 2001 if all of the payments of principal on account of the Term Loans due or to become due through December 31, 2001 have been paid prior to such commencement date, and further provided that , without waiving or modifying the obligation of 23 the Borrowers to so clean up the Revolving Credit Loans and Swing Line Loans, in no event shall such clean up commence until all of the payments of principal on account of the Term Loans due through December 31, 2001 have been paid in full. 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 Original 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 monthly in arrears on the last day of each month and on the last day of the Revolving Credit Commitment Period, commencing on the first of such dates to occur after the date hereof. The Lenders acknowledge receipt of such fees for the period commencing on the Original Closing Date through April 30, 2001. (b) 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 consecutive quarterly installments, according to the amortization schedule set forth on Schedule 1.1D (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 consecutive quarterly installments, according to the amortization schedule set forth on Schedule 1.1E (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 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. 24 (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 the 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-2 with appropriate insertions as to date and principal amount (together with any alternative more 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, 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 first to the Tranche B Term Loans until paid in full and then to the Tranche A Term Loans until paid in full, all such payments to be applied to installments of principal in inverse order of scheduled maturity. 25 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 (e) 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 (e) 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 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 (e) of this Section 2.12. (c) If, for any fiscal year of the Borrowers ending after the Original 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 (e) 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. 26 (d) Daily, upon the request of the Administrative Agent at any time, whether or not an Event of Default exists, the Borrowers shall deliver or cause to be delivered to the Administrative Agent (or as the Administrative Agent may direct) all cash receipts from the sale of inventory and other assets, all collections of accounts and other cash payments received by the Borrowers from any Person or from any source or on account of any sale or other transaction or event. Except as otherwise provided in this Section 2.12, all such amounts so delivered to the Administrative Agent or its designee shall be applied in reduction of the outstanding Revolving Credit Loans and, subject to the terms of this Agreement, may be reborrowed. (e) Except as provided in Section 2.12(d) hereof, 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 first to the Tranche B Term Loans until paid in full and then to the Tranche A Term Loans until paid in full, all such payments to be applied to installments of principal in 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 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 27 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. (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 unfit 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. 28 (e) Additional Interest shall be payable on the date that the Obligations become due and payable in full (whether by acceleration or otherwise), which payment shall be allocated to the Lenders pro rata based upon the weighted outstanding loan balances due to each of them from the date hereof through June 30, 2002. 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 (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 29 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, provided that payments received by the Administrative Agent pursuant to Section 2.12(d) shall be settled weekly (or more frequently in the Administrative Agent's discretion). 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. (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 30 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 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 31 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 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, fee 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 32 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 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, 33 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, 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, Fleet National Bank (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. 34 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. 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 35 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 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 (A) 36 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 (B) 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). (b) Each Letter of Credit shall be subject to the Uniform Customs and, to the extent not inconsistent therewith, the laws of the Commonwealth of Massachusetts. (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 monthly 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 37 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 monthly 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. (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 38 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. 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 Commonwealth of Massachusetts, 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 39 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 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, was prepared giving effect (as if such events had occurred on such date) to (i) the Recapitalization, (ii) the borrowings under this Agreement made on the Original 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, 2000 and the related combined statements of income and of cash flows for the fiscal years ended on such dates, reported on by PriceWaterhouseCoopers 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 May 5, 2001 and the related unaudited combined statements of income and of cash flows for the three-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 three-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). 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 40 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, 2000 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, 2000. 4.2 No Change. (a) Since December 31, 2000, 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, 2000 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. 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 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). 41 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. Except for the defaults being waived as of the date hereof, 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. Except for the defaults being waived as of the date hereof, 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. 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 42 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 Original Closing Date, 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 in Section 3(l) 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, as the same may be amended from time to time with consent of the Administrative Agent, constitute all of the direct or indirect Subsidiaries of the Parent. 43 4.16 Purpose of Loans; Limitations on Use. The proceeds of the Term Loans were initially used to finance the Recapitalization and to pay related fees and expenses. The proceeds of Tranche B Term Loan shall be used to refinance the term loans under the Existing Agreement (other than the Tranche A Term Loans). The Revolving Credit Loans shall be used to finance the working capital needs of the Borrowers and their Subsidiaries (provided that the proceeds of the Revolving Credit Loans may not be utilized to prepay the principal balance of the Term Loans) and to pay regularly scheduled Tranche B Term Loan payments, provided that the Borrowers may use the proceeds of the Revolving Credit Loans to make the December 31, 2001 Tranche B Term Loan principal payment only if and to the extent that, after giving effect to such borrowing as a Revolving Credit Loan, the aggregate principal balance of all Revolving Credit Loans does not exceed $15,000,000.00, and, after making such principal payment on account of the Tranche B Term Loan, the aggregate principal balance of all Revolving Credit Loans may not thereafter exceed $15,000,000.00 through January 30, 2002. 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. (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 44 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 the Existing Agreement, 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, 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 45 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 constitutes 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 is 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 each Mortgage constitutes 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. The Borrowers and their Subsidiaries, on a consolidated basis, are and after giving effect 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 Original Closing Date, each of the representations 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 was subject to the satisfaction, prior to or concurrently with the making of such extension of credit on the Original Closing Date, of the following conditions precedent, each of which was satisfied or waived on the Original Closing Date: (a) Loan Documents. The Administrative Agent 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, 46 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 Administrative Agent 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 Administrative Agent (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 Administrative Agent shall have received (in a form reasonably satisfactory to the Administrative Agent), 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 Administrative Agent, 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 Original 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 Lenders. (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 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 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 Original Closing Date and such financial statements shall not reflect 47 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 Administrative Agent relating to the Lender's security interest in the Borrower's assets for more than 20% of the Borrowers' leases on the Original 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 Original Closing Date through the final maturity of the Term Loans. (h) Lien Searches. The Administrative Agent 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 Original Closing Date pursuant to documentation satisfactory to the Administrative Agent. (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 Administrative Agent and in form and substance satisfactory to the Administrative Agent, of the inventory of the Borrowers. (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. 48 (n) Closing Certificate. The Administrative Agent shall have received, with a counterpart for each Lender, a certificate of each Loan Party (other than the Individual Shareholders), dated the Original 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 Administrative Agent 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 Administrative Agent shall have received all fees, expenses and other consideration required to be paid on or before the Original Closing Date. (q) Legal Opinions. The Administrative Agent shall have received, with a counterpart for each Lender, the following executed legal opinions: (i) the executed legal opinion of Pepper Hamilton LLP, 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 Administrative Agent; 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 Administrative Agent may reasonably require. (r) Pledged Stock; Stock Powers. The Administrative Agent 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 duty 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 Administrative Agent to be filed, registered or recorded in order to create in favor of the Administrative Agent, 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. 49 (t) Surveys. The Administrative Agent 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 Administrative Agent and the Title Insurance Company by an independent professional licensed land surveyor satisfactory to the Administrative Agent 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 Administrative Agent 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 Original Closing Date. Each such policy shall (i) be in an amount satisfactory to the Administrative Agent; (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 approve by the Administrative Agent; (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 issued by title companies satisfactory to the Administrative Agent (including any such title companies acting as co-insurers or reinsurers, at the option of the Administrative Agent). The Administrative Agent 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 Administrative Agent, the Administrative Agent 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. 50 (w) Copies of Documents. The Administrative Agent 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 Administrative Agent may deem appropriate, of all other documents affecting the property covered by each Mortgage. (x) Solvency Opinion. The Administrative Agent shall have received, with a copy for each Lender, an opinion from an independent valuation firm satisfactory to the Administrative Agent 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 Administrative Agent 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 Effectiveness of this Agreement. This Amended and Restated Credit Agreement shall not be effective until the Borrowers satisfy each of the following conditions (as reasonably determined by the Administrative Agent: (a) Loan Documents. The Administrative Agent shall have received (i) this Agreement, executed and delivered by a duly authorized officer of the Parent, each of the Borrowers, and each Lender, with a counterpart for each Lender, and (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. (b) Approvals. All governmental and third party approvals necessary or advisable in connection with 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 financing contemplated hereby or the continuing operations of the Borrowers. (c) Closing Certificate. The Administrative Agent 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. (d) Corporate Proceedings of Loan Parties. The Administrative Agent 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 51 of the Loan Documents to which it is a party, and (ii) in the case of the Borrowers, the borrowings contemplated hereunder. (e) Amendment Fees. The Administrative Agent shall have received payment of an amendment fee for the pro rata account of the Lenders in the sum of $421,000.00. The amendment fee shall be fully earned on the Closing Date and shall not be subject to refund or rebate under any circumstances. (f) Legal Opinions. The Administrative Agent shall have received, with a counterpart for each Lender, the following executed legal opinions: (i) the executed legal opinion of Pepper Hamilton LLP, counsel to the Parent, substantially in the form of Exhibit H-1 as modified to reflect the transactions effected pursuant to this Agreement; and (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 as modified to reflect the transactions effected pursuant to this Agreement. 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 Administrative Agent may reasonably require. (g) Waiver of Claims. The Administrative Agent shall have received a release and waiver of claims executed by the Loan Parties in favor of each of the Lenders and the Administrative Agent, in such form as the Administrative Agent may reasonably require. (h) Amendment of Subordination Agreement. The Subordination Agreement shall have been amended in form and substance satisfactory to the Administrative Agent. (i) No Default. No Default or Event of Default shall exist. (j) No Material Adverse Change. The Lenders shall be satisfied that there has been no material adverse change in the assets, business, financial condition, or income of the Loan Parties since December 31, 2000. (k) Principal Payment. On the Closing Date, the Borrowers shall make a principal payment in such amount as may be necessary to reduce the principal balance of the Tranche B Term Loans to $45,427,272.10 and shall make such additional payments as may be necessary to reduce the principal balance of the Revolving Credit Loans so that the Borrowers do not violate the Borrowing Base limitation at the time of closing. (l) Other Documents. There shall have been delivered to the Administrative Agent such additional instruments and documents as the Administrative Agent or counsel to the Administrative Agent reasonably may require or request. 52 5.3 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. (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 5.3 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 (provided that financial statements for the year ended December 31, 2000 may be delivered on or before June 30, 2001), 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 PriceWaterhouseCoopers 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 53 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 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, 54 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; (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; (f) monthly, on or before the tenth Business Day of each month, a Borrowing Base certificate as of the last day of the immediately preceding fiscal month, in form reasonably acceptable to the Administrative Agent; (g) on or before March 31, 2002, evidence (reasonably satisfactory to the Required Lenders) of the Borrowers' ability to repay the Obligations in full by June 30, 2002. Such evidence shall reasonably demonstrate to the Lenders that the Borrowers are progressing toward the consummation of a sale, refinancing, equity infusion or other transaction, the result of which will be the full repayment of the Lenders by June 30, 2002. The Borrowers shall keep the Administrative Agent advised at all times of all material developments regarding any such transactions and, subject to confidentiality provisions, shall furnish the Administrative Agent with copies of all proposals, offers, offering memoranda, agreements and other materials developed or received by the Borrowers in connection therewith; (h) within five Business Days prior to the commencement of each of the Borrowers' fiscal quarters, a schedule of projected weekly cash flows (including receipts 55 and disbursements) for such quarter commencing with the quarter beginning May 6, 2001; and (i) 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 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, inspect and appraise any of its properties (provided that, prior to the occurrence of an Event of Default, such appraisals shall be limited to one per calendar year at the expense of the Borrower) 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; 56 (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. 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. [Intentionally Omitted.] 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 57 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 Original 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 Original Closing Date, deliver to the 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 Original 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 or, with the consent of the Administrative Agent or a party to a guarantee and a security agreement, 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. Maintain at all times 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 Original 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. 58 6.14 Intentionally Omitted. 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. 6.16 Intentionally Omitted. 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:
Fiscal Quarter Combined Total Debt Ratio First Quarter 2001 4.76 to 1.0 Second Quarter 2001 4.89 to 1.0 Third Quarter 2001 4.79 to 1.0 Fourth Quarter 2001 3.62 to 1.0 First Quarter 2002 3.63 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 First Quarter 2001 $85,400,000
59
Fiscal Quarter Net Worth Second Quarter 2001 $81,200,000 Third Quarter 2001 $75,900,000 Fourth Quarter 2001 $89,600,000 First Quarter 2002 $85,100,000
(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:
Fiscal Quarter Combined Interest Coverage Ratio First Quarter 2001 1.16 to 1.0 Second Quarter 2001 1.16 to 1.0 Third Quarter 2001 1.19 to 1.0 Fourth Quarter 2001 1.56 to 1.0 First Quarter 2002 1.62 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:
Fiscal Quarter Combined Fixed Charge Coverage Ratio First Quarter 2001 0.72 to 1.00 Second Quarter 2001 0.67 to 1.00 Third Quarter 2001 0.66 to 1.00 Fourth Quarter 2001 0.76 to 1.00 First Quarter 2002 0.77 to 1.00
7.2 Limitation on Indebtedness. Create, incur, assume or suffer to exist (in each case, to "Incur") any Indebtedness, except: 60 (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) Without expanding the limitation imposed by Section 7.8 below, 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 $2,500,000.00 at any time outstanding; and (d) Indebtedness outstanding on the Original Closing Date and 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 Original Closing Date and outstanding 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 Original Closing Date and that the amount of Indebtedness secured thereby is not increased; 61 (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 (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 Original Closing Date and outstanding on the date hereof or as 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. 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 62 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 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 in kind on the Subordinated Debt; (b) so long as (i) no Default or Event of Default shall have occurred and be continuing, (ii) all scheduled principal payments on the Term Loans through December 31, 2001 have been paid as and when due, payments of cash interest on the Subordinated Debt in an amount not to exceed the lesser of (x) fifty percent (50%) of the interest accrued on the Subordinated Debt from and after January 1, 2001, or (y) $1,500,000.00; 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 63 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 (a) the fiscal year of the Borrowers ending on or about February 2, 2002, $6,025,000.00, and (b) the first two fiscal quarters of the Borrowers commencing on February 3, 2002, $3,000,000.00; 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; (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 (other than as contemplated on the Closing Date), (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 Original Closing Date; (e) amend, modify or change, the Shareholders Agreement or the 64 Registration Rights Agreement in a manner that would adversely affect the lights 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 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 the Saturday closest to January 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 65 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. 7.18 Limitations on Stores. Permit the total number of retail stores to exceed 240 as of the last day of the fiscal year ending on February 2, 2002 or at any time thereafter through June 30, 2002 or such time as the Obligations are satisfied in full and this Agreement has terminated. 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 66 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 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 67 (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 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, 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, (ii) the Parent shall cease to own and control, of record and beneficially, directly, 60% of the capital stock of each Borrower which is a direct Subsidiary of the Parent, or the Designated Borrower shall cease to own and control, of record and beneficially, directly, 60% of the capital stock of each Borrower which is an indirect Subsidiary of the Parent, (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% 68 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 waiting; or (m) There shall have occurred an "Event of Default" as defined in the Purchase Agreement; 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. 69 In addition to the foregoing, upon the first to occur of the failure of the Borrowers to comply with any of Sections 2.7, 6.2(g), or paragraph (a) of this Section 8 (with respect to the Tranche B Term Loan principal payment due on December 31, 2001), as and when due, the Parent will immediately deliver to the Administrative Agent (for the pro rata account of the Lenders) the Lender Warrants or the Lender Warrants Alternative (at the option of the Parent); provided that in the event that all Obligations are paid in full on or before June 30, 2002, Lender Warrants authorizing the acquisition of 2 1/2% of the equity interests shall be surrendered for no consideration and without having been exercised (the balance of the Lender Warrants may, in such circumstances be retained by the Lenders) or if the Lender Warrants Alternative has been delivered to the Administrative Agent, in the event that all Obligations are paid in full on or before June 30, 2002 the Lenders shall refund $1,000,000.00 of the Lender Warrants Alternative to the Parent. 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 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 70 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. 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 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, 71 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 famished 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 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 lights 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. 72 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 pail 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. 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 73 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 eight) 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 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 74 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 light of offset, or any release of the Borrowers or any such other Person or of any such collateral security, guarantee 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 75 make any change in the application of any prepayment of the Loans specified in the first sentence of Section 2.12(e) 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. I 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 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: Kirkland 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 76 The Designated Borrower: Kirkland's, Inc. 805 North Parkway Jackson, Tennessee 38305 Attention: Reynolds Faulkner, Lowell Pugh, Esquire 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 Hamilton LLP 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: Fleet National Bank 100 Federal Street Boston, Massachusetts 02110 Attention: Sanghamitra Dutt Telecopy: (617) 434-4775 Telephone: (617) 434-4540 with a copy to: Riemer & Braunstein, LLP Three Center Plaza Boston, Massachusetts 02108 Attention: David S. Berman, Esq. Telecopy: (617) 880-3456 Telephone: (617) 523-9000 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. 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 77 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 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. 78 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 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 Lender Affiliate or, with the consent of the Designated Borrower and the Administrative Agent (which, in each case, shall not be unreasonably withheld or delayed), 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, 79 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 Event of Default 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 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 80 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 in the case of an Assignee which is already a Lender or is a Lender Affiliate), 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 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 Original 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. 81 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 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 without regard to the adequacy of any other Collateral. 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 82 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 COMMONWEALTH OF MASSACHUSETTS. 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 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 Acknowledgments. 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 83 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 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. 11.17 Amendment and Restatement. This Agreement amends and restates the Existing Agreement in its entirety. All of the other Loan Documents executed in connection with the Existing Agreement remain in full force and effect, provided that in the event of any inconsistency between the terms hereof and the terms of the Loan Documents, this Agreement 84 shall control. The Parent and the Borrowers specifically acknowledge and agree that any and all Collateral previously granted to secure the Obligations under the Existing Agreement shall continue to secure all Obligations hereunder. 11.18 Waiver of Defaults. Upon the execution of this Agreement, the Lenders shall be deemed to have waived (i) any defaults which may have occurred through the date hereof under Sections 6.1, 6.2, 6.3, 6.7(a) (as it relates to defaults under the sections identified herein), 6.11 (as it relates to the opening of stores for which UCC-1 Financing Statements have been delivered in connection with the execution of this Agreement), 6.15, 7.1, 7.8, 7.10 and 7.17 of the Existing Agreement, and (ii) Section 7.10 as it relates to the charter amendment contemplated by the waiver and amendment to the Purchase Agreement dated as of the date hereof. The Borrowers warrant and represent that, except for the foregoing sections specifically enumerated in this Section 11.18, there are no other defaults under the Existing Agreement. Based on this representation, upon the execution of this Agreement, the Lenders shall be deemed to have waived any other defaults which may have occurred under the Existing Agreement through the date hereof. Nothing contained herein shall be deemed to constitute a waiver by the Lenders of any default of any term, covenant or provision of this Agreement. 11.19 Waiver of Default Interest. Upon the effectiveness of this Agreement, the Lenders shall be deemed to have waived all accrued and unpaid interest under the Existing Agreement which was in excess of the rates of interest set forth in Sections 2.15(a) and (b) thereof. 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. KIRKLAND HOLDINGS L.L.C. By: /s/ David M. Mussafer -------------------------------------------- Title: President KIRKLAND'S, INC. KIRKLAND'S STORES, INC. kirklands.com, inc. By: /s/ Robert E. Alderson -------------------------------------------- Title: President and Chief Executive Officer FLEET NATIONAL BANK, as Administrative Agent and as a Lender By: /s/ Sanghamitra Dutt -------------------------------------------- Name: Sanghamitra Dutt Title: Authorized Officer 85 LEHMAN COMMERCIAL PAPER INC., as advisor and arranger By: /s/ Michelle Swanson -------------------------------------------- Name: Michelle Swanson Title: Authorized Signatory 86 SYNDICATED LOAN FUNDING TRUST By: LEHMAN COMMERCIAL PAPER INC. not in its individual capacity but solely as asset manager By: /s/ Michelle Swanson -------------------------------------------- Name: Michelle Swanson Title: Authorized Signatory HIBERNIA NATIONAL BANK By: /s/ Howard M. Guidry -------------------------------------------- Name: Howard M. Guidry Title: Vice President AMSOUTH BANK By: /s/ Robert I. Hart -------------------------------------------- Name: Robert I. Hart Title: SVP of Special Assets MITSUI LEASING CAPITAL CORPORATION By: /s/ Seiichiro Nozaki -------------------------------------------- Name: Seiichiro Nozaki Title: President UNION PLANTERS BANK OF JACKSON, TENNESSEE By: /s/ Frank Hudacek -------------------------------------------- Name: Frank Hudacek Title: EVP BANCORPSOUTH BANK By: /s/ Christopher Keefe Edwards -------------------------------------------- Name: Christopher Keefe Edwards Title: First Vice Present 87 CRESCENT/MACH I PARTNERS, L.P. By: TCW ASSET MANAGEMENT COMPANY, as Investment Manager By: /s/ Richard F. Kurth -------------------------------------------- Name: Richard F. Kurth Title: Vice President TCW LEVERAGED INCOME TRUST, II, L.P. By: TCW ADVISERS (BERMUDA), LTD., as General Partner By: /s/ Mark L. Gold -------------------------------------------- Name: Mark L. Gold Title: Managing Director By: TCW INVESTMENT MANAGEMENT COMPANY, as Investment Advisor By: /s/ Richard F. Kurth -------------------------------------------- Name: Richard F. Kurth Title: Vice President INDOSUEZ CAPITAL FUNDING IIA, LTD. By: INDOSUEZ CAPITAL as Portfolio Advisor By: /s/ Melissa Marano -------------------------------------------- Name: Melissa Marano Title: Vice President VAN KAMPEN PRIME RATE INCOME TRUST By: Van Kampen Investment Advisory Corp. By: /s/ Darvin D. Pierce -------------------------------------------- Name: Darvin D. Pierce Title: Principal VAN KAMPEN SENIOR FLOATING RATE FUND By: Van Kampen Investment Advisory Corp. By: /s/ Darvin D. Pierce -------------------------------------------- Name: Darvin D. Pierce Title: Principal 88 EX-10.3 8 g75423ex10-3.txt AMENDED AND RESTATED REGISTRATION RIGHTS AGREEMENT Exhibit 10.3 EXECUTION - ------------------------------------------------------------------------------- AMENDED AND RESTATED REGISTRATION RIGHTS AGREEMENT among KIRKLAND'S, INC. AND THE OTHER PARTIES SPECIFIED HEREIN - ------------------------------------------------------------------------------- Dated as of April 15, 2002 AMENDED AND RESTATED REGISTRATION RIGHTS AGREEMENT THIS AMENDED AND RESTATED REGISTRATION RIGHTS AGREEMENT (the "Agreement") amends and restates a Registration Rights Agreement dated as of June 12, 1996, and is made as of the 15th day of April, 2002, 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"), - SSM VENTURE PARTNERS, L.P. - JOSEPH R. HYDE, III - JOHNSTON C. ADAMS, JR. - JOHN H. PONTIUS - CT/KIRKLAND EQUITY PARTNERS, L.P., - R-H CAPITAL PARTNERS, L.P., - TCW/KIRKLAND EQUITY PARTNERS, L.P., - CAPITAL RESOURCE LENDERS II, L.P. ("CRL"), - ALLIED CAPITAL CORPORATION ("Allied"), - CAPITAL TRUST INVESTMENTS, LTD. ("Capital Trust"), - THE MARLBOROUGH CAPITAL INVESTMENT FUND, L.P. ("Marlborough" and together with CRL, Allied and Capital Trust, the "Mezzanine Warrant Holders"), - GLOBAL PRIVATE EQUITY II LIMITED PARTNERSHIP, - ADVENT DIRECT INVESTMENT PROGRAM LIMITED PARTNERSHIP, - ADVENT PARTNERS LIMITED PARTNERSHIP, - CARL KIRKLAND, - ROBERT KIRKLAND, - ROBERT ALDERSON, - THE AMY KATHERINE ALDERSON TRUST, (the "AKA Trust"), - THE ALLISON LEIGH ALDERSON TRUST (the "ALA Trust"), - THE CARL T. KIRKLAND GRANTOR RETAINED ANNUITY TRUST 2001-1 (the "CTK GRAT"), and - STEVEN COLLINS (Carl Kirkland, Robert Kirkland, Robert Alderson, the AKA Trust, the ALA Trust, the CTK GRAT and Steven Collins being herein referred to collectively as the "Individual Investors"). WHEREAS, on June 12, 1996, Holdings, the Company, and those companies then affiliated with the Company (the "Affiliated Companies") and certain other parties consummated the transactions contemplated by a Recapitalization Agreement, dated as of April 26, 1996 (the "Recapitalization Agreement"), which, among other things, included the issuance by the Company and the Affiliated Companies of shares of Class A Preferred Stock, Class B Preferred Stock and Class C Preferred Stock in accordance with the terms of the Recapitalization Agreement. Capitalized terms used but not defined herein have the meanings set forth in the Recapitalization Agreement; WHEREAS, in connection with the Company's execution of the Senior Subordinated Note and Warrant Purchase Agreement dated on or about June 12, 1996 (the "Mezzanine Purchase Agreement"), pursuant to which the Mezzanine Warrant Holders have loaned a total of $20,000,000 in subordinated debt to the Company and the Affiliated Companies, the Mezzanine Warrant Holders received warrants to purchase shares of Common Stock ("Mezzanine Warrants" and the shares subject to the Mezzanine Warrants, the "Mezzanine Warrant Shares"); and WHEREAS, in connection with the transactions contemplated by the Recapitalization Agreement, the Company granted options to purchase shares (the "Option Shares") of Common Stock to Carl Kirkland and Robert Alderson; and WHEREAS, as an inducement to completion of the transactions contemplated by the Recapitalization Agreement and the Mezzanine Purchase Agreement, the Company and the Affiliated Companies provided on June 12, 1996 certain registration rights pursuant to the terms of the Registration Rights Agreement dated as of June 12, 1996 (the "Original Registration Rights Agreement"); and WHEREAS, in connection with the consummation of the transactions contemplated by the sixth amendment to that credit agreement between the Company, the Affiliated Companies, BankBoston, N.A. and the other lenders specified therein dated on or about July 7, 1999, the Company and the Affiliated Companies issued to certain investors warrants to purchase shares of Common Stock (the "1999 Warrants", and the shares subject to the 1999 Warrants the "1999 Warrant Shares"); WHEREAS, on or about December 31, 1999, (i) the Affiliated Companies merged with and into Kirkland's Stores, Inc., a wholly owned subsidiary of the Company (the "Merger"), (ii) pursuant to the Merger; the Mezzanine Warrants and the 1999 Warrants became exercisable only with respect to shares of Common Stock of the Company; -2- WHEREAS, in connection with the consummation of the transactions contemplated by a Securities Purchase Agreement dated on or about August 8, 2000 (the "Purchase Agreement"), the Company issued to the purchasers specified in the Purchase Agreement additional shares of Common Stock, shares of Class D Preferred Stock and warrants to purchase shares of Common Stock (the "2000 Warrants," and together with the 1999 Warrants and the Mezzanine Warrants, the "Warrants," and the shares subject to the 2000 Warrants (the "2000 Warrant Shares"), together with the Mezzanine Warrant Shares and the 1999 Warrant Shares, the "Warrant Shares"); and WHEREAS, the Company desires to hereby amend and restate the Original Registration Rights Agreement, as amended, to incorporate the Class D Preferred Stock, the 1999 Warrant Shares, the 2000 Warrant Shares and otherwise reflect the Company's current capital structure. 