-----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, MTPoikHdP2VID2GNeR8FYP49pev8bwW1RWPCwduNzL+WsI8BIR/jNKNkBnWpZ5hF C/ZmHK5Y25LI9TX1mEI6LQ== 0000891020-96-000284.txt : 19960401 0000891020-96-000284.hdr.sgml : 19960401 ACCESSION NUMBER: 0000891020-96-000284 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19951231 FILED AS OF DATE: 19960329 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SUN SPORTSWEAR INC CENTRAL INDEX KEY: 0000856711 STANDARD INDUSTRIAL CLASSIFICATION: APPAREL & OTHER FINISHED PRODS OF FABRICS & SIMILAR MATERIAL [2300] IRS NUMBER: 911132690 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-18054 FILM NUMBER: 96541216 BUSINESS ADDRESS: STREET 1: 6520 SOUTH 190TH ST CITY: KENT STATE: WA ZIP: 98032 BUSINESS PHONE: 2062513565 10-K405 1 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended DECEMBER 31, 1995 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from __________________ to ________________________ Commission file number 0-18054 SUN SPORTSWEAR, INC. -------------------- (Exact name of registrant as specified in its charter) Washington 91-1132690 - ------------------------------------ ---------------------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 6520 South 190th Street, Kent, Washington 98032 - ----------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (206) 251-3565 -------------- Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK NO PAR Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [ X ] NO [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (subsection 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] As of March 15, 1996, there were issued and outstanding 5,748,500 shares of Common Stock, no par value. The aggregate market value of Common Stock held by non-affiliates as of March 15, 1996 was $4,793,212 based on the average of the high and low prices of such stock as reported by the NASDAQ National Market System. DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT ITEMS IN FORM 10-K -------- ------------------ The Company's Proxy Statement to Shareholders for its 1996 Annual Meeting Part III, Items 10-13
2 PART I ITEM 1 - BUSINESS Sun Sportswear, Inc. ("Sun" or the "Company") designs, sources, prints, markets and sells an extensive array of imprinted, dyed and decorated casual sportswear for men, women and children, including a variety of T-shirts, sweatshirts and bottoms. The Company sells women's & girls' and men's & boys' apparel bearing both proprietary and licensed designs to approximately 30 national and regional retail chains, including Wal-Mart, Target, Kmart, Montgomery Ward, Sears, and JC Penney. The Company maintains an internal graphics design department of approximately 48 artists and support personnel and operates modern screen printing facilities in Kent, Washington (part of the Seattle metropolitan area). Sun, for its core product line, purchases blank T-shirts, sweatshirts, sweatpants, tank tops, nightshirts and other similar garments from domestic and foreign suppliers and screen prints designs onto those garments. Sun licenses from third parties the rights to use or distribute certain characters and trademarks, which have recently included Looney Tunes(C), joint Looney Tunes(C)/Major League Baseball(R), Pocahontas((C) Disney), Lion King((C) Disney), 101 Dalmatians((C) Disney), Garfield(R), Batman Forever((TM) and (C) DC Comics), and Winnie the Pooh((C) Disney). Sun also creates proprietary art designs based on concepts developed by its merchandising staff and updates established designs and characters. Art design categories range from recreational and outdoor to seasonal, regional and "attitude" themes. The Company is a Washington corporation formed in 1981. Its principal executive offices are located at 6520 South 190th Street, Kent, Washington 98032. Its telephone number at that address is (206) 251-3565. PRODUCTS General. The Company designs, sources, prints, markets and sells an extensive array of imprinted, dyed and decorated casual sportswear for adults and children, including its core product line of screen printed T-shirts, tank tops, sweatshirts and bottoms. Imprinted garments display either licensed or proprietary designs and characters. Sun procures garments in a variety of styles, including basic, pocket, long-sleeved and oversized T-shirts, as well as tank tops, nightshirts, and sweatpants. In addition, the Company designs and markets more detailed, fashion-oriented garments, some of which are also imprinted. The more detailed, fashion-oriented garments include shorts, polo shirts, women's leggings and casual skirts, and button-front baseball jerseys. The Company's largest sales category in 1995 was women's and girls' garments. Sales of those products represented approximately 69%, 59% and 34% of total gross sales in 1995, 1994 and 1993, respectively. Gross sales of women's and girls' products decreased to $67.0 million in 1995 from $69.4 million in 1994. Gross sales of men's and boys' products decreased to $29.8 million in 1995 from $48.2 million in 1994. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - 1995 and 1994 - Sales" below. Design and Product Development. Sun continually monitors current garment and art design trends through frequent visits to retailers and trade shows, reviews of popular and trade publications, and other activities. The product development process also involves production feasibility studies, analysis and documentation of garment and art trends, as well as costing structure and prototype preparation for customers and trade shows, and limited test sales. Sun's internal graphic design department of approximately 48 artists and support personnel creates the art work for virtually all of the Company's products, including designs incorporating licensed characters and trademarks and original designs proprietary to the Company. Because retailers demand a consistent flow of new merchandise, Sun creates over 2,000 new graphics annually. Sun responds quickly to seasonal demands and 2 3 trends involving popular characters and themes. Historically, market acceptance of Sun's core screen printed products has largely depended upon the basic appeal of their graphic designs. Sun's 18 employees in its product design and merchandising department participate in the design development process and determine the particular shape, style, color and fabric content of garments. In addition Sun's designers and merchandisers assist in designing decorative features, such as embroidery, and incorporating the graphic designs into the garments. Licensed Designs and Characters. Sun first introduced products displaying characters and trademarks licensed or under distribution agreements from third parties in August 1987. Characters and trademarks currently licensed include Looney Tunes(C), joint Looney Tunes(C)/Major League Baseball(R), Pocahontas((C) Disney), Lion King((C) Disney), 101 Dalmatians((C) Disney), Garfield(R), Batman Forever((TM) and (C) DC Comics), and Winnie the Pooh((C) Disney). The Company's artists typically create multiple variations and refinements of a given trademark or character, including different lettering, poses, activities or dress. Sun acquires rights to use trademarks and characters only on specified types of garments, pays each licensor royalties on products sold displaying the licensed trademark or character, and typically guarantees a minimum royalty that may approach $500,000 depending on the trademark or character. See "Management's Discussion and Analysis of Financial Condition and Results of Operations, 1995 versus 1994 - Gross Margins". Sun's royalty costs are reflected in higher prices charged to Sun's customers for licensed products. See "Note 2 to Financial Statements" below. Licensed products accounted for approximately 82%, 75%, and 56% of the Company's total gross sales in 1995, 1994 and 1993, respectively. The Company's experience has been that some licenses quickly gain intense popularity, but have relatively short sales cycles that can end quickly. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - 1995 and 1994 - Net Sales" below. The impact on income of fluctuations in sales of licensed products can be magnified because licensed products generally carry a higher gross margin. Sales and income are also affected if licensed products offered by the Company's competitors become unusually successful. Sun believes that, because of its design and production capabilities and its visibility in the industry, it is among the group of screen printing apparel companies that can successfully compete for attractive licensing opportunities. The Company has designated an executive officer as its director of licensing, with responsibility for its licensing efforts, to help Sun compete more effectively for new licensing opportunities. Sun intends to pursue licensors that have new characters and marks, and anticipates that licensed products will be a significant portion of the Company's annual sales in the future. However, there can be no assurance that licensors will develop or offer to Sun desirable arrangements, or that Sun will be able to retain such licenses. Proprietary Designs and Characters. Sun's artists create original designs and characters that are proprietary to the Company and continually update and refine successful designs. Proprietary designs are based on a wide variety of themes, including "attitude", recreational, outdoor, wildlife, western, sports, patriotic, humor and seasonal themes. Designs are executed with different printing techniques and inks, which in the past have included raised "puff" ink, glitter, "goop" ink and heat sensitive inks. Proprietary products accounted for approximately 18%, 25% and 44% of the Company's total gross sales in 1995, 1994 and 1993, respectively. The level of copyright and trademark protection available to the Company for proprietary designs and characters varies depending on a number of factors, including the degree of originality and the distinctiveness of the associated trademarks and designs. The Company has obtained or has applied for federal registration of the Rude Dog(R), Surf Outlaw(R), EPIC(R), U.S.A. Unique Sportswear Attitude(R), GUTS(R), GRRLS Rule(TM), Hangin' On The Rim(R) and other trademarks for use on various types of apparel, and may seek registration of other 3 4 proprietary marks in the future. There can be no assurance, however, that these applications will result in registrations. Cut-and-Sewn Products. Sun has also developed the capability to offer more detailed, fashion-oriented products, such as polo shirts, women's leggings and casual skirts, and button-front baseball shirts, by becoming more involved at the garment manufacturing stage through use of a process called "cut-and-sew". With the "cut-and-sew" process, Sun is able to purchase fabric and then have garments manufactured by contractors to patterns designed by the Company. This capability allows Sun to offer a broader variety of garment styles including garments that are "rotary printed", a printing technique that involves printing a design on fabric before it is "cut-and-sewn". Some of these "cut-and-sewn" products are screen printed by Sun, and others go directly into Sun's product lines to complement the Company's offerings. Sales of "cut-and-sewn" products accounted for 17%, 16% and 11% of gross sales for the years ended December 31, 1995, 1994 and 1993, respectively. See "Production, Cut-and-Sew Manufacturing" below. SOURCING Sun purchases fabric, trim, blank T-shirts and other garments for its screen printed apparel from approximately 27 domestic and 8 international suppliers. Approximately 71% of garments sold in 1995 were produced by domestic suppliers and the remainder by international manufacturers. No manufacturer supplied the Company with more than 18% of total garments sold during 1995. Sun's foreign suppliers are currently located in Pakistan, Peru, Honduras and Mexico. The relative proportion of garments purchased from domestic and foreign suppliers may vary over time depending, in part, on competitive factors in the world economy. Generally, basic garments and garments requiring short delivery times are purchased from domestic suppliers, while products that require greater finishing detail or allow longer delivery times are purchased overseas. Sun believes that its relationship with a number of active suppliers in both the domestic and foreign markets will enable the Company to continue to obtain a sufficient supply of garments to satisfy its requirements. Generally, each supplier agrees to produce finished garments in accordance with samples and specifications provided by Sun. No contractual obligations exist between Sun and suppliers except on an order-by-order basis. Company representatives regularly visit the facilities of both foreign and domestic suppliers to ensure quality and compliance with Sun's specifications. Sun also conducts quality control inspections of garments at its facilities, which include testing for shrinkage, dye and finish consistency, color fastness, size specification adherence, construction strength and uniformity. Sun's arrangements with overseas suppliers are subject to the risks of doing business abroad. Imports of garments are subject to bilateral textile agreements between the United States and various foreign countries which impose limitations on the amount of certain categories of merchandise that can be imported from those countries into the United States. The Company's future results could be adversely affected by additional bilateral or unilateral trade restrictions, a loss of or significant change in existing quotas resulting in a decrease in permissible imports, the imposition of additional quotas, duties, taxes or other charges on imports, significant fluctuations in the value of the dollar against foreign currencies, political instability resulting in the disruption of trade from exporting countries or restrictions on the transfer of funds. Imports of materials are also affected by the cost of transportation into the United States. 