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 $.01 of each of the Company and/or any 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 Kirkland's, Inc. or any successor by merger or similar corporate consolidation thereto. (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. -3- (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 and Robert Alderson, the AKA Trust, the ALA Trust and the CTK GRAT. (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, assuming the maximum potential exercise of the 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, Class B Preferred Stock and Class D Preferred Stock of the Company 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 Company 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. -4- (t) "Registrable Securities" shall mean (i) shares of Common Stock held by the Shareholders from time to time and shall include Warrant Shares, provided the warrants under which the Warrant Shares may be purchased are exercised no later than the effective date of any registration with respect to which the Holder of such warrants (A) demanded a Demand Registration, (B) is a Demand Piggybacker, or (C) requested a Piggyback Registration as to the Common Stock issuable upon exercise of such 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 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 Warrants, and who is or who becomes a party to this Agreement pursuant to the terms hereof. (v) "Shareholders Agreement" shall mean that certain Amended and Restated Shareholders Agreement dated as of 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. (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 any shares of Common Stock previously sold to the public in a public offering) shall be -5- 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, a demand (i) may 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 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. -6- 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 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 18 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 -7- 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 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 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 -8- 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 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, -9- accountant or agent in connection with such registration statement, which information shall be subject to reasonable restrictions concerning confidentiality and nondisclosure. (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, 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 -10- 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. (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 -11- forthwith discontinue disposition of 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. (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 -12- 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 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), and (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 -13- 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 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 Individual 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. -14- (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. (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 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. -15- 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 of 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 beneficially owns (within the meaning of Rule 13d-3 of the 1934 Act or any successor rule) five percent (5%) or more of the 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 S-8 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. 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 signature page, agreeing the assume and be bound by the obligations imposed upon Holders pursuant to this Agreement. 13. Indemnification. In the event any Registrable Securities are included in a registration statement under this Agreement: -16- (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 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 -17- 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 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 -18- liabilities (or actions in respect thereof) referred to above in this subsection (d) shall be deemed 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. Subsequent Issuances by the Company. If the Board of Directors of the Company determines that any Person hereafter issued hereafter issued any Common Stock, Preferred Stock or Warrants by the Company should become a party to this Agreement, then the execution of a Counterpart to this Agreement by such Person shall result in such Person being deemed to be a Shareholder hereunder for all purposes of this Agreement. 16. 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. 17. 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. 18. 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 courier service for delivery to that person or, in the case of telex, TWX, or telecopy when dispatched. -19- If to Holdings, to: Kirkland Holdings L.L.C. 75 State Street Boston, MA 02109 Attention: David M. Mussafer Telecopy No.: (617) 951-0568 With a copy to: Pepper Hamilton LLP 3000 Two Logan Square Philadelphia, PA 19103 Attention: Robert A. Friedel, Esq. Telecopy No.: (215) 981-4750 If to the Management Investors or the Company, to: Kirkland's, Inc. P.O. Box 7222 Jackson, TN 38303-7222 Attention: Robert Alderson Telecopy No.: (731) 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 760 Sanders Chapel Road Union City, Tennessee 38261 Telecopy No.: (731) 885-7850 With a copy to: Warner Law Firm PLC 308 West Church Street Union City, Tennessee 38261 Attention: John L. Warner, Jr., Esquire Telecopy No.: (731) 885-2440 -20- 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 Allied Capital Corporation 1919 Pennsylvania Avenue, N.W. 3rd Floor Washington, D.C. 20006 Attention: Susan Gallagher Telecopy No.: (202) 659-2053 The Marlborough Capital Investment Fund, L.P. 9 Newbury 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 If to any other party hereto, to the address of record as most recently provided to the Company. Upon request by any party hereto, the Company agrees to provide address and telecopier information for any other party for the purpose of providing a notice in accordance with this Section 18. 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. 19. 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 -21- shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. 20. Headings. The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. 21. Governing Law. This Agreement shall be governed by and construes in accordance with the laws of the State of Delaware. 22. 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. 23. 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. 24. Parties Benefited. Nothing in this Agreement, express or implied, is intended to confer upon any third party any rights, remedies, obligations or liabilities. 25. 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. IN WITNESS WHEREOF, this Amended and Restated Registration Rights Agreement has been executed as of the date and year first above written. KIRKLAND HOLDINGS L.L.C. By: ---------------------------------------- Name: Title: KIRKLAND'S, INC. By: ---------------------------------------- Name: Title: -22- SSM VENTURE PARTNERS, L.P. By: ---------------------------------------- Name: Title: ------------------------------------------- JOSEPH R. HYDE, III ------------------------------------------- JOHNSTON C. ADAMS, JR. ------------------------------------------- JOHN H. PONTIUS -23- CT/KIRKLAND EQUITY PARTNERS, L.P. By: ---------------------------------------- Name: Title: R-H CAPITAL PARTNERS, L.P. By: ---------------------------------------- Name: Title: TCW/KIRKLAND EQUITY PARTNERS, L.P. By: ---------------------------------------- Name: Title: -24- CAPITAL RESOURCE LENDERS II, L.P., by CAPITAL RESOURCE PARTNERS II, L.P., its General Partner By: ---------------------------------------- Name: Title: ALLIED CAPITAL CORPORATION By: ---------------------------------------- Name: Title: THE MARLBOROUGH CAPITAL INVESTMENT FUND, L.P., by MARLBOROUGH CAPITAL MANAGEMENT, L.P., its general partner By: ---------------------------------------- Margaret Lanoix, its authorized partner CAPITAL TRUST INVESTMENTS, LTD. By: ---------------------------------------- Name: Title: -25- GLOBAL PRIVATE EQUITY II LIMITED PARTNERSHIP By: ---------------------------------------- Name: Title: ADVENT DIRECT INVESTMENT PROGRAM LIMITED PARTNERSHIP By: ---------------------------------------- Name: Title: ADVENT PARTNERS LIMITED PARTNERSHIP By: ---------------------------------------- Name: Title: -26- ------------------------------------------- CARL KIRKLAND ------------------------------------------- ROBERT KIRKLAND ------------------------------------------- ROBERT ALDERSON THE AMY KATHERINE ALDERSON TRUST By: ---------------------------------------- Name: Title: THE ALLISON LEIGH ALDERSON TRUST By: ---------------------------------------- Name: Title: THE CARL T. KIRKLAND GRANTOR RETAINED ANNUITY TRUST 2001-1 By: ---------------------------------------- Name: Title: ------------------------------------------- STEVEN COLLINS -27- EXHIBIT A COUNTERPART THIS INSTRUMENT forms part of the Amended and Restated Registration Rights Agreement (the "Agreement") made as of the 1st day of April 2002, among Kirkland Holdings L.L.C., Kirkland's Inc., SSM Venture Partners, L.P., Joseph R. Hyde, III, Johnston C. Adams, Jr., John H. Pontius, CT/Kirkland Equity Partners, L.P., R-H Capital Partners, L.P., TCW/Kirkland Equity Partners, L.P., Capital Resource Lenders II, L.P., Allied Capital Corporation, The Marlborough Capital Investment Fund, L.P., Capital Trust Investments, Ltd., Global Private Equity II Limited Partnership, Advent Direct Investment Program Limited Partnership, Advent Partners Limited Partnership, Carl Kirkland, Robert Kirkland, Robert Alderson, The Amy Katherine Alderson Trust, The Allison Leigh Alderson Trust, The Carl T. Kirkland Grantor Retained Annuity Trust 2001-1 and Steven Collins, and any additional Shareholders of the Company (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 enure 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 ___________, 200_ . ------------------------------------------- (Signature of Shareholder) ------------------------------------------- (Name in block letters) -28- EX-10.5 9 g75423ex10-5.txt EMPLOYMENT AGREEMENT/KIRKLAND'S & CARL KIRKLAND EXHIBIT 10.5 (AS AMENDED THROUGH JULY 31, 2000) 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 sixth 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 February 1 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 February 1, 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 majority shareholders, including Executive (the "Recapitalization Agreement") through February 1, 1997. The annual payment to be made with respect to any period during which the Term terminated prior to the applicable February 1 payment date will be prorated based on the portion of a year which has elapsed from February 1 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) 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 -2- 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. (b) Confidential Information. Executive agrees that, during and after the Restricted Period, Executive shall keep secret and retain in strictest confidence, and shall not use for Executive'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 Executive while employed by the Company. Notwithstanding the provisions of this Section 6.1(b), Executive, while Robert Kirkland and any investment funds managed by Advent International Corporation are (directly or indirectly) shareholders in the Company, may communicate with Robert Kirkland or Advent International Corporation any information which a shareholder, under Tennessee law, is entitled to receive. 6.2. Rights and Remedies Upon Breach. If Executive breaches, or threatens to commit a breach of, any of the provisions contained in Section 6.1 (the "Restrictive Covenants"), the Company shall have the following rights and remedies, each of which rights and remedies shall be independent of the others and severally enforceable, and each of which is in addition to, and not in lieu of, any other rights and remedies available to the Company under law or in equity: (a) Specific Performance. The right and remedy to have the Restrictive Covenants specifically enforced by any court of competent jurisdiction, it being agreed that any breach or threatened breach of the Restrictive Covenants would cause irreparable injury to the Company and that money damages would not provide an adequate remedy to the Company. (b) Accounting. The right and remedy to require Executive to account for and pay over to the Company all compensation, profits, monies, accruals, increments or other benefits derived or received by Executive as the result of any action constituting a breach of the Restrictive Covenants. 6.3. Blue-Pencilling. If any court determines that any of the Restrictive Covenants, or any part thereof, is unenforceable because of the duration or geographical scope of such provision, such court shall have the power to reduce the duration or scope of such provision, as the cast! may be, and, in its reduced form, such provision shall then be enforceable. 6.4. Enforceability in Jurisdictions. The Company and Executive intend to and hereby confer jurisdiction to enforce the Restrictive Covenants upon the courts of Shelby County, Tennessee or Davidson County, Tennessee or any federal or district court within those counties. If the courts of any one or more of such jurisdictions hold the Restrictive Covenants unenforceable by reason of the breadth of such scope or otherwise, it is the intention of the Company that such determination not bar or in any way affect the right of -3- the Company to the relief provided above in the courts of any other jurisdiction within the geographical scope of such Restrictive Covenants. 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 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. 8. Consulting Agreement. If the Term is not extended on the fourth anniversary of the date hereof or upon any expiration of any Term renewal period which expiration occurs prior to the seventh anniversary of the date hereof, the parties shall enter into a Consulting Agreement (the "Consulting Agreement") on such date. The terms of the Consulting Agreement shall include the following: (i) annual compensation at the rate of $712,500 ("Consulting Compensation"), prorated for any partial year; (ii) a term expiring on the seventh anniversary of the date of this Agreement (the "Consulting Term"); (iii) the termination of the Consulting Agreement upon the occurrence of a Change in Control, Qualified Public offering, Sale or Refinancing; (iv) the continued payment of Consulting Compensation for the remainder of the Consulting Term (subject to clause (iii)) as a death or Disability benefit to the Executive or Executive's executors, legal -4- representatives or administrators, upon the Disability or death of Executive; and (v) any additional terms mutually agreed upon by Executive and the Company. 9. Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the Company and Executive and their respective successors, executors, administrators, heirs and/or permitted assigns; provided, however, that neither Executive 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. 10. Subordination. The obligations of the Company set forth in this Agreement with respect to $712,500 of the Annual Salary 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 10, payment shall be made to the Executive as soon its 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 Executive for any purpose as having received any payment of compensation any earlier than the date actually paid to the Executive by cash or check if the Executive's compensation is reduced because of subordination under this Section 10 or because of any other reason whatsoever. 11. 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. 12. Entire Agreement; Amendments. This Agreement along with the Stock option 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 employment of Executive with the Company. This Agreement may not be changed or modified, except by an Agreement in writing signed by each of the parties hereto. 13. 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. 14. Governing Law. This Agreement shall be construed and enforced in accordance with the laws of the State of Tennessee. 15. Survival of Provisions. The provisions of this Agreement set forth in Sections 6 and 15 hereof shall survive the termination of Executive's employment hereunder. 16. 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. -5- 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: KIRKLANDS, INC. By: /s/ Robert E. Alderson By: /s/ Bruce Moore ---------------------- --------------- Title: VP/Sec Name: Title: V.P. Agreed to and Accepted: /s/ Carl Kirkland ----------------- Carl Kirkland -6- 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-10.6 10 g75423ex10-6.txt EMPLOYMENT AGREEMENT/KIRKLAND'S AND R. ALDERSON EXHIBIT 10.6 (AS AMENDED THROUGH JULY 31, 2000) KIRKLAND'S, INC. P.O. Box 7222 Jackson, TN 38303-7222 June 12, 1996 Mr. Robert Alderson Senior Vice President Kirkland's, Inc. 805 North Parkway Jackson, Tennessee 38305 Dear Mr. Alderson: 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 Chief Administrative 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 sixth 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 the Board of Directors of the Company (the "Board"). Executive shall report to the President and Chief Executive Officer of the Company. 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 $424,500 (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) $149,500 payable annually in arrears on February 1 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 February 1, 1997 shall be a prorated portion of $149,500 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 majority shareholders, including Executive (the "Recapitalization Agreement") through February 1, 1997. The annual payment to be made with respect to any period during which the Term terminated prior to the applicable February 1 payment date will be prorated based on the portion of a year which has elapsed from February 1 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) 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 -2- 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. (b) Confidential Information. Executive agrees that, during and after the Restricted Period, Executive shall keep secret and retain in strictest confidence, and shall not use for Executive'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 Executive while employed by the Company. Notwithstanding the provisions of this Section 6.1(b), Executive, while Robert Kirkland and any investment funds managed by Advent International Corporation are (directly or indirectly) shareholders in the Company, may communicate with Robert Kirkland or Advent International Corporation any information which a shareholder, under Tennessee law, is entitled to receive. 6.2. Rights and Remedies Upon Breach. If Executive breaches, or threatens to commit a breach of, any of the provisions contained in Section 6.1 (the "Restrictive Covenants"), the Company shall have the following rights and remedies, each of which rights and remedies shall be independent of the others and severally enforceable, and each of which is in addition to, and not in lieu of, any other rights and remedies available to the Company under law or in equity: (a) Specific Performance. The right and remedy to have the Restrictive Covenants specifically enforced by any court of competent jurisdiction, it being agreed that any breach or threatened breach of the Restrictive Covenants would cause irreparable injury to the Company and that money damages would not provide an adequate remedy to the Company. (b) Accounting. The right and remedy to require Executive to account for and pay over to the Company all compensation, profits, monies, accruals, increments or other benefits derived or received by Executive as the result of any action constituting a breach of the Restrictive Covenants. 6.3. Blue-Pencilling. If any court determines that any of the Restrictive Covenants, or any part thereof, is unenforceable because of the duration or geographical scope of such provision, such court shall have the power to reduce the duration or scope of such provision, as the cast! may be, and, in its reduced form, such provision shall then be enforceable. 6.4. Enforceability in Jurisdictions. The Company and Executive intend to and hereby confer jurisdiction to enforce the Restrictive Covenants upon the courts of Shelby County, Tennessee or Davidson County, Tennessee or any federal or district court within those counties. If the courts of any one or more of such jurisdictions hold the Restrictive Covenants unenforceable by reason of the breadth of such scope or otherwise, it is the intention of the Company that such determination not bar or in any way affect the right of -3- the Company to the relief provided above in the courts of any other jurisdiction within the geographical scope of such Restrictive Covenants. 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 $149,500 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 $149,500 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 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. 8. Consulting Agreement. If the Term is not extended on the fourth anniversary of the date hereof or upon any expiration of any Term renewal period which expiration occurs prior to the seventh anniversary of the date hereof, the parties shall enter into a Consulting Agreement (the "Consulting Agreement") on such date. The terms of the Consulting Agreement shall include the following: (i) annual compensation at the rate of $149,500 ("Consulting Compensation"), prorated for any partial year; (ii) a term expiring on the seventh anniversary of the date of this Agreement (the "Consulting Term"); (iii) the termination of the Consulting Agreement upon the occurrence of a Change in Control, Qualified Public offering, Sale or Refinancing; (iv) the continued payment of Consulting Compensation for the remainder of the Consulting Term (subject to clause (iii)) as a death or Disability benefit to the Executive or Executive's executors, legal -4- representatives or administrators, upon the Disability or death of Executive; and (v) any additional terms mutually agreed upon by Executive and the Company. 9. Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the Company and Executive and their respective successors, executors, administrators, heirs and/or permitted assigns; provided, however, that neither Executive 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. 10. Subordination. The obligations of the Company set forth in this Agreement with respect to $149,500 of the Annual Salary 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 10, payment shall be made to the Executive as soon its 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 Executive for any purpose as having received any payment of compensation any earlier than the date actually paid to the Executive by cash or check if the Executive's compensation is reduced because of subordination under this Section 10 or because of any other reason whatsoever. 11. 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. 12. Entire Agreement; Amendments. This Agreement along with the Stock option 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 employment of Executive with the Company. This Agreement may not be changed or modified, except by an Agreement in writing signed by each of the parties hereto. 13. 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. 14. Governing Law. This Agreement shall be construed and enforced in accordance with the laws of the State of Tennessee. 15. Survival of Provisions. The provisions of this Agreement set forth in Sections 6 and 15 hereof shall survive the termination of Executive's employment hereunder. 16. 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. -5- 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: KIRKLANDS, INC. By: /s/ Bruce Moore By: /s/ Carl Kirkland --------------- ----------------- Title: V.P. Name: Title: President Agreed to and Accepted: /s/ Robert Alderson ------------------- Robert Alderson -6- 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-10.7 11 g75423ex10-7.txt EMPLOYMENT AGREEMENT/KIRKLAND'S AND R. FAULKNER EXHIBIT 10.7 EMPLOYMENT AGREEMENT (AS AMENDED THROUGH JULY 31, 2000) THIS AGREEMENT (the "Agreement"), made as of the 2nd day of February, 1998, by and between KIRKLAND'S, INC., a Tennessee corporation, (the "Company"), and REYNOLDS C. FAULKNER ("Executive"). Executive is an individual who, by education, training and experience, is skilled in matters of corporate finance, accounting and administration. The Company desires to employ Executive as its Senior Vice President and Chief Financial Officer and thereby gain the benefit of Executive's knowledge and experience, and Executive desires to accept such employment pursuant to the terms of this Agreement. NOW THEREFORE, in consideration of these premises and the mutual promises contained herein, and intending to be legally bound hereby, the parties agree as follows: SECTION 1. Definitions. 1.1. "Affiliate" of a Person means 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 other governing body) 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. In any event and without limiting the generality of the foregoing, any Person owning 10% or more of the voting securities of another Person shall be deemed to control that Person. 1.2. "Board" means the Board of Directors of the Company. 1.3. "Cause" means the occurrence of any of the following material violations, as determined in good faith by the Board: (i) Executive's failure, refusal or inability (other than due to mental or physical disability) to perform, in any material respect, his duties to the Company, which failure continues for more than fifteen (15) days after written notice thereof from the Company, (ii) alcohol abuse or use of controlled drugs (other than in accordance with a physician's prescription), (iii) illegal conduct or gross misconduct of Executive which is materially and demonstrably injurious to the Company, its affiliates or subsidiaries including, without limitation, fraud, embezzlement, theft or proven dishonesty in the course of his employment, (iv) conviction of a misdemeanor involving moral turpitude or a felony, or (v) the entry of a plea of guilty or nolo contendere to a misdemeanor involving moral turpitude or a felony. 1.4. "Competing Business" means any business primarily engaged in the retail sale of specialty gifts, decorative accessories or home furnishings, or any Significant Supplier. 1.5. "Financial Advisory Services" means financial advisory services other than consulting or advisory services regarding wholesale or retail purchasing, store location planning, store or display configuration, inventory control or purchase tracking systems or retail marketing strategy. 1.6. "Good Reason" means that any of the following has occurred with respect to the Executive: (a) the assignment to Executive of any duties inconsistent in any respect with Executive's position (including status, offices, titles and reporting requirements), authority, duties or responsibilities as contemplated by Section 2 of this Employment Agreement, or any other action by the Company which results in a material diminution in such position, authority, duties or responsibilities, excluding for this purpose an isolated, insubstantial and inadvertent action not taken in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by Executive; (b) a reduction by the Company in Executive's Annual Salary; provided, however, that if the salaries of substantially all of the Company's senior executive officers (including the Company's President and CEO) are contemporaneously and proportionately reduced, a reduction in the Executive's Annual Salary to an amount not less than $225,000 will not constitute "Good Reason" hereunder; (c) the failure by the Company, without Executive's consent, to pay to him any portion of his current compensation, except pursuant to a compensation deferral elected by Executive, or to pay to Executive any portion of an installment of deferred compensation under any deferred compensation program of the Company within thirty days of the date such compensation is due; other than an isolated, insubstantial and inadvertent failure not occurring in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by Executive; (d) a material diminution in the 401(k), medical, health and life insurance benefits, if any, enjoyed by Executive under the Company's plans or arrangements as of the date hereof, except as required by law, or the failure by the Company to provide Executive with a minimum of three (3) weeks of paid vacation days annually; (e) the relocation of the Company's principal executive offices to a location more than 35 miles from the location of such offices on the Effective Date, or the Company's requiring Executive to be based anywhere other than the Company's principal executive offices, except for required travel on the Company's business; or (f) the failure of the Company to obtain a satisfactory agreement from any successor to assume and agree to perform this Agreement. -2- 1.7. "Intellectual Property" means (a) all inventions (whether patentable or unpatentable and whether or not reduced to practice), all improvements thereto, and all patents, (b) all trademarks, service marks, trade dress, logos, trade names, fictitious names, brand names, brand marks and corporate names, together with all translations, adaptations, derivations, and combinations thereof and including all goodwill associated therewith, and all applications, registrations, and renewals in connection therewith, (c) all copyrightable works, all copyrights, and all applications, registrations, and renewals in connection therewith, (d) all mask works and all applications, registrations, and renewals in connection therewith, (e) all trade secrets and confidential business information (including ideas, research and development, know-how, formulas, compositions, manufacturing and production processes and techniques, technical data, designs, drawings, specifications, customer and supplier lists, pricing and cost information, and business and marketing plans and proposals), (f) all computer software (including data, source codes and related documentation), (g) all other proprietary rights, (h) all copies and tangible embodiments thereof (in whatever form or medium), or similar intangible personal property created by, created for, or otherwise belonging to the Company. 1.8. "Option Agreement" means the option agreement between Executive and the Company dated as of February 2, 1998. 1.9. "Person" means 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. 1.10. "Proprietary Information" means confidential, proprietary, business and technical information or trade secrets of the Company or of any subsidiary or Affiliate of the Company. 1.11. "Restrictive Covenants" means the provisions contained in Section 5.1 of this Agreement. 1.12. "Significant Supplier" means, as of a given date, a supplier of specialty gifts, decorative accessories or home furnishings whose aggregate sales to the Company, its affiliates or subsidiaries during the three (3) year period immediately preceding that given date exceeded $400,000. 1.13. "Term" means the period beginning on the date hereof and ending on the earlier of: (i) June 12, 2002, or (ii) the date that Executive's employment by the Company is terminated. SECTION 2. Duration of Agreement; Duties. Executive will be employed as the Company's Chief Financial Officer. Executive's employment by the Company may be terminated by the Company at any time; provided, however, that during the Term, the terms and conditions of Executive's employment by the Company shall be as herein set forth. Executive will report to the President and the CEO of the Company. Executive will render his services hereunder to the Company and its Affiliates and shall use his best efforts, judgment and energy in the performance of the duties assigned to him. During the Term, Executive will devote substantially all of his business time and services to the Company to perform such duties as may be -3- customarily incident to his position and as may reasonably be assigned from time to time by the Board. During the Term, Executive will not serve as a director of any other corporation without the prior consent of the Company. SECTION 3. Compensation and Benefits. 3.1. 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 5 hereof, an initial base salary at an annual rate of $225,000 (as the same may hereafter be increased, 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, and which shall be withheld and paid in accordance with the Company's normal payroll practices for its similarly situated employees from time to time then in effect. 3.2. Signing Bonus. Within six months of the date hereof, the Company shall pay Executive a signing bonus in an amount equal to $100,000. 3.3. Annual Bonus. To the extent determined by the Board, in its absolute discretion, Executive will be eligible to receive a bonus of up to $100,000 per annum with respect to each fiscal year of the Company during the Term, commencing with the fiscal year ending December 31, 1998. 3.4. Benefits. Executive will be entitled to the benefits provided on Schedule I hereto. In addition, Executive will be entitled to receive the same benefits enjoyed by other executive officers of the Company from time to time (as determined by the Board in good faith, in its absolute discretion), which benefits, as of this date, include the benefits set forth on Schedule II hereto. For purposes of this Agreement, "Benefits" means the benefits contemplated by this Section 3.3. SECTION 4. Payment of Expenses. The Company will pay all reasonable and necessary expenses incurred by Executive in the performance of his duties hereunder, in accordance with the Company's standard practices and policies regarding the payment or reimbursement of expenses. -4- SECTION 5. Non-Compete; Confidentiality; Non-Solicitation. 5.1. 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 do any of the following, directly or indirectly, without the prior written consent of the Company (except in Executive's capacity as an employee of the Company, and in the best interests of the Company): (i) engage or participate in any Competing Business; (ii) become interested in (as owner, stockholder, lender, partner, co-venturer, director, officer, employee, agent or consultant) any person, firm, corporation, association or other entity engaged in any Competing Business; (iii) arrange or facilitate the solicitation by a Competing Business of any Significant Supplier; (iv) 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) influence or attempt to influence any Person to either (1) terminate or modify any employment, consulting, agency, distributorship or other arrangement with the Company, or (2) employ, or arrange to have any other Person or entity employ, any Person who has been employed by the Company as an employee, agent or distributor of the Company at any time during the Restricted Period. Notwithstanding the foregoing, Executive may provide investment banking or other Financial Advisory Services to a Competing Business and may hold less than five percent (5%) of the outstanding securities of any class of any publicly-traded securities of any company. (b) Confidentiality. Executive recognizes and acknowledges that the Proprietary Information is a valuable, special and unique asset of the business of the Company. As a result, both during the Term and five (5) years thereafter, Executive shall not, without the prior written consent of the Company, for any reason either directly or indirectly divulge to any third-party or use for his own benefit, or for any purpose other than the exclusive benefit of the Company, any Proprietary Information revealed, obtained or developed in the course of his employment by the Company. Such Proprietary Information shall include, but shall not be limited to, the intangible personal property described in Section 5.1(c), any information relating to business plans or studies, business procedures, costs, finances, marketing data, methods, the identities of customers, contractors and suppliers and prospective customers, contractors and suppliers, the terms of contracts and agreements with customers, contractors and suppliers, the Company's -5- relationship with actual and prospective customers, contractors and suppliers, and the Company's course of dealing with, any such actual or prospective customers, contractors and suppliers, personnel information, customer and vendor credit information, and any other materials that have not been made available to the general public, 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; provided, however, that nothing herein contained shall restrict Executive's ability to make such disclosures during the Term as may be necessary or appropriate to the effective and efficient discharge of his duties as an employee hereunder or as such disclosures may be required by law; and further provided, that nothing herein contained shall restrict Executive from divulging or using for his own benefit or for any other purpose any Proprietary Information which is publicly available, so long as such information did not become available to the public as a direct or indirect result of Executive's breach of this Section 5.1(b). In the event that Executive or any of its representatives becomes legally compelled to disclose any of the Proprietary Information, Executive will provide the Company with prompt written notice so that the Company may seek a protective order or other appropriate remedy. Failure by the Company to mark any of the Proprietary Information as confidential or proprietary shall not affect its status as Proprietary Information under the terms of this Agreement. (c) Property. All right, title and interest in and to Proprietary Information shall be and remain the sole and exclusive property of the Company. During the Term, Executive shall not remove from the Company's offices or premises any documents, records, notebooks, files, correspondence, reports, memoranda or similar materials of or containing Proprietary Information, or other materials or property of any kind belonging to the Company unless necessary or appropriate (as reasonably determined by Executive) in accordance with Executive's duties and responsibilities to the Company and, in the event that such materials or property are removed, all of the foregoing shall be returned to their proper files or places of safekeeping as promptly as possible after the removal shall serve its specific purpose. Executive shall not make, retain, remove and/or distribute any copies of any of the foregoing for any reason whatsoever except as may be necessary in the discharge of his assigned duties and shall not divulge to any third person the nature of and/or contents of any of the foregoing or of any other oral or written information to which he may have access or with which for any reason he may become familiar, except as disclosure shall be necessary or appropriate (as reasonably determined by Executive) in the performance of his duties; and upon the termination of his employment with the Company, he shall leave with or return to the Company all originals and copies of the foregoing then in his possession, whether prepared by Executive or by others. 5.2. Rights and Remedies Upon Breach. (a) Specific Enforcement. Executive acknowledges that the Restrictive Covenants are reasonable and necessary to protect the legitimate interests of the Company and its Affiliates and that the Company would not have entered into this Agreement in the absence of such restrictions. Executive also acknowledges that any breach by him of the Restrictive Covenants will cause continuing and irreparable injury to the Company for which monetary damages would not be an adequate remedy. Executive shall not, in any action or proceeding to enforce any of the provisions of this Agreement, assert the claim or defense that such an adequate remedy at law exists. In the event of such breach by Executive, the Company shall have the right to enforce the Restrictive Covenants by seeking injunctive or other relief in any court and this Agreement shall not in any way limit remedies of law or in equity otherwise available to the Company. If an action at law or in equity is necessary to enforce or interpret the -6- terms of this agreement, the prevailing party shall be entitled to recover, in addition to any other relief, reasonable attorneys' fees, costs and disbursements. (b) Extension of Restrictive Period. In the event that Executive breaches any of the Restrictive Covenants contained in Section 5.1(a), then the Restricted Period shall be extended for a period of time equal to the period of time that Executive is in breach of such restriction. (c) Accounting. If Executive is determined by any court, arbitrator, mediator or other adjudicative body to have breached any of the Restrictive Covenants, the Company will have the right and remedy to require Executive to account for and pay over to the Company all compensation, profits, monies, accruals, increments or other benefits derived or received by Executive as the result of any action constituting a breach of the Restrictive Covenants. This right and remedy will be in addition to, and not in lieu of, any other rights and remedies available to the Company under law or in equity. 5.3. Judicial Modification. If any court determines that any of the Restrictive Covenants, or any part thereof, is unenforceable because of the duration or geographical scope of such provision, such court shall have the power to modify such provision and, in its modified form, such provision shall then be enforceable. 5.4. Disclosure of Restrictive Covenants. Executive agrees to disclose the existence and terms of the restrictive covenants set forth in this Section 5 to any employer that Executive may work for after the termination of Executive's employment at the Company. 5.5. Acknowledgments. Executive acknowledges that the Restrictive Covenants contained in Section 5.1(a) are included herein in order to induce the Company to employ Executive pursuant to the other terms of this Agreement. Executive further acknowledges that the duration and geographic scope of Section 5.1(a) are reasonable given the nature of this Agreement. 5.6. Enforceability in Jurisdictions. If a court of any jurisdiction holds the Restrictive Covenants unenforceable by reason of their breadth or scope or otherwise, it is the intention of the parties hereto that such determination not bar or in any way affect the right of the Company to the relief provided above in the courts of any other jurisdiction within the geographical scope of such Restrictive Covenants. -7- SECTION 6. Termination. Executive's employment hereunder may be terminated by the Company or Executive at any time. Upon termination, Executive shall be entitled only to such compensation and benefits as described in this Section 6. In the event of any termination, the Company and Executive will have such rights and remedies as may be available to either of them under this Agreement, at law, in equity or otherwise, for any breach by the other of this Agreement. 6.1. Termination Without Cause or For Good Reason. If Executive's employment by the Company is terminated by the Company without Cause or by Executive for Good Reason prior to the third anniversary of the date hereof, the Executive shall be entitled to payment of (i) all accrued and unpaid Annual Salary and Benefits through the date of such termination, (ii) a lump sum amount equal to the present value of (determined by applying the highest interest rate then in effect under any credit agreement to which the Company is a party) twelve (12) months of his Annual Salary, and (iii) a pro-rated annual bonus (determined by the Board in good faith, in its absolute discretion) based on the portion of the year during which Executive was employed by the Company. All Annual Salary and other Benefits shall cease at the time of such termination, subject to the terms of any benefits or compensation plan then in force and applicable to Executive, and the Company shall have no further liability or obligation by reason of such termination; provided, however, that this paragraph will not affect stock options granted to Executive by the Company, the terms of which are governed by the Option Agreement. 6.2. Any Other Termination. If Executive's employment by the Company is terminated for any reason other than as set forth in Section 6.1, the Company's obligation to Executive (or, in the case of Executive's death, to Executive's estate) will be limited solely to the payment of accrued and unpaid Annual Salary and Benefits through the date of such termination. All Annual Salary and Benefits will cease at the time of such termination, subject to the terms of any benefits or compensation plans then in force and applicable to Executive, and the Company shall have no further liability or obligation hereunder by reason of such termination; provided, however, that this paragraph will not affect stock options granted to Executive by the Company, the terms of which are governed by the Option Agreement. SECTION 7. Other Agreements. Executive represents, warrants and, where applicable, covenants to the Company that: (a) there are no restrictions, agreements or understandings whatsoever to which Executive is a party which would prevent or make unlawful Executive's execution of this Agreement or Executive's employment hereunder, or which is or would be inconsistent or in conflict with this Agreement or Executive's employment hereunder, or would prevent, limit or impair in any way the performance by Executive of his obligations hereunder; -8- (b) Executive's execution of this Agreement and Executive's employment hereunder shall not constitute a breach of any contract, agreement or understanding, oral or written, to which Executive is a party or by which Executive is bound; and (c) Executive is free to execute this Agreement and to be employed by the Company as an employee pursuant to the provisions set forth herein. (d) Executive shall disclose the existence and terms of this Agreement to any employer that the Executive may work for during the Restricted Period. SECTION 8. Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the Company and Executive and their respective successors, executors, administrators, heirs and/or permitted assigns; provided, however, that neither Executive 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. SECTION 9. Notice. Any notice or communication required or permitted under this Agreement shall be made in writing and (a) sent by overnight courier, (b) mailed by certified or registered mail, return receipt requested or (c) sent by telecopier, addressed as follows: If to Executive: Mr. Reynolds C. Faulkner c/o Kirkland's, Inc. 805 N. Parkway P.O. Box 7222 Jackson, Tennessee 38308-7222 Fax: (901) 664-9345 -9- If to Company: Kirkland's, Inc. 805 N. Parkway P.O. Box 7222 Jackson, Tennessee 38308-7222 Fax: (901) 664-9345 Attn: Robert Alderson, Esquire and to: Mr. David Mussafer Advent International Corporation 101 Federal Street Boston, Massachusetts 21110 Fax: (617) 443-0322 with a copy to: Julia D. Corelli, Esquire Pepper Hamilton LLP 3000 Two Logan Square 18th & Arch Streets Philadelphia, Pennsylvania 19103 Fax: (215) 981-4750 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. SECTION 10. Entire Agreement; Amendments. This Agreement and the Option Agreement contain 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 relating to the employment of Executive with the Company. This Agreement may not be changed or modified, except by an Agreement in writing signed by each of the parties hereto. SECTION 11. Waiver. Any waiver by either party of any breach of any term or condition in this Agreement shall not operate as a waiver of any other breach of such term or condition or of any other term or condition, nor shall any failure to enforce any provision hereof operate as a waiver of such provision or of any other provision hereof or constitute or be deemed a waiver or release of any other rights, in law or in equity. -10- SECTION 12. Governing Law. This Agreement shall be governed by, and enforced in accordance with, the laws of the State of Tennessee without regard to the application of the principals of conflicts or choice of laws. SECTION 13. Survival of Provisions. The provisions of this Agreement set forth in Sections 4 through 8 and, 10 through 15 hereof shall survive the termination of Executive's employment hereunder. SECTION 14. Severability. Whenever possible, each provision of this Agreement will be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement is held to be invalid, illegal or unenforceable in any respect under any applicable law or rule in any jurisdiction, such invalidity, illegality or unenforceability will not affect any other provision or the effectiveness or validity of any provision in any other jurisdiction, and this Agreement will be reformed, construed and enforced in such jurisdiction as if such invalid, illegal or unenforceable provision had never been contained herein. SECTION 15. Section Headings. The section headings in this Agreement are for convenience only; they form no part of this Agreement and shall not affect its interpretation. SECTION 16. Counterparts and Facsimiles. This Agreement may be executed, including execution by facsimile signature, 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. IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by its duly authorized officers, and Executive has executed this Agreement, on July 15th, 1998, effective as of the date first above written. KIRKLAND'S, INC. By: /s/ Carl Kirkland ------------------------------------ Title: Chief Executive Officer ------------------------------------ EXECUTIVE /s/ Reynolds C. Faulkner ------------------------------------ -11- KIRKLAND'S, INC. REYNOLDS C. FAULKNER EMPLOYMENT AGREEMENT SCHEDULE I ADDITIONAL BENEFITS 1. Life Insurance. A life insurance policy (in addition to life insurance benefits generally provided or available to other employees of the Company) with a face amount of $500,000 with the beneficiary to be designated by Executive and issued on the basis of being paid up at age 65. The policy will (a) contain a waiver of premium in the event of disability (to the extent available at commercially reasonable rates), and (b) permit (upon termination of employment with the Company) the transfer of ownership of such policy to Executive, such transfer to be with all benefits, values and other ownership rights incident thereto at the time of such transfer, without cost to Executive, who may thereafter continue coverage under such policy at his own cost. 2. Relocation Expenses. Reasonable and necessary moving expenses, as follows: a. Agent's commissions on sale of existing home, if any; provided, however, that Executive will engage in independent efforts to sell his existing home for a period of at least one (1) month prior to engaging an agent for that purpose. b. Attorney's fees incurred in the sale of Executive's existing home. c. Airfare for two (2) trips from Atlanta for Executive's wife to shop for a home in Tennessee. d. Payment of moving company fees incurred in the transport of Executive's personal belongings to Tennessee. 3. Car Allowance. $600 per month. 4. Commuting Expenses. Airfare, lodging, telephone, and other reasonable and necessary commuting expenses incurred by Executive prior to relocating to Tennessee; provided, however, that such commuting expenses will be paid only through June, 1998. 5. Legal Fees. Reasonable and necessary legal fees and costs incurred in the review and negotiation of this contract; provided, however, that if such fees and costs exceed $2500, Executive will receive $2500, plus one-half of the amount of such fees and costs in excess of $2500. -12- KIRKLAND'S, INC. REYNOLDS C. FAULKNER EMPLOYMENT AGREEMENT SCHEDULE II BASIC BENEFITS AS OF FEBRUARY 1998 1. Group health insurance (partially subsidized by the Company). 2. 401(k) plan participation, after completion of one (1) year of service. 3. Three weeks of paid vacation annually. -13- EX-10.8 12 g75423ex10-8.txt EMPLOYMENT AGREEMENT/KIRKLAND'S AND H.R. HARVEY EXHIBIT 10.8 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT is entered into effective as of June 18, 2001, between H.R. Harvey ("Employee") and KIRKLAND'S, INC., a Tennessee corporation with principal offices in Jackson, Tennessee ("Employer"). RECITALS 1. Employee desires employment with Employer as Senior Vice President of Merchandising, General Merchandise Manager for the Kirkland's retail stores (the "Stores"). 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. Employer hereby employs Employee, and Employee accepts employment as Vice President of Merchandising in accordance herewith. 2. Scope of Duties. Employee shall serve as Senior Vice President of Merchandising, General Merchandise Manager for the Stores. In such role, Employee shall perform those duties as from time to time assigned by the Chief Executive Officer and Board of Directors of Employer. In such capacity, Employee shall report to the Chief Executive Officer. 3. Term. The term of this Agreement shall commence on the Effective Date hereinafter provided and continue until termination as herein provided. 4. Compensation. As base compensation for the services rendered hereunder to Employer, Employee shall be paid an annual base salary of $225,000.00, paid twice monthly, in arrears. Employee shall also receive a monthly automobile allowance of $600.00, subject to applicable taxes and deductions. In addition, for 2001 and 2002, Employee shall be eligible for an annual bonus of 40% of base salary (prorated for 2001). The bonus criteria shall be determined by Employer, but will generally meet the standards set for other merchandising executives in the company (see Exhibit A attached hereto). Bonus amount may change after 2002, subject to agreement of Employee and Employer. Employee shall receive a "signing bonus" in the amount of $20,000.00 payable thirty (30) days after employment commences, which is repayable within thirty (30) days of termination if Employee resigns during the first year of employment. Employee shall also be eligible for "family coverage", 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 resulting from denial of coverage by the insurer. Employee is solely responsible to make valid claims for benefits thereunder. Subject to insurer approval, Employee shall waive the initial two-year, higher co-pay provision generally applicable to new Plan member provided, however, Employer shall reimburse Employee for COBRA costs in the interim period between commencement of employment and the effective date of Employee's coverage. 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 Employer's employees in accordance with existing policies, which shall not accrue in the event of termination. Employee is entitled to two weeks of paid vacation in 2001, and three weeks paid vacation each year thereafter. 5. Expense Reimbursement. (a) Moving Expenses. Employer agrees to pay directly or reimburse Employee for: (1) any and all reasonable moving expenses, as approved in advance by Employer; (2) closing costs on Employee's new home in Jackson, TN, not to exceed $5,000.00; (3) reasonable temporary housing costs (not food/incidentals) for up to ninety (90) days from commencement of employment; (4) such other relocation costs (including one (1) months' lease on existing house in Myrtle Beach, SC) as are pre-approved by Employer in its discretion. Employee hereby agrees to repay such payments/reimbursements 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. 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 sales volume and proper operation of the Stores. 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 of Employer. Employee shall at all times conduct such duties and his personal affairs in a manner that is satisfactory to Employer and so as to not in any manner injure the reputation of 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 -2- 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, 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 Employer to Employer prior to receiving final compensation for wages and expenses. 8. Confidentiality; Restrictive Covenant. Employee understands and agrees that the information used by Employee in the performance of duties hereunder is proprietary to Employer and the Stores and represents, in the specific areas of inventory procurement and management, marketing and sales, and store operations, highly confidential and valuable information (collectively "Information"), the loss of which would be economically injurious to Employer and the Stores. Accordingly, in consideration of this Agreement, and the vendor/supplier contacts and 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 of confidentiality, Employee agrees, additionally, that for a period of two years 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 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 Employer's business competition is typically national or regional chain retail operations specializing in or having a substantial inventory mix involving "gifts, decorative accessories, and home furnishings" and related items. The foregoing restriction shall not apply to department stores or to a vendor who is not engaged in operation of retail stores. 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 Employer to disassociate their employment relationship with Employer 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 Stores may be difficult or impossible to determine. 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 -3- owned or controlled by the principals of Employer. This Agreement (and all rights and benefits hereunder) 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: General Counsel 805 North Parkway Jackson, TN 38305 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 June 18, 2001. EXECUTED by the parties as provided below. EMPLOYEE: EMPLOYER: KIRKLAND'S, INC. /s/ H.R. Harvey By /s/ Robert E. Alderson - ------------------ ---------------------- H.R. Harvey (Title) President and CEO -4- **EXAMPLE ONLY** EXHIBIT A PROPOSED ANNUAL BONUS CRITERIA I. INTRODUCTION The annual bonus opportunity is intended to reward each management participant for his or her contributions to the success of Kirkland's. Criteria shall be set by March 31 of each calendar year, and shall include potential rewards both for corporate and individual performance. Final bonus payments shall be determined and paid no later than March 31 of the following year. II. MAXIMUM BONUS OPPORTUNITY Maximum bonus opportunity for calendar 2001 is $_______. III. BONUS CRITERIA A. 50% - CORPORATE PERFORMANCE Participant is eligible for this portion of the bonus based on the Company's achievement of its budgeted EBITDA, before management bonus expense, as approved by the Company's Board of Directors. EBITDA is defined as consolidated earnings before interest, taxes, depreciation and amortization as determined in the Company's audited financial statements. The EBITDA target for 2001 is $22M. Bonus will be awarded based on the following table: Actual EBITDA % of Bonus As % of Budget Earned -------------- ------ 95% or higher 100% 92.5% - 94.9% 50% 90% - 92.4% 25% Below 90% 0% B. 25% - INDIVIDUAL GOALS Participant is eligible for this portion based on achievement of the following goals: Criteria (to be determined) Bonus --------------------------- ----- 1. Comparable store sales increase of __% or more 2. Total Company sales of $_____ million or more 3. Total Company gross margin of ___% or more 4. . . . . . . . . . . . . . . . . . . . . . . . . 5. . . . . . . . . . . . . . . . . . . . . . . . . C. 25% - DISCRETIONARY Participant is eligible for this portion of the bonus at the discretion of the Company's Chief Executive Officer. Criteria for this discretionary bonus include team leadership, development of merchandising personnel, store visits, teamwork with executive officers on special projects, and other factors. -5- EX-10.9 13 g75423ex10-9.txt EMPLOYMENT AGREEMENT/KIRKLAND'S AND ED WISE EXHIBIT 10.9 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT is entered into effective as of December 4, 2000 ("Effective Date"), between Ed Wise ("Employee") and KIRKLAND'S, INC., a Tennessee corporation with principal offices in Jackson, Tennessee ("Employer"). RECITALS 1. Employee desires employment with Employer as Senior Vice President of Operations/Director of Stores ("Director") for the Kirkland's retail stores (the "Stores"). 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. Employer hereby employs Employee, and Employee accepts employment as Director in accordance herewith. 2. Scope of Duties. Employee shall serve as Director for the Kirkland's stores. In such role, Employee shall perform those duties as from time to time assigned by the President, Chief Executive Officer, and Board of Directors of Employer. In such capacity, Employee shall report to the President and Executive Committee of Employer, and shall perform any additional duties with respect to the Stores as directed by Employer. 3. Term. The term of this Agreement shall commence on the Effective Date herein provided and continue until termination as herein provided. 4. Compensation. As base compensation for the services rendered hereunder to Employer, Employee shall be paid an annual base salary of $175,000.00, paid twice monthly, in arrears. Employee shall also receive a monthly automobile allowance of $600.00, subject to applicable taxes and deductions. In addition, upon terms and conditions from time to time established by Employer's Executive Committee, Employee shall be eligible for an annual bonus. In 2001, the bonus opportunity is a maximum of $40,250.00 and the 2002 bonus opportunity will be not less than $50,000.00. The bonus criteria and amount after 2002 shall be determined by Employer, but will generally meet the standards set for other operations executives in the company (see Exhibit A attached hereto). Employee shall receive a "signing bonus" in the amount of $20,000.00, payable within thirty (30) days of commencing employment. Such bonus will be repaid to Company within thirty (30) days of Employee's termination if Employees resigns within one year. Employee shall also be eligible for "family coverage", 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 resulting from denial of coverage by the insurer. Employee is solely responsible to make valid claims for benefits thereunder. Subject to insurer approval, Employer shall waive the initial two year higher co-pay provision generally applicable to new Plan members. 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 Employer's employees in accordance with existing policies, which shall not accrue in the event of termination. Employee will be given three weeks paid vacation each year beginning in 2001. 5. Expense Reimbursement. (a) Moving Expenses. Employer agrees to reimburse Employee for any and all reasonable moving expenses, as approved in advance by Employer, as well as: (1) the real estate agent's fee on sale of Employee's home in Maryland, and (2) closing costs on Employee's new home in Jackson, TN, in an amount up to $5,000.00; Employer also agrees to reimburse reasonable temporary housing expenses, (not food) for up to ninety (90) days. With prior approval, Employer will pay such other miscellaneous relocation costs as Employer might incur. Employee hereby agrees to repay all such amounts 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. 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 sales volume and proper operation of the Stores. 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 President of Employer. Employee shall at all times conduct such duties and Employee's personal affairs in a manner that 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" -2- 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, 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 Employer to Employer prior to receiving final compensation for wages and expenses. 8. Confidentiality; Restrictive Covenant. Employee understands and agrees that the information used by Employee in the performance of duties hereunder is proprietary to Employer and the Stores and represents, in the specific areas of inventory procurement and management, marketing and sales, and store operations, highly confidential and valuable information (collectively "Information"), the loss of which would be economically injurious to Employer and the Stores. Accordingly, in consideration of this Agreement, and the training and 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 of confidentiality, Employee agrees, additionally, that for a period of two years 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 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 Employer's business competition is typically national or regional chain retail operations specializing in or having a substantial inventory mix involving home furnishings/decor and "gifts and decorative accessories" and related items. The foregoing restriction shall not apply to department stores. 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 Employer to disassociate their employment relationship with Employer 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 Stores may be difficult or impossible to determine. 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 -3- or other transfer or transaction involving third parties, or except to an entity owned or controlled by the principals of Employer. This Agreement (and all rights and benefits hereunder) 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: General Counsel 805 North Parkway Jackson, TN 38305 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 December 4, 2000. EXECUTED by the parties as provided below. EMPLOYEE: EMPLOYER: KIRKLAND'S, INC. /s/ Ed Wise By /s/ Robert E. Alderson - --------------------------- ---------------------- Ed Wise [Signature Dated 10/24/00] (Title) President -4- "EXAMPLE" EXHIBIT A PROPOSED ANNUAL BONUS CRITERIA I. INTRODUCTION The annual bonus opportunity is intended to reward each management participant for his or her contributions to the success of Kirkland's. Criteria shall be set by March 31 of each calendar year, and shall include potential rewards both for corporate and individual performance. Final bonus payments shall be determined and paid no later than March 31 of the following year. II. MAXIMUM BONUS OPPORTUNITY Maximum bonus opportunity for calendar 2000 is $40,250. III. BONUS CRITERIA A. 50% ($20,125) - CORPORATE PERFORMANCE Participant is eligible for this portion of the bonus based on the Company's achievement of its budgeted EBITDA, before management bonus expense, as approved by the Company's Board of Directors. EBITDA is defined as consolidated earnings before interest, taxes, depreciation and amortization as determined in the Company's audited financial statements. Bonus will be awarded based on the following table: Actual EBITDA % of Bonus As % of Budget Earned -------------- ------ 95% or higher 100% 92.5% - 94.9% 50% 90% - 92.4% 25% Below 90% 0% B. 25% ($10,062.50) - INDIVIDUAL GOALS Participant is eligible for this portion based on achievement of the following goals: Criteria (to be determined - EXAMPLE ONLY) Bonus ------------------------------------------ ----- 1. Comparable store sales increase of __% or more $ 4,025 2. Total Company sales of $_____ million or more 4,025 3. Total Company gross margin of ___% or more 2,012.50 ---------- $10,062.50 4. To be determined 5. To be determined -5- C. 25% ($10,062.50) - DISCRETIONARY Participant is eligible for this portion of the bonus at the discretion of the Company's CEO, President, and CFO. Criteria for this discretionary bonus include team leadership, development of operations personnel, store visits, teamwork with executive officers on special projects, and other factors. -6- EX-10.10 14 g75423ex10-10.txt 1996 EXEC. INCENTIVE & NON-QUALIFIED STOCK OPTION EXHIBIT 10.10 KIRKLAND'S, INC. 1996 EXECUTIVE INCENTIVE AND NON-QUALIFIED STOCK OPTION PLAN (AS AMENDED THROUGH APRIL 17, 2002) 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 to encourage stock ownership by such employees by issuing options to such persons to acquire or increase their proprietary interest in the Company. 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. 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 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 the Company. "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. "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 "Non-Employee Director" 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 -2- 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. 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 shares subject to any Option will be treasury shares of Common Stock. Options will not be granted with respect to more than 23,500 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 -3- 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. 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. 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 -4- 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: (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 -5- 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 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 -6- 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. Shareholders 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 shareholders 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 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. -7- 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 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. -8- EX-10.11 15 g75423ex10-11.txt 2002 INCENTIVE PLAN EXHIBIT 10.11 KIRKLAND'S, INC. 2002 EQUITY INCENTIVE PLAN 1. PURPOSE; DEFINITIONS. The purpose of the Kirkland's, Inc. 2002 Equity Incentive Plan (the "Plan") are to (a) enable Kirkland's, Inc. (the "Company") and its affiliated companies to recruit and retain highly qualified employees, directors and consultants; (b) provide those employees, directors and consultants with an incentive for productivity; and (c) provide those employees, directors and consultants with an opportunity to share in the growth and value of the Company. For purposes of the Plan, the following initially capitalized words and phrases have the meanings defined below, unless the context clearly requires a different meaning: (a) "Award" means a grant of Options, SARs or Restricted Shares pursuant to the provisions of this Plan. (b) "Award Agreement" means, with respect to any particular Award, the written document that sets forth the terms of that particular Award. (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 a 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 belonging to the Company without the consent of the Company; or (v) breaches any agreement with or duty to the Company. However, notwithstanding the foregoing, if an Participant is bound by the terms of an employment agreement with the Company or any Subsidiary that includes a definition of "cause," the determination of whether that Participant has been terminated for "Cause" will be made in accordance with that employment agreement. (e) "Change in Control" means (i) the sale, transfer, assignment or other disposition (including by merger or consolidation) by shareholders of the Company, in one transaction or a series of related transactions, of more than 50% of the voting power represented by the then outstanding capital stock of the Company to one or more persons, (ii) the sale of substantially all the assets of the Company, or (iii) the liquidation or dissolution of the Company. (f) "Code" means the Internal Revenue Code of 1986, as amended from time to time, and any successor thereto. (g) "Committee" means a committee appointed by the Board in accordance with Section 2 of this Plan. (h) "Director" means a member of the Board. (i) "Disability" means a condition rendering a Participant Disabled. (j) "Disabled" means, with respect to any Participant (i) entitled to benefits under a long-term disability policy or program of the Company, or (ii) if the Participant is not covered by any such policy or program, when the Participant is prevented by a physical or mental impairment from engaging in any substantial, gainful activity for a period of at least six (6) months, as determined by the Board, in its sole and absolute discretion; provided, however, notwithstanding the foregoing, if an Participant is bound by the terms of an employment agreement with the Company or any Subsidiary that includes a definition of "disabled" or disability," the determination of whether that Participant is "Disabled" for purposes of this Plan will be made in accordance with that employment agreement. (k) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (l) "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 last 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 last preceding date on which there were reported Share prices; or (iii) 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, the Fair Market Value will be determined by the Board acting in its discretion, which determination will be conclusive. (m) "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. (n) "Non-Employee Director" will have the meaning set forth in Rule 16b-3(b)(3)(i) promulgated by the Securities and Exchange Commission under the Exchange Act, or any successor definition adopted by the Securities and Exchange Commission; provided, however, that the Board may, to the extent necessary to comply with Section 162(m) of the Code or -2- regulations thereunder, require each "Non-Employee Director" to also be an "outside director," as that term is defined in regulations under Section 162(m) of the Code. (o) "Non-Qualified Stock Option" means any Option that is not an Incentive Stock Option. (p) "Option" means any option to purchase Shares (including Restricted Shares, if the Board so determines) granted pursuant to Section 5 hereof. (q) "Participant" means an employee, consultant or director of the Company or a Subsidiary to whom an Award is granted. (r) "Restricted Shares" means Shares that are subject to restrictions pursuant to Section 8 hereof. (s) "SAR" means a share appreciation right granted under the Plan and described in Section 6 hereof. (t) "Share" means a share of common stock, no par value, of the Company, subject to substitution or adjustment as provided in Section 3(c) 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. 