4 5 Sun operates under time constraints in producing and delivering finished screen printed products. Although customers often place orders for garment styles as long as 20 weeks in advance, customers generally select the specific art designs to be printed on ordered garments every 30 days for delivery within as few as two days following the design selection. This limited lead time requires Sun to have blank garments available for printing on short notice. Consequently, the Company maintains a substantial inventory of blank stock and often orders blank garments substantially in advance of the anticipated time of screen printing and shipment. Sales of garments obtained from "package" suppliers accounted for 83% of gross sales in 1995. "Package" suppliers produce or purchase the requisite fabric and other materials and then perform dyeing and garment fabrication. Sales of garments obtained from "cut-and-sew" suppliers accounted for 17% of gross sales in 1995. With "cut-and-sewn" garments, Sun purchases fabric from various mills and hires "cut-and-sew" contractors to perform garment fabrication. To minimize the risk of excess inventory, the Company generally sources "cut-and-sewn" garments only after receipt of purchase orders from customers. Sun purchases fabric for use in "cut-and-sew" operations primarily from domestic suppliers. Several of these suppliers also provide blank garments that Sun uses for its screen printed apparel. Sun uses approximately 19 domestic "cut-and-sew" contractors and 6 offshore "cut-and-sew" contractors. PRODUCTION General. Operations at the Company's production facilities in Kent, Washington include art and design, merchandising, market research and development, receipt and quality control inspection of incoming blank or dyed garments, screen printing, decorating, the addition of customer price tickets and hang tags to finished products, hangering or poly-bagging, packing and shipment. Sun believes its ability to respond quickly to changes in customer requirements and to meet delivery schedules consistently is an important factor in the Company's success. The Company has expanded its bar-coding capabilities to assist in rapid stock control of its inventory. The Company is in the process of implementing a computerized manufacturing information system (MRP and MRPII) to make its product through-put more efficient. See "Management's Discussion and Analysis of Financial Condition and Results of Operations, 1995 and 1994, Addition of Integrated Management Information System" below. The Company devotes substantial attention to preventive maintenance and employee training for its printing equipment. Each press is operated by a group of trained employees who work together as a team. The Company believes that this approach contributes to the flexibility, quality and speed of its production process. Screen Printing. The screen printing process begins with the preparation of a design by the Company's artists. Sun tests new designs for printability and color dynamics, and produces sales and production samples. Sun also stocks over 140 pigment colors and numerous ink bases, which allows for in-house development of new ink applications and techniques. In the printing process, screens are positioned in automatic printing presses where inks are pressed through the screen in order to duplicate the design on the garment. Garments bearing designs on different portions of the garment may move through the printing process several times. Following printing, the garments are dried, making the printed design permanent and washable. In 1995, the cost of blank garments represented approximately 62% of the cost of finished garments, with labor, ink and other production and licensing costs accounting for the remaining 38%. The Company has 15 automatic screen printing presses at its Kent facility. The Company's screen printing presses have a projected maximum annual capacity of approximately 26.7 million garments. In 1995, Sun sold approximately 19 million garments, of which 17 million, or 91% were screen printed. The Company's 5 6 printing capacity in Kent includes two belt presses which permit a design to be printed over an entire side of a garment ("overall print" designs), eleven 12-color "spot" printing presses, and two Ultimate presses which can print either "spot" designs or "overall print" designs. Sun has also used independent subcontractors to print garments during peak production periods and believes that additional subcontractors are readily available if needed in the future. Sun operates equipment at its Kent facility that assists the Company in placing garments on hangers prior to shipment. To meet customers' needs, the Company also has the ability to affix price tags and other product information and can ship garments poly-bagged or folded. These services reduce the time required to prepare the garments for display and thereby enable customers to stock their racks and shelves more quickly. "Cut-and-Sew" Manufacturing. The "cut-and-sew" process involves Sun purchasing finished fabric and hiring "cut-and-sew" contractors to cut the fabric to specific patterns developed by Sun's merchandisers and sew the component pieces to produce garments that may have greater complexity and detail than package purchased blank garments. In October 1993, Sun permanently closed its internal "cut-and-sew" operations at its Johnson City, Tennessee facilities. See "Note 4 to Financial Statements" below. Labor. Sun generally increases or reduces the size of its warehouse, screen printing and distribution labor force in connection with seasonal production demands through the use of temporary labor. Sun generally hires seasonal laborers from a regular pool, thereby increasing both the level of experience and the loyalty of its workforce. Regulations. The Company is subject to federal, state and local environmental laws and regulations, including laws relating to employee knowledge of, exposures to, and disposal of inks, dyes, photographic chemicals and cleaning solvents. Sun believes that its operations comply with applicable environmental laws and regulations. Although the Company continues to make capital expenditures for environmental protection, it does not anticipate that significant expenditures will be required to remain in compliance with environmental requirements. SALES AND MARKETING The Company's marketing and sales efforts emphasize development and maintenance of close relationships with customers, regular presentation of samples and prototypes of new styles and designs, and responsiveness to customer requirements. Sun's in-house marketing and sales efforts are directed and implemented by management of the Company, including the Senior Vice President - Sales and Merchandising, the Merchandising Managers and the Design Managers. These individuals devote substantial time and attention to direct dealings with customers, regularly make personal visits to their headquarters and stores and participate in industry trade shows. Sales are generally made by personal visits to customers by these managers and by sales representatives, who typically meet with customers at least every 30 days to take orders for particular designs and to show new designs and garments. Since March 1992, all marketing and sales efforts have been conducted in-house. The Company emphasizes customer service. The Company's 5 full-time employees in its customer service areas coordinate orders and shipments and are in daily contact with customers. The Company maintains an electronic data interchange (EDI) capability through which customers using automated inventory management systems may communicate orders electronically to the Company. 6 7 The Company distributes garments to approximately 30 national and regional retail chains in the United States, including Wal-Mart, Target, Kmart, Montgomery Ward, Hills Department Stores, Sears, Kids `R Us, Venture and JC Penney. Approximately 96% of the Company's gross sales in 1995 were made to its ten largest customers. Gross sales to Wal-Mart, Target and Kmart represented approximately 88% of total gross sales in 1995, approximately 88% of total gross sales in 1994, and approximately 82% of total gross sales in 1993. For additional information concerning sales to major customers, see "Note 9 of Notes to Financial Statements" below. Sun is not party to any long-term, multiple-shipment agreements with its customers. SEASONALITY The Company's highest sales and heaviest production demands historically occur in the first, second and fourth quarters of each year. During the first, second and fourth quarters, spring and summer products - which include T-shirts, tank tops, shorts and similar garments - and back-to-school products are produced and sold. During the third and part of the fourth quarter, winter season products - which include sweatshirts and long sleeve T-shirts - and holiday products are produced and sold. See "Management's Discussion & Analysis of Financial Conditions - 1995 and 1994 - Quarterly Net Sales - Seasonality" below. COMPETITION The Company's strategy focuses on anticipating and meeting the demands of customers with volume purchasing requirements. Sun believes that it is one of the few screen printing companies capable of concurrently providing several large customers with high volumes of screen printed products, together with the variety of designs and styles required by those customers. The Company believes, however, that other businesses possess the resources and familiarity with Sun's customer base to enter into, and compete with the Company in its principal market. More generally, the Company's core screen printed products compete with other printed apparel, including apparel displaying licensed characters and the colors and symbols of professional sports teams and colleges and universities; with branded apparel; with apparel from vertical mills such as Hanes or Fruit of the Loom; and with a wide variety of other clothing suitable for work, recreation or casual wear. Competitive factors include product quality, price, ability to meet delivery requirements and other aspects of customer service, changes in styles and consumer preferences, degree of customer preference for a limited number of vendors, and the limited availability of shelf and rack space. The Company has developed a product merchandising and manufacturing capability that enables it to complement and expand its core screen printed product line by offering more detailed, fashion-oriented garments. See "Business - Products" above. Producers of branded and other more fashion-oriented garments include companies such as Cutler Sports Apparel, Allison Manufacturing, Jerry Leigh Inc., Jem Sportswear and Heather Hill Sportswear. Some of the Company's competitors, including Hanes and Fruit of the Loom, have greater financial, manufacturing and marketing resources than the Company. 7 8 BACKLOG Sun typically receives information from customers concerning projected purchases several months in advance of delivery, with written purchase orders for particular garments being submitted shortly before shipment. In addition, customers may cancel or reschedule orders with little or no penalty. Typically the backlog of firm orders at any point in time represents less than 10% of expected sales for the upcoming 12 months. For these reasons, Sun does not believe that backlog at any one point in time is a meaningful indicator of long-term future sales. At December 31, 1995, the Company's backlog of firm orders was approximately $8.6 million, all of which the Company expects to fill during 1996. At December 31, 1994, the Company's backlog of firm orders was approximately $4.7 million. EMPLOYEES At December 31, 1995, the Company employed 508 full-time employees, including 152 managerial, sales, creative art and clerical employees and 356 employees engaged in manufacturing, warehousing and distribution. None of the Company's employees are covered by a collective bargaining agreement. The Company believes that its employee relations are good. RECENT DEVELOPMENTS In February 1996, the company initiated a restructuring plan, that, among other things, resulted in the combining of Sun's Women's and Girls' Division and Men's and Boys' Division. Sandra L. Teufel assumed leadership of the combined Women's/Girls' and Men's/Boys' operations, as Senior Vice President - Sales and Merchandising. Ms. Teufel had most recently served as Sun's Senior Vice President - Women's and Girls' Division. The restructuring plan also resulted in the elimination of approximately 30 indirect positions from the Company's workforce, including Kenneth R. Schrang's position as Senior Vice President - Men's and Boys' Division. EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company are listed below:
NAME AGE POSITION ---- --- -------- Larry C. Mounger 58 Chairman of the Board William S. Wiley 48 President and Chief Executive Officer L. Kaye Counts 41 Executive Vice President and Chief Operating Officer Sandra L. Teufel 41 Senior Vice President - Sales and Merchandising Kevin C. James 38 Senior Vice President and Chief Financial Officer
Larry C. Mounger was elected to the Board of Directors in April 1991 and has been Chairman of the Board since January 1993. Mr. Mounger served as Chief Executive Officer and President from January 1993 to October 1995. Mr. Mounger served as Chairman and Chief Executive Officer and other positions of Pacific Trail 8 9 from 1955 to 1993. Pacific Trail was an outerwear garment company located in Seattle, Washington which designed, manufactured and marketed garments throughout the United States. He is a past President of the National Apparel and Textile Association. William S. Wiley was appointed President and Chief Executive Officer and elected to the Board of Directors in October 1995. Mr. Wiley was engaged by the Company as a re-engineering consultant from January to October 1995. Mr. Wiley was an active principal in Wiley, Pene & Company, a business building/turnaround consulting firm from 1990 to 1995. From 1987 to 1990, Mr. Wiley served as a consultant and manager in the business building/restructuring consulting firm of Clyde, Hamstreet and Company. Mr. Wiley practiced law for Gleaves, Swearingen, Larsen and Potter from 1975 to 1987, where he became partner in 1980. From 1969 through 1972, Mr. Wiley served as a process and operations engineer for Atlantic Richfield . L. Kaye Counts has been Chief Operating Officer since December 1990 and became Executive Vice President in February 1994. Ms. Counts joined the Company in June 1982 and served as a custom sales manager and plant manager from June 1982 to March 1984, as operations manager from March 1984 to December 1986, then as Vice President Operations from December 1986 through February 1994. Prior to joining Sun, she was production coordinator from 1980 to 1982 for Sunrise Design, Inc., a custom screen printing business located in Seattle. Sandra L. Teufel was appointed Senior Vice President - Sales and Merchandising in February 1995. Ms. Teufel joined the Company in September 1988 and served as Merchandise Manager for the (then newly-formed) Women's and Girls' Division until September 1992, and as Vice President - Women's and Girls' Division from September 1992 until February 1995. Prior to joining Sun, Ms. Teufel was a part-owner of Nothing but Fun, and Head Designer at Normandee Rose from 1985 through 1988 (both are garment manufacturing companies based in Seattle, Washington). Ms. Teufel served as Head Designer at Union Bay Sportswear from 1981 to 1984 and as a Designer for Britannia Sportswear from 1977 to 1981. Kevin C. James became Senior Vice President and Chief Financial Officer in February 1994, and served as Vice President Finance of the Company from March 1991 until February 1994. Prior to joining Sun, Mr. James served from 1989 to 1991 as Vice President Finance and other positions for Fone America, Inc., a telecommunications company located in Portland, Oregon. From 1983 to 1988, he served as Chief Financial Officer and other positions for Klukwan, Inc., a diversified forest products company located in Juneau, Alaska. From 1980 to 1983, Mr. James worked in public accounting. ITEM 2 - PROPERTIES Sun's headquarters and principal production operations are located in a 230,000-square foot building in Kent, Washington, a suburb of Seattle. The facility centralizes the Company's administrative, design, production and the majority of its warehousing functions in one building. This facility has allowed the installation of equipment that facilitates handling and hangering of finished garments and equipment for on-site production of samples and prototype garments. The lease for this facility provides for a rental of $115,000 per month, plus insurance, taxes and other charges, and expires in October 1999, with an option to renew for two consecutive five-year terms. The Company also has a five year option to purchase the facility beginning in October 1994, for a mutually agreeable fair market price. The Kent facility is leased from an affiliate of David A. Sabey, who was formerly Chairman of the Board of Directors and the majority shareholder of the Company. The Company also leases a 51,500 square foot satellite warehouse in Kent, Washington from an unrelated third party. The lease, which expires in January 1997, provides for a rental of $14,800 per month, plus insurance, taxes and other charges. 9 10 The Company believes that its plants and equipment are maintained in good operating condition and devotes substantial attention to preventive maintenance of the equipment. ITEM 3 - LEGAL PROCEEDINGS As previously disclosed, a lawsuit is pending in the Supreme Court of the State of New York, County of Oneida, the basis of which is a Complaint filed on February 14, 1994 against Sun Sportswear, Inc.; E.R.O. Industries, Inc.; Toys 'R Us, Inc.; Grace International Apparel, Inc.; and Bradlees Department Store; by plaintiff Dustin Allen Pack. The 8 year-old plaintiff allegedly caught fire while lying in a polyester slumber sack (manufactured by E.R.O. Industries, Inc. and sold by Toys `R Us, Inc.), watching television and playing with a butane lighter. He was allegedly wearing a flannel shirt (manufactured by Grace International Apparel, Inc. and sold by Bradlees Department Stores) over a T-shirt (manufactured by Sun Sportswear, Inc. and sold by Bradlees Department Stores). Plaintiff seeks compensatory damages of $150 million and punitive damages of $50 million against all defendants under various tort law theories, including false labeling and flammability of the slumber sack against its manufacturer and for negligence against all defendants together. Sun has tendered the defense of this suit to its insurance carrier, which is opposing the suit vigorously. Sun believes its coverage is sufficient in the event it is held liable for compensatory damages. While its coverage may not extend to punitive damage awards, the Company believes there are no grounds for such damages. Although it cannot predict with certainty the outcome of this suit, the Company believes its disposition should not result in a material adverse effect on the results of operations or the financial condition of the Company. In July of 1995, Bradlees Department Stores filed for Chapter 11 protection. The effect of Bradlees Chapter 11 filing, if any, on this lawsuit has not been determined at this time. The only other legal proceedings to which the Company is a party involve routine matters that are incidental to its business. The Company does not believe that the resolution of these matters will have a material effect on the results of operations or financial condition of the Company. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 10 11 PART II ITEM 5 - MARKET PRICES AND DIVIDENDS ON COMMON STOCK The Company's Common Stock, no par value, is traded over the counter on The Nasdaq Stock Market under the symbol SSPW. The following table sets forth the range of the high and low trade prices for the Company's Common Stock:
HIGH LOW ---- --- CALENDAR YEAR 1994 First Quarter 8-1/2 5-1/2 Second Quarter 7 4-3/4 Third Quarter 5-7/8 3-1/2 Fourth Quarter 5-3/4 4-1/4 CALENDAR YEAR 1995 First Quarter 5-1/8 4-1/4 Second Quarter 4-1/2 3-3/4 Third Quarter 5 4-1/4 Fourth Quarter 4-5/8 2-9/16
The NASDAQ quotations, above, reflect inter-dealer prices, without retail mark-ups, mark-downs, or commission and may not necessarily represent actual transactions. As of March 15, 1996, the Common Stock of the Company was held by approximately 125 shareholders of record, which encompassed approximately 1800 beneficial shareholders. The present policy of the Company is to retain future earnings to provide funds for the operation and expansion of its business. The Company has not paid cash dividends since it became a public company in December 1989, and does not plan to pay cash dividends in the foreseeable future. 11 12 ITEM 6 - SELECTED FINANCIAL DATA The following data, insofar as it relates to each of the years 1991 to 1995, has been derived from audited financial statements, including the balance sheets at December 31, 1995 and 1994, the related statements of income and of cash flows for each of the years in the periods ended December 31, 1995, 1994 and 1993, and notes thereto appearing elsewhere herein. The data should be read in conjunction with the financial statements, related notes and other financial information included herein.
For the year ended December 31, 1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- (Amounts in thousands except per share data) Income Statement Data: Proprietary sales $ 17,454 $ 28,923 $ 47,572 $ 59,996 $ 63,538 Licensed sales 79,335 88,665 60,365 12,836 9,589 Sales deductions (2,824) (4,375) (3,164) (2,187) (1,332) -------- --------- --------- -------- -------- Net sales 93,965 113,213 104,773 70,645 71,795 Cost of goods sold 84,570 95,879 87,911 59,770 58,170 -------- --------- --------- -------- -------- Gross margin 9,395 17,334 16,862 10,875 13,625 -------- --------- --------- -------- -------- Operating expenses: Selling 3,649 3,781 3,358 2,829 2,485 Design and pattern 2,492 2,527 2,298 1,987 1,934 General and administrative 7,691 6,712 5,656 5,844 5,533 Provision for doubtful accounts and factoring fees 132 72 130 155 (134) Manufacturing cessation -0- -0- 898 152 -0- -------- --------- --------- -------- -------- 13,964 13,092 12,340 10,967 9,818 -------- --------- --------- -------- -------- Operating (loss) income (4,569) 4,242 4,522 (92) 3,807 -------- --------- --------- -------- -------- Other (income) expense: Interest expense 1,267 677 519 483 605 Joint venture discontinuation -0- -0- -0- 259 -0- Other, net (201) (112) (228) (52) (119) -------- --------- --------- -------- -------- 1066 565 291 690 486 -------- --------- --------- -------- -------- Income (loss) before provision for income taxes (5,635) 3,677 4,231 (782) 3,321 Provision (benefit) for income taxes (1,899) 1,228 1,494 (265) 1,129 -------- --------- --------- -------- -------- Net (loss) income $ (3,736) $ 2,449 $ 2,737 $ (517) $ 2,192 ======== ========= ========= ======== ======== Net (loss) income per share $ (0.65) $ 0.43 $ 0.49 $ (0.09) $ 0.39
(continued) 12 13 ITEM 6 - (CONTINUED)
December 31, 1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- (Amounts in thousands) Balance Sheet Data: Total assets $ 47,315 $ 62,384 $ 42,247 $ 40,278 $ 36,089 Working capital 21,419 25,031 22,981 19,418 22,497 Notes payable 13,500 15,987 3,453 4,317 -0- Current portion of long-term debt 246 377 2,656 3,259 949 Long-term debt (less current portion) 109 338 617 -0- 3,059 Shareholders' equity 26,018 29,750 26,820 23,902 24,419
13 14 ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage relationship of certain income statement items to net sales and the dollar increase or decrease as a percentage of such items from period to period.
Dollar Increase (Decrease) as a Percentage Year ended ------------------- December 31, 1994 1993 --------------------------------- to to 1995 1994 1993 1995 1994 ---- ---- ---- -------------------- Gross sales Proprietary sales 18.6% 25.5% 45.4% (40)% (39)% Licensed sales 84.4 78.3 57.6 (11) 47 Sales deductions (3.0) (3.8) (3.0) (35) 38 ----- ----- ----- Net sales 100.0 100.0 100.0 (17) 8 Cost of goods sold 90.0 84.7 83.9 (12) 9 Gross margin 10.0 15.3 16.1 (46) 3 Operating expenses 14.9 11.5 11.8 7 6 Interest expense 1.3 0.6 0.5 87 30 Other (income) (0.2) (0.1) (0.2) 80 (51) and expense Provision (benefit) for income taxes (2.0) 1.1 1.4 (255) (18) ----- ----- ----- Net (loss) income (4.0)% 2.2% 2.6% (253) (11) ===== ===== =====