2. ADMINISTRATION. The Plan will 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. 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; provided, however, that if the Company has a class of securities required to be registered under Section 12 of the Exchange Act, all members of any Committee established pursuant to this Section 2 will be Non-Employee Directors. 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 therefore, fill vacancies however caused, or remove all members of the Committee and thereafter directly administer the Plan. Members of the Board 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 will 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. -3- The Board will have full authority to grant Awards under this Plan. In particular, the Board will 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 the type of Award to be granted hereunder; (c) to determine the number of Shares, if any, to be covered by each such Award; (d) to establish the terms of each Award Agreement; (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. The Board will have the authority to adopt, alter and repeal such administrative rules, guidelines and practices governing the Plan as it, from time to time, deems advisable; to interpret the terms and provisions of the Plan and any Award Agreement; to amend the terms of any Award Agreement, provided that the Participant consents to such amendment or that such amendment does not have a material adverse effect on the Participant; 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 deems necessary to carry out the intent of the Plan. All decisions made by the Board pursuant to the provisions of the Plan will be final and binding on all persons, including the Company and Participants. No member of the Board will be liable for any good faith determination, act or omission in connection with the Plan or any Award. 3. SHARES SUBJECT TO THE PLAN. (a) Shares Subject to the Plan. The Shares to be subject or related to awards under the Plan will 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 _______ and the Company will reserve for the purposes of the Plan such number of Shares. No Participant will receive Options or SARs with respect to more than _______ Shares in any calendar year. (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 will again become available for grant under the Plan. If any Share is received in satisfaction of the exercise price payable upon exercise of an Option, or if any Share is withheld -4- pursuant to Section 11(d) in settlement of a tax obligation associated with an Award, that Share will become available for grant under the Plan. (c) Other Adjustment. In the event of any merger, reorganization, consolidation, recapitalization, stock distribution or dividend, stock split or combination, or other similar event or transaction affecting the Shares, substitutions or adjustments may be made by the Board, in its sole and absolute discretion, to the aggregate number, type and issuer of the securities reserved for issuance under the Plan, to the limit on the number of shares that may be subject to Options or SARs granted to a single Participant in any calendar year, and to the number, type, issuer and price of securities subject to outstanding Awards. (d) Change Control. Notwithstanding anything to the contrary set forth in this Plan, upon or in anticipation of any Change in Control, the Board may, in its sole and absolute discretion and without the need for the consent of any Participant, take one or more of the following actions contingent upon the occurrence of that Change in Control: (i) cause all outstanding Options and SARs to become fully vested and immediately exercisable; (ii) cause all outstanding Restricted Shares to become non-forfeitable; (iii) cancel any Option in exchange for an option to purchase common stock of any successor corporation, which new option satisfies the requirements of Treas. Reg. ss. 1.425-1(a)(4)(i) (without regard to whether the original Option was intended to be an Incentive Stock Option), (iv) cancel any Restricted Shares in exchange for a restricted shares of the common stock of any successor corporation, (v) redeem any Restricted Share for cash and/or other substitute consideration with a value equal to the Fair Market Value of an unrestricted Share on the date of the Change in Control, and/or (vi) cancel any Option or SAR in exchange for cash and/or other substitute consideration with a value equal to the (A) the number of Shares subject to that Option or SAR, multiplied by (B) the difference between the Fair Market Value per Share on the date of the Change in Control and the exercise price of that Option or SAR. 4. ELIGIBILITY. Employees, directors, consultants, and other individuals who provide services to the Company or its Subsidiaries are eligible to be granted Awards. 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. 5. OPTIONS. Options may be either: (i) Incentive Stock Options or (ii) Non-Qualified Stock Options. The Award Agreement evidencing any Option will incorporate the following terms and conditions and may contain such additional terms and conditions (not inconsistent with the terms of this Plan) as the Board deems appropriate, in its sole discretion: (a) Option Price. The exercise price per Share purchasable under a Non-Qualified Stock Option will be determined by the Board. The exercise price per Share purchasable under an Incentive Stock Option will not be less than 100% of the Fair Market Value of one 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 -5- of the Company or of a Subsidiary will have an exercise price per Share of not less than 110% of Fair Market Value of one Share on the date of the grant. (b) Option Term. The term of each Option will be fixed by the Board, but no Option will be exercisable more than ten (10) 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 (5) years. No Option may be exercised by any person after expiration of the term of the Option. (c) Method of Exercise. Subject to the terms of the applicable Award Agreement 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 will be accompanied by payment in full of the purchase price, either by certified or bank check, or such other means 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 previously acquired Shares based on the Fair Market Value of the Shares on the date the Option is exercised. No Shares will be issued upon exercise of an Option until full payment therefore has been made. A Participant will 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. (d) Incentive Stock Option Limitations. In the case of an Incentive Stock Option, 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 will not exceed $100,000. For purposes of applying the foregoing limitation, Incentive Stock Options will be taken into account in the chronological order in which they were granted. Any Option not meeting such limitation will be treated for all purposes as a Non-Qualified Stock Option. (e) Termination of Employment. Unless otherwise specified in the applicable Award Agreement, Options will be subject to the terms of Section 7 with respect to exercise following termination of employment. (f) Transferability of Options. Except as may otherwise be specifically determined by the Board with respect to a particular Option, no Option will be transferable by the Participant other than by will or by the laws of descent and distribution, and all Options will be exercisable, during the Participant's lifetime, only by the Participant or, in the event of his Disability, by his personal representative. 6. STOCK APPRECIATION RIGHTS. (a) Grant. The grant of an SAR provides the holder the right to receive the appreciation in value of Shares between the date of grant and the date of exercise. SARs may be -6- granted alone ("Stand-Alone SARs") or in conjunction with all or part of any Option ("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 will 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 will 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 will 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, will no longer be exercisable to the extent the related Tandem SARs have been exercised. Upon the exercise of a Tandem SAR, a Participant will 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, will 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 will have become vested and exercisable as of the date of exercise. Upon the exercise of a Stand-Alone SAR, a Participant will 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 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. The Award Agreement evidencing any SAR will incorporate the following terms and conditions and will contain such additional terms and -7- conditions, not inconsistent with the terms of the Plan, as the Board deems appropriate in its sole and absolute discretion: (i) Term of SAR. Unless otherwise specified in the Award Agreement, the term of a Tandem SAR will be identical to the term of the associated Option, and the term of a Stand-Alone SAR will be ten (10) years. (ii) Exercisability. SARs will vest and become exercisable at such time or times and subject to such terms and conditions as will be determined by the Board at the time of grant; provided that, unless otherwise specified in the Award Agreement, a Tandem SAR will vest and become exercisable in the same manner and at the same time as the associated Option. (iii) Termination of Employment. Unless otherwise specified in the Award Agreement, SARs will be subject to the terms of Section 7 with respect to exercise upon termination of employment. 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 one (1) year 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. (c) Cause. If a Participant's service is terminated for Cause: (i) any Option or SAR not already exercised will 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 will be immediately and automatically forfeited and the Company will refund to the Participant the Option exercise price paid for such Shares, if any. (d) Other Termination. If a Participant's service with the Company or any Subsidiary terminates for any reason other than death, Disability, or Cause, any Option or SAR held by such -8- 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 at such time as may be specified by the Board at or after the time of grant, but in no event later than the expiration of the stated term of such Option or SAR; provided, however, that if the Board does not specifically provide for any post-termination exercise period, then any Option or SAR held by such terminated Participant will expire immediately upon the date of such termination. 8. RESTRICTED SHARES. (a) Issuance. Restricted Shares may be issued either alone or in conjunction with other Awards. The Board will determine the time or times within which Restricted Shares may be subject to forfeiture, and all other conditions of such Awards. (b) Awards and Certificates. The Award Agreement evidencing the grant of any Restricted Shares will contain such terms and conditions, not inconsistent with the terms of the Plan, as the Board deems appropriate in its sole and absolute discretion. The prospective recipient of an Award of Restricted Shares will not have any rights with respect to such Award, unless and until such recipient has executed an Award Agreement and has delivered a fully executed copy thereof to 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. A share certificate will be issued in connection with each Award of Restricted Shares. Such certificate will be registered in the name of the Participant receiving the Award and will bear the following legend and/or any other legend required by this Plan, the Award Agreement, the Company's shareholders' agreement, if any, and any applicable law: THE TRANSFERABILITY OF THIS CERTIFICATE AND THE SHARES REPRESENTED HEREBY ARE SUBJECT TO THE TERMS AND CONDITIONS OF THE KIRKLAND'S, INC. 2002 INCENTIVE PLAN AND AN AGREEMENT ENTERED INTO BETWEEN THE REGISTERED OWNER AND KIRKLAND'S, INC. COPIES OF THAT PLAN AND AGREEMENT ARE ON FILE IN THE PRINCIPAL OFFICES OF KIRKLAND'S, INC. AND WILL BE MADE AVAILABLE TO THE HOLDER OF THIS CERTIFICATE WITHOUT CHARGE UPON REQUEST TO THE SECRETARY OF THE COMPANY. Share certificates evidencing Restricted Shares be held in custody by the Company or in escrow by an escrow agent until the restrictions thereon have lapsed. As a condition of any Restricted Share award, the Participant may be required to deliver 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 will be subject to the following restrictions and conditions: -9- (i) During a period commencing with the date of an Award of Restricted Shares and ending at such time or times as specified by the Board (the "Restriction Period"), the Participant will not be permitted to sell, transfer, pledge, assign or otherwise encumber Restricted Shares awarded under the Plan. The Board may condition the lapse of restrictions on Restricted Shares upon the continued employment or service of the recipient, the attainment of specified individual or corporate performance goals, or such other factors as the Board may determine, in its sole and absolute discretion. (ii) Except as provided in this Paragraph (ii) or Section 8(c)(i), once the Participant has been issued a certificate or certificates for Restricted Shares, the Participant will 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. Any distributions or dividends paid in the form of securities with respect to Restricted Shares will be subject to the same terms and conditions as the Restricted Shares with respect to which they were paid, including, without limitation, the same Restriction Period. (iii) Subject to the applicable provisions of the Award Agreement, if a Participant's service with the Company terminates prior to the expiration of the Restriction Period, all of that Participant's Restricted Shares which then remain subject to forfeiture will then be forfeited automatically. (iv) If and when the Restriction Period expires without a prior forfeiture of the Restricted Shares subject to such Restriction Period (or if and when the restrictions applicable to Restricted Shares lapse pursuant to Sections 3(d)), the certificates for such Shares will be replaced with new certificates, without the portion restrictive legends described in Section 8(b) applicable to such lapsed restrictions, and such new certificates will be promptly delivered to the Participant, the Participant's representative (if the Participant has suffered a Disability), or the Participant's estate or heir (if the Participant has died). 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 will be made that would impair the rights of a Participant with respect to an Award that is outstanding under the Plan without the Participant's consent, or that, 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: (i) increase the total number of Shares reserved for the purposes of the Plan (except as otherwise provided in Section 3(c)), or (ii) change the persons or class of persons eligible to receive Awards. -10- 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 will 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. 11. GENERAL PROVISIONS. (a) The Board may require any Participant to represent to and agree with the Company in writing that the Participant is acquiring securities of the Company for investment purposes and without a view to distribution thereof and as to such other matters as the Board believes are appropriate. The certificate evidencing any 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 will 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 will 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 will not confer upon any person the right to continued employment or engagement by the Company or such Subsidiary, nor will it interfere in any way with the right of the Company or such Subsidiary to terminate the employment or engagement of any of its service providers 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, the Participant will 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 part of the Award that gives rise to the withholding requirement. The obligations of the Company under this Plan are conditioned on such payment or arrangements and the Company will, to the extent permitted by law, have the right to deduct any such taxes from any payment otherwise due to the Participant. -11- 12. EFFECTIVE DATE OF PLAN. This Plan will become effective on the date that it is adopted by the Board; provided, however, that all Options intended to be Incentive Stock Options will automatically be converted into Non-Qualified Stock Options if the Plan is not approved by the Company's stockholders 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. 13. TERM OF PLAN. This Plan will continue in effect until terminated in accordance with Section 9; provided, however, that no Incentive Stock Option will be granted hereunder on or after the tenth (10th) anniversary of the date of shareholder approval of the Plan; but provided further, that Incentive Stock Options granted prior to such tenth (10th) anniversary may extend beyond that date. 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 will not be construed as rendering any other provisions contained herein as invalid or unenforceable, and all such other provisions will be given full force and effect to the same extent as though the invalid or unenforceable provision was not contained herein. 15. GOVERNING LAW. This Plan and all Awards made and actions taken thereunder will 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. 16. BOARD ACTION. Notwithstanding anything to the contrary set forth in this Plan, any and all actions of the Board 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, will 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). -12- 17. NOTICES. Any notice to be given to the Company pursuant to the provisions of the Plan will be addressed to the Company in care of its Secretary (or such other person as the Company may designate from time to time) at its principal executive office, and any notice to be given to a Participant will be delivered personally or addressed to him or her at the address given beneath his or her signature on his or her Award Agreement, or at such other address as such Participant may hereafter designate in writing to the Company. Any such notice will be deemed duly given on the date and at the time delivered via personal, courier or recognized overnight delivery service or, if sent via telecopier, on the date and at the time telecopied with confirmation of delivery or, if mailed, on the date five (5) days after the date of the mailing (which will be by regular, registered or certified mail). Delivery of a notice by telecopy (with confirmation) will be permitted and will be considered delivery of a notice notwithstanding that it is not an original that is received. ADOPTION AND APPROVAL OF PLAN DATE PLAN ADOPTED BY BOARD: _____________ DATE PLAN APPROVED BY STOCKHOLDERS: _____________ EFFECTIVE DATE OF PLAN: _____________ -13- EX-10.12 16 g75423ex10-12.txt EMPLOYEE STOCK PURCHASE PLAN EXHIBIT 10.12 KIRKLAND'S, INC. 2002 EMPLOYEE STOCK PURCHASE PLAN 1. Purpose and Effective Date. (a) Purpose. The purpose of the Plan is to provide Eligible Employees with an opportunity to increase their interest in the success of the Company by purchasing Stock from the Company on favorable terms and to pay for such purchases through payroll deductions. The Plan is intended to satisfy the requirements of Section 423 of the Code and will be interpreted accordingly. (b) Effective Date. The Plan is effective as of the first date that Stock is sold to the public pursuant to an effective registration statement filed by the Company with the Securities and Exchange Commission. 2. Administration. (a) Committee Composition. The Plan will be administered by the Committee. The Committee will consist exclusively of one or more directors of the Company, who will be appointed by the Board. (b) Committee Responsibilities. The Committee will interpret the Plan and make all other policy decisions relating to the operation of the Plan. The Committee may adopt such rules, guidelines and forms as it deems appropriate to implement the Plan. The Committee's determinations under the Plan will be final and binding on all persons. 3. Enrollment And Participation. (a) Offering Periods. While the Plan is in effect, two overlapping Offering Periods will commence in each calendar year. The Offering Periods will consist of the 24-month periods commencing on each February 1st and August 1st, except that the first Offering Period will commence on the date of the IPO and end on July 31, 2004. (b) Accumulation Periods. While the Plan is in effect, two Accumulation Periods will commence in each calendar year. The Accumulation Periods will consist of the six-month periods commencing on each February 1st and August 1st, except that the first Accumulation Period will commence on the date of the IPO and end on July 31, 2002. (c) Enrollment. Any individual who, on the day preceding the first day of an Offering Period, qualifies as an Eligible Employee may elect to become a Participant in the Plan for such Offering Period by executing the enrollment form prescribed for this purpose by the Committee. The enrollment form must be filed with the Company at the prescribed location at least 15 days prior to the commencement of such Offering Period. (d) Duration of Participation. Once enrolled in the Plan, a Participant will continue to participate in the Plan until he or she ceases to be an Eligible Employee, withdraws from the Plan under Section 5(a) or reaches the end of the Accumulation Period in which his or her employee contributions were discontinued under Section 4(d) or 8(b). A Participant who discontinued employee contributions under Section 4(d) or withdrew from the Plan under Section 5(a) may again become a Participant, if he or she then is an Eligible Employee, by following the procedure described in Subsection (c) above. A Participant whose employee contributions were discontinued automatically under Section 8(b) will automatically resume participation at the beginning of the earliest Accumulation Period ending in the next calendar year, if he or she then is an Eligible Employee. (e) Applicable Offering Period. For purposes of calculating the Purchase Price under Section 7(b), the applicable Offering Period will be determined as follows: (i) Once a Participant is enrolled in the Plan for an Offering Period, such Offering Period will continue to apply to him or her until the earliest of (A) the end of such Offering Period, (B) the end of his or her participation under Subsection (d) above or (C) re-enrollment in a subsequent Offering Period under Paragraph (ii) below. (ii) If the Fair Market Value of Stock on the last trading day before the commencement of the Offering Period in which the Participant is enrolled is higher than on the last trading day before the commencement of any subsequent Offering Period, the Participant will automatically be re-enrolled for such subsequent Offering Period. (iii) When a Participant reaches the end of an Offering Period but his or her participation is to continue, then such Participant will automatically be re-enrolled for the Offering Period that commences immediately after the end of the prior Offering Period. 4. Employee Contributions. (a) Frequency of Payroll Deductions. A Participant may purchase shares of Stock under the Plan solely by means of payroll deductions. Payroll deductions, as designated by the Participant pursuant to Subsection (b) below, will occur on each payday during participation in the Plan. (b) Amount of Payroll Deductions. An Eligible Employee will designate on the enrollment form the portion of his or her Compensation that he or she elects to have withheld for the purchase of Stock. Such portion may be any whole percentage of the Eligible Employee's Compensation not less than 1% and not more than 15%. (c) Changing Withholding Rate. If a Participant wishes to change the rate of payroll withholding, he or she may do so by filing a new enrollment form with the Company at the prescribed location at any time. The new withholding rate will be effective as soon as reasonably practicable after such form has been received by the Company. (d) Discontinuing Payroll Deductions. If a Participant wishes to discontinue employee contributions entirely, he or she may do so by filing a new enrollment form with the Company at the prescribed location at any time. Payroll withholding will cease as soon as reasonably practicable after such form has been received by the Company. (In addition, employee contributions may be discontinued automatically pursuant to Section 8(b).) A Participant who has discontinued employee contributions may resume such contributions by filing a new enrollment form with the Company at the prescribed location. Payroll withholding will resume as soon as reasonably practicable after such form has been received by the Company. -2- 5. Withdrawals and Re-enrollment. (a) Withdrawals. A Participant may elect to withdraw from the Plan by filing the prescribed form with the Company at the prescribed location at any time before the last day of an Accumulation Period. As soon as reasonably practicable thereafter, payroll deductions will cease and the entire amount credited to the Participant's Plan Account will be refunded to him or her in cash, without interest. No partial withdrawals will be permitted. (b) Re-enrollment. A former Participant who has withdrawn from the Plan will not be a Participant until he or she re-enrolls in the Plan under Section 3(c). Re-enrollment may be effective only at the commencement of an Offering Period. 6. Change in Employment Status. (a) Termination of Employment. Termination of employment as an Eligible Employee for any reason, including death, will be treated as an automatic withdrawal from the Plan under Section 5(a). (A transfer from one Participating Company to another will not be treated as a termination of employment.) (b) Leave of Absence. For purposes of the Plan, employment will not be deemed to terminate when the Participant goes on a military leave, a sick leave or another bona fide leave of absence, if the leave was approved by the Company in writing. Employment, however, will be deemed to terminate 90 days after the Participant goes on a leave, unless a contract or statute guarantees his or her right to return to work. Employment will be deemed to terminate in any event when the approved leave ends, unless the Participant immediately returns to work. (c) Death. In the event of the Participant's death, the amount credited to his or her Plan Account will be paid to a beneficiary designated by him or her for this purpose on the prescribed form or, if none, to the Participant's estate. Such form will be valid only if it was filed with the Company at the prescribed location before the Participant's death. 7. Plan Accounts and Purchase of Shares. (a) Plan Accounts. The Company will maintain a Plan Account on its books in the name of each Participant. Whenever an amount is deducted from the Participant's Compensation under the Plan, such amount will be credited to the Participant's Plan Account. Amounts credited to Plan Accounts will not be trust funds and may be commingled with the Company's general assets and applied to general corporate purposes. No interest will be credited to Plan Accounts. (b) Purchase Price. The Purchase Price for each share of Stock purchased at the close of an Accumulation Period will be 85% of the lower of: (i) the Fair Market Value on the last day of such Accumulation Period; or (ii) the Fair Market Value on the first day of the applicable Offering Period (as determined under Section 3(e)). -3- (c) Number of Shares Purchased. As of the last day of each Accumulation Period, each Participant will be deemed to have elected to purchase the number of shares of Stock calculated in accordance with this Subsection (c), unless the Participant has previously elected to withdraw from the Plan in accordance with Section 5(a). The amount then in the Participant's Plan Account will be divided by the Purchase Price, and the number of shares that results will be purchased from the Company with the funds in the Participant's Plan Account. The foregoing notwithstanding, no Participant will purchase more than [25,000] shares of Stock with respect to any Accumulation Period nor more than the amounts of Stock set forth in Sections 8(b). (d) Available Shares Insufficient. If the aggregate number of shares that all Participants elect to purchase during an Accumulation Period exceeds the maximum number of shares remaining available for issuance under Section 13(a), then the number of shares to which each Participant is entitled will be determined by multiplying the number of shares available for issuance by a fraction, the numerator of which is the number of shares that such Participant has elected to purchase and the denominator of which is the number of shares that all Participants have elected to purchase. (e) Issuance of Stock. Certificates representing the shares of Stock purchased by a Participant under the Plan will be issued to him or her as soon as reasonably practicable after the close of the applicable Accumulation Period, except that the Committee may determine that such shares will be held for each Participant's benefit by a broker designated by the Committee (unless the Participant has elected that certificates be issued to him or her). Shares may be registered in the name of the Participant or jointly in the name of the Participant and his or her spouse as joint tenants with right of survivorship or as community property. (f) Unused Cash Balances. An amount remaining in the Participant's Plan Account that represents the Purchase Price for any fractional share will be carried over in the Participant's Plan Account to the next Accumulation Period. Any amount remaining in the Participant's Plan Account that represents the Purchase Price for whole shares that could not be purchased by reason of Subsection (c) above, Section 8(b) or Section 13(a) will be refunded to the Participant in cash, without interest. 8. Limitations on Stock Ownership. (a) Five Percent Limit. Any other provision of the Plan notwithstanding, no Participant will be granted a right to purchase Stock under the Plan if such Participant, immediately after his or her election to purchase such Stock, would own stock possessing more than 5% of the total combined voting power or value of all classes of stock of the Company or any parent or Subsidiary of the Company. For purposes of this Subsection (a), the following rules will apply: (i) Ownership of stock will be determined after applying the attribution rules of Section 424(d) of the Code; and (ii) Each Participant will be deemed to own any stock that he or she has a right or option to purchase under this or any other plan or arrangement. (b) Dollar Limit. Any other provision of the Plan notwithstanding, no Participant will purchase Stock with a Fair Market Value in excess of the following limit: -4- (i) In the case of Stock purchased during an Offering Period that commenced in the current calendar year, the limit will be equal to (A) $25,000 minus (B) the Fair Market Value of the Stock that the Participant previously purchased in the current calendar year (under this Plan and all other employee stock purchase plans of the Company or any parent or Subsidiary of the Company). (ii) In the case of Stock purchased during an Offering Period that commenced in the immediately preceding calendar year, the limit will be equal to (A) $50,000 minus (B) the Fair Market Value of the Stock that the Participant previously purchased (under this Plan and all other employee stock purchase plans of the Company or any parent or Subsidiary of the Company) in the current calendar year and in the immediately preceding calendar year. (iii) In the case of Stock purchased during an Offering Period that commenced in the second preceding calendar year, the limit will be equal to (A) $75,000 minus (B) the Fair Market Value of the Stock that the Participant previously purchased (under this Plan and all other employee stock purchase plans of the Company or any parent or Subsidiary of the Company) in the current calendar year and in the two preceding calendar years. 9. Rights Not Transferable. The rights of any Participant under the Plan, or any Participant's interest in any Stock or moneys to which he or she may be entitled under the Plan, will not be transferable by voluntary or involuntary assignment or by operation of law, or in any other manner other than by beneficiary designation or the laws of descent and distribution. If a Participant in any manner attempts to transfer, assign or otherwise encumber his or her rights or interest under the Plan, other than by beneficiary designation or the laws of descent and distribution, then such act will be treated as an election by the Participant to withdraw from the Plan under Section 5(a). 10. No Rights as an Employee. Nothing in the Plan or in any right granted under the Plan will confer upon the Participant any right to continue in the employ of a Participating Company for any period of specific duration or interfere with or otherwise restrict in any way the rights of the Participating Companies or of the Participant, which rights are hereby expressly reserved by each, to terminate his or her employment at any time and for any reason, with or without cause. 11. No Rights as a Stockholder. A Participant will have no rights as a stockholder with respect to any shares of Stock that he or she may have a right to purchase under the Plan until such shares have been purchased on the last day of the applicable Accumulation Period. 12. Securities Law Requirements. Shares of Stock will not be issued under the Plan unless the issuance and delivery of such shares comply with (or are exempt from) all applicable requirements of law, including (without limitation) the Securities Act of 1933, as amended, the rules and regulations promulgated thereunder, state securities laws and regulations, and the regulations of any stock exchange or other securities market on which the Company's securities may then be traded. 13. Stock Offered Under the Plan. (a) Authorized Shares. The aggregate number of shares of Stock available for purchase under the Plan will be _______, subject to adjustment pursuant to this Section 13. -5- (b) Adjustments. The aggregate number of shares of Stock offered under the Plan, the share limit described in Section 7(c) and the price of shares that any Participant has elected to purchase will be adjusted proportionately by the Committee for any increase or decrease in the number of outstanding shares of Stock resulting from a subdivision or consolidation of shares or the payment of a stock dividend, any other increase or decrease in such shares effected without receipt or payment of consideration by the Company, the distribution of the shares of a Subsidiary to the Company's stockholders or a similar event. (c) Reorganizations. Any other provision of the Plan notwithstanding, immediately prior to the effective time of a Corporate Reorganization, the Offering Period and Accumulation Period then in progress will terminate and shares will be purchased pursuant to Section 7, unless the Plan is assumed by the surviving corporation or its parent corporation pursuant to the plan of merger or consolidation. The Plan will in no event be construed to restrict in any way the Company's right to undertake a dissolution, liquidation, merger, consolidation or other reorganization. 14. Amendment or Discontinuance. The Board will have the right to amend, suspend or terminate the Plan at any time and without notice. Except as provided in Section 13, any increase in the aggregate number of shares of Stock to be issued under the Plan will be subject to approval by a vote of the stockholders of the Company. 15. Definitions. Capitalized terms used herein have the meanings set forth in this Section 15. (a) "Accumulation Period" means a period during which contributions may be made toward the purchase of Stock under the Plan, as determined pursuant to Section 3(b). (b) "Board" means the Board of Directors of the Company, as constituted from time to time. (c) "Code" means the Internal Revenue Code of 1986, as amended. (d) "Committee" means a committee of the Board, as described in Section 2. (e) "Company" means Kirkland's, Inc. (f) "Compensation" means (i) the total compensation paid in cash to a Participant by a Participating Company, including salaries, wages, bonuses, incentive compensation, commissions, overtime pay and shift premiums, plus (ii) any pre-tax contributions made by the Participant under Section 401(k) or 125 of the Code. "Compensation" will exclude all non-cash items, moving or relocation allowances, cost-of-living equalization payments, car allowances, tuition reimbursements, imputed income attributable to cars or life insurance, severance pay, fringe benefits, contributions or benefits received under employee benefit plans, income attributable to the exercise of stock options, and similar items. The Committee will determine whether a particular item is included in Compensation. (g) "Corporate Reorganization" means: (i) The consummation of a merger or consolidation of the Company with or into another entity, or any other corporate reorganization; or -6- (ii) The sale, transfer or other disposition of all or substantially all of the Company's assets or the complete liquidation or dissolution of the Company. (h) "Eligible Employee" means any employee of a Participating Company who meets both of the following requirements: (i) His or her customary employment is for more than five months per calendar year and for more than 20 hours per week; and (ii) He or she has been an employee of a Participating Company for at least 12 consecutive months. (i) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (j) "Fair Market Value" means, as of any specified date: (i) the closing price of the Stock as reported on the principal nationally recognized stock exchange on which Stock is traded, or if no price is are reported on that date, the closing price on the last preceding date on which there were reported Stock prices; (ii) if the Stock is not listed or admitted to unlisted trading privileges on a nationally recognized stock exchange, the closing price of the Stock on that date as reported by The Nasdaq Stock Market, or if no price is reported for that date, the closing price of the Stock on the last preceding date for which there were reported Stock prices; or (iii) if the Stock is not listed or admitted to unlisted trading privileges on a nationally recognized stock exchange or traded on The Nasdaq Stock Market, the fair market value of one share of Stock, as determined by the Board in its discretion, which determination will be conclusive and binding on all persons. Notwithstanding the foregoing, the Fair Market Value on the first day of the first Offering Period will be equal to the price set forth in the final prospectus included in the Form S-1 filed with the Securities and Exchange Commission in connection with the IPO. (k) "IPO" means the first offering of Stock to the public pursuant to an effective registration statement filed by the Company with the Securities and Exchange Commission. (l) "Offering Period" means a period with respect to which the right to purchase Stock may be granted under the Plan, as determined pursuant to Section 3(a). (m) "Participant" means an Eligible Employee who elects to participate in the Plan, as provided in Section 3(c). (n) "Participating Company" means (i) the Company and (ii) each present or future Subsidiary designated by the Committee as a Participating Company. (o) "Plan" means this Kirkland's, Inc. 2002 Employee Stock Purchase Plan, as amended from time to time. -7- (p) "Plan Account" means the account established for each Participant pursuant to Section 7(a). (q) "Purchase Price" means the price at which Participants may purchase Stock under the Plan, as determined pursuant to Section 7(b). (r) "Stock" means the Common Stock of the Company. (s) "Subsidiary" means any corporation (other than the Company) in an unbroken chain of corporations beginning with the Company, if each of the corporations other than the last corporation in the unbroken chain owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. -8- EX-10.13 17 g75423ex10-13.txt AMENDED AND RESTATED SHAREHOLDERS AGREEMENT Exhibit 10.13 EXECUTION =============================================================================== AMENDED AND RESTATED SHAREHOLDERS AGREEMENT among KIRKLAND'S, INC., AND THE OTHER PARTIES SPECIFIED HEREIN =============================================================================== Dated as of April 15, 2002 TABLE OF CONTENTS
SECTIONS PAGE ---- 1. Certain Defined Terms......................................................................................3 2. Prohibited Transfers.......................................................................................8 3. Preemptive Rights.........................................................................................10 4. Third Party Offers to Shareholders; Participation Rights..................................................12 5. Stock Splits, Etc.........................................................................................16 6. Joinder Requirements......................................................................................16 7. Failure to Deliver Shares.................................................................................17 8. Termination...............................................................................................17 9. Registration Rights.......................................................................................18 10. Financial Reports and Information.........................................................................18 11. Company Governance Provisions.............................................................................18 12. Specific Performance......................................................................................20 13. Legend....................................................................................................20 14. Notices...................................................................................................21 15. Issuance of Stock by the Company..........................................................................23 16. Entire Agreement and Amendments...........................................................................23 17. Expenses..................................................................................................24 18. Dividends.................................................................................................24 19. Amendment to Charter......................................................................................24 20. Governing Law; Successors and Assigns.....................................................................24 21. Waivers...................................................................................................25 22. Severability..............................................................................................25 23. Captions..................................................................................................25 24. Counterparts..............................................................................................25 25. Attorney's Fees...........................................................................................25 26. Parties Benefited.........................................................................................25 27. Successors and Assigns....................................................................................25 28. Prior Agreement Void......................................................................................25
AMENDED AND RESTATED SHAREHOLDERS AGREEMENT THIS AMENDED AND RESTATED SHAREHOLDERS AGREEMENT (the "Agreement") amends and restates a Shareholders Agreement dated as of June 12, 1996, and is made as of the 15th day of April, 2002, 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 "Company" or the "Representative"), - SSM VENTURE PARTNERS, L.P., - JOSEPH R. HYDE, III, - JOHNSTON C. ADAMS, JR., - JOHN H. PONTIUS, - CT/KIRKLAND EQUITY PARTNERS, L.P., - R-H CAPITAL PARTNERS, L.P., - TCW/KIRKLAND EQUITY PARTNERS, L.P., - CAPITAL RESOURCE LENDERS II, L.P. ("CRL"), - ALLIED CAPITAL CORPORATION ("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"), - GLOBAL PRIVATE EQUITY II LIMITED PARTNERSHIP, - ADVENT DIRECT INVESTMENT PROGRAM LIMITED PARTNERSHIP, - ADVENT PARTNERS LIMITED PARTNERSHIP, - CARL KIRKLAND, - ROBERT KIRKLAND, - ROBERT ALDERSON, - THE AMY KATHERINE ALDERSON TRUST, (the "AKA Trust"), - THE ALLISON LEIGH ALDERSON TRUST (the "ALA Trust"), - THE CARL T. KIRKLAND GRANTOR RETAINED ANNUITY TRUST 2001-1 (the "CTK GRAT"), and - STEVEN COLLINS (Carl Kirkland, Robert Kirkland, Robert Alderson, the AKA Trust, the ALA Trust, the CTK GRAT and Steven Collins being herein referred to collectively as the "Individual Investors"). WHEREAS, on June 12, 1996, Holdings, the Company, those companies then affiliated with the Company (collectively, the "Affiliated Companies") and certain of the Individual Investors consummated the transactions contemplated by a Recapitalization Agreement (the "Recapitalization Agreement") which, among other things, included the issuance by the Company and the Affiliated Companies of shares of Common Stock, Class A Preferred Stock, Class B Preferred Stock and Class C Preferred Stock in accordance with the terms of the Recapitalization Agreement; WHEREAS, in connection with the Company's consummation of the transactions contemplated by that certain Senior Subordinated Note and Warrant Purchase Agreement dated on or about June 12, 1996, as amended and in effect as of the date hereof (the "Mezzanine Purchase Agreement"), pursuant to which the Mezzanine Warrant Holders loaned a total of $20,000,000 in subordinated debt to the Company and the Affiliated Companies and the Mezzanine Warrant Holders received warrants to purchase shares of Common Stock of the Company and the Affiliated Companies ("Mezzanine Warrants" and the shares subject to the Mezzanine Warrants, the "Mezzanine Warrant Shares"); WHEREAS, in connection with the transactions contemplated by the Recapitalization Agreement, the Company granted to the Management Investors options to purchase shares of Common Stock and the Company subsequently granted Reynolds C. Faulkner options to purchase shares of Common Stock, in each case pursuant to the Company's 1996 Executive Incentive and Non-Qualified Stock Option Plan and the respective option agreements governing such options (collectively, as the same may be amended hereafter, the "Option Agreements", and the shares underlying such options are referred to herein as the "Option Shares"); WHEREAS, on or about June 12, 1996, as an inducement to completion of the transactions contemplated by the Recapitalization Agreement and the Mezzanine Purchase Agreement discussed above, Holdings, the Company, the Mezzanine Warrant Holders and certain of the Individual Investors 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 the Shareholders Agreement dated as of June 12, 1996, as amended (the "Original Shareholders Agreement"); -2- WHEREAS, in connection with the consummation of the transactions contemplated by the sixth amendment to that credit agreement between the Company, the Affiliated Companies, BankBoston, N.A. and the other lenders specified therein dated on or about July 7, 1999, the Company and the Affiliated Companies issued to certain investors warrants to purchase shares of Common Stock (the "1999 Warrants", and the shares subject to the 1999 Warrants the "1999 Warrant Shares"); WHEREAS, on or about December 31, 1999, (i) the Affiliated Companies merged with and into Kirkland's Stores, Inc., a wholly owned subsidiary of the Company (the Merger"), (ii) pursuant to the Merger the Mezzanine Warrants and the 1999 Warrants became exercisable only with respect to shares of Common Stock of the Company and the Class A Preferred Stock, the Class B Preferred Stock, and the Class C Preferred Stock remained issued and outstanding in the Company only, and (iii) the Company amended the Original Shareholders Agreement to reflect the Merger; WHEREAS, in connection with the consummation of the transactions contemplated by a Securities Purchase Agreement dated on or about August 8, 2000 (the "Purchase Agreement"), the Company issued to the purchasers specified in the Purchase Agreement additional shares of Common Stock, shares of Class D Preferred Stock and warrants to purchase shares of Common Stock (the "2000 Warrants" and the shares subject to the 2000 Warrants, the "2000 Warrant Shares"); and WHEREAS, the Company desires to hereby amend and restate the Original Shareholders Agreement, as amended, to incorporate into the scope of the Original Shareholders Agreement the Class D Preferred Stock, the 1999 Warrants, the 2000 Warrants, the 1999 Warrant Shares and the 2000 Warrant Shares, and otherwise reflect the Company's current capital structure. NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and undertakings of the Company 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 and not previously defined 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 -3- 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 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) "Bona Fide Offer" shall mean a bona fide written offer from any Person other than the Company 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, Class C Preferred Stock or Class D Preferred Stock having an aggregate stated value equal to the amount set forth. (f) "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 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 or Options, in each case which are fully vested and then owned by any Shareholder. (g) "Common Shares" shall mean issued and outstanding shares of Common Stock. (h) "Common Stock" shall mean the common stock, par value $.01 per share, of the Company. (i) "Consulting Agreement" shall mean the Consulting Agreement by and between Robert Kirkland and the Company and dated on or about June 12, 1966, as the same may have been or may hereafter be amended. (j) "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. (k) "Equity" means all initial capital contributed to the Company by the Shareholders as of June 12, 1996, 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 June 12, 1996; (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. (l) "Excluded Securities" shall mean, collectively: -4- (i) All options available for grant under a Stock Option Plan and all shares of Common Stock purchaseable under a Stock Option Plan; (ii) Common Stock to be issued as a stock dividend; (iii) Common Stock issuable upon the exercise of warrants or rights or upon conversion or exchange of convertible or exchangeable securities; (iv) Shares of any class of the 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 the Company; (v) Any securities to be issued by the Company pursuant to the acquisition by the Company of any Person by means of merger, stock purchase, reorganization, purchase of substantially all the assets or otherwise in which the Company, or the 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 (vi) Any securities to be issued pursuant to a Public Offering. (m) "Fully Diluted Common Stock" means the number of Common Shares plus the number of shares of Common Stock issuable upon conversion, exchange or exercise of other outstanding securities of the Company. (n) "Management Investors" shall mean Carl Kirkland and Robert Alderson. (o) "Mezzanine Investor" shall mean any Mezzanine Warrant Holder or any other Person who holds, from time to time, any Mezzanine Warrants or Warrant Shares, and who is or who becomes a party to this Agreement pursuant to the terms hereof. (p) "Management Agreements" shall mean those letter agreements dated June 12, 1996, providing for employment of the Management Investors with the Company, as the same may have been or may hereafter be amended. (q) "Management Pledge Agreement" shall mean the Management Pledge Agreement dated June 12, 1996, executed by certain of the Individual Investors in favor of the First National Bank of Boston, as Administrative Agent, as the same may have been or may hereafter be amended. (r) "Options" shall mean incentive stock or non-qualified options granted pursuant to a Stock Option Plan, including without limitation the Options granted pursuant to the Option Agreements. -5- (s) "Parent Pledge Agreement" shall mean the Parent Pledge Agreement dated June 12, 1996, executed by Holdings in favor of The First National Bank of Boston, as Administrative Agent, as the same may have been or may hereafter be amended. (t) "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. The reversion of Stock from a trust described in clause (iv) above to the Individual Investor who is the settlor of such trust shall also constitute a "Permitted Transfer." (u) "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. (v) "Preferred Stock" shall mean the Class A Preferred Stock, the Class B Preferred Stock, the Class D Preferred Stock and, where applicable, the Class C Preferred Stock, of the Company. (w) "Public Offering" shall mean the sale of shares of Common Stock in a registered underwritten public offering resulting in gross proceeds to the Company of at least Thirty Million Dollars ($30,000,000). (x) "Securities" shall mean all shares of capital stock, options, warrants, notes, bonds or other equity or debt securities offered or sold by the Company from time to time on or after the date hereof. (y) "Shareholder" shall mean any Person who holds, from time to time, any Shares or Warrants, and who or which is or becomes a party to this Agreement pursuant to the terms hereof. (z) "Shares" shall mean and include all issued and outstanding shares of Common Stock or Preferred Stock now owned or hereafter acquired by the Shareholders. (aa) "Stock" shall mean and include all shares of Common Stock and Preferred Stock of the Company, including without limitation, shares of Common Stock issued, issuable or transferable on the exercise of Options, 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 the Company which may be issued in exchange for -6- 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). (bb) "Stock Option Plan" shall mean any Stock Option Plan adopted by the Company providing for the issuance of the shares of Common Stock to employees of the Company or Company subsidiaries. (cc) "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. (dd) "Warrants" shall mean the Mezzanine Warrants, 1999 Warrants, 2000 Warrants or other warrants issued by the Company from time to time hereafter. 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 Class D Preferred Stock Preamble Company 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)
-7- Kirkland's Preamble Individual Investors Preamble Marlborough Preamble Mezzanine Purchase Agreement Preamble Mezzanine Warrant Holders Preamble Mezzanine Warrants Preamble Non-Selling Shareholders 4(a) Notice of Acceptance 3(c) Notice of Refused Securities 3(c) Offer 3(b) Offered A/B/D Preferred Shares 4(g)(ii)(B) Offered C Preferred Shares 4(g)(ii)(C) Offered Common Shares 4(g)(ii)(A) Offered Shares 4(a) Outside Offer 3(f) Participating Shareholder (4)(g)(i) Participation Right 4(g)(ii) Preemptive Offer 3(a) Preferred A/B/D 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) Transferring Shareholder 7 Unpurchased Remaining Offered Shares 4(c) Unpurchased Remaining Shares Notice 4(c) 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 Company or as expressly provided in this Agreement. No Transfer shall be effective and the Company shall not, and shall not be compelled to, recognize -8- 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 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 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) 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. (e) 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 Company) delivered to the Company 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 Company) may be purchased by the Company 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, -9- 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 lender executes against, or otherwise obtains an ownership interest in, the pledged shares or their proceeds, (iii) if any other Individual Investor is the borrower and pledgor, the Management Agreement, if any, of such Individual Investor will terminate in the event the lender executes against, or otherwise obtains an ownership interest in, the shares pledged by that Individual Investor or their proceeds, 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, the Company shall not issue, sell or exchange, agree to issue, sell or exchange, or reserve or set aside for issuance, sale or exchange, any Securities unless the Company shall have first offered (the "Preemptive Offer") to sell such Securities to the Company's Shareholders on the terms set forth herein. 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 Company 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 Company pursuant to the offer (the "Offer"), and the Common Equity Percentage applicable to the Shareholder receiving such notice. The 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 Company, 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. The Company shall not 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 Company shall give written notice (the -10- "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 Company 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 Company 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 Company 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 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 the 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 Company 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 Company 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 Company may rescind all Notices of Acceptance tendered by Shareholders by providing written notice of such rescission to each Accepting Shareholder and the Company shall not sell any Securities pursuant to the Outside Offer. -11- (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 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 Company and its counsel, and such Shareholder or other purchaser and such Shareholder's or other purchaser's counsel. (i) The Shareholders hereby waive any preemptive rights that they may have in connection with the grant of options to purchase 1,918 shares of Common Stock at $0.01 per share to a consultant as of July 1, 2001 and the grant of options to purchase up to 9,200 shares of Common Stock at $71.00 per share to management employees on November 29, 2001. The Board of Directors determined that these exercise prices were not less than the fair market value of the Common Stock on the respective grant dates. 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 the Company ("Offered Shares") which it desires to accept, it must give written notice ("First Refusal Notice") to the Company 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 the 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 Company 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 Company 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") the Company 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"). The Company shall notify the Selling Shareholder within the Company Option Period whether the Company will exercise such -12- right, such notice (the "Company Notice") specifying the amount of Offered Shares to be purchased by the Company, if any (any remaining amount being the "Remaining Offered Shares"). A notice by the Company that it will purchase Offered Shares is herein referred to as a "Company Purchase Notice.") The Company Option Period shall expire on the thirtieth day after the First Refusal Notice or the date the Company gives a Company Notice indicating that the Company 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 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 Company and Non-Selling Shareholders shall be deemed rescinded if all of the Offered Shares are not to be purchased pursuant thereto. (e) If the Company 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 Company or such other place as the Selling Shareholder and the Company (if the Company is a purchaser) 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 Company and Non-Selling Shareholders, then, within ten (10) days after the earlier of (i) the -13- 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 Company 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 Company 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 Company 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 Company 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: (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, Class B Preferred Stock or Class D Preferred Stock (the "Offered A/B/D Preferred Shares," and the aggregate stated value of the Offered A/B/D Preferred Shares being herein referred to as the "Preferred A/B/D Value"), a number of shares of Class A Preferred Stock, -14- Class B Preferred Stock or Class D Preferred Stock (without regard to voting rights) having an aggregate stated value equal to the product of the Preferred A/B/D Value times a fraction, the numerator of which is the aggregate stated value of the shares of Class A Preferred Stock, Class B Preferred Stock or Class D Preferred Stock owned by such Participating Shareholder and the denominator of which is the sum of the Preferred A/B/D Value and the aggregate stated value of all shares of Class A Preferred Stock, Class B Preferred Stock and Class D Preferred Stock owned by all Participating Shareholders and the Selling Shareholder. The number of Offered A/B/D Preferred Shares to be sold by the Selling Shareholder to the Purchasers shall be reduced by the number of Offered A/B/D Preferred Shares having an aggregate stated value equal to the aggregate stated value of the shares of Class A Preferred Stock, Class B Preferred Stock or Class D 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 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 -15- 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 the Company after the date of this Agreement 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 eighty percent (80%) 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 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 Common 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 -16- 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 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 eighty percent (80%) 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 Company. 7. Failure to Deliver Shares. If a Shareholder (the "Transferring Shareholder") becomes obligated to Transfer any Stock to the Company 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 such other Shareholder, as the case may be, may, at its 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 Company, 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 Company, such other Shareholder or purchaser, as the case may be, a new certificate or certificates representing such Stock; provided, however, the Company 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 Company its agreement to indemnify, defend and hold harmless the Company, its officers and employees, successors and assigns, from any and all losses, claims, damages or liabilities (or actions in respect thereof) to which the Company may become subject as a result of, arising out of, or based upon the Company so canceling and issuing Stock, and such other Shareholder or purchaser, as the case may be, shall reimburse the Company for any legal or other expenses reasonably incurred by the Company in connection therewith. All of the Transferring Shareholder's rights in and to such Stock shall terminate as of the date of such Notice. 8. Termination. Except as provided in Section 16 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%). -17- 9. Registration Rights. The Shareholders shall have the registration and other rights set forth in the Amended and Restated Registration Rights Agreement dated as of 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 Company, for so long as this Agreement shall be in effect, the Company agrees to furnish each of the Shareholders with audited consolidated and consolidating financial statements of the Company 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 Company's independent certified public accountants (which shall be of recognized national standing), including such accountant's management letters to the Company and a breakdown of all the Shareholders of the Company, listing next to each Shareholder's name, the Shareholder's Common Equity Percentage. (b) If for any period the Company shall have any subsidiary or subsidiaries whose accounts are consolidated with those of the Company, then in respect of such period the financial statements delivered pursuant to the foregoing Section 10(a) shall be the consolidated financial statements of the 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 Company to their lenders or released to the public and copies of all regular and periodic reports, if any, filed by the Company with the Securities and Exchange Commission or any securities exchange. (d) Upon request from any Shareholder including any Selling Shareholder to the Company, the 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. 11. Company Governance Provisions. (a) 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 the Company's 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 Company will take all necessary or desirable actions within its control, in order to cause: (i) the election to the Board of Directors of the Company of: -18- (A) two (2) representatives nominated by Advent International Corporation, but only for so long as investment funds affiliated with Advent International Corporation have a Common Equity Percentage (directly or indirectly through Holdings) of at least fifteen percent (15%); (B) one representative nominated 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); (C) one representative nominated 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%); (D) One (1) representative nominated by Carl Kirkland, so long as he remains an employee (or retired employee) of the Company and he has a Common Equity Percentage of at least four percent (4%) of the outstanding shares of Common Stock; (E) One (1) representative nominated by Robert Alderson, so long as he remains an employee (or retired employee) of the Company and he has a Common Equity Percentage of at least four percent (4%) of the outstanding shares of Common Stock; and (F) One (1) representative nominated by SSM Venture Partners, L.P., but only for so long as SSM Venture Partners, L.P. (or any of its affiliates) has a Common Equity Percentage of at least two percent (2%); and (ii) the removal from the Board of any representative nominated as provided in Section 11(a)(i) upon the express written request of the designator thereof or upon the failure of any of the thresholds specified in Section 11(a)(i) with respect to such particular nominator. (b) in the event that any representative nominated as provided in Section 11(a)(i) for any reason ceases to serve as a member of the Board of Directors of the Company during his term of office, the resulting vacancy on each Board to be filled by a representative nominated by the person who or which nominated the ceasing director; provided that if such person ceases to serve as a member of the Board of Directors because the nominator thereof ceases to meet the thresholds set forth in Section 11(a)(i), such vacancy shall be filled as required by the bylaws of the Company, as amended from time to time. (c) If the Company receives a written notice requesting that any action be taken to implement the provisions of Section 11, the Company and each Shareholder agree -19- 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. (d) Absent cause, neither the Company nor the Shareholders will take any action to remove any Board representative nominated pursuant to Section 11(a)(i) without the advance written consent of the Person who or which nominated that director. (e) Each of Capital Trust and CRL shall, at all times that it has a right to nominate directors pursuant to Section 11(a)(i) hereof, have a representative on each committee of the Board of Directors of the Company unless, and only for so long as, it waives in writing such right with respect to a specific committee. (f) Unless an individual nominated to serve on the Board of Directors of the Company hereunder expressly agrees in writing otherwise, such nominee shall not be deemed to be the deputy of or otherwise required to discharge his or her duties on the Board under the direction of, or with special attention to the interests of, the Person designating such nominee to serve on the Board. (g) Nothing in this Agreement shall limit the size of the Board of Directors of the Company or the Board's ability to mandate any procedure for nominating or voting for any directors except to the extent specifically set forth in this Section 11. 12. Specific Performance. Because of the unique character of the shares of Stock, the Company 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 Company or the other Shareholders of the Company may have. 13. Legend. Each certificate issued on or after April 15, 2002 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, as amended and restated as of April 15, 2002, 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." -20- 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, 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. 75 State Street Boston, MA 02109 Attention: David M. Mussafer Telecopy No.: (617) 951-0568 With a copy to: Pepper Hamilton LLP 3000 Two Logan Square Philadelphia, PA 19103 Attention: Robert A. Friedel, Esq. Telecopy No.: (215) 981-4750 If to the Management Investors or the Company or The Amy Katherine Alderson Trust The Allison Leigh Alderson Trust The Carl T. Kirkland Grantor Retained Annuity Trust 2001-1, to: Kirkland's, Inc. P.O. Box 7222 Jackson, TN 38303-7222 Attention: Robert Alderson Telecopy No.: (731) 664-9345 -21- 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 760 Sanders Chapel Road Union City, Tennessee 38261 Telecopy No.: (731) 885-7850 With a copy to: Warner Law Firm PLC 308 West Church Street Union City, Tennessee 38261 Attention: John L. Warner, Jr., Esquire Telecopy No.: (731) 885-2440 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 Allied Capital Corporation 1919 Pennsylvania Avenue, N.W. 3rd Floor Washington, D.C. 20006 Attention: Susan Gallagher Telecopy No.: (202) 659-2053 -22- The Marlborough Capital Investment Fund, L.P. 9 Newbury 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 If to any other party hereto, to the address of record as most recently provided to the Company. Upon request by any party hereto, the Company agrees to provide address and telecopier information for any other party for the purpose of providing a notice in accordance with this Section 14. 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. Issuance of Stock by the Company. If the Board of Directors of the Company determines that any Person hereafter issued Stock or Warrants by the Company should become a party to this Agreement, then the execution of a Counterpart to this Agreement by such Person shall result in such Person being deemed to be a Shareholder hereunder for all purposes of this Agreement. 16. 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 -23- 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 modified, amended or terminated without the consent of such Shareholder, and (ii) the terms and provisions of this Section 16 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. 17. Expenses. The Company 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 Agreement 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. 18. Dividends. The Company shall not allow the payment of dividends on the Class A Preferred Stock, the Class B Preferred Sock or the Class D 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 to the Company under the Consulting Agreement shall have been made to Robert Kirkland. 19. 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 Company will take all necessary or desirable actions within its control, in order to cause an amendment to the Company's charter to increase the authorized Common Stock of the Company upon exercise by holders of Class A Preferred Stock, Class B Preferred Stock or Class D Preferred Stock of their rights to convert such stock into shares of Common Stock. 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. -24- 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 as the court shall fix as reasonable attorney's fees incurred by such prevailing party. 26. Parties Benefited. 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. 28. Prior Agreement Void. This Amended and Restated Shareholders Agreement amends and restates the Original Shareholders Agreement and such Original Shareholders Agreement is of no further force or effect. -25- IN WITNESS WHEREOF, the parties have executed this Amended and Restated Shareholders Agreement under seal as of the date first above written. KIRKLAND HOLDINGS L.L.C. By: ---------------------------------------- Name: Title: KIRKLAND'S, INC. By: ---------------------------------------- Name: Title: -26- SSM VENTURE PARTNERS, L.P. By: ---------------------------------------- Name: Title: ------------------------------------------- JOSEPH R. HYDE, III ------------------------------------------- JOHNSTON C. ADAMS, JR. ------------------------------------------- JOHN H. PONTIUS -27- CT/KIRKLAND EQUITY PARTNERS, L.P. By: ---------------------------------------- Name: Title: R-H CAPITAL PARTNERS, L.P. By: ---------------------------------------- Name: Title: TCW/KIRKLAND EQUITY PARTNERS, L.P. By: ---------------------------------------- Name: Title: -28- CAPITAL RESOURCE LENDERS II, L.P., by CAPITAL RESOURCE PARTNERS II, L.P., its General Partner By: ---------------------------------------- Name: Title: ALLIED CAPITAL CORPORATION By: ---------------------------------------- Name: Title: THE MARLBOROUGH CAPITAL INVESTMENT FUND, L.P., by MARLBOROUGH CAPITAL MANAGEMENT, L.P., its general partner By: ---------------------------------------- Margaret Lanoix, its authorized partner CAPITAL TRUST INVESTMENTS, LTD. By: ---------------------------------------- Name: Title: -29- GLOBAL PRIVATE EQUITY II LIMITED PARTNERSHIP By: ---------------------------------------- Name: Title: ADVENT DIRECT INVESTMENT PROGRAM LIMITED PARTNERSHIP By: ---------------------------------------- Name: Title: ADVENT PARTNERS LIMITED PARTNERSHIP By: ---------------------------------------- Name: Title: -30- ------------------------------------------- CARL KIRKLAND ------------------------------------------- ROBERT KIRKLAND ------------------------------------------- ROBERT ALDERSON THE AMY KATHERINE ALDERSON TRUST By: ---------------------------------------- Name: Title: THE ALLISON LEIGH ALDERSON TRUST By: ---------------------------------------- Name: Title: THE CARL T. KIRKLAND GRANTOR RETAINED ANNUITY TRUST 2001-1 By: ---------------------------------------- Name: Title: ---------------------------------------- STEVEN COLLINS -31- EXHIBIT A TO AMENDED AND RESTATED SHAREHOLDERS AGREEMENT COUNTERPART THIS INSTRUMENT forms part of the Amended and Restated Shareholders Agreement (the "Agreement") made as of the 1st day of April, 2002, among Kirkland Holdings L.L.C., Kirkland's Inc., SSM Venture Partners, L.P., Joseph R. Hyde, III, Johnston C. Adams, Jr., John H. Pontius, CT/Kirkland Equity Partners, L.P., R-H Capital Partners, L.P., TCW/Kirkland Equity Partners, L.P., Capital Resource Lenders II, L.P., Allied Capital Corporation, The Marlborough Capital Investment Fund, L.P., Capital Trust Investments, Ltd., Global Private Equity II Limited Partnership, Advent Direct Investment Program Limited Partnership, Advent Partners Limited Partnership, Carl Kirkland, Robert Kirkland, Robert Alderson, The Amy Katherine Alderson Trust, The Allison Leigh Alderson Trust, The Carl T. Kirkland Grantor Retained Annuity Trust 2001-1 and Steven Collins, and any additional Shareholders of the Company (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 ___________, 20__. ---------------------------------- (Signature of Shareholder) --------------------------------- (Name in block letters) A-1 EX-10.14 18 g75423ex10-14.txt STOCK OPTION AGREEMENT/KIRKLAND'S AND CARL KIRLAND EXHIBIT 10.14 STOCK OPTION AGREEMENT UNDER THE KIRKLAND'S, INC. 1996 EXECUTIVE INCENTIVE AND NON-QUALIFIED STOCK OPTION PLAN (AS AMENDED THROUGH APRIL 17, 2002) THIS STOCK OPTION AGREEMENT ("Agreement") was originally made and entered into as of June 12, 1996, by and among KIRKLAND'S, INC. ("Kirkland's") (the "Company"), and CARL KIRKLAND (referred to individually as the "Optionee"), and is hereby amended and restated as of April 17, 2002. W I T N E S S E T H: WHEREAS, the parties hereto entered into that certain Stock Option Agreement ("Original Agreement") under the Kirkland's, Inc. 1996 Executive Incentive and Non-Qualified Stock Option Plan dated June 11, 1996 ("Original Agreement"), pursuant to which on June 12, 1996 (the "Grant Date"), the Company granted to the Optionee an option to purchase shares of the Company's voting common stock, each with a par value $0.01 (the "Common Stock"). WHEREAS, the Company and certain companies which were affiliated with the Company (the "Affiliates") have reorganized their corporate structure by merger of the Affiliates into a newly formed wholly-owned subsidiary of Kirkland's (the "Merger"). WHEREAS, the Original Agreement provided for the option to purchase 2% of the fully diluted Common Stock, and the parties desire to fix the number of share subject to the option evidenced hereby. NOW, THEREFORE, in consideration of the mutual covenants and obligations contained herein, and intending to be legally bound, the parties, subject to the terms and conditions set forth herein, agree as follows: 1. Confirmation of Grant of Option. Subject to the terms and conditions set forth herein, the Company confirms that the Option granted to the Optionee pursuant to the Original Agreement represents by 3,950 shares of Common Stock in the Company (the "Shares"). The Company and the Optionee agree that the Original Agreement, as amended and restated, represents only the Option to purchase shares of Common Stock as described in the preceding sentence, and no longer represents the option or right to purchase a stated percentage of the fully diluted outstanding Common Stock and no longer represents the option or right to purchase shares of common stock of the Affiliates. 2. Nature of the Option. The Option is intended to be an "incentive stock option," as that term is described by Section 422 of the Internal Revenue Code of 1986, as amended. 3. Exercise Price. The exercise price shall be forty-five cents ($0.45) per Share. Payment of the aggregate exercise price shall entitle the Optionee to receive the Aggregate Number of shares of Common Stock. 4. Exercise of Option. The Option shall be exercisable during its term only in accordance with the terms and provisions of this Agreement as follows: a. Right to Exercise. The Option shall vest and be exercisable as follows: (i) The Option shall become 100% vested 24 hours prior to the closing of an Asset Sale, Public Offering, or Stock Sale, provided that such vesting shall occur only if Optionee shall have been employed by the Company at anytime within the three (3) month period prior to such event, or, if within the twelve (12) months prior to such event, Optionee shall have died or become disabled while employed by the Company. If not exercised at or in connection with such closing of the Asset Sale, Public Offering or Stock Sale, the Option shall terminate immediately following such closing; provided that if all Shareholders do not sell their Common Stock in the Public Offering or Stock Sale, the Option will remain exercisable in accordance with the terms of the option Plan. (ii) The Option shall be exercisable in whole and not in part. (iii) The Option may be terminated at any time by agreement between the Optionee and the Company. (iv) The Option shall terminate upon the closing of an initial public offering of Common Stock that does not qualify as a Public Offering as defined herein. (v) If not sooner vested or terminated, the Option shall become 100% vested on the eighth (8th) anniversary of the Grant Date. b. Method of Exercise. The Option shall be exercisable by written notice which shall state the election to exercise the Option, the number of Shares in respect of which this option is being exercised and such other representations and agreements as to the optionee's investment intent with respect to such interest as may be required by the Company hereunder. Such written notice shall be signed by the optionee and shall be delivered in person or by certified mail to the Chairman of the Board or such other person as may be designated by the Board. The written notice shall be accompanied by payment of the purchase price. Payment of the purchase price shall be by check or such other consideration or method of payment as may be authorized by the Board. c. Restrictions on Exercise. The Option may not be exercised if the issuance of Shares upon such exercise would constitute a violation of any applicable federal or state securities laws or other laws or regulations. As a condition to the exercise of the Option, the Company may require the Optionee to enter into a Stock Purchase Agreement and to make any representation and warranty to the Company as may be required by or advisable under any applicable law or regulation or as may be reasonably requested by the Board. d. Shareholders Agreement. The shares of Common Stock purchased upon exercise of the Option shall be subject to the terms and conditions of the Shareholders Agreement. -2- 5. Anti-Dilution Adjustments to Aggregate Number. Under certain conditions, the Aggregate Number is subject to adjustment as set forth herein. The Aggregate Number shall be subject to adjustment from time to time as follows and thereafter as adjusted shall be deemed to be the Aggregate Number hereunder. a. In case at any time or from time to time after April 17, 2002 the Company shall: (i) take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend payable in, or other distribution of, Common Stock; (ii) subdivide its outstanding shares of Common Stock into a larger number of shares of Common Stock; or (iii) combine its outstanding shares of Common Stock into a smaller number of shares of Common Stock; then the Aggregate Number in effect immediately prior thereto shall be adjusted so that the Optionee shall thereafter be entitled to receive, upon exercise of the Option, the number of shares of Common Stock that such holder would have been entitled to receive after the occurrence of such event had the Option been exercised immediately prior to the occurrence of such event. b. In case at any time or from time to time after April 17, 2002 the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive any dividend or other distribution (collectively, a "Distribution") of: (i) cash (other than dividends payable out of earnings or any surplus legally available, for the payment of dividends under the laws of the state of incorporation of the Company), (ii) any evidences of its indebtedness, any shares of its capital stock (other than additional shares of Common Stock or Convertible Securities) or any other securities or property of any nature whatsoever (other than cash), or (iii) any options or warrants or other rights to subscribe for or purchase any of the following: any evidences of its indebtedness (other than Convertible Securities), any shares of its capital stock (other than additional shares of Common Stock or Convertible Securities) or any other securities or property of any nature whatsoever, then the Optionee shall be entitled to receive upon the exercise of the Option at any time on or after the taking of such record the number of shares of Common Stock to be received upon exercise of the option determined as stated herein and, in addition and without further payment, the cash, stock, securities, other property, options, warrants and/or other rights to which the optionee would have been entitled by way of the Distribution and subsequent dividends and distributions if such holder (x) had exercised the Option immediately prior to such Distribution, and (y) had retained the Distribution in respect of the Common Stock and all subsequent -3- dividends and distributions of any nature whatsoever in respect of any stock or securities paid as dividends and distributions and originating directly or indirectly from such Common Stock. A reclassification of the Common Stock into shares of Common Stock and shares of any other class of stock shall be deemed a distribution by the Company to the holders of the Common Stock of such shares of such other class of stock within the meaning of this paragraph (b) and, if the outstanding shares of Common Stock shall be changed into a larger or smaller number of shares of Common Stock as a part of such reclassification, such event shall be deemed a subdivision or combination, as the case may be, of the outstanding shares of Common Stock within the meaning of paragraph (a) of this Section 5. c. In case at any time or from time to time after April 17, 2002 and prior to a public offering of Common Stock, the Company shall (except as hereinafter provided) issue or sell any additional shares of Common Stock at a price per share which is less than the Fair Market Value Per Share, then the Aggregate Number in effect immediately prior thereto shall be adjusted immediately so that the Aggregate Number thereafter shall be an amount equal to the product of (x) the percentage represented by the fraction, the numerator of which is such Aggregate Number in effect immediately prior to such issuance or sale and the denominator of which is the total outstanding shares of Fully Diluted Common Stock (as calculated immediately before such issuance or sale) and (y) the total number of shares of Fully Diluted Common Stock (as calculated immediately after such issuance or sale). The provisions of this paragraph (c) shall not apply to any issuance of additional shares of Common Stock for which an adjustment is provided under Section 5(a). No adjustment of the Aggregate Number shall be made under this Section 5(c) upon the issuance of any additional shares of Common Stock which are issued pursuant to the exercise of any Options or Warrants, or upon exercise of any warrants or other, subscription or purchase rights if an adjustment shall previously have been made (or if no adjustment shall have been required) upon issuance of such warrants or other rights pursuant to Section 5(d). d. In case at any time or from time to time after April 17, 2002 and prior to an initial public offering of Common Stock, the Company shall (except as hereinafter provided) take a record of the holders of its Common Stock for the purpose of entitling them to receive a distribution of, or shall in any manner issue or sell, any warrants or other rights to subscribe for or purchase (x) any shares of Common Stock or (y) any Convertible Securities, whether or not the rights to subscribe, purchase, exchange or convert thereunder are immediately exercisable, at a purchase price per share of Common Stock which is less than the Fair Market Value Per Share, then the Aggregate Number in effect immediately prior thereto shall be adjusted immediately so that the Aggregate Number thereafter shall be an amount equal to the product of (x) the percentage represented by the fraction, the numerator of which is such Aggregate Number in effect immediately prior to such distribution, issuance or sale and the denominator of which is the total outstanding shares of Fully Diluted Common Stock (as calculated immediately before such distribution, issuance or sale) and (y) the total number of shares of Fully Diluted Common Stock outstanding (as calculated immediately after such issuance or sale). e. In case at any time or from time to time after April 17, 2002 and prior to an initial public offering of Common Stock, the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a distribution of, or -4- shall in any manner issue or sell, Convertible Securities, whether or not the rights to exchange or convert thereunder are immediately exercisable, at an exercise price per share of Common Stock which is less than the Fair Market Value Per Share, then the Aggregate Number in effect immediately prior thereto shall be adjusted immediately so that the Aggregate Number thereafter shall be an amount equal to the product of (x) the percentage represented by the fraction, the numerator of which is such Aggregate Number in effect prior to such issuance or sale and the denominator of which is the total outstanding shares of Fully Diluted Common Stock (as calculated immediately before such issuance or sale) and (y) the total number of shares of Fully Diluted Common Stock outstanding (as calculated immediately after such issuance or sale). No adjustment of the Aggregate Number shall be made under this Section 5(e) upon the issuance of any Convertible Securities which are issued pursuant to the exercise of any warrants or other subscription or purchase rights if an adjustment shall previously have been made or if no such adjustment shall have been required upon the issuance of such warrants or other rights pursuant to Section 5(e). f. Upon the expiration or termination of any of the Warrants, the Aggregate Number in effect prior to the expiration or termination of any such Warrants shall be adjusted immediately so that the Aggregate Number in effect immediately after such expiration or termination shall be an amount equal to the product of (x) the percentage represented by the fraction, the numerator of which is such Aggregate Number in effect prior to such expiration or termination and the denominator of which is the total outstanding shares of Fully Diluted Common Stock (as calculated immediately before such expiration or termination) and (y) the total number of shares of Fully Diluted Common Stock outstanding (as calculated immediately after such expiration or termination). g. The following provisions shall be applicable to the making of adjustments of the Aggregate Number hereinbefore provided for in this Section 5: (i) The sale or other disposition of any issued shares of Common Stock owned or held by or for the account of the Company (also referred to as treasury stock) shall be deemed an issuance thereof for purposes of this Section 5. (ii) The adjustments required by the preceding paragraphs of this Section 5 shall be made whenever and as often as any specified event requiring an adjustment shall occur, except as expressly provided herein. For purpose of any adjustment, any specified event shall be deemed to have occurred at the close of business on the date of its occurrence. (iii) In computing adjustments under this Section 5, fractional interests in Common Stock shall be taken into account to the nearest one-thousandth (.001) of a share and shall be aggregated until they equal one whole share. (iv) If the Company shall take a record of the holders of the Common Stock for the purpose of entitling them to receive a dividend, distribution, warrant or subscription or purchase rights under Sections 5(a) through 5(e) hereof, but abandon its plan to pay or deliver such dividend, distribution, warrants, subscription or purchase rights, then no -5- adjustment shall be required by reason of the taking of such record and any such adjustment previously made in respect thereof shall be rescinded and annulled. (v) Notwithstanding anything herein to the contrary, no adjustment shall be made to the Aggregate Number as a result of the issuance of (A) options similar to the Option granted pursuant to similar option agreements dated June 12, 1996 of the Company and other management shareholders of the Company, or (B) shares of Common Stock issued upon exercise of such other similar options, or (C) shares of Common Stock issued upon exercise of the Warrants. (vi) Upon the expiration or termination of any of the warrants or other rights or options referred to in Section 5(d) above or the Convertible Securities referred to in Section 5(e) above, the Aggregate Number after the expiration or termination of any such warrants, rights, options or Convertible Securities, the issuance of which caused an adjustment to the Aggregate Number, shall be readjusted to such Aggregate Number as would have been obtained had the adjustment made upon the issuance of such warrants, rights, options or Convertible Securities, been made upon the basis of the issuance of only the number of shares of Common Stock actually issued upon the exercise of such warrants, options or rights, upon the conversion or exchange of such securities or upon the exercise of the options or rights related to such securities and subsequent conversion or exchange thereof. (vii) For purposes of Sections 5(c), (d) and (e) hereof, the date as of which the applicable Fair Market Value Per Share shall be computed shall be the date of actual issuance of such additional shares of Common Stock, warrants or Convertible Securities, as applicable. (viii) The consideration for any additional shares of Common Stock issuable pursuant to any options, warrants or other rights to subscribe for or purchase the same shall be the consideration received or receivable by the Company for issuing such options, warrants or other rights, plus the additional consideration payable to the Company upon the exercise of such options, warrants or other rights. The consideration for any additional shares of Common Stock issuable pursuant to the terms of any Convertible Securities; shall be the consideration received or receivable by the Company for issuing any options, warrants or other rights to subscribe for or purchase such Convertible Securities, plus the consideration paid or payable to the Company in respect of the subscription for or purchase of such Convertible Securities, plus the additional consideration, if any, payable to the Company upon the exercise of the right of conversion, exercise or exchange of such Convertible Securities. In case of the issuance at any time of any additional shares of Common Stock or Convertible Securities in payment or satisfaction of any dividend upon any class of stock other than Common Stock, the Company shall be deemed to have received for such additional shares of Common Stock or Convertible Securities a consideration equal to the amount of such dividend so paid or satisfied. h. If any event occurs as to which the other provisions of this Section 5 are not strictly applicable but the lack of any provision for the exercise of the rights of a holder of options would not fairly protect the purchase rights of such holder in accordance with the essential intent and principles of such provisions, or, if strictly applicable, would not fairly protect the conversion rights of such holder in accordance with the essential intent and principles -6- of such provisions, then the Company shall appoint a firm of independent certified public accountants in the United States (which may be the regular auditors of the Company) of recognized national standing in the United States, which shall give their opinion as to the adjustments, if any, necessary to preserve, without dilution, on a basis consistent with the essential intent and principles established in the other provisions of this Section 5, the exercise rights of the Optionee. Upon receipt of such opinion, the Company shall forthwith make the adjustments described therein. i. Within forty-five (45) days after the end of each fiscal quarter during which an event occurred that resulted in an adjustment pursuant to this Section 5, and at any time upon the request of the Optionee, the Company shall cause to be promptly mailed to the optionee by first-class mail, postage prepaid, notice of each adjustment or adjustments to the Aggregate Number effected since the date of the last such notice and a certificate of Kirkland's Chief Financial Officer or, in the case of any such notice delivered within forty-five (45) days after the end of a fiscal year, a firm of independent public accountants in the United States selected by the Company (who may be the regular accountants employed by the Company), in each case, setting forth the Aggregate Number after such adjustment, a brief statement of the facts requiring such adjustment and the computation by which such adjustment was made. The fees and expenses of such accountants shall be paid by the Company. j. The occurrence of a single event shall not trigger an adjustment of the Aggregate Number under more than one paragraph of this Section 5. k. The expiration or other termination of any of the Warrants shall trigger an adjustment to the Aggregate Number so that the Aggregate Number after such adjustment is the same as it would have been had the initial Aggregate Number set forth in Section 1 hereof been calculated without taking such expired or terminated Warrants into account. l. No adjustment shall be made to the Aggregate Number upon issuance of Employee Options, Warrants or Contingent Warrants, or the issuance of Common Stock upon exercise thereof. m. Notwithstanding any provision. to the contrary herein, any combination or consolidation of the Company or any transfer of shares permitted under Section 2 of the Stockholders Agreement, in either case, which does not materially alter the aggregate ultimate ownership of the Company shall not constitute an Asset Sale or Stock Sale as defined in Section 9 hereof. In the event of any such combination or consolidation, this Option shall be exercisable into the same number of shares of Common Stock of such combined or consolidated Company as the number of shares of Common Stock of the Company into which it was exercisable immediately prior to such combination or consolidation. 6. Investment Representations. Unless the Shares have been registered under the Act, in connection with the acquisition of this Option, the Optionee represents and warrants as follows: -7- a. The Optionee is acquiring this Option, and upon exercise of this option, he will be acquiring the Shares for investment for his own account, not as a nominee or agent, and not with a view to, or for resale in connection with, any distribution thereof, except as may be specifically contemplated and disclosed in the context of the Asset Sale, Public Offering or Stock Sale which triggers exercisability of the Option. b. The Optionee has a preexisting business or personal relationship with the Companies and by reason of his business or financial experience, has, and could reasonably be assumed to have, the capacity to protect his interests in connection with the acquisition of this Option and the Shares. 7. Non-Transferability of Option. This Option may not be sold, pledged (except pursuant to the Management Pledge Agreement executed by Optionee in favor of The First National Bank of Boston, as Administrative Agent and dated on or about June 12, 1996, or any other senior secured loan facility of the Company), assigned, hypothecated, gifted, transferred or disposed of in any manner either voluntarily or involuntarily by operation of law, other than by will or by the laws of descent or distribution, and may be exercised during the lifetime of the Optionee only by such optionee or, in the event of his disability by his personal representative. Subject to the foregoing, the terms of this Option shall be binding upon the executors, administrators, heirs, successors and assigns of the optionee. 8. Ability to Restructure. The existence of the Option shall not affect in any way the right or power of the Company or its Shareholders to make or authorize any or all adjustments, recapitalizations, organizations or other changes in the Company's capital structure or its business, or any merger or consolidation of the Company, or any issue of bonds, debentures, preferred or prior preference stock ahead of or affecting the Common Stock or the rights thereof, or dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding whether of a similar character or otherwise. 9. Definitions. Terms not otherwise defined in this Agreement shall have the following respective meanings: a. "Act" means the Securities Act of 1933, as amended. b. "Aggregate Number" means 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 5 hereof. The initial Aggregate Number is the number of Shares identified in Section 1 hereof. c. "Asset Sale" means the sale of all or a majority in value of the Company, assets and the subsequent liquidation or dissolution of the Company, if as a result of such events, the Shareholders shall have realized a Rate of Return of at least thirty-five (35%) percent on their Equity, after taking into account the amount and timing of all capital contributions (and distributions) to (from) the Company by (to) the Shareholders. d. "Board" means the Board of Directors of Kirkland's. -8- e. "Contingent Warrants" means warrants for up to three and one-half percent (3.5%) of the Common Stock issued to the holders of the Mezzanine Debt (as defined in the Recapitalization Agreement) and exercisable only if certain conditions (as set forth therein) occur. f. "Convertible Securities" means securities convertible into or exchangeable for shares of Common Stock. g. "Employee Options" means Options to purchase Common Stock granted pursuant to the Option Plan. h. "Equity" means all initial capital contributed to the Company 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, (ii) shares of capital stock shall be valued without regard to voting rights, and (iii) Class C Preferred Stock shall not be considered Equity. i. "Fair Market Value Per Share" means the fair market value per share of Common Stock (which shall be determined without regard to voting rights) as determined by the Board or the Option Committee of the Board. j. "Fully Diluted Common Stock" means shares of Common Stock assuming exercise of the Management Options and all of the Warrants, and conversion, exercise or exchange of all other securities then outstanding and convertible, exercisable or exchangeable into shares of Common Stock. k. "Option Plan" shall mean the Kirkland's Inc. 1996 Executive Incentive and Non-Qualified Stock Option Plan. l. "Management Letter" means that certain letter agreement among Optionee and the Company dated June 12, 1996, and relating to employment of optionee by the Company, as the same may have been previously amended or may be amended hereafter. m. "Management Options" means this option and all similar options granted to the other Management Shareholders (as such term is defined in the Recapitalization Agreement), as the same may have been previously amended or may be amended hereafter. n. "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. o. "Public Offering" means the sale of shares of the Company's capital stock in a registered underwritten public offering, if the Shareholders then realize (or are treated as realizing pursuant to the definition of "Rate of Return") 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) the Shareholders. -9- p. "Rate of Return" shall mean the internal rate of return for the investment by the Shareholders in the Equity. Rate of Return shall be calculated based on the following: (i) in the context of an Asset Sale, the distributions to the Shareholders resulting from the Asset Sale; (ii) in the context of a Public Offering, 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; and (iii) in the context of a Stock Sale, the amount actually realized by the Shareholders in the Stock Sale, or the amount that would be realized if (A) all Shareholders were selling Common Stock at the same price per share of Common Stock as the selling Shareholders realize in the Stock Sale (before commissions but after other transaction expenses), and (B) all Shareholders were selling Class A Preferred Stock and Class B Preferred Stock. for its aggregate stated value plus all accrued and unpaid dividends. q. "Recapitalization Agreement" means the Recapitalization Agreement among the Company, Kirkland Holdings L.L.C., the Optionee and the other management shareholders of the Company dated June 12, 1996, as the same may have been previously amended or may be amended hereafter. r. "Shareholders" means the holders of Common Stock from time to time outstanding. s. "Shareholders Agreement" means that certain Shareholders Agreement dated June 12, 1996 among the Company and certain holders of its capital stock and warrants to purchase Common Stock, as the same may have been previously amended or may be amended hereafter. t. "Stock Sale" means the acquisition of more than fifty percent (50%) of the outstanding shares of common stock of the Company by a Person or group of Persons (other than non-cash sales or exchanges of Common Stock among the Shareholders of the Company), if as a result of such event, the Shareholders would have realized (or be treated as having realized pursuant to the definition of "Rate of Return") a Rate of Return of at least thirty-five (35%) percent on their Equity, after taking into account the amount and timing of all capital contributions (and distributions) to (from) the Company by (to) the Shareholders. u. "Warrants" means the warrants for ten percent (10%) of the Common Stock issued to the holders of the Mezzanine Debt (as defined in the Recapitalization Agreement) on June 12, 1996. 10. Governing Law. This Agreement shall be governed by and construed in accordance with the internal laws of the State of Tennessee. 11. Entire Agreement. This Agreement, together with the Management Letter and the Recapitalization Agreement, and the other exhibits attached thereto or hereto, represents the entire agreement between the parties. -10- 12. Amendment. This Agreement may only amended by a writing signed by each of the parties hereto. 13. 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 LLP, 3000 Two Logan Square, 18th and Arch Streets, Philadelphia, PA 19103, Attention: Robert A. Friedel, 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. 14. Waiver. Any waiver by either party of a breach of any provision of this Agreement shall not operate as or be construed to be a waiver of any other breach of such provision or of any breach of any other provision of this Agreement. The failure of a party to insist upon strict adherence to any term of this Agreement on one or more occasions shall not be considered a waiver or deprive that party of the right thereafter to insist upon strict adherence to that term or any other term of this Agreement. Any waiver must be in writing. [SPACE INTENTIONALLY LEFT BLANK) -11- IN WITNESS WHEREOF, the Company has caused this instrument to be executed by their duly authorized representative, and the Optionee has hereunto affixed his hand and seal, the 17th day of April 2002. /s/ Carl Kirkland --------------------------- CARL KIRKLAND ATTEST: KIRKLAND'S, INC. By: /s/ Lowell Pugh By: /s/ Robert Alderson ----------------------- --------------------------- Lowell Pugh Robert Alderson Secretary Chief Executive Officer -12- EX-10.16 19 g75423ex10-16.txt SUBLEASE AGREEMENT/SOUTHWIND PROPERTIES & KIRKLAND EXHIBIT 10.16 SUBLEASE AGREEMENT BETWEEN SOUTHWIND PROPERTIES AND KIRKLAND'S, INC. March 5, 2001 Duplicate Original 1 Of 2 William C. Bell, Jr. Rainey, Kizer, Butler, Reviere & Bell, P.L.C. P.O. Box 1147 -105 South Highland Ave. Jackson, TN 38302-1147 (731) 423-2414 File No. 01436\51312 TABLE OF CONTENTS 1. Leased Premises/Conditions Precedent ......................................... 1 2. Construction of Improvements ................................................. 2 3. Lease Term ................................................................... 2 4. Option Terms ................................................................. 2 5. Holdover By Tenant ........................................................... 3 6. Rent ......................................................................... 4 (a) Initial Term ............................................................ 4 (b) First Option Term ....................................................... 5 (c) Second Option Term ...................................................... 5 (d) Third Option Term ....................................................... 6 (e) Proration of Rent ....................................................... 6 (f) Late Charges ............................................................ 6 7. Utilities .................................................................... 7 8. Taxes ........................................................................ 7 9. Repairs And Maintenance ...................................................... 7 (a) Maintenance and Repair Obligations ...................................... 7 (b) Default with Respect to Tenant's Repair and Maintenance Obligations ..... 8 (c) Default with Respect to Landlord's Repair and Maintenance Obligations ... 8 10. Insurance .................................................................... 9 11. Improvements ................................................................. 10 12. Damage Or Destruction To Improvements On Leased Premises ..................... 10 13. Use Of Premises .............................................................. 12 14. Condemnation ................................................................. 13 (a) Total Taking in the Event of Condemnation ............................... 13 (b) Partial Taking in the Event of Condemnation ............................. 13 15. Quiet Enjoyment .............................................................. 14
-i- 16. Subordination Of Lease/Attornment ............................................ 14 17. Surrender Upon Termination ................................................... 15 18. Assignment And Sub-letting ................................................... 15 19. Events Of Default By Tenant And Remedies Of Landlord ......................... 15 (a) Events of Default Defined ............................................... 15 (b) Remedies on Default ..................................................... 17 (c) Effect of Termination Rights Upon Tenant's Event Of Default ............. 18 (d) No Remedy Exclusive ..................................................... 19 (e) No Additional Waiver Implied By One Waiver .............................. 19 (f) Right of Entry .......................................................... 19 (g) Notice of Default ....................................................... 20 20. Landlord Defaults And Tenant Remedies ........................................ 20 21. Tenant's Indemnity Of Landlord ............................................... 22 22. Landlord Indemnity Of Tenant ................................................. 23 23. Notices ...................................................................... 24 24. Periodic Financial Reporting By Tenant ....................................... 24 25. Environmental Requirements Of Tenant ......................................... 25 (a) Landlord's Warranty ..................................................... 25 (b) Environmental Covenants of Tenant ....................................... 25 (c) Definition of Environmental Laws ........................................ 26 (d) Definition of Hazardous Materials ....................................... 27 (e) Definition of Environmental Contamination ............................... 27 26. Environmental Requirements Of Landlord ....................................... 27 27. Expansions to Building(s) on Leased Premises ................................. 28 28. Lease Termination Rights of Tenant ........................................... 29 29. Miscellaneous ................................................................ 29 (a) Entire Agreement ........................................................ 29 (b) Recordation ............................................................. 30 (c) Binding Effect .......................................................... 30 (d) Governing Law ........................................................... 30 (e) Captions ................................................................ 30
-ii- (f) Severability ............................................................ 30 (g) Rules Of Construction ................................................... 31 (h) Duplicate Originals ..................................................... 31 (i) Attorney's Fees ......................................................... 31 (j) Estoppel Certificate .................................................... 31 (k) No Landlord Liens ....................................................... 31
-iii- SUBLEASE AGREEMENT THIS SUBLEASE AGREEMENT made and entered into this 5th day of March, 2001, by and between Southwind Properties, a Tennessee general partnership ("Landlord"), and Kirkland's, Inc., a Tennessee corporation ("Tenant"). RECITALS: A. Landlord has leased the Leased Premises (defined below) from the Industrial Development Board of the City of Jackson, Tennessee (the "IDB"), pursuant to that certain Lease Agreement dated February 4, 2000 (the "Original Lease"). Landlord and the IDB intend to enter into a Restated Lease Agreement dated December __, 2000 (the "Restated Lease") upon terms acceptable to Tenant. B. Pursuant to the Restated Lease, certain rights are granted to the IDB and to First Tennessee Bank National Association (the "Bank), as more particularly described in the Restated Lease. C. Landlord desires to sublease its interest in the Leased Premises under the Restated Lease to Tenant as provided herein. In consideration of the parties' respective representations, covenants and agreements herein contained, the Landlord and Tenant agree as follows: 1. LEASED PREMISES/CONDITIONS PRECEDENT. The Landlord does hereby sublease to the Tenant, and the Tenant subleases from the Landlord, in accordance with the terms and conditions of this Agreement, the premises described in EXHIBIT A located in Madison County, Tennessee, in good repair at the date of the beginning of this Lease Term, which 1 shall herein be referred to as the "Leased Premises." 2. CONSTRUCTION OF IMPROVEMENTS. Prior to the commencement of the Lease Term, Landlord, at Landlord's expense, agrees to construct those improvements to the Leased Premises described in the scope of work attached hereto as EXHIBIT B (the "Improvements"). Upon execution of this Lease, Landlord and Tenant shall sign EXHIBIT B to signify their approval of the scope of work. The dates for beginning and completing construction of the Improvements shall be deferred for a period equal to any delay caused by reason of labor controversy, act of God, fire, or other casualty, governmental regulations, or other causes beyond the reasonable control of Landlord. In such event, the Commencement Date (defined in paragraph 3) for Tenant's occupancy of the Leased Premises shall be postponed on a day for day basis. Tenant shall have the right after Tenant takes possession of the Leased Premises to submit to Landlord a "punch list" of incomplete or defective construction items within the Leased Premises within sixty (60) days after Tenant takes possession, and Landlord agrees to correct the items on the punch list. Landlord will remain liable for any latent defects in the Leased Premises (established by engineering and architectural experts who have to be mutually acceptable to both parties). 3. LEASE TERM. The initial term of this Sublease Agreement shall commence on March 15, 2001 (the "Commencement Date"); and, subject to the Lease Termination Rights of Tenant set forth in paragraph 28 of this Lease, shall continue until March 31, 2008 (the "Initial Term"). 4. OPTION TERMS. At the expiration of the Initial Term, if this Lease then shall be 2 in full force and effect, and the Tenant shall not be in default hereunder beyond any applicable cure period, and if Landlord is still the Lessee under the Restated Lease, or if Landlord is the fee, simple owner of the Leased Premises, the Tenant shall have the option to extend the term of this Sublease, upon the same terms, provisions, and conditions provided herein, for three (3) consecutive five (5) year terms (the "Option Terms"), with the first such Option Term beginning as of and from the expiration of the Initial Term and the second and third Option Terms beginning from the expiration of the extended term. Each such Option Term must be exercised by written notice in the manner provided in this Lease Agreement below, not less than six (6) months prior to the expiration of the Initial Term, or the subject Option Term, as the case may be. Time is of the essence for providing written notice not less than six (6) months prior to the expiration of the applicable term, and failure to provide such notice shall render any Options null and void. As used in this Lease Agreement and unless otherwise specified, "Lease Term" shall mean the Initial Term and any Option Terms properly exercised by Tenant. The Option Terms shall be subject to the Lease Termination Rights of Tenant set forth in paragraph 28 of this Lease. 5. HOLDOVER BY TENANT. In the event the Tenant remains in possession of the Leased Premises beyond the expiration of the Initial Term without properly exercising the first Option Term or if Tenant remains in possession beyond the expiration of any validly exercised Option Term, or if Tenant remains in possession after termination of this Lease as provided in paragraph 29 hereof, such tenancy shall be deemed month-to-month only, with thirty (30) days' written notice required by either party to terminate such tenancy. Except as provided in the last sentence is this paragraph 5, the Rent during such holdover 3 tenancy shall be 125% of the amount of the Rent that was payable immediately prior to the commencement of the holdover occupancy. Otherwise, the holdover tenancy shall be subject to all provisions of this Lease Agreement. However, in the event that Tenant and Landlord engage in good faith negotiations for an extension of the term of this Lease for a period up to two (2) months after the expiration of the Lease, then Tenant shall be obligated to pay rent in the amount of Rent at the expiration of the preceding term for such sixty (60) day period. 6. RENT. Subject to the provisions for increased rent for expansion of the improvements as provided in paragraph 28, the following rent provisions shall apply for the Leased Premises prior to any expansion: (a) INITIAL TERM. The Tenant shall pay the Landlord monthly rent for use of the Leased Premises during the first five (5) years and 1/2 month of the Initial Term (i.e. March 15, 2001 -- March 31, 2006) ("Years 1-5") in the amount of Sixty-Seven Thousand Six Hundred Seventy and No/100 Dollars ($67,670.00). After Years 1-5 and for the remainder of the Initial Term, the monthly rent shall increase to Seventy One Thousand Seven Hundred Thirty and 20/100 Dollars ($71,730.20). The rent during the Initial Term (the "Initial Term Rent") shall become due and payable in advance on the first day of each month, without setoff rights, except as provided in paragraph 10(c). Monthly Rent shall be prorated for the period March 15, 2001 through March 31, 2001, and shall be $37,109.00. The Initial Term Rent shall be paid to the Landlord at the address contained below in this Lease Agreement, until such time as the Landlord shall notify the Tenant, in writing, of a different address to which the payment shall be sent. 4 (b) FIRST OPTION TERM. If Tenant exercises its option for the first Option Term, the monthly rent during the first three (3) years of the first Option Term ("Years 8-10") shall be in the amount of Seventy One Thousand Seven Hundred Thirty and 20/100 Dollars ($71,730.20). After Years 8-10, and for the remainder of the first Option Term, the monthly rent shall increase to Seventy Six Thousand Thirty Four and 01/100 Dollars ($76,034.01). The rent during the first Option Term (the "First Option Term Rent") shall become due and payable in advance on the first day of each month, without setoff rights, except as provided in paragraph 10(c). The First Option Term Rent shall be paid to the Landlord at the address contained below in this Lease Agreement, until such time as the Landlord shall notify the Tenant, in writing, of a different address to which the payment shall be sent. (c) SECOND OPTION TERM. If Tenant exercises its option for the second Option Term, the monthly rent during the first three (3) years of the second Option Term ("Years 13-15") shall be in the amount of Seventy-Six Thousand Thirty Four and 01/100 Dollars ($76,034.01). After Years 13-15, and for the remainder of the second Option Term, the monthly rent shall increase to Eighty Thousand Five Hundred Ninety-Six and 05/100 Dollars ($80,596.05) during the second Option Term (the "Second Option Term Rent"). The Second Option Term Rent shall become due and payable in advance on the first day of each month, without setoff rights, except as provided in paragraph 10(c). The Second Option Term Rent shall be paid to the Landlord at the address contained below in this Lease Agreement, until such time as the Landlord shall notify the Tenant, in writing, of a different address to which the payment shall be sent. 5 (d) THIRD OPTION TERM. If Tenant exercises its option for the third Option Term, the monthly rent during the first three (3) years of the third Option Term ("Years 18-20") shall be in the amount of Eighty Thousand Five Hundred Ninety-Six and 05/100 Dollars ($80,596.05). After Years 18-20, and for the remainder of the third Option Term, the monthly rent shall increase to Eighty-Five Thousand Four Hundred Thirty-One and 82/100 Dollars ($85,431.32). The rent payable during the third Option Term (the "Third Option Term Rent") shall become due and payable in advance on the first day of each month, without setoff rights, except as provided in paragraph 10(c). The Third Option Term Rent shall be paid to the Landlord at the address contained below in this Lease Agreement, until such time as the Landlord shall notify the Tenant, in writing, of a different address to which the payment shall be sent. As used in this Lease Agreement, the term "Rent" shall include the Initial Term Rent, the First Option Term Rent, the Second Option Term Rent, and the Third Option Term Rent, unless otherwise specified. (e) PRORATION OF RENT. All Rent shall be prorated if the Initial Term or any Option Term does not commence on the first (1st) day of a calendar month or expire on the last day of a calendar month. (f) LATE CHARGES. A late charge shall be payable in the amount of one percent (1%) of the Rent then in effect in the event that Tenant shall have failed to pay when due any installment of monthly Rent or additional rent within fifteen (15) days after the due date thereof and such failure shall have occurred two (2) times during any calendar year. 6 7. UTILITIES. Tenant shall contract for all utility service required on the Leased Premises and shall be liable for payment of all utility services received during its occupancy of the Leased Premises. 8. TAXES. Tenant acknowledges that the Leased Premises are owned by the IDB, and that assets owned by the Board are exempt from ad valorem taxation in the State of Tennessee under TCA Section 7-53-305. Landlord agrees to "pass on" to Tenant any payment in lieu of tax ("PILOT") benefits granted to Landlord in its lease with the IDB, and Tenant agrees to make all PILOT payments required to be made pursuant to the PILOT Program attached as EXHIBIT C, and any and all other taxes assessed against Landlord as a lessee of the Leased Premises from the IDB, including within such taxes to be paid by Tenant, any leasehold taxes if such are assessed against Landlord by any taxing authority, all of such taxes to be paid before becoming delinquent. 9. REPAIRS AND MAINTENANCE. (a) MAINTENANCE AND REPAIR OBLIGATIONS. Landlord shall be responsible for maintaining the roof, foundation, slab, HVAC units (including all necessary replacements thereof), and structural walls of the Leased Premises during the Lease Term and for repaving parking lots at the time of the end of the useful life of the prior paving of such parking lots ("Landlord's Repair Obligations"). With the exception of Landlord's Repair Obligations, Tenant shall at all times put, keep and maintain the Leased Premises in good repair and appearance, including without limitation: the landscaping; windows; plumbing and electrical systems; and routine maintenance and patching and sealing of parking lots. 7 Tenant shall promptly make all repairs and replacements (substantially equivalent in quality and workmanship to the original work) of every kind and nature, which may be required to be made upon or in connection with any of the Leased Premises in order to keep and maintain the Leased Premises in as good repair and appearance as they were as of the commencement of the Initial Term, ordinary wear and tear excepted. Tenant shall, in all events, make all repairs for which it is responsible hereunder promptly, and all repairs shall be done in a good, proper, and workmanlike manner. Landlord shall, in all events, make the Landlord repair obligations promptly, and all repairs shall be done in a good, proper, and workmanlike manner. (b) DEFAULT WITH RESPECT TO TENANT'S REPAIR AND MAINTENANCE OBLIGATIONS. If Tenant shall be in default of Tenant's maintenance and repair obligations hereunder, Landlord may, after thirty (30) days' notice to Tenant and failure of Tenant to cure such default, but immediately upon notice in the event of an emergency, do whatever is necessary to cure such default for the account of and at the expense of Tenant. All actual and reasonable costs and expenses so incurred by Landlord shall constitute additional Rent payable by Tenant under this Lease Agreement and shall be paid with the next installment of Rent that becomes due. (c) DEFAULT WITH RESPECT TO LANDLORD'S REPAIR AND MAINTENANCE OBLIGATIONS. If Landlord shall be in default of Landlord's Repair Obligations hereunder after notice to Landlord of the Repair obligations, and a reasonable opportunity to complete such Repair Obligations, Tenant may, after thirty (30) days notice to Landlord of Landlord's failure to make such repairs within a reasonable time, but immediately upon notice in the event of 8 an emergency, do whatever is reasonably necessary to cure such default at the expense of Landlord. If Landlord does not pay the cost and expenses so incurred by Tenant within thirty (30) days after invoiced by Tenant, Tenant shall have the right to offset such amount against its rent obligations hereunder. 10. INSURANCE. Landlord shall maintain fire and extended coverage insurance and earthquake coverage on the building and appurtenances located on the Leased Premises with the replacement cost endorsement, in accordance with comparable industry standards, with a financially responsible insurer duly authorized to do business in the State of Tennessee. The costs of and premiums thereof shall be charged to and paid to Landlord by the Tenant as additional rent. Tenant shall, at Tenant's expense, obtain and keep in force during the Lease Term, commercial general liability insurance coverage with limits of not less than $2,000,000 per occurrence for bodily injury and property damage, insuring both Landlord and Tenant against liability arising out of Tenant's use and occupancy of the Leased Premises and all areas appurtenant thereto. All such liability policies shall name Tenant as the insured party, and Landlord and Landlord's designated mortgagees as additional insureds. The Tenant shall furnish the Landlord with a certificate from the insurance companies indicating the issuance of the required liability insurance coverage required in this paragraph. Landlord may, but shall not be obligated, to maintain tune element insurance coverage (loss of rents) covering the loss of rental income for a period chosen by Landlord that may occur as a result of loss or damage to the building(s) located on the Leased Premises. 9 11. IMPROVEMENTS. Tenant agrees that it will not make any alterations to the Leased Premises that would diminish the value of the Leased Premises, after giving consideration to the completed alteration, without Landlord's prior written consent. Any alterations by Tenant, at Tenant's expense, the cost of which (per alteration or group of related alterations) exceeds One Hundred Thousand and No/100 Dollars ($100,000.00) shall be deemed a "Significant Alteration." All Significant Alterations shall require Landlord's prior written consent. Prior to making any Significant Alterations, Tenant shall submit written plans and specifications for such work to Landlord and shall obtain Landlord's prior written consent to the same. Tenant may make alterations other than Significant Alterations or alterations that would not diminish the value of the Leased Premises without the prior written consent of Landlord. Any alterations or additions will be at Tenant's expense and will remain a portion of the Leased Premises upon expiration of the rights of Tenant under this Lease. Trade fixtures and other equipment owned by the Tenant and installed on or within the Leased Premises by Tenant shall remain as personal property, and may be removed upon termination of the Lease, but only upon the condition that any repairs necessary due to removal of such trade fixtures or equipment be made by Tenant at its own expense. 12. DAMAGE OR DESTRUCTION TO IMPROVEMENTS ON LEASED PREMISES. Except as provided in the next two (2) grammatical paragraphs of this paragraph 12, if the improvements on the Leased Premises (excluding the parking lot, lights, landscaping, and fences) are damaged or destroyed by fire or other casualty insured under the fire and extended casualty insurance policy applicable to the Leased Premises (the "Casualty"), the 10 insurance proceeds from such policy shall be used to repair and/or restore the Leased Premises to substantially the condition it was in immediately prior to the Casualty within one hundred eighty (180) days following the date of Landlord's receipt of the insurance proceeds. However, if the Casualty renders the improvements on the Leased Premises untenantable, in the reasonable opinion of Tenant, and the estimated time for restoration thereof exceeds one hundred-eighty (180) days from the date of the Landlord's receipt of the insurance proceeds, then Tenant may terminate this Lease Agreement by the delivery of written notice to the Landlord within fifteen (15) days following the date on which Landlord notifies Tenant of the estimated time for restoration. Landlord must provide that estimate to Tenant within sixty (60) days following its receipt of the insurance proceeds. Further, (i) if there are less than three (3) years remaining in the existing term of this Lease (whether the Initial Term or any option Term) at the time of any Casualty; and (ii) if Tenant does not provide written notice to Landlord within thirty (30) days of the date of the Casualty that it is waiving its Termination Rights as set forth in paragraph 28 for a period of five (5) years from the date of completion of the repairs or restoration of the Leased Premises; and (iii) if the Casualty renders the improvements on the Leased Premises untenantable, in the reasonable opinion of Landlord; and (iv) if Tenant does not exercise the next renewal Option Term, then Landlord shall have no obligation to repair or restore the Leased Premises, and Landlord may terminate this Lease Agreement by the delivery of written notice to Tenant within sixty (60) days following the date of the Casualty, unless Tenant exercises the next renewal Option Term at such time and waives its 11 Termination Rights for such five (5) year period as described above at such time. If Tenant exercises the next renewal Option and waives its Termination Rights before such sixty (60) day period, Landlord shall be obligated to repair and restore the Leased Premises to substantially the condition it was in immediately prior to the Casualty. The obligation to repair or restore the Leased Premises shall not exceed the scope of the original construction of the improvements on the Leased Premises. If the Lease is not terminated, Tenant shall replace and/or restore its furniture, equipment and trade fixtures. Rent payable under this Lease Agreement shall be abated proportionately according to the floor area of the building improvements on the Leased Premises which is usable by the Tenant, and such abatement shall continue for the period commencing with such damage or destruction and ending with the completion of such work of repair and/or reconstruction of the Leased Premises as provided herein. Landlord shall be entitled to receive the proceeds payable in respect of any time element insurance that Landlord maintains in accordance with the terms of this Lease Agreement. 13. USE OF PREMISES. The Tenant agrees that the Leased Premises are to be used solely and exclusively for storage, warehouse, and distribution, with appropriate offices for the management of such distribution center, unless otherwise consented to in writing in advance by Landlord, in its sole and absolute discretion. Further, Tenant agrees: (i) to use and occupy the Leased Premises in a careful, safe, proper and lawful manner; and (ii) not to permit any unlawful nuisance, trade or custom, or condition thereon; and (iii) not to commit any waste upon, or do any damage to the Leased Premises, ordinary wear and tear excepted. Further Tenant agrees that it shall not bring or knowingly allow any 12 hazardous materials or hazardous substances (as defined by the state of Tennessee statutes and United States of America statutes) to be brought onto the Leased Premises, unless done in accordance with applicable laws for hazardous materials or substances. 14. CONDEMNATION. (a) TOTAL TAKING IN THE EVENT OF CONDEMNATION. In the event of a "taking" of all or a substantial part of the Leased Premises (defined as greater than one-half of the usable floor space of the building improvements on the Leased Premises) by any governmental authority under eminent domain proceedings, this Lease shall terminate on the date when the Leased Premises shall be so taken, and the rent shall be abated as of that date. No part of any award for the property and improvements shall belong to the Tenant. However, the Tenant shall have the right to make a separate claim with the condemning authority for the value of the Tenant's leasehold interest and/or moving or relocation expenses; provided, however, that such separate claim shall not reduce or adversely affect the amount of the Landlord's award. (b) PARTIAL TAKING IN THE EVENT OF CONDEMNATION. If any part of the Leased Premises (being less than a substantial part) of the Leased Premises shall be taken as aforesaid, and such partial taking shall render that portion not so taken unsuitable for the business of the Tenant as reasonably determined by Tenant, then this Lease shall terminate as set forth in subparagraph (a) above. If such partial taking is not sufficiently extensive to render the Leased Premises unsuitable for the business of the Tenant as reasonably determined by Tenant, then this Lease shall continue in effect except that the monthly rental payment shall be reduced in the same proportion that floor space of any 13 building improvements so taken bears as to the original floor space leased. Upon receipt of the award in condemnation, Landlord shall make all necessary repairs or alterations so as to constitute the Leased Premises a complete architectural unit. However, in no event shall the Landlord be required to spend for such work an amount in excess of the net amount received free and clear by Landlord's damages for the part of the Leased Premises so taken. Tenant shall not be entitled to and expressly waives any claims or any condemnation or other award for such taking, whether whole or partial, and whether for diminution in value of the leasehold or to the fee, or otherwise; except that the Tenant shall have the right, to the extent permitted by law, and provided by the same shall not reduce the Landlord's award, to claim from the condemnor, but not the Landlord, such compensation as may be recoverable by Tenant in its own right for the damage to the Tenant's business. 15. QUIET ENJOYMENT. Landlord covenants that it is seized of the Leased Premises and has the full right to enter into this Lease Agreement, and that the Tenant shall have the quiet and peaceful possession of the Leased Premises during the Lease Term, as against lawful acts of third parties and as against the acts of all parties claiming title to, or right to possession of the Leased Premises. 16. SUBORDINATION OF LEASE/ATTORNMENT. This Lease shall be subordinate to the rights of the IDB under the Restated Lease. Tenant shall enter into a subordination, nondisturbance, and attornment agreement in a form acceptable to Bank and Tenant. Further, this Lease shall be subordinate to any renewal, amendment, or modification of the Restated Lease to the extent that such amendment or modification does not change 14 Tenant's right of quiet enjoyment of the Leased Premises in accordance with the terms hereof. 17. SURRENDER UPON TERMINATION. At the expiration of the Lease Term or Option Terms, or any holdover tenancy, or after termination of the Lease because of Tenant's Termination Rights set forth in paragraph 28 hereof, as the case may be, Tenant shall surrender the Leased Premises in as good a condition as it was at the beginning of the Lease Term, reasonable use and wear and tear and damages by casualty or the elements excepted. At such expiration, the Tenant shall have the right to remove any fixtures or equipment owned by it, provided, however, that in so doing, the Tenant shall repair, at its expense, any damage caused by such removal. 18. ASSIGNMENT AND SUB-LETTING. Tenant shall not have the right to assign or sub-let the Leased Premises without the prior written consent of Landlord, such consent not to be unreasonably delayed or withheld. 19. EVENTS OF DEFAULT TENANT AND REMEDIES OF LANDLORD. (a) EVENTS OF DEFAULT DEFINED. The following shall be "Events of Default" under this Lease Agreement and the term "Events of Default" or "Default" shall mean, whenever they are used in this Lease Agreement, any one or more of the following events: (1) Delinquency in the due and punctual payment of any Rent, additional Rent, or additional payment under this Lease Agreement when such Rent or additional payment shall become payable, and such default shall continue for ten (10) days after payment is due; provided, however, that for the two delinquent payments for any calendar year (January - 15 December) Landlord must give written notice of non-payment, and Tenant shall have ten (10) days from the date of delivery of such notice before a default hereunder;. (2) Delinquency by the Tenant in the performance or compliance with any of the conditions or covenants contained in this Lease Agreement, other than payment of Rent or additional payments, for a period of thirty (30) days after written notice thereof from the Landlord to the Tenant, except for any default not susceptible of being cured within such thirty (30) day period, in which event the time permitted to the Tenant to cure such default shall be extended for so long as shall be reasonably necessary to cure such default, provided the Tenant commences promptly and proceeds diligently to cure such default, and provided further that such period of time shall not be so extended as to jeopardize the interest of the Landlord in this Lease Agreement or the Leased Premises or so as to subject the Landlord or the Tenant to any civil or criminal liabilities. (3) The filing by the Tenant of a voluntary petition in bankruptcy, or adjudication of the Tenant as a bankrupt, or assignment, partial or general, by the Tenant for the benefit of its creditors, or the entry by the Tenant into an agreement of composition with creditors, or the approval by a court of competent jurisdiction of a petition applicable to the Tenant in any proceeding for their reorganization instituted under the provisions of the general bankruptcy act, as amended, or under any similar act 16 which may hereafter be enacted. (4) The assignment or sub-letting of the Leased Premises in violation of this Lease Agreement. (5) Contravention of the use restriction provision contained in this Lease Agreement and continues for thirty (30) days after notice by Landlord. (b) REMEDIES ON DEFAULT. Whenever any Event of Default referred to herein shall have occurred, the Landlord may take any one or more of the following remedial steps: (1) Landlord may re-enter and take possession of the Leased Premises without terminating this Lease Agreement, and sublease the Leased Premises for the account of the Tenant, holding the Tenant liable for the difference in the rent and other amounts payable by such Subtenant in such subleasing and the rents and other amounts payable by the Tenant hereunder. (2) In the event of payment default hereunder, Landlord may terminate this Lease Agreement and demand and collect from Tenant as damages the discounted present value (determined based on then commercially reasonable rates) of the entire unpaid balance of Rent for balance of the Lease Term that remains as of the effective date of termination. (3) Landlord may terminate this Lease Agreement and exclude the Tenant from possession of the Leased Premises and may Lease the Leased Premises to another for the account of the Tenant, holding the Tenant 17 liable for all rent and other payments due up to the effective date of such leasing and for the excess, if any, of the Rent and other amounts payable by the Tenant under this Lease Agreement had the Lease Term or any renewal thereof not have been terminated over the rents and other amounts which are payable by such new Tenant under such new lease. (4) The remedies herein specified are to be exercised by the Landlord in pursuance of the availability of these remedies as provided for under the laws of the State of Tennessee; and in pursuance of these laws the Landlord may take whatever action at law and equity is available in the enforcement of these remedies, and otherwise as may appear necessary or desirable to collect rents due, or to become due, or to enforce specific performance and observation of any obligation, agreement or covenant of the Tenant under this Lease Agreement. (c) EFFECT OF TERMINATION RIGHTS UPON TENANT'S EVENT OF DEFAULT. If an Event of Default occurs as to Tenant, Tenant shall have the option of terminating the Lease as provided in paragraph 28. However, in order to prevent all available remedies to Landlord, Tenant must complete the following within thirty (30) days of Landlord's notice of its intent to exercise its remedies: (1) cure the Event of Default; and (2) give the Notice of Intent to Terminate six (6) months before the desired termination date required in paragraph 28, or alternatively pay 18 the rent that would be due during the succeeding six (6) months after Notice of Intent to Terminate; and (3) pay the Lease Termination Fee set forth in paragraph 28. (d) NO REMEDY EXCLUSIVE. No remedy herein conferred upon or reserved to the Landlord is intended to be exclusive of any other available remedy or remedies, but each and every remedy shall be cumulative and alternative and shall be in addition to every other remedy given under this Lease Agreement, now or hereafter existing at law or in equity or by statute, unless Tenant takes the actions permitted in subparagraph (c) above. No delay or omission to exercise any right or power shall be construed to be a waiver thereof, but any such right and power may be exercised from time to time as often as may be deemed expedient. In order to entitle the Landlord to exercise any remedy reserved to them in this paragraph, it shall not be necessary to give any notice other than such notice as may be herein expressly required, or as required by law. (e) NO ADDITIONAL WAIVER IMPLIED BY ONE WAIVER. In the event any agreement contained in this Lease Agreement should be breached and thereafter waived, such waiver shall be limited to the particular breach so waived and shall not be deemed to waive any other breach hereunder. (f) RIGHT OF ENTRY. Landlord and/or its representatives, may enter the Leased Premises at any reasonable time, before or after default by Tenant, for purposes including without limitation taking possession after default, inspecting the Leased Premises, performing any work which the Landlord may elect to undertake made necessary by reason of the Tenant's default under the terms of this Lease Agreement, 19 exhibiting the Leased Premises for sale or posting any appropriate notices, including those pertaining to availability for leasing during the last six (6) months of any term if Tenant has not exercised the next Option Term. Such right of entry may be exercised by the Landlord or its representatives without the same constituting an eviction of the Tenant in whole or in part. Notwithstanding the foregoing, if Tenant is not in default hereunder, Landlord shall give reasonable notice to Tenant before entering the Leased Premises (provided that no notice shall be required in the event of an emergency). Landlord agrees that it will not materially interfere with Tenant's use of the Leased Premises, and Landlord agrees to repair any damage it causes as a result of such activity. (g) NOTICE OF DEFAULT. Tenant shall give written notice to IDB of any alleged default by Landlord. 20. LANDLORD DEFAULTS AND TENANT REMEDIES. Any one or more of the following shall constitute a default by the Landlord: (a) if Landlord is adjudicated bankrupt or insolvent and such adjudication is not vacated within thirty (30) days from the date of such adjudication; (b) the admission in writing by Landlord of its inability to pay its debts when due; (c) the appointment of a receiver or trustee for the business or property of Landlord, unless such appointment is vacated within ninety (90) days after its entry; (d) Landlord making an assignment for the benefit of its creditors; (e) the failure of Landlord to pay any amounts due to Tenant within thirty (30) days after written notice from Tenant that the same is due; or 20 (f) the failure by Landlord to cure any failure to perform or observe any of its covenants under this Lease within sixty (60) days after written notice thereof from Tenant, unless such failure is of such nature that it cannot be cured within such sixty (60) day period, in which case Landlord shall have such additional time as is necessary to cure so long as Landlord commences the curing within such sixty (60) day period and thereafter diligently pursues the curing. Upon any occurrence of any default by Landlord, Tenant shall have the right to sue for damages, or specific performance, or other remedies it may have at law or in equity. Upon the occurrence of any default by Landlord, in addition to notice to the IDB and to Landlord, Tenant agrees to also give notice to the holder of any mortgage (the "Mortgage Holder") on the Leased Premises, to the extent Tenant shall have received written notice of any such Mortgage Holder. Tenant agrees that such Mortgage Holder shall have sixty (60) days after written notice thereof from Tenant to cure such default, unless such failure or default is of such nature that it cannot be cured within such sixty (60) day period, in which case the Mortgage Holder shall have such additional time to cure so long as Mortgage Holder commences the curing within such sixty (60) days and thereafter diligently pursues the curing. In addition, Tenant may cure Landlord's default and offset the reasonable expense thereof against rent thereafter accruing. Finally, if in Tenant's reasonable business judgment, Landlord's default materially interferes with Tenant's use of the Leased Premises ("Landlord's Material Default"); and if Tenant reasonably determines that it is impractical for Tenant to attempt to cure such default and offset the cost thereof against rent, and if the original written notice of default in this paragraph 20 to Landlord indicated that the default was a Landlord Material Default, then Tenant shall have the right to terminate this Lease with no further liability to Landlord (except for sums already due prior 21 to the termination), and exercise any other legal or equitable right or remedy it may have if Landlord does not cure the Landlord Material Default within the time allowed. 21. TENANT'S INDEMNITY OF LANDLORD. Unless caused by the negligence or willful misconduct of Landlord, its agents, contractors, or employees, the Tenant shall indemnify the Landlord against all claims, actions, damages, liabilities and expenses, including reasonable attorney's fees and other professional fees incurred by the Landlord as a result of: (a) Failure of the Tenant to perform any covenant required to be performed by the Tenant hereunder; and (b) Any accident, occurrence, injury or damage which shall happen in or on the Leased Premises, or resulting from the operation of Tenant's business; and (c) The failure to comply with any requirements of any governmental authorities; and (d) Any mechanics' lien, security agreement or mortgage filed, with regard to the Leased Premises, and equipment therein, or any materials used to repair or alteration of the Leased Premises incurred by Tenant. In the event any mechanics or materialmen's, or other liens shall be filed against the Leased Premises or any improvements or appurtenances thereon by reason of or arising out of any labor or material services furnished or alleged to have been furnished to or for the Tenant at or on the Leased Premises, the Tenant shall, within thirty (30) days after written notice from the Landlord, pay or bond the same or procure the discharge thereof in such manner as may be provided by law or cause other acts to be done which will provide reasonable assurance that the 22 Leased Premises shall not be sold to satisfy any such lien. The Tenant shall defend, on behalf of the Landlord, at the expense of Tenant, any action, suit or proceeding which may be brought for the enforcement of any such lien or liens or similar claims against the Leased Premises, and the Tenant shall pay any damage and discharge any judgment entered thereon and save harmless the Landlord from any claim or damage resulting therefrom. Notwithstanding the foregoing, Landlord shall be responsible for any materialmen's or mechanic's liens filed against the Leased Premises in connection with any of Landlord's work (including without limitation the work described on EXHIBIT B hereto), and any work in fulfillment of Landlord's repair obligations under this Lease; (e) Any environmental contamination to the Leased Premises, caused by Tenant, its agents, employees, contractors, or invitees. (f) Tenant's indemnity shall not include the intentional or negligent acts or omissions of Landlord, its officers, agents, contractors, or employees. (g) Tenant's indemnity obligations under this paragraph 22 shall survive the termination of this Lease with respect to any occurrence that arose or took place prior to such termination. 22. LANDLORD INDEMNITY OF TENANT. Landlord shall indemnify the Tenant against any and all claims, actions, damages, liability, and expenses, including reasonable attorney's fees and other professional fees, in connection with any accident, occurrence, injury, or damage which shall happen in or on the Leased Premises as a result of the negligence or intentional misconduct of Landlord, its officers, agents, contractors, or employees. Notwithstanding the foregoing, Landlord's indemnity shall not include the 23 intentional or negligent acts or omissions of Tenant, its officers, agents, contractors, employees, or licensees. Landlord's indemnity obligations under this paragraph 23 shall survive the termination of the Lease with respect to any such occurrence that took place prior to such termination. 23. NOTICES. All notices hereunder shall be in writing and shall be delivered in person or sent by certified mail or overnight courier service or sent by facsimile transmission to the address or facsimile numbers of the parties shown below. Notice shall be effective upon delivery when received by the party to whom delivered and shall be effective two (2) days after mailing and one (1) day after overnight courier when deposited with the United States Postal Service, or an overnight courier service, respectively. If such notice is sent by facsimile, such notice shall be deemed received by the recipient upon receipt by the sender of an acknowledgment or transmission report generated by the machine from which the facsimile was sent indicating that the facsimile was sent in its entirety to the recipient's facsimile number.
LANDLORD: TENANT: IDB - --------- ------- --- Southwind Properties Kirkland's, Inc. Industrial Development Board 529 Old Hickory Blvd. 805 North Parkway of the City of Jackson Jackson, TN 38305 Jackson, TN 38305 c/o General Counsel Fax No. (731) 661-0195 ATTN: General Counsel 312 East Lafayette Fax No. (731) 664-9345 Jackson, TN 33301 Fax No. (731) 424-0562
24. PERIODIC FINANCIAL REPORTING BY TENANT. During the Lease Term, and Option Terms, if applicable, Tenant shall provide to Landlord, annually, within thirty (30) days of request by Landlord, copies of all financial statements, including at least Tenant's Annual 24 Profit and Loss Statement and Annual Balance Sheet, required to be furnished by Landlord to Landlord's primary lender, or requested by any potential purchaser of the Leased Premises. The form of such statements shall be as customarily prepared by Tenant. Landlord agrees to keep all financial statements confidential and request Landlord's lender and any potential purchaser do the same. 25. ENVIRONMENTAL REQUIREMENTS OF TENANT. (a) LANDLORD'S WARRANTY. Landlord warrants that to Landlord's knowledge, the Leased Premises are not in violation of any Environmental Laws. (b) ENVIRONMENTAL COVENANTS OF TENANT. Throughout the Tenant's occupancy of the Leased Premises, Tenant agrees to comply with all requirements of Environmental Laws relating to air quality, water quality, solid waste disposal, hazardous waste disposal, hazardous or toxic substances, and the protection of health and environment. Further, Tenant immediately shall notify Landlord should Tenant become aware of: (i) any hazardous substance or other environmental problems or liability with respect to the Leased Premises; or (ii) any lien, action, or notice of environmental problems with respect to Tenant's business or with respect to the Leased Premises. Tenant shall at its own cost and expense, take all action as shall be necessary for the "cleanup" of any environmental contamination to the Leased Premises caused by Tenant, its agents, employees, contractors, or invitees, including all removal and remedial action in accordance with all applicable Environmental Laws. Further, Tenant shall pay or cause 25 to be paid at its own expense all clean up, administrative, and enforcement cost of all applicable governmental agencies which may be asserted against the Leased Premises with respect to any environmental contamination caused by Tenant. All costs, including without limitation, those costs set forth above, damages, liabilities, claims, and expenses (including reasonable attorney's fees and expenses) which are incurred by Landlord with respect to environmental contamination caused by Tenant, without the requirement of waiting for the ultimate outcome of any litigation, claim, or other proceedings, shall be paid by Tenant to Landlord, as incurred, within ten (10) days after notice from Landlord, itemizing the amount incurred to the date of such notice. Tenant shall provide Landlord with copies of all environmental permits from any governmental agency or organization as to Tenant's storage, processing, or locating of Hazardous Materials on or about the Leased Premises. Notwithstanding anything herein to the contrary, Tenant shall not be responsible for any Hazardous Materials in or environmental contamination to the Leased Premises that exists prior to Tenant's possession of the Leased Premises. (c) DEFINITION OF ENVIRONMENTAL LAWS. The term "Environmental Law" means any and all federal, state, regional, county, or local laws, statutes, rules, regulations or ordinances; and any state, regional, county or local statute, law, rule, regulation or ordinance relating to public health, safety or the discharges, emissions, or disposal to air, water, land or groundwater, to the withdrawal or use of groundwater, to the use, handling or disposal or polychlorinated biphenyls (PCBs), asbestos, or urea formaldehyde, to the treatment, storage, disposal or management of Hazardous Materials, to exposure to 26 Hazardous Materials, to the transportation, storage, disposal, management or release or gaseous or liquid substances, and any regulation, order, injunction, judgment, declaration, notice or demand issues thereunder. (d) DEFINITION OF HAZARDOUS MATERIALS. The term "Hazardous Materials" means any hazardous, toxic or dangerous materials, substances, chemicals, waste or pollutants that is from time to time defined by pursuant to or is regulated under any of the Environmental Laws, including without limitation, asbestos, PCBs petroleum derivatives or by-products, other hydrocarbons, including without limitation any material, substances, pollutants or wastes that are defined as a hazardous waste under RCRA or defined as a hazardous substance under CERCLA. (e) DEFINITION OF ENVIRONMENTAL CONTAMINATION. The term "Environmental Contamination" shall be defined by applicable federal and state cleanup standards. 26. ENVIRONMENTAL REQUIREMENTS OF LANDLORD. In the event any environmental survey, assessment, or inspection is required for any construction permit, Landlord shall be responsible for the cost of such survey, assessment, or inspection. Landlord shall remove any existing known Hazardous Materials from the Leased Premises prior to delivery of possession thereto to Tenant. Landlord has provided Tenant with a Phase I Environmental Assessment of the Leased Premises at the time of the execution of this Lease, and Landlord agrees to indemnity Tenant from any and all claims, actions, liens, demands, costs, damages, expenses, fines, and judgments (including legal costs and attorneys fees) as a result of any conditions identified in the Phase I Environmental Assessment. 27 27. EXPANSIONS TO BUILDING(S) ON LEASED PREMISES. Upon written request from Tenant (the "Expansion Notice") received by Landlord at any time prior to the expiration of the Initial Term, and provided that Tenant exercises its option to renew for the first Option Term, Landlord agrees, at Landlord's expense, to use diligent, good faith efforts to develop schematic plans and specifications for an addition to the building(s) on the Leased Premises (the "Expansion") that are satisfactory to Tenant, The plans and specifications for the Expansion must, in all events, be consistent with and must not exceed plans and specifications for a normal and customary, non-airconditioned, typical distribution/warehouse center. Landlord and Tenant must agree upon the plans and specifications for the Expansion. The additional rent payable by Tenant for the Expansion shall range between Two and 68/100 Dollars ($2.68) per square foot and Three and 00/100 Dollars ($3.00) per square foot. The rental amount for the Expansion shall be agreed upon by Landlord and Tenant prior to the commencement of construction of the Expansion, and be subject to the six percent (6%) increases in rent from the previous rent amount at every time the rent in paragraph 6 increases, i.e., 5 years, 10 years, 15 years after the beginning of the Initial Term. (For example, if an Extension occurs in year 3 of the Initial Term, and the rent is agreed upon at $2.80 per square foot, the rent for the Expansion will increase to $2.97 per square foot in year 5 of the Initial Term, even though it is only 2 years after the Expansion. The next rent increase will occur in year 10 of the Lease (during the first Option Term). Upon the agreement of Landlord and Tenant as to the plans and specifications for the Expansion and the rental amount to be paid therefor, the parties shall execute an addendum to this Lease setting forth relevant terms relating 28 to the Expansion. 28. LEASE TERMINATION RIGHTS OF TENANT. The Tenant shall have the right during the Initial Term, and any Option Terms (provided no expansion has begun) to terminate the Lease by giving not less than six (6) months written advance notice to Landlord ("Notice Of Intent To Terminate") of the desired termination date, and paying a lease termination fee as a condition precedent to the termination of the Lease equivalent to what the rent would be for the next twelve (12) months after the desired termination date ("Lease Termination Fee"), payable in cash to Landlord at the time of the Lease termination ("Termination Rights") and as a condition precedent to the Lease termination. At any time after an Expansion Notice, as defined in paragraph 27, the Lease Termination Rights would continue to apply. However, the Lease Termination Fee shall change and would be equivalent to what the rent would be for the next eighteen (18) months after the desired termination date, payable in cash to Landlord at the time of the Lease termination and as a condition precedent to the Lease termination. 29. MISCELLANEOUS. (a) ENTIRE AGREEMENT. This Lease Agreement contains the entire agreement and understanding between the parties. There are no oral understandings, terms or conditions and no party hereto has relied upon any representations, express or implied, not contained in this Lease Agreement. This Lease Agreement cannot be changed or supplemented orally, but only by an agreement in writing and signed by the party against whom enforcement of any waiver, change, modification or discharge is sought. 29 (b) RECORDATION. Landlord or Tenant may record a Short Form Lease, at the expense of whomever wants to record such instrument. (c) BINDING EFFECT. All covenants, conditions and obligations contained herein or implied by law shall be binding upon the Landlord, the Tenant, their heirs, successors, legal representatives and assigns; provided, however, in the event of a sale of the Leased Premises, Landlord shall be personally relieved of all obligations hereunder and the Tenant bound to such new owner as a Landlord. (d) GOVERNING LAW. This Lease Agreement is prepared and entered into with the intention that the laws of the State of Tennessee shall govern its construction. (e) CAPTIONS. The captions or headings in this Lease Agreement are for convenience only and in no way define, limit or describe the scope or intent of any provision of this Lease Agreement. (f) SEVERABILITY. If any clause, paragraph or part of this Lease Agreement, for any reason, should be finally adjudged by any court of competent jurisdiction to be unconstitutional or invalid, such judgment shall not affect, impair or invalidate the remainder of this Lease Agreement but shall be confined in its operation to the clause, sentence, paragraph or any part thereof directly involved in the controversy in which such judgment has been rendered. The unconstitutionality, invalidity or ineffectiveness of any one or more provisions or covenants contained in this Lease Agreement shall not relieve the Tenant from liability to make the payments of Rent provided for in this Lease Agreement. 30 (g) RULES OF CONSTRUCTION. The normal rules of construction which require the terms of an Agreement to be construed most strictly against the drafter of such Agreement are hereby waived since each party has been represented by counsel or has had the opportunity to be represented by counsel in the drafting and negotiations of this Agreement. (h) DUPLICATE ORIGINALS. This Lease Agreement may be executed in one or more counterparts, each of which should be deemed an original, but all of which together shall constitute but one and the same instrument. (i) ATTORNEY'S FEES. In the event of any dispute or claim arising out of the terms and provisions of this Agreement, the parties agree that the prevailing party in any court proceeding shall be entitled to recover, in addition to any award made in such proceeding, from the non-prevailing party, the prevailing party's reasonable attorney's fees. (j) ESTOPPEL CERTIFICATE. Tenant shall at any time upon not less than thirty (30) days' prior written notice from Landlord, execute and deliver to Landlord a statement in writing certifying that: (i) this Lease is unmodified and is in full force and effect and the date to which Rent or other payments are paid in advance; (ii) to Tenant's knowledge, there are not any uncured defaults by Landlord under this Lease, or specifying any defaults if any such defaults are claimed; and (iii) any such other information as may reasonably be required by Landlord. (k) NO LANDLORD LIENS. Landlord hereby waives and releases any Landlord's liens it might have in Tenant's personal property located on the Leased Premises. 31 IN WITNESS WHEREOF, the parties have executed this Lease Agreement, effective the day and date first shown above deemed an original, but all of which together shall constitute but one and the same instrument. SEPARATE SIGNATURE PAGES 32 SIGNATURE PAGE 1 OF 2 LANDLORD: SOUTHWIND PROPERTIES By: /s/ Larry P. Becker ----------------------------- Title: Managing Partner ----------------------- STATE OF TENNESSEE : COUNTY OF MADISON : Personally appeared before me Larry P. Becker, with whom I am personally acquainted, and who acknowledged that he/she executed the within instrument for the purposes therein contained, and who further acknowledged that he/she is the Managing Partner of SOUTHWIND PROPERTIES, a Tennessee General Partnership, and is authorized by said partnership to execute this instrument on its behalf. Witness my hand, at office this the 2nd day of March, 2001. /s/ Teresa Sanders -------------------------------- Notary Public My Commission Expires: [MY COMM. EXPIRES DEC. 17, 2001 STAMP]. [TERESA SANDERS NOTARY STAMP] 33 SIGNATURE PAGE 2 OF 2 TENANT: KIRKLAND'S, INC. By: /s/ Robert E. Anderson ----------------------------- Title: President ----------------------- STATE OF TENNESSEE : COUNTY OF MADISON : Personally appeared before me Robert E. Anderson, with whom I am personally acquainted, and who acknowledged that he/she executed the within instrument for the purposes therein contained, and who further acknowledged that he/she is the President of KIRKLAND'S, INC., a Tennessee Corporation, and is authorized by said corporation to execute this instrument on its behalf. Witness my hand, at office this the 6th day of March, 2001. /s/ Teresa A. Riley -------------------------------- Notary Public My Commission Expires: April 24, 2001. [TERESA A. RILEY NOTARY STAMP] 34 EXHIBIT C PAYMENT IN LIEU OF TAX SUMMARY [OCTOBER 18, 2000] 1. DEFINITIONS. For purposes of this summary, the following terms or phrases shall have the meanings assigned in this paragraph: (a) "Base Period" means the time period beginning January 1, 2001 and ending June 30, 2010. (b) "Board" means the Industrial Development Board of the City of Jackson. (c) "Company" means Kirkland's, Inc., a corporation organized under the laws of the State of Tennessee. (d) "Company Site" means (1) the Southwind Property, (2) a Phase III Qualified Existing Facility, (3) a Phase IV Qualified Existing Facility, or (4) any other warehouse or distribution facility constructed after January 1, 2001 on the Phase-III Land or the Phase IV Land and, with respect to each of the foregoing, either owned by the Company or leased by the Company (as Lessee) for purposes of conducting the Company's business operations. (e) "Equipment" means all industrial machinery and equipment purchased by the Company and installed by the Company at a Company Site during the Base Period. (f) "Equipment Component" means the aggregate items of Equipment installed during any single calendar year during the Base Period. (g) "Headquarters Facility" means a new office headquarters building which will serve as the principal executive offices of the Company to be constructed on any site in Jackson, Tennessee during the Base Period. (h) "Phase I Project" means the Southwind Property. (i) "Phase II Project" means collectively the Southwind Property together with the Southwind Building Addition. (j) "Phase III Improvements" means a proposed warehouse or distribution facility, or facilities, and related building improvements to be constructed on the Phase III Land by or for the benefit of the Company and used exclusively by the Company in conducting its business operations. (k) "Phase III Land" means that certain unimproved parcel of land presently owned by Madison County, Tennessee consisting of approximately 22.02 acres which lies immediately north of and contiguous to the Southwind Property. (l) "Phase III Project" means collectively the Phase III Land and Phase III Improvements, or, in the alternative, a Phase III Qualified Existing Facility. (m) "Phase III Qualified Existing Facility" means a pre-existing building facility in Madison County, Tennessee acquired by the Company or leased exclusively by the Company (as Lessee), and used exclusively by the Company in conducting its business operations, subject, however, to the conditions set forth, in Section 4 hereof. (n) "Phase III Existing Facility Notice" means written notice from the Company to the Board given at least forty-five (45) days prior to the date that the Company intends to acquire or occupy a Phase III Qualified Existing Facility. (o) "Phase IV Improvements" means a distribution facility to be constructed by or for the benefit of the Company on the Phase IV Land to be used exclusively by the Company in conducting its business operations. (p) "Phase IV Land" means that certain unimproved parcel of land owned by Madison County, Tennessee consisting of approximately 35 acres off of Bobrick Drive in Jackson, Tennessee and in a northwesterly direction from the existing Bobrick plant facility. (q) "Phase IV Project" means collectively the Phase IV Land and Phase IV Improvements, or in the alternative, a Phase IV Qualified Existing Facility. (r) "Phase IV Qualified Existing Facility" means a pre-existing building facility in Madison County, Tennessee, acquired by the Company or leased exclusively by the Company (as Lessee), and used exclusively by the Company in conducting its business operations, subject, however, to the conditions set forth in Section 6 hereof. (s) "Phase IV Existing Facility Notice" means written notice from the Company to the Board given at least forty-five (45) days prior to the date that the Company intends to acquire or occupy a Phase IV Qualified Existing Facility. (t) "PILOT" means payments to the City of Jackson, Tennessee and Madison County, Tennessee in lieu of ad valorem taxes ordinarily assessable against the Equipment and the Phase I Project, Phase II Project, Phase III Project, and Phase IV Project and/or Headquarters Facility, as applicable. (u) "Southwind" means Southwind Properties, a Tennessee partnership. (v) "Southwind Building" means the building structure situated on the Southwind Property as of the date hereof, consisting of approximately 303,000 square feet. (w) "Southwind Building Addition" means a proposed addition to the Southwind Building, consisting of a minimum addition of 50,000 square feet and having a minimum cost of $1,000,000.00. (x) "Southwind Property" means that certain parcel of land owned by the Board consisting of approximately 28 acres and currently leased to Southwind by the Board pursuant to Lease Agreement dated February 4, 2000. 2. PHASE I AND PHASE II PROJECT - PILOT. If Southwind Building is acquired by the Company or leased exclusively by the Company (as Lessee) and used exclusively by the Company in conducting its business operations no later than June 30, 2002, then the PILOT incentive for the Phase I Project will be based upon the following PILOT schedule: (a) PHASE I PILOT.
YEAR PILOT PERCENTAGE - ---- ---------------- 1 Year of Occupancy by the Company 0% 2 25% 3 25% 4 25% 5 25% 6 25% 7 25% 8 25% 9 25% 10 25% 11 25% 12 25% 13 25% 14 25% 15 25%
(b) PHASE II PILOT. If the Southwind Building Addition is completed and occupied exclusively by the Company on or prior to June 30, 2005, then the PILOT schedule for the Phase II Project shall be revised and shall be as follows:
YEAR PILOT PERCENTAGE - ---- ---------------- 1 Year of Completion of Southwind Building Addition 25% 2 25% 3 25% 4 25% 5 25% 6 25% 7 25% 8 25% 9 25% 10 25% 11 25% 12 25% 13 25% 14 25% 15 25%
3. PHASE III PROJECT - PILOT. The PILOT incentive for the Phase III Project will be based upon the size of the Phase III Improvements as follows: (a) If on or prior to June 30, 2006, there exist Phase III Improvements having minimum square footage of 75,000 square feet (the "First Phase III Improvement"), the PILOT incentive for the Phase III Project will be based upon the following PILOT schedule:
YEAR PILOT PERCENTAGE - ---- ---------------- 1 Year of Completion of the First Phase III Improvement 25% 2 25% 3 25% 4 25% 5 25% 6 25% 7 25% 8 25% 9 25% 10 25% 11 25% 12 25% 13 25% 14 25% 15 25%
(b) If by June 30, 2008, there is constructed additional facilities added to the First Phase III Improvements, with such additions being in a minimum square footage of 100,000 square feet (the Second Phase III Improvements), then the PILOT incentive shall be revised for the Phase III Project as follows:
YEAR PILOT PERCENTAGE - ---- ---------------- 1 Year of Completion of the Second Phase III Improvements 25% 2 25% 3 25% 4 25% 5 25% 6 25% 7 25% 8 25% 9 25% 10 25% 11 25% 12 25% 13 25% 14 25% 15 25%
(c) If by June 30, 2009, there is constructed additional facilities, to be added to the First Phase III Improvements and Second Phase III Improvements, with such additions having a minimum square footage of 100,000 square feet (the "Third Phase III Improvements"), then, in such event the PILOT schedule for the Phase III Project shall be revised and shall be as follows:
YEAR PILOT PERCENTAGE - ---- ---------------- 1 Year of Completion of the Third Phase III Improvements 25% 2 25% 3 25% 4 25% 5 25% 6 25% 7 25% 8 25% 9 25% 10 25% 11 25% 12 25% 13 25% 14 25% 15 25%
4. PHASE III PROJECT - PILOT FOR PHASE III QUALIFIED EXISTING FACILITY. If the Phase III Project consists of a Phase III Qualified Existing Facility, the following PILOT incentives for a Phase III Qualified Existing Facility shall be granted upon satisfaction of the following conditions: (a) The Board shall have received the Phase III Existing Facility Notice; (b) The Phase II Project shall, as of the date of the Phase III Existing Facility Notice, have minimum additional building improvements of 50,000 square feet; (c) No portion of the Phase I Project, Phase II Project, or Phase III Project, or other facility occupied by the Company located in Madison County, Tennessee, will be vacated by the Company as the result of the Company's proposed occupancy of the Phase III Qualified Existing Facility; (d) The Phase III Qualified Existing Facility shall not have been previously owned by or occupied by, or leased to the Company; and (e) The number of Company employees will increase as a result of the Company's occupancy of the Phase III Qualified Existing Facility.
YEAR PILOT PERCENTAGE - ---- ---------------- 1 Year of Occupancy of Phase III Qualified Existing Facility 25% 2 25% 3 25% 4 25% 5 25% 6 25% 7 25% 8 25% 9 25% 10 25% 11 25% 12 25% 13 25% 14 25% 15 25%
5. PHASE IV PROJECT - PILOT. If Phase IV Improvements are constructed on the Phase IV Land on or prior to June 30, 2010, with the Phase IV Improvements having a minimum square footage of 100,000 square feet, then the PILOT incentive for the Phase IV Project will be based upon the following PILOT schedule:
YEAR PILOT PERCENTAGE - ---- ---------------- 1 Year of Completion of Phase IV Improvement 25% 2 25% 3 25% 4 25% 5 25% 6 25% 7 25% 8 25% 9 25% 10 25% 11 25% 12 25% 13 25% 14 25% 15 25%
6. PHASE IV PROJECT - PILOT FOR PHASE IV QUALIFIED EXISTING FACILITY. If the Phase IV Project consists of a Phase IV Qualified Existing Facility, the following PILOT incentives for a Phase IV Qualified Existing Facility shall be granted upon satisfaction of the following conditions: (a) The Board shall have received the Phase IV Existing Facility Notice; (b) The Phase III Project shall, as of the date of the Phase IV Existing Facility Notice, have minimum building improvements of 100,000 square feet; (c) No portion of the Phase I Project, Phase II Project or Phase III Project, or other facility occupied by the Company located in Madison County, Tennessee will be vacated by the Company as the result of the Company's proposed occupancy of the Phase IV Qualified Existing Facility; (d) The Phase IV Qualified Existing Facility shall not have been previously owned by or occupied by, or leased to the Company; and (e) The number of Company employees will increase as a result of the Company's occupancy of the Phase IV Qualified Existing Facility.
YEAR PILOT PERCENTAGE - ---- ---------------- 1 Year of Occupancy of Phase IV Qualified Existing Facility 25% 2 25% 3 25% 4 25% 5 25% 6 25% 7 25% 8 25% 9 25% 10 25% 11 25% 12 25% 13 25% 14 25% 15 25%
7. EQUIPMENT - PILOT. For each Equipment Component installed on a Company Site, the PILOT schedule for such Equipment Component shall be as follows:
YEAR PILOT PERCENTAGE - ---- ---------------- 1 Year of Installation of Equipment Component 0% 2 0% 3 0% 4 0% 5 0% 6 35% 7 35% 8 55% 9 55% 10 75%
11 75% 12 90% 13 90% 14 90% 15 100%
8. HEADQUARTERS FACILITY - PILOT. In the event there is constructed a Headquarters Facility, the PILOT schedule for the Headquarters Facility shall be as follows:
YEAR PILOT PERCENTAGE 1 Year of Completion of Headquarters Facility 0% 2 0% 3 0% 4 0% 5 0% 6 35% 7 35% 8 55% 9 55% 10 75% 11 75% 12 90% 13 90% 14 90% 15 100%
EX-21 20 g75423ex21.txt SUBSIDIARIES OF KIRKLAND'S EXHIBIT 21 SUBSIDIARIES OF REGISTRANT
STATE OF OTHER JURISDICTION OF OTHER NAMES UNDER CORPORATION OR WHICH SUBSIDIARY NAME OF SUBSIDIARY ORGANIZATION DOES BUSINESS Kirkland's Stores, Inc. Tennessee kirklands.com, inc. Tennessee
EX-23.1 21 g75423ex23-1.txt CONSENT OF PRICEWATERHOUSECOOPERS LLP EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the use in this Registration Statement on Form S-1 of our report dated April 19, 2002 relating to the financial statements of Kirkland's Inc., which appear in such Registration Statement. We also consent to the reference to us under the heading "Experts" in such Registration Statement. PricewaterhouseCoopers LLP Memphis, Tennessee April 22, 2002 -----END PRIVACY-ENHANCED MESSAGE-----