1995 VERSUS 1994, AND FUTURE OUTLOOK NET SALES. Net sales for 1995 decreased 17% to $94.0 million from $113.2 million in 1994. The primary reason for this decrease was the sales decline suffered by the Company in the second half of 1995 caused by the soft retail environment, and decreases in the sales of men's and boys' products. Gross sales of men's and boys' products decreased 38% to $29.8 million in 1995 from $48.2 million in 1994. The Company believes this decrease was primarily the result of the Major League Baseball strike, the non-renewal of the Company's joint Looney Tunes(C)/National Football League(R) license and a difficult retail sales environment. Women's and girls' gross sales decreased by 3.5% to $67.0 million in 1995 from $69.4 million in 1994. The Company believes this decrease was due to the soft retail environment in the second half of 1995. Gross sales of licensed products decreased by 11% to $79.3 million in 1995 from $88.7 million in 1994. The decrease in licensed product sales was primarily the result of a decrease in sales of garments bearing Looney Tunes((C) Warner Bros.), joint Looney Tunes(C)/National Football League(R) and Lion King((C) Disney) licensed 14 15 designs. These licensed sales decreases were partially offset by an increase in sales of garments bearing Pocahontas((C) Disney), 101 Dalmatians((C) Disney) and Winnie the Pooh((C) Disney) designs. Gross sales of proprietary products decreased by 40% to $17.4 million in 1995 from $28.9 million in 1994. The Company believes this decrease was primarily the result of the soft retail environment and strong competition from garments bearing licensed characters and trademarks. Gross sales to Sun's largest three customers decreased 18% in 1995 versus sales in 1994. Gross sales to Sun's other customers decreased 18% in 1995 versus 1994. These decreases were primarily the result of the factors discussed above. Sales deductions, consisting of sales returns, discounts and allowances, decreased to $2.8 million in 1995 from $4.4 million in 1994. This decrease was primarily due to decreases in the amount of product returns. GROSS MARGIN. Gross margin as a percentage of net sales decreased to 10.0 % in 1995 from 15.3% in 1994 (see "Note 1 to Financial Statements" above). This decrease was primarily the result of four factors. First, the reduced overall sales levels in 1995 had a disproportionate effect on gross margin due to the diminished capacity to cover the Company's fixed costs. Second, in the last half of 1995, the Company accrued over $2 million in one-time inventory markdowns arising from expected losses on the sale of surplus inventory. The Company believes these markdowns were necessary because of the sluggish retail market and competitive selling pressures in the screenprint environment. Third, 1995 margins were negatively impacted by efforts to reduce men's inventory, including customer incentives and substitution of existing, higher value inventory to fill customer orders for lower value product. The Company is continuing its efforts to reduce inventory, and as a result of such reduction efforts, the Company believes its gross margin will be negatively impacted in the first half of 1996 by 1% to 2% of net sales (see "Liquidity and Capital Resources" below). Fourth, in the third quarter of 1995, the Company recorded over $350,000 in charges arising from minimum royalty commitments the Company made (with regard to certain of its license contracts) which are not anticipated to be recovered through licensed product sales. The Company believes these reserves for unmet minimum royalty obligations were necessary because of the overall sluggish retail market and competitive selling pressures in the screenprint environment. OPERATING EXPENSES. Operating expenses increased to $14.0 million (or 14.9% of net sales) in 1995 from $13.1 million (or 11.6% of net sales) in 1994 (see "Note 1 to Financial Statements - Reclassifications" below). This increase was primarily attributable to an increase in general and administrative expenses. General and administrative expenses increased to $7.7 million (or 8.2% of net sales) in 1995 from $6.7 million (or 5.9% of net sales) in 1994. This increase was primarily the result of added costs associated with the Company's management information system (see "Addition of Integrated Management Information System" below), and $747,000 in consulting costs associated with the Company's ongoing re-engineering efforts to reduce its sourcing, printing and distribution costs (see "Re-engineering Efforts" below). INTEREST EXPENSE. Interest expense increased 87% to $1,267,000 in 1995 from $677,000 in 1994 primarily as a result of higher borrowing levels and higher interest rates in 1995. NET (LOSS) INCOME. The Company experienced a net loss of $3.7 million for 1995 compared to net income of $2.4 million in 1994, as a result of the factors described above. RE-ENGINEERING EFFORTS. The Company believes it can reduce its sourcing, printing and distribution costs, by re-engineering its operating processes. To assist in these re-engineering efforts, in the first quarter of 1995 the Company engaged re-engineering, sourcing and business development experts. The Company incurred $747,000 in consulting expense in 1995, and believes it will incur $50,000 in such expenses during 1996. The Company 15 16 expects its per unit manufacturing and operating costs to decrease as a result of these efforts beginning in 1996. As has been previously disclosed in the Company's public documents, in October 1995 the Company appointed one of its re-engineering consultants, William S. Wiley, as Chief Executive Officer, President and Director. ADDITION OF INTEGRATED MANAGEMENT INFORMATION SYSTEM. In order to decrease manufacturing costs and decrease inventory levels, the Company acquired and began installing an integrated management information system in 1994 (at a cost of approximately $1.5 million). The Company expects to achieve operating efficiencies as a result of this new system beginning in 1996. NON-RENEWAL OF JOINT LOONEY TUNES(C)/NATIONAL FOOTBALL LEAGUE(R) LICENSE. The National Football League(R) did not renew Sun's joint license for Looney Tunes ((C) Warner Bros.) characters combined with National Football League(R) team trademarks (the sell-off period under this license expired June 30, 1995). The National Football League indicated to the Company that the NFL did not renew in order to strategically consolidate the number of licensees holding rights to its properties. The Company believes its other Looney Tunes(C) and joint Looney Tunes(C) licenses will not be affected by this action. Sales of Looney Tunes(C)/National Football League(R) products were $1.8 million in 1995 and $4.5 million in 1994. 1994 AND 1993 NET SALES. Net sales for 1994 increased 8.1% to $113.2 million from $104.8 million in 1993. The primary reason for that increase was the increase in gross sales of licensed goods from $60.4 million in 1993 to $88.7 million during 1994. The increase in licensed sales was primarily attributable to the popularity of the Warner Bros.' Looney Tunes(C), joint Looney Tunes(C)/Major League Baseball(R) and joint Looney Tunes(C)/National Football League(R) licensed products, and the popularity of The Lion King ((C) Disney) licensed products. Partially offsetting the increase in licensed products was a decrease in gross sales of proprietary products by 39.2% from $47.6 million in 1993 to $28.9 million in 1994. The Company believes this decrease was the result of increased competition from garments bearing licensed designs, and of the overall sales decrease in men's and boys' products. Gross sales of women's and girls' apparel increased 91% to $69.4 million in 1994 from $36.3 million in 1993. The Company believes this increase was due to the strong design and merchandising abilities of this division, coupled with a strong license portfolio, which resulted in strong sell-through at retail. Gross sales of men's and boys' products decreased 32% to $48.2 million in 1994 from $71.2 million in 1993. The Company believes this decrease was primarily attributable to reduced sales calling efforts and garment sourcing issues caused by staff turnover that occurred in 1994, the Major League Baseball(R) and National Hockey League(R) strikes, and a difficult retailing environment in the last quarter of 1994. Gross sales to Sun's largest three customers increased 16.2% in 1994 versus 1993. This increase was primarily the result of sales increases to Sun's third largest customer in 1994. Gross sales to Sun's other customers decreased 27.2% in 1994 versus 1993. This decrease was primarily the result of decreases in sales of men's and boys' products. Sales deductions, consisting of sales returns, discounts and allowances, increased to $4.4 million in 1994 from $3.2 million in 1993. The increase was primarily due to two factors. First, sales allowances increased due to the higher sales levels in 1994. Second, one large order was returned in the second quarter of 1994 due to distribution errors. 16 17 GROSS MARGIN. Gross margin as a percentage of net sales decreased to 15.3% in 1994 from 16.1% in 1993. See "Liquidity and Capital Resources" below. This decrease was primarily the result of the fact that sales of "cut-and-sewn" products - which generally carried lower margins than package products - were higher in the 1994 period, sales returns and allowances were higher in 1994 than in 1993, and distribution costs increased in 1994 due to expanded sales to Sun's third largest customer (this customer had greater requirements for product ticketing, hangering and packaging). The above factors were partially offset by lower levels of sub-contract printing - which is less profitable than in-house printing - in 1994 versus 1993; and higher levels of licensed products sales - which generally carried higher margins than proprietary products - in 1994 than in 1993. OPERATING EXPENSES. Operating expenses increased to $13.1 million (or 11.6% of net sales) in 1994 compared to $12.3 million (or 11.8% of net sales) for 1993. This dollar increase was primarily attributable to increases in selling, design-pattern, and general-administrative expenses in 1994. The 1994 increase was partially offset by $898,000 in charges recorded in 1993 associated with the closure of the Company's Johnson City, Tennessee "cut-and-sew" facility. See "Note 4 to Financial Statements" below. Selling expense increased to $3.8 million or 3.3% of net sales in 1994 from $3.4 million or 3.2% of net sales in 1993. The dollar increase was primarily the result of the costs of additional personnel hired to support the higher 1994 sales volume in the Women's and Girls' Division and non-recurring severance payments. Design and pattern expense increased to $2.5 million or 2.2% of net sales in 1994 from $2.3 million or 2.2% of net sales in 1993. The dollar increase was primarily due to "learning curve" costs associated with the Company's computer-aided-design system. General and administrative expense increased to $6.7 million or 5.9% of net sales in 1994 from $5.7 million or 5.4% of net sales in 1993. This increase was primarily the result of the start-up costs associated with the Company's management information system (see "Addition of Integrated Management Information System" above) and the costs of additional personnel hired to support the higher 1994 sales volume in the Women's and Girls' Division. INTEREST EXPENSE. Interest expense for 1994 was $676,000 versus $519,000 in 1993, as a result of higher borrowing levels and higher interest rates. NET INCOME. Net income decreased to $2.4 million in 1994 from $2.7 million in 1993, as a result of the factors described above. 17 18 QUARTERLY NET SALES-SEASONALITY The Company's net sales fluctuate from quarter to quarter. Quarterly net sales for 1995, 1994, and 1993 are set forth below.
Net Sales (Dollar amounts in thousands) ----------------------------------------------------------------------------- 1995 1994 1993 ----------------------------------------------------------------------------- Amount Percent Amount Percent Amount Percent First Quarter $ 25,720 27.4% $ 27,224 24.0% $ 22,301 21.3% Second Quarter 30,582 32.5 27,375 24.2 31,849 30.4 Third Quarter 16,225 17.3 26,634 23.6 24,434 23.3 Fourth Quarter 21,438 22.8 31,980 28.2 26,188 25.0 -------- ----- -------- ----- -------- ----- Total $ 93,965 100.0% $113,213 100.0% $104,772 100.0% ========= ===== ======== ===== ======== =====
The Company's highest sales and heaviest production demands generally occur in the first, second and fourth quarters of each year. During the first, second and fourth quarters, spring and summer products - which include T-shirts, tank tops, shorts and similar garments - and back-to-school products are produced and sold. During the third and part of the fourth quarter, winter season products - which include sweatshirts and long sleeve T-shirts - and holiday products are produced and sold. LIQUIDITY AND CAPITAL RESOURCES The Company finances working capital needs primarily from "internally generated funds" (which the Company defines as net income plus depreciation) and short term borrowing under a credit agreement. At December 31, 1995, the Company's Bank credit agreement provided for a line of credit facility (including commercial and standby letters of credit) of up to $27,000,000. At December 31, 1995, total outstanding commercial letters of credit were $919,245 and approximately $1.8 million was available for borrowing. The borrowing rate for the revolving portion of the line was the prime rate or lower. All the Company's assets, including accounts receivable and inventories, were pledged as security for borrowings under the Bank credit agreement. In February 1996, the Company replaced its Bank credit agreement with a credit agreement provided by Heller Financial, Inc. The Heller credit agreement provides for a line of credit (including commercial letters of credit) of up to $24,000,000 and expires in February 1998. At March 15, 1996, approximately $9.0 million was available for borrowing. The borrowing rate for the revolving portion of the line is the prime rate. All the Company's assets, including accounts receivable and inventories, are pledged as security for borrowings under the Heller credit agreement. Under the agreement, the amount borrowed at any time, together with letters of credit issued on behalf of the Company, may not exceed 85% of eligible accounts receivable and 60% of eligible inventory - up to $8.5 million. The Heller credit agreement requires compliance with certain financial covenants principally relating to working capital, tangible net worth, ratio of debt to equity, expenditures for fixed assets, minimum earnings (before taxes, interest and depreciation), interest coverage, restrictions on the payment of dividends and restrictions on the incurrence of long-term debt. The Company is in compliance with the Heller debt covenants. Inventory levels decreased by $6,524,000 or 21.6% from December 31, 1994 to December 31, 1995, primarily as a result of the Company's concerted efforts to operate its business with lower levels of inventory. The Company believes there was over $3.6 million (net of inventory markdown reserves of $4.5 million) of 18 19 impaired surplus inventory on hand at December 31, 1995, which is expected to be sold at little or no margin in the first half of 1996 (see "Management's Discussion and Analysis of Financial Condition and Results of Operations, 1995 versus 1994 - Gross Margin", above). Accounts receivable decreased by 46% to $13.1 million from December 31, 1994 to December 31, 1995 was a result of lower sales in the fourth quarter of 1995 than in the fourth quarter of 1994. The Company has an agreement with Heller Financial, Inc. that is intended to transfer the collection risk to Heller for Sun's accounts receivable for essentially all of its customers other than Target and Wal-Mart. Under the agreement, Heller assumes 70% of the collection risk associated with Kmart receivables (to a maximum of $4,000,000 in gross receivables) and 100% of the collection risk associated with the Company's other covered receivables. Heller receives a fee equal to .65% of the gross amount of Kmart receivables and .55% of the gross amount of all other covered receivables for assuming such collection risk. Notes payable (borrowings under the Company's line of credit) decreased $2.5 million or 15.6% and accounts payable decreased $8.0 million or 61.7% from December 31, 1994 to December 31, 1995. The net decrease in notes payable and accounts payable was primarily the result of lower levels of garment purchases in the fourth quarter of 1995 than in the fourth quarter of 1994. During 1995, the Company purchased approximately $1.2 million of machinery and equipment for production, warehouse, distribution and office use. The Company anticipates that total expenditures for machinery and equipment will be less than $1,000,000 during 1996. Sun's primary ongoing cash needs are for working capital and capital expenditures. The Company believes that its cash needs through the remainder of 1996 will be met by internally generated funds and borrowings under its Heller credit facility. INFLATION From time to time, Sun's suppliers of blank garments and materials increase their prices. Further, Sun increases its employees' compensation relative to increases in the cost of living. Sun's mass merchant customers have historically sold Sun's more basic products at predetermined sales price points, many of which have not risen during the last few years. Because Sun's customers generally operate on a fixed markup percentage, their strategy of not increasing their sales price points has made it difficult for the Company to pass on any cost increases relative to its more basic products. 19 20 ITEM 8 - FINANCIAL STATEMENTS PAGE ---- Report of Independent Accountants 21 Financial Statements: Balance Sheets as of December 31, 1995 and 1994 22-23 Statements of Income for the years ended December 31, 1995, 1994 and 1993 24 Statements of Changes in Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993 25 Statements of Cash Flows for years ended December 31, 1995, 1994 and 1993 26 Notes to Financial Statements 27-34 20 21 Report of Independent Accountants To The Board of Directors and Shareholders of Sun Sportswear, Inc. In our opinion, the accompanying balance sheets and related statements of income, of changes in shareholders' equity and of cash flows present, fairly, in all material respects, the financial position of Sun Sportswear, Inc. at December 31, 1995 and 1994, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ Price Waterhouse LLP PRICE WATERHOUSE LLP Seattle, Washington February 23, 1996 21 22 SUN SPORTSWEAR, INC. BALANCE SHEETS
DECEMBER 31, ----------------------------------------- 1995 1994 ------------ ------------ ASSETS CURRENT ASSETS: Cash $ 2,006,633 $ 1,217,171 Accounts receivable, net of allowance for doubtful accounts of $46,317 and $46,524, respectively (Note 11) 13,102,275 24,424,834 Inventories, net (Note 3) 23,631,358 30,155,618 Prepaid expenses and other current assets 959,872 596,919 Deferred income taxes (Note 9) 788,332 760,710 Federal income tax receivable 1,979,535 -0- ------------ ------------ Total current assets 42,468,005 57,155,252 EQUIPMENT AND LEASEHOLD IMPROVEMENTS, net: (Note 4) 4,831,994 5,216,920 OTHER ASSETS: 15,107 11,943 ------------ ------------ Total assets $ 47,315,106 $ 62,384,115 ============ ============
(continued) See accompanying notes to financial statements 22 23 SUN SPORTSWEAR, INC. BALANCE SHEETS (CONTINUED)
DECEMBER 31, ------------------------------------------ 1995 1994 ------------- ------------- LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Notes payable (Note 5) $ 13,500,000 $ 15,987,000 Accounts payable 4,985,953 13,038,144 Accrued royalties payable 1,753,745 1,720,536 Accrued wages and taxes payable 512,078 781,651 Accrued interest payable 51,263 53,813 Accrued income taxes payable -0- 166,059 Current portion of long-term debt (Note 6) 245,652 376,636 ------------- ------------- Total current liabilities 21,048,691 32,123,839 ------------- ------------- NONCURRENT LIABILITIES: Long-term debt, net of current portion (Note 6) 92,354 338,005 Deferred income taxes (Note 9) 155,642 172,046 ------------- ------------- Total noncurrent liabilities 247,996 510,051 ------------- ------------- SHAREHOLDERS' EQUITY: Common stock, no par value, 20,000,000 shares authorized; 5,748,500 shares at 12/31/95 and 5,747,125 shares at 12/31/94 issued and outstanding 21,618,339 21,613,691 Retained earnings 4,400,080 8,136,534 ------------- ------------- Total shareholders' equity 26,018,419 29,750,225 ------------- ------------- COMMITMENTS AND CONTINGENCIES (Note 2 and Note 10) Total liabilities and shareholders' equity $ 47,315,106 $ 62,384,115 ============= =============
See accompanying notes to financial statements 23 24 SUN SPORTSWEAR, INC. STATEMENTS OF INCOME
For the year ended December 31, --------------------------------------------------------------- 1995 1994 1993 ----------- ----------- ----------- Proprietary sales $17,454,421 $28,922,739 $47,571,508 Licensed sales 79,335,040 88,665,196 60,365,230 Sales deductions (2,824,136) (4,375,039) (3,164,246) ----------- ----------- ----------- Net sales (Note 8) 93,965,325 113,212,896 104,772,492 Cost of goods sold 84,569,855 95,878,764 87,910,600 ----------- ----------- ----------- Gross margin 9,395,470 17,334,132 16,861,892 ----------- ----------- ----------- Operating expenses: Selling 3,649,256 3,781,116 3,357,862 Design and pattern 2,492,222 2,527,013 2,297,864 General and administrative 7,690,321 6,712,365 5,655,760 Provision for doubtful accounts and factoring fees (Note 11) 132,284 71,586 130,264 Manufacturing cessation (Note 4) -0- -0- 898,450 ----------- ----------- ----------- 13,964,083 13,092,080 12,340,200 ----------- ----------- ----------- Operating (loss) income (4,568,613) 4,242,052 4,521,692 ----------- ----------- ----------- Other (income) expense: Interest expense 1,267,442 676,612 519,006 Other, net (200,981) (111,236) (227,903) ----------- ----------- ----------- 1,066,461 565,376 291,103 ----------- ----------- ----------- (Loss) income before provision for income taxes (5,635,074) 3,676,676 4,230,589 (Benefit) provision for income taxes (Note 9) (1,898,620) 1,228,000 1,494,000 ----------- ----------- ----------- Net (loss) income $(3,736,454) $ 2,448,676 $ 2,736,589 =========== =========== =========== (Loss) earnings per share: $(0.65) $ 0.43 $ 0.49 ======= ====== ====== Weighted average shares 5,748,249 5,722,121 5,610,996 outstanding
See accompanying notes to financial statements 24 25 SUN SPORTSWEAR, INC. STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Common Stock --------------------------------- Retained Shares Amount earnings Total --------- ------------ ------------ ------------ Balance, December 31, 1992 5,609,000 $ 20,950,447 $ 2,951,269 $ 23,901,716 Exercise of stock options including tax benefit of $80,074 28,500 182,074 182,074 Net income for the year ended December 31, 1993 2,736,589 2,736,589 --------- ------------ ------------ ------------ Balance, December 31, 1993 5,637,500 21,132,521 5,687,858 26,820,379 Exercise of stock options including tax benefit of $109,498 109,625 481,170 481, 170 Net income for the year ended December 31, 1994 2,448,676 2,448,676 --------- ------------ ------------ ------------ Balance, December 31, 1994 5,747,125 21,613,691 8,136,534 29,750,225 Exercise of stock options, -0- tax benefit 1,375 4,648 4,648 Net loss for the year ended December 31, 1995 (3,736,454) (3,736,454) --------- ------------ ------------ ------------ Balance, December 31, 1995 5,748,500 $ 21,618,339 $ 4,400,080 $ 26,018,419 ========= ============ ============ ============
See accompanying notes to financial statements 25 26 SUN SPORTSWEAR, INC. STATEMENTS OF CASH FLOWS
For the year ended December 31, ---------------------------------------------------------- 1995 1994 1993 ------------ ------------ ------------ Cash flows from operating activities: Net (loss) income $ (3,736,454) $ 2,448,676 $ 2,736,589 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 1,526,015 1,225,139 1,102,448 (Gain) loss on disposal of equipment (18,054) 1,025 730,025 Decrease (increase) in accounts receivable 11,322,559 (10,644,227) (1,840,415) Decrease (increase) in inventories 6,524,260 (8,094,570) 20,180 (Increase) decrease in federal income tax receivable, accrued and deferred (2,189,620) 92,158 544,695 (Increase) decrease in other assets (366,117) (84,790) 273,505 (Decrease) increase in accounts payable (6,754,384) 5,925,735 (1,801,897) (Decrease) increase in accrued liabilities (238,914) 938,153 375,318 ------------ ------------ ------------ Net cash provided by (used in) operating activities 6,069,291 (8,192,701) 2,140,448 ------------ ------------ ------------ Cash flows from investing activities: Capital expenditures (1,169,168) (1,953,218) (2,215,259) Proceeds from sale of equipment 46,133 70,956 202,031 ------------ ------------ ------------ Net cash used in investing activities (1,123,035) (1,882,262) (2,013,228) ------------ ------------ ------------ Cash flows from financing activities: (Decrease) increase in outstanding checks in excess of funds on deposit (1,297,807) 186,329 1,170,819 Net (repayments) borrowings under line of credit agreement (2,487,000) 12,534,000 (864,000) Proceeds from issuance of long-term debt -0- -0- 923,052 Principal payments under long-term debt (376,635) (2,558,454) (909,258) Proceeds from issuance of common stock for employee stock options 4,648 481,171 102,000 ------------ ------------ ------------ Net cash (used in) provided by financing activities (4,156,794) 10,643,046 422,613 ------------ ------------ ------------ Net increase in cash 789,462 568,083 549,833 Cash at beginning of period 1,217,171 649,088 99,255 ------------ ------------ ------------ Cash at end of period $ 2,006,633 $ 1,217,171 $ 649,088 ============ ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 1,269,992 $ 688,174 $ 541,360 Income taxes $ 291,000 $ 1,251,000 $ 1,462,000
26 27 SUN SPORTSWEAR, INC. NOTES TO FINANCIAL STATEMENTS NOTE 1 - OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES: OPERATIONS The Company is engaged in designing, sourcing, printing and wholesale distributing of imprinted, dyed, and decorated casual apparel. Products consist primarily of garments printed with designs which are subject to license or distributor agreements with third parties, and proprietary designs developed by the Company. Revenues from operations are principally generated in the United States. RECLASSIFICATIONS Certain reclassifications have been made to prior year amounts (including reclassification of distribution costs from "operating expenses" to "cost of goods sold") to conform to the presentation of the December 31, 1995 financial statements. INVENTORIES Inventories are stated at the lower of cost or market, cost being determined using the first-in, first-out (FIFO) method. Cost includes the purchase price of unprinted garments, the cost of manufacturing "cut-and-sewn" garments and the cost of production of printed garments. EQUIPMENT AND LEASEHOLD IMPROVEMENTS Furniture, vehicles, equipment and leasehold improvements are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the respective assets for furniture, vehicles and equipment and over the lease term or useful life for leasehold improvements. ACCOUNTS PAYABLE Outstanding checks in excess of funds on deposit of $1,003,000 and $2,299,000 at December 31, 1995 and 1994, respectively, have been classified as accounts payable. ACCRUED ROYALTIES PAYABLE Royalties are accrued when the related licensed garments are shipped. Additionally, the Company periodically reviews its royalty agreements, which contain guaranteed minimum payments, and accrues the amount of the guaranteed minimum royalties not expected to be met by sales of the licensed product. INCOME TAXES The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 (FAS 109), Accounting for Income Taxes. Deferred taxes have been provided on income and expense items that are reported in different periods for financial and tax reporting purposes. REVENUE RECOGNITION Sales are recognized when finished garments are shipped from the Company's facilities. SALES DEDUCTIONS Sales discounts and allowances are accrued as sales are recorded. Sales returns, the other component of sales deductions, are accrued when the Company believes sales returns will occur. 27 28 ESTIMATES BY MANAGEMENT The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. EARNINGS PER SHARE Earnings per share has been computed based upon the weighted average number of shares outstanding for all periods presented. Fully diluted earnings per share does not differ materially from primary earnings per share. NOTE 2 - COMMITMENTS: The Company has historically leased office, warehouse and manufacturing space in Kent, Washington from a company owned by David Sabey, the majority shareholder until December 1992 (at which time Mr. Sabey divested himself of all his shares in the Company). The current lease requires monthly payments of $115,000 plus operating and maintenance expense of the facility. Rent expense for leases with Sabey totaled $1,389,000, $1,386,000 and $1,404,000 in 1995, 1994 and 1993 respectively. The Company has an option to purchase the facility it presently occupies during the five year period October 6, 1994 through October 5, 1999 for a mutually agreeable fair market price. This lease expires in 1999. The Company also leases warehouse space in Kent, Washington from a third party. The lease expires in January 1997. Rent expense for this third party lease, and other expired leases, in 1995, 1994 and 1993 totaled $181,000, $89,000 and $198,000, respectively. Future minimum rent commitments under all operating leases for periods after December 31, 1995 are as follows:
Rent Commitments ---------------- 1996 $ 1,572,100 1997 1,380,000 1998 1,380,000 1999 1,035,000 ----------- $ 5,367,100 ===========
Sun acquires rights to use trademarks and characters on specified types of garments, under license agreements from third parties. At December 31, 1995, the Company was party to approximately 52 such license agreements. Under these license agreements, the Company pays royalties of between 4% and 14% of the sales price of products sold displaying the licensed character or trademark. Royalty expense for Sun's license agreements totaled $9,004,513, $9,354,684 and $6,350,413 in 1995, 1994 and 1993 respectively. These license agreements typically require that the Company guarantee a minimum royalty payment. Unmet guaranteed minimum royalty commitments under all licensing agreements in place at December 31, 1995, are as follows:
Royalty Commitments ------------------- 1996 $ 920,000 1997 429,000 ------------ $ 1,349,000 ============
At December 31, 1995, the Company had an allowance of $691,000 recorded on its balance sheet primarily to cover 1996 and 1997 minimum royalty commitments which are not anticipated to be recovered through licensed product sales. (See "Note 11 - Valuation and Qualifying Accounts") 28 29 NOTE 3 - INVENTORIES: Inventories are composed of:
December 31, ------------------------------------- 1995 1994 ----------- ----------- Garments in process $ 2,244,781 $ 2,205,577 Unprinted finished garments 19,827,823 24,544,341 Printed finished garments 5,617,347 5,965,455 Supplies 407,064 521,000 Lower of cost or market allowance (4,465,657) (3,080,755) ----------- ----------- $23,631,358 $30,155,618 =========== ===========
NOTE 4 - EQUIPMENT AND LEASEHOLD IMPROVEMENTS: Equipment and leasehold improvements are summarized by major classifications as follows:
December 31, Estimated ------------------------------------- useful lives 1995 1994 ------------ ----------- ----------- Production equipment 5-7 $ 3,658,352 $ 3,500,342 Leasehold improvements 5-10 1,271,542 1,157,422 Computer hardware and software 3-5 2,996,638 1,507,205 Furniture and fixtures 5 1,116,112 1,111,640 Distribution equipment 5-10 1,452,716 1,395,543 Warehouse equipment 5-7 395,797 338,507 Vehicles 5 12,417 27,317 ----------- ----------- 10,903,574 9,037,976 Construction in progress 509 922,373 LESS - Accumulated depreciation (6,072,089) (4,743,429) ----------- ----------- $ 4,831,994 $ 5,216,920 =========== ===========
In October 1993, the Company permanently discontinued all operations, including "cut-and-sew" garment manufacturing operations, at its Tennessee facility which resulted in charges to operations for shutdown expense of $898,000 during the year ended December 31, 1993. NOTE 5 - NOTES PAYABLE: Notes payable consist of the following:
Interest rate at December 31, December 31, ------------------------------- 1995 1995 1994 ---------------- ------------ ------------ Bank line of credit, portion Prime based 8.50% $ -0- $ 3,987,000 Bank line of credit, portion LIBOR based 7.94% 13,500,000 12,000,000 ------------ ------------ $ 13,500,000 $ 15,987,000 ============ ============
At December 31, 1995, the Company's Bank credit agreement provided for a line of credit facility (including commercial and standby letters of credit) of up to $27,000,000. At December 31, 1995, total 29 30 outstanding commercial letters of credit were $919,245 and approximately $1.8 million was available for borrowing. The borrowing rate for the revolving portion of the line was the prime rate or lower. All the Company's assets, including accounts receivable and inventories, were pledged as security for borrowings under the Bank credit agreement. In February 1996, the Company replaced its Bank credit agreement with a credit agreement provided by Heller Financial, Inc. The Heller credit agreement provides for a line of credit (including commercial letters of credit) of up to $24,000,000. The borrowing rate for the revolving portion of the line is the prime rate and all the Company's assets, including accounts receivable and inventories, are pledged as security for borrowings under the Heller credit agreement. The Heller credit agreement requires compliance with certain financial covenants principally relating to working capital, tangible net worth, ratio of debt to equity, expenditures for fixed assets, minimum earnings (before taxes, interest and depreciation), interest coverage, restrictions on the payment of dividends and restrictions on the incurrence of long-term debt. The weighted average interest rate for the Bank line of credit was 8.06% for 1995 and 6.73% for 1994. NOTE 6 - LONG-TERM DEBT: Long-term debt consists of the following:
Interest rate at December 31, December 31, --------------------------------- 1995 1995 1994 --------------- ------------- ------------- Notes payable to GE Capital in monthly installments of $25,694 Variable - 5.91% $ 338,006 $ 617,112 Other notes payable Various -0- 97,529 ------------- ------------- 338,006 714,641 LESS - Current installments (245,652) (376,636) ------------- ------------- Long-term debt $ 92,354 $ 338,005 ============= =============
The notes payable to GE Capital were paid off in February 1996. NOTE 7 - CASH PROFIT SHARING, 401-K PROFIT SHARING PLAN, STOCK OPTION PLANS, AND RETIREMENT BENEFITS: The Company has a Cash Profit Sharing Plan for its employees ("Cash Plan"). Under the Cash Plan, the Board of Directors determines, at its discretion, a percentage of the Company's net profits to be distributed to employees on an annual basis. The amount of the distribution to any employee is based upon the employee's compensation level and in some instances, length of service with the Company. The Cash Plan is administered by a committee of senior management employees appointed by the Board of Directors. The amount charged to expense under the Cash Plan totaled $94,000, $194,000 and $321,000 in 1995, 1994 and 1993, respectively. Effective January 1, 1992, the Company established a 401-K profit sharing plan for qualifying employees. Employee contributions to the 401-K plan are matched by the Company dollar for dollar on the first $200 contributed to the plan; then $.25 for every $1 up to 6.0% of the employee's gross earnings. Employees are fully vested in the 401-K plan after three years of service. The 401-K plan is administered by a non-related, third 30 31 party. The amount charged to expense under the 401-K plan totaled $66,000, $57,000 and $54,000 in 1995, 1994 and 1993, respectively. In October 1989, the Board of Directors approved stock option plans for Company employees and directors coincident with the completion of the public offering of common stock of the Company. The plans provide for the issuance of options to purchase common stock to employees and non-employee directors of the Company, at an exercise price in most cases equal to the fair market value at the date of grant. The maximum term of options granted is ten years. Options to employees are granted at the discretion of the Compensation Committee of the Board of Directors. Options granted to non-employee directors are granted in accordance with a formula set forth in the director plan. A total of 660,000 common stock shares have been reserved for issuance under these plans. Options granted and outstanding during the three years ended December 31, 1995 are:
Director Plan Employee Plan --------------------------- ---------------------------- Shares Price/Share Shares Price/Share ------- ------------ ------- ------------- Options at December 31, 1992 22,000 $6.00-$11.25 252,250 $3.25 - $6.25 Options granted 11,000 $3.75 173,750 $3.19 - $3.38 Options canceled (17,000) $6.00-11.25 (36,250) $3.25 - $6.25 Options exercised -0- - - (28,500) $3.25 - $4.50 ------- ------- Options at December 31, 1993 16,000 $3.75-$6.00 361,250 $3.19 - $6.00 Options granted 2,000 $5.88 141,750 $4.38 - $5.88 Options canceled -0- (72,125) $3.19 - $6.00 Options exercised -0- (109,625) $3.25 - $4.50 ------- ------- Options at December 31, 1994 18,000 $3.75-$6.00 321,250 $3.38 - $5.88 Options granted 2,000 $4.125 54,500 $4.125 Options canceled (1,000) $4.125 (8,875) $4.38 - $5.88 Options exercised -0- - - (1,375) $3.38 ------- ------- Options at December 31, 1995 19,000 $3.75-$6.00 365,500 $3.25 - $5.88 ======= ========
Options outstanding under the Director Plan are subject to one year vesting periods, carry a five year term, and at December 31, 1995, options for 18,000 shares were exercisable. Options outstanding under the Employee Plan are subject to vesting periods of up to four years, carry a ten year term, and at December 31, 1995, options for 268,541 shares were exercisable. In October 1995, the Financial Accounting Standards Board issued SFAS 123, "Accounting for Stock-Based Compensation", which establishes financial accounting and reporting standards for stock-based employee compensation plans and for the issuance of equity instruments to acquire goods and services from non-employees. The Company has not determined the method of adoption for the year ended December 31, 1996. NOTE 8 - INDUSTRY PROFILE AND MAJOR CUSTOMERS: The Company operates almost exclusively in one industry, which is the wholesale distribution of imprinted, dyed and decorated casual apparel. The Company's customers consist of large retail mass merchants. A substantial portion of the Company's customers' ability to honor their obligations is dependent on the retail apparel economic sector. 31 32 The Company has three major customers who are mass merchants. The percentage of gross sales for each customer and the total percentage of gross sales for the three customers are as follows:
Percentage of gross sales Total percentage for Kmart, Target and Wal- of gross sales for Mart, respectively the three customers For the year ended December 31, 1995 17%, 24% and 47% 88% 1994 19%, 29% and 40% 88% 1993 8%, 38% and 36% 82%
NOTE 9 - INCOME TAXES: In January 1993, the Company prospectively adopted Statement of Financial Accounting Standards No. 109 (FAS 109), Accounting for Income Taxes. FAS 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. The impact of adopting FAS 109 was not significant to the Company. The provision (benefit) for income taxes was as follows :
For the year ended December 31, ------------------------------------------------ 1995 1994 1993 ----------- ----------- ----------- Current $(1,854,594) $ 1,554,000 $ 1,299,668 Deferred (44,026) (326,000) 194,332 ----------- ----------- ----------- $(1,898,620) $ 1,228,000 $ 1,494,000 =========== =========== ===========
Deferred tax assets (liabilities) at December 31 comprised the following:
1995 1994 --------- --------- Inventory capitalization $ 463,749 $ 599,749 Allowance for doubtful accounts 15,748 15,818 Accrued expenses 39,116 42,774 Accrued royalties 235,077 102,369 Other 78,907 44,265 --------- --------- Gross deferred tax assets 832,597 804,975 Less - Depreciation (199,907) (216,311) --------- --------- $ 632,690 $ 588,664 ========= =========
1995 1994 --------- --------- Net current deferred tax asset $ 788,332 $ 760,710 Net noncurrent deferred tax liability (155,642) (172,046) --------- --------- $ 632,690 $ 588,664 ========= =========
NOTE 10 - CONTINGENCIES The only legal proceedings to which the Company is a party involve routine matters that are incidental to its business. The Company does not believe that the resolution of these matters will have a material effect on the results of operations or financial condition of the Company. 32 33 NOTE 11 - VALUATION AND QUALIFYING ACCOUNTS Activity of the Company's allowance for doubtful accounts follows:
For the year ended December 31, ----------------------------------- 1995 1994 1993 -------- -------- --------- Balance, beginning of the year $ 46,524 $ 88,000 $ 258,000 Provision for doubtful accounts -0- -0- -0- Chargeoffs/collections (207) (41,476) (170,000) -------- -------- --------- Balance, end of the year $ 46,317 $ 46,524 $ 88,000 ======== ======== =========
During 1993, 1994 and 1995, the Company had an agreement with Heller Financial, Inc. intended to transfer the collection risk to Heller for Sun's accounts receivable for essentially all of its customers other than Target, Kmart and Wal-Mart. Under the agreement, Heller assumed 100% of the collection risk associated with the Company's covered receivables. Heller received a fee equal to .55% of the gross amount of covered receivables for assuming such collection risk. The amount charged to expense for factoring fees was $48,000, $80,000 and $169,000 in 1995, 1994 and 1993, respectively. This agreement expires in 1997. In February 1996, Sun amended the risk-transfer agreement with Heller, whereby Heller also assumes 70% of the collection risk associated with the Kmart receivables for a fee equal to .65% of the gross amount of such receivables. Activity of the Company's lower of cost or market inventory reserves follows:
For the year ended December 31, ------------------------------------------- 1995 1994 1993 ----------- ----------- ----------- Balance, beginning of the year $ 3,080,755 $ 1,501,876 $ 919,725 Accruals 3,773,078 2,470,097 895,360 Chargeoffs (2,388,176) (891,218) (313,209) ----------- ----------- ----------- Balance, end of the year $ 4,465,657 $ 3,080,755 $ 1,501,876 =========== =========== ===========
Activity of the Company's unmet guaranteed minimum royalty reserves follows:
For the year ended December 31, ------------------------------------ 1995 1994 1993 --------- --------- -------- Balance, beginning of the year $ 301,085 $ 147,333 $ -0- Accruals 693,643 350,000 147,333 Chargeoffs (303,325) (196,248) -0- --------- --------- -------- Balance, end of the year $ 691,403 $ 301,085 $147,333 ========= ========= ========
NOTE 12 - RELATED PARTY TRANSACTIONS During 1995, Sun hired the consulting firm of Wiley, Pene and Company to assist in the Company's re-engineering efforts. Wiley, Pene and Company was paid $243,000 from March to October 1995 for its services. Wiley, Pene and Company is owned by Robert Pene, a former director of Sun, who resigned from the Company's Board of Directors in September 1995; and by William S. Wiley, who was appointed as the Company's Chief Executive Officer, President and Director in October 1995. 33 34 NOTE 13 - SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED): Quarterly financial information for the years ended December 31, 1995 and 1994 is as follows:
First Second Third Fourth Quarter Quarter Quarter Quarter Total ------- ------- ------- ------- ----- 1995 Net sales $ 25,720,562 $30,581,505 $ 16,224,578 $ 21,438,680 $ 93,965,325 Cost of goods sold 22,522,498 25,310,087 17,097,761 19,639,509 84,569,855 ------------ ----------- ------------ ------------ ------------ Gross margin 3,198,064 5,271,418 (873,183) 1,799,171 9,395,470 Operating expenses 3,627,428 3,662,095 3,504,743 3,169,817 13,964,083 Other expense 330,034 314,033 152,794 269,600 1,066,461 ------------ ----------- ------------ ------------ ------------ (Loss) income before provision for income taxes (759,398) 1,295,290 (4,530,720) (1,640,246) (5,635,074) (Benefit) provision for income taxes (258,000) 440,000 (1,540,500) (540,120) (1,898,620) ------------ ----------- ------------ ------------ ------------ Net (loss) income $ (501,398) $ 855,290 $ (2,990,220) $ (1,100,126) $ (3,736,454) ============ =========== ============ ============ ============ Net (loss) income per share $(0.09) $0.15 $(0 .52) $(0.19) $(0.65)
First Second Third Fourth Quarter Quarter Quarter Quarter Total ------- ------- ------- ------- ----- 1994 Net sales $27,224,201 $27,374,640 $26,633,787 $31,980,268 $113,212,896 Cost of goods sold 22,394,136 22,778,232 23,230,396 27,476,000 95,878,764 ----------- ----------- ----------- ----------- ------------ Gross margin 4,830,065 4,596,408 3,403,391 4,504,268 17,334,132 Operating expenses 3,304,038 3,373,498 3,129,524 3,285,020 13,092,080 Other expense 59,258 69,235 167,585 269,298 565,376 ----------- ----------- ----------- ----------- ------------ Income before provision for income taxes 1,466,769 1,153,675 106,282 949,950 3,676,676 Provision for income taxes 498,000 377,579 51,808 300,613 1,228,000 ----------- ----------- ----------- ----------- ------------ Net income $ 968,769 $ 776,096 $ 54,474 $ 649,337 $ 2,448,676 =========== =========== =========== =========== ============ Net income per share $0.17 $0.14 $0.01 $0.11 $0.43
The sum of quarterly earnings per share will not necessarily equal the earnings per share reported for the entire year, due to rounding. 34 35 ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT For certain information with respect to executive officers of Sun Sportswear, Inc., see "Item I, Executive Officers" above. The other information required by Part III, Item 10, is incorporated by reference from Sun Sportswear, Inc.'s Proxy Statement relating to Sun Sportswear, Inc.'s 1996 Annual Meeting of Shareholders. Such Proxy Statement will be filed pursuant to Regulation 14A within 120 days of December 31, 1995. ITEM 11 - EXECUTIVE COMPENSATION The information required by Part III, Item 11, is incorporated by reference from Sun Sportswear, Inc.'s Proxy Statement relating to Sun Sportswear, Inc.'s 1996 Annual Meeting of Shareholders. Such Proxy Statement will be filed pursuant to Regulation 14A within 120 days of December 31, 1995. ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Part III, Item 12, is incorporated by reference from Sun Sportswear, Inc.'s Proxy Statement relating to Sun Sportswear, Inc.'s 1996 Annual Meeting of Shareholders. Such Proxy Statement will be filed pursuant to Regulation 14A within 120 days of December 31, 1995. ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Part III, Item 13, is incorporated by reference from Sun Sportswear, Inc.'s Proxy Statement relating to Sun Sportswear, Inc.'s 1996 Annual Meeting of Shareholders. Such Proxy Statement will be filed pursuant to Regulation 14A within 120 days of December 31, 1995. PART IV ITEM 14 - EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K 1. FINANCIAL STATEMENTS The following financial statements are filed as part of this form in Part II, Item 8: - Report of Independent Public Accountants - Balance Sheets as of December 31, 1995 and 1994 - Statements of Income for the years ended December 31, 1995, 1994, and 1993 - Statements of Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993 - Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993 - Notes to Financial Statements 2. EXHIBITS The required exhibits are included at the back of this Form and are described on the Exhibit Index immediately preceding the first such exhibit. 3. REPORTS ON FORM 8-K Form 8-K was filed October 6, 1995. 35 36 SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF KENT, STATE OF WASHINGTON, ON MARCH 14, 1996. SUN SPORTSWEAR, INC. (REGISTRANT) BY: /S/ WILLIAM S. WILEY ---------------------------- William S. Wiley, President and Chief Executive Officer PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS, IN THE FOLLOWING CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE --------- ----- ---- /s/ William S. Wiley Chief Executive Officer, March 14, 1996 - ---------------------------------- President and Director William S. Wiley (Principal Executive Officer) /s/ Larry C. Mounger Chairman of the Board March 14, 1996 - ---------------------------------- Larry C. Mounger /s/ James H. Williams Director March 14, 1996 - ---------------------------------- James H. Williams /s/ Paul R. Rollins, Jr. Director March 14, 1996 - ---------------------------------- Paul R. Rollins, Jr. /s/ James A. Walsh Director March 14, 1996 - ---------------------------------- James A. Walsh /s/ Kevin C. James Senior Vice President, March 14, 1996 - ---------------------------------- Chief Financial Officer Kevin C. James (Principal Financial Officer) /s/ Michael J. Sandhorst Controller March 14, 1996 - ---------------------------------- (Principal Accounting Officer) Michael J. Sandhorst
36 37 1995 10-K Index to Exhibits
Exhibit No. Description Page - ----------- ----------- ---- 3.1 Restated Articles of Incorporation of the Registrant. * 10.1 1989 Employee Stock Option Plan of the Registrant. * 10.2.1 1989 Director Stock Option Plan of the Registrant, as amended. *95Q* 10.4 Industrial Lease, dated April 3, 1989, between the Registrant and Sabey Corporation. * 10.9 Tax Claims and Access Agreement, dated as of October 6, 1989, between the Registrant and David A. Sabey. * 10.12 Form of Indemnification Agreement between the Company and its directors. *91* 10.18 Employment Agreement between Registrant and Kevin James, Senior Vice President and Chief Financial Officer. *94* + 10.19 Employment Agreement between Registrant and L. Kaye Counts, Executive Vice President and Chief Operating Officer. *94* + 10.20 License Agreement between Registrant and The Walt Disney Company for The Lion King(C) characters. *94* 10.21 License Agreement between Registrant and The Walt Disney Company for Pocahontas(C) characters. *94* 10.23.1 Employment Agreement between Registrant and Sandra L. Teufel, Senior Vice President - Sales and Merchandising. 38-43+ 10.25 License Agreement between Registrant and The Walt Disney Company for The Hunchback of Notre Dame(C) characters. 44-68 10.26 License Agreement between Registrant and The Walt Disney Company for Winnie the Pooh(C) characters. 69-91 10.27 Credit Agreement, dated as of February 13, 1996, between the Registrant and Heller Financial, Inc. 92-143 29 Proxy Statement to Shareholders for Sun's 1996 Annual Meeting of Shareholders. ++
* Filed as an exhibit to Form S-1 Registration Statement (No. 33-31688), and incorporated herein by reference. *91* Filed as an exhibit to Form 10-K for the year ended December 31, 1991 and incorporated herein by reference. *94* Filed as an exhibit to Form 10-K for the year ended December 31, 1994 and incorporated herein by reference. *95Q* Filed as an exhibit to Form 10-Q for the quarter ended June 30, 1995 and incorporated herein by reference. ++ To be filed within 120 days of December 31, 1995, pursuant to General Instruction G to Form 10-K + Employment Contract for Named Executive Officer __________________________________ 37 EX-10.23.1 2 EMPLOYMENT AGREEMENT 1 EXHIBIT 10.23.1 EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT ("Agreement"), dated as of January 1, 1996 and entered into this 6th day of February, 1996 by and between SUN SPORTSWEAR, INC., a Washington corporation ("Employer"), and SANDRA L. TEUFEL, a resident of Mercer Island, Washington ("Employee"). AGREEMENTS In consideration of the mutual promises and covenants set forth below, Employer and Employee agree as follows: 1. Employment. Employer hereby employs Employee and Employee hereby accepts employment with Employer in the Puget Sound area of Washington State upon the terms and conditions set forth herein. 2. Term. The term of this Agreement shall begin on January 1, 1996 and shall end on December 31, 1996, unless earlier terminated pursuant to Paragraph 7 hereof. 3. Compensation. For all services rendered by Employee hereunder, Employer agrees to pay and grant Employee and Employee agrees to accept the following: 3.1 An annual base salary of two hundred fifty thousand dollars ($250,000) relating to Employee's duties as Senior Vice President of Sales and Merchandising for the Women's and Men's Divisions of Employer, payable at the times and in the manner set by Employer's standard payroll policy; 3.2 An annual bonus as set forth on Exhibit A attached hereto and by this reference incorporated herein. 4. Duties of Employee. Employee is employed as Senior Vice President of Sales and Merchandising for the Women's and Men's Divisions of Employer with such duties, responsibilities and authority as are consistent with such position. Employee shall report to the Chief Executive Officer and perform such additional duties as are assigned to her by such Officer and/or by the Board of Directors of Employer and which are within the scope of duties and responsibilities normally performed by a corporate officer in such position. 4.1 During the term of this Agreement, Employee shall devote her full time, attention and efforts to the conduct of the business of Employer and the performance of her duties hereunder. Employee shall not engage in any other business activity, whether pursued for gain, profit, or otherwise; provided that Employee shall not be prevented from investing her personal assets in entities in a manner that will not require her services to help conduct the affairs of such entities. 4.2 The parties have discussed the mutual importance to Employee and Employer of development and succession planning in Employee's Divisions. The parties therefore agree that Employee shall use her best efforts to train, develop and strengthen her staff. 38 2 5. Benefits. Employee shall be entitled to all rights and benefits for which she is eligible under Employer's 401(k), health, life and disability insurance plans to the extent Employer maintains any or all such plans, provided that nothing herein shall obligate Employer to establish or maintain any such plans. 6. Vacation. Employee shall be entitled to a total of four (4) weeks vacation each year. 7. Termination and Extension. This Agreement may be terminated prior to December 31, 1996 upon mutual agreement in writing and signed by both parties. An extension of this Agreement continuing beyond December 31, 1996 may be mutually agreed to in a writing signed by both parties prior to such date. Such extended agreement may contain such additional and amended terms and conditions as are mutually agreed to by both parties. 8. Nondisclosure of Confidential Information. 8.1 Employee will not, during or after the term of this Agreement, directly or indirectly, except in the ordinary course of fulfilling Employee's duties and responsibilities hereunder, use, disseminate, or disclose to any person, firm, corporation or other business entity for any purpose whatsoever, information disclosed to Employee or known by Employee as a consequence of or through her employment hereunder, which is not generally known in the industry in which Employer is or may become engaged, about Employer's business or activities, including without limitation, information about Employer's products, services, procedures, pricing, research, development, inventions, manufacturing, purchasing, accounting, engineering, marketing, merchandising or selling. 8.2 Upon termination of this Agreement, Employee shall immediately return to Employer all documents, records, files, notebooks, computer disks, and similar repositories containing the information described in Section 8.1 above, including copies thereof, then in Employee's possession or under her control whether prepared by her or by others. 8.3 Employee agrees to keep the terms of this Agreement confidential and not discuss any terms with any employee of Employer other than its Chief Executive Officer, and with any person other than the Chairman of the Compensation Committee of Employer, unless disclosure is otherwise required by law. 8.4 So long as Employee is not in default under the terms of this Agreement, should Employee be terminated by Employer prior to the expiration of this Agreement, Employee shall be entitled to cash severance pay on the date of termination in the amount of $62,500, provided, however, no severance shall be due if the termination is for cause as defined in Exhibit B, attached hereto and by this reference made a part hereof. 9. Saving Provision. Employer and Employee agree that the nondisclosure provisions set forth above, including, without limitation, the scope, duration and geographic extent of such restrictions, are fair and reasonably necessary for the protection of Employer's legitimate business interests. In the event a court of competent jurisdiction should decline to enforce any of such provisions, they shall be deemed to be modified to restrict Employee to the maximum extent which the court shall find enforceable. 39 3 10. Injunctive Relief. Employee acknowledges that the breach or threatened breach of any of the nondisclosure provisions or other agreements contained in this Agreement would give rise to irreparable injury to Employer, which injury would be inadequately compensable in money damages. Employer may, therefore, seek and obtain a restraining order or injunction prohibiting the breach or any threatened breach of any provision, requirement or covenant of this Agreement, in addition to and not in limitation of any other legal remedies which may be available. 11. Miscellaneous. 11.1 All rights of Employer and Employee pursuant to this Agreement shall survive termination of employment hereunder. 11.2 Any notice required to be given under this Agreement shall be sufficient if in writing and delivered personally or sent by registered or certified mail to Employee at her last known address and to Employer at its principal office. 11.3 This Agreement contains the entire agreement between Employer and Employee relating to the subject matter hereof and no modification of this Agreement shall be valid unless made in writing and signed by both parties. 11.4 No waiver by Employer of any default or breach by Employee of any term, condition or covenant of this Agreement shall be deemed to be a waiver of any subsequent default or breach of the same or any other term, condition or covenant contained herein. 11.5 The rights and obligation of Employee hereunder are personal and may not be assigned to any other person. This Agreement will bind and benefit any successor of Employer, whether by merger, sale of assets, reorganization or other form of acquisition, disposition or business reorganization. In the event of Employee's death, any benefits due or to become due under this Agreement, including compensation, shall become a part of Employee's estate and shall be distributed to her personal representative. 11.6 If Employer or Employee brings an action or other proceeding against the other to enforce any of the terms or conditions of this Agreement, the prevailing party in any such action or proceeding shall be paid reasonable attorneys' fees and costs by the other party. 11.7 This Agreement shall be governed by and construed in accordance with the laws of the State of Washington. EXECUTED as of the day and year first above written. EMPLOYER: EMPLOYEE: - ---------- -------- By: /s/ William S. Wiley By: /s/ Sandra L. Teufel -------------------- -------------------- William S. Wiley Sandra L. Teufel Chief Executive Officer Sun Sportswear, Inc. By: /S/ Paul R. Rollins, Jr. ------------------------ Paul R. Rollins, Jr., Chairman Compensation Committee
40 4 EXHIBIT A The following sets forth the terms of the Incentive Compensation Plan referred to in Paragraph 3.2 defining Employee's annual bonus, it being agreed by Employer and Employee that Employee's annual bonus for 1996 shall be determined, as follows: I. Contribution Margin Criteria. Employee shall receive as an annual bonus for 1996 for meeting the "Consolidated Divisional Contribution Margin Criteria" bonus component four percent (4%) of the amount by which the "Consolidated Divisional Contribution Margin" exceeds $5,461,000, it being agreed that the maximum Employee can earn under this Criteria I is $350,000, subject to the following conditions: (i) The Women's and Men's Divisions shall have a 1996 "Consolidated Divisional Contribution Margin" of $5,461,000 or greater before any bonus is due under this Section I (which shall be calculated in accordance with the standard method used by Employer to prepare its books and records). (ii) The reserves referenced in Section II shall be deducted from the "Consolidated Divisional Margin Contribution" for purposes of calculating the bonus due hereunder, except that in no case shall the bonus due hereunder be reduced below $50,000 as a result of such deduction. II. Inventory Criteria. A reserve shall be created based on the status of the Employer's inventories at year end based on the following criteria: (i) For inventory twelve months old and older, a reserve of 50% of the cost thereof. (ii) For inventory between nine and twelve months old, a reserve of 25% of the cost thereof. 41 5 EXHIBIT B For purposes of the Section 8.4, "cause" shall be defined as a material breach by Employee of any term or condition of the Employment Agreement, a material failure by Employee to perform her duties or to comply with Employer's policies and regulations applicable to Employee, misconduct by Employee which is materially detrimental to Employer, or acts of dishonesty by Employee or her conviction of a felony. A material breach by Employee of any term or condition of the Employment Agreement, and a material failure by Employee to perform her duties or to comply with Employer's policies and regulations applicable to Employee, shall not be regarded as "cause" as defined hereunder, unless and until Employee is given written notice of such breach or failure within a reasonable period of time following its discovery by Employer, and Employee fails to cure the breach or correct the failure within ten (10) days thereafter. 42 EX-10.25 3 LICENSE AGREEMENT 1 EXHIBIT 10.25 The Walt Disney Company 500 South Buena Vista Street Burbank, California 91521 July 14, 1995 Sun Sportswear, Inc. 6520 South 190th Street Kent, WA 98032 Re: THE HUNCHBACK OF NOTRE DAME Dear Sirs/Mesdames: We hereby agree with you as follows: 1. MEANING OF TERMS As used in this Agreement: A. "LICENSED MATERIAL" means the graphic representations of the following: THE HUNCHBACK OF NOTRE DAME characters, but only such characters and depictions of such characters as may be designated by us; and designated still scenes from the motion picture identified in Subparagraph 1.B. hereafter. B. "TRADEMARKS" means "WALT DISNEY" and "DISNEY", the representations of Licensed Material included in Subparagraph 1.A. above, and the logo of the following motion picture in which Licensed Material included in Subparagraph 1.A above appears: THE HUNCHBACK OF NOTRE DAME C. "ARTICLES" means the following items on or in connections with which the Licensed Material and/or the Trademarks are reproduced or used: (1) Short sleeve t-shirts (2) Long sleeve t-shirts (3) Fleece sweatshirts (4) Novelty knit tops (5) Turtlenecks (6) Knit shorts (7) Knit bottoms The Articles identified above as Articles Numbers 1 - 5 are to be manufactured in Girls' sizes 4 - 6 X and 7 - 16, Junior Girls' sizes 3 - 13 and Women's/Plus sizes S, M, L, XL, XXL and XXXL. Articles Numbers 6 - 7 are to be manufactured in Junior Girls' sizes 3 - 13 and Women's/Plus sizes S, M, L, XL, XXL and XXXL. 44 2 Articles Numbers 1 - 7 above may include spot screens, four color process prints, allover prints, garment dyes, rotary prints, and oversize graphics but may not include embellishments or embroideries. D. "MINIMUM PER ARTICLE ROYALTY" means for each Article identified herein which is sold the sum indicated herein: None. E. PRINCIPAL TERM" means the period commencing July 3, 1995, and ending December 31, 1997. F. "TERRITORY" means the United States, United States PX's wherever located, and United States territories and possessions, excluding Puerto Rico, Guam, Commonwealth of Northern Mariana Islands and Palau. However, if sales are made to chain stores in the United States which have stores in Puerto Rico, such chain stores may supply Articles to such stores in Puerto Rico. G. "ROYALTIES" means a royalty in the amounts set forth below in Subparagraphs 1.G.(1)(a), (b), and (c) and Royalties shall be further governed by the provisions contained in Subparagraphs 1.G.(2)-(5): (1)(a) twelve percent (12%) of your Net Invoiced Billings to authorized retailers for Articles shipped by you from a location in the Territory for delivery to a customer located in the Territory ("F.O.B. In Sales"); or (b) sixteen percent (16%) of your Net Invoiced Billings to authorized retailers when your customer located in the Territory bears the costs (e.g., shipping, duties, and the like) of obtaining delivery in the Territory of Articles manufactured outside the Territory ("F.O.B. Out Sales"); or (c) if a Minimum Per Article Royalty has been specified in Subparagraph 1.D. above, and it would result in a higher royalty to be paid for the Articles, you agree to pay the higher royalty amount. (2) The sums which we are paid as Royalties on any sales to your Affiliates shall be no less than the sums paid on sales to customers not affiliated with you, and if such Affiliate is a reseller of the Articles, the sale to such Affiliate shall not be counted as a sale for Royalty calculation purposes; in such case, the relevant sale for Royalty calculation purposes shall be that of such Affiliate. (3) All sales of Articles shipped to a customer outside the Territory pursuant to a distribution permission shall bear a 45 3 Royalty at the rate for F.O.B. Out Sales. However, sales of Articles to our Affiliates outside the Territory shall bear a Royalty at the rate for F.O.B. In Sales. (4) Royalties payable shall be not less for each Article sold than the Minimum Per Article Royalty, if such a Royalty has been specified in Subparagraph 1.D. No Royalties are payable on the mere manufacture of Articles. (5) The full Royalty percentage shall be payable on close-out or other deep discount sales of Articles, including sales to employees. H. "NET INVOICED BILLINGS" means the following: (1) actual invoiced billings (i.e., sales quantity multiplied by your selling price) for Articles sold, and all other receivable of any kind whatsoever, received in payment for the Articles, whether received by you or any Affiliate of yours, except as provided in Subparagraphs 1.G.(2), and 1.H.(2), less "Allowable Deductions" as hereinafter defined. (2) The following are not part of Net Invoiced Billings: invoiced charges for transportation of Articles within the Territory which are separately identified on the sales invoice, and taxes on the sale. I. "ALLOWABLE DEDUCTIONS" means the following: (1) volume discounts and other discounts separately identified on your sales invoices as being applicable to sales of Articles licensed hereunder or to combined sales of such Articles and other products not licensed by us, and post-invoice credits granted and properly documented as applicable to sales of Articles licensed hereunder or to combined sales of such Articles and other products not licensed by us; in the event that a post-invoice credit is issued for combined sales of Articles and other products not licensed by us, and you cannot document the portion of the credit applicable to the Articles, you may apply only a pro rata portion of the credit to the Articles. (2) The following are not Allowable Deductions, whether granted on sales invoices or as post-invoice credits: cash discounts granted as terms of payment; early payment discounts; allowances or discounts relating to advertising; mark down allowances; costs incurred in manufacturing, importing, selling or advertising Articles; freight costs incorporated in the selling price; and uncollectible accounts. 46 4 J. "ROYALTY PAYMENT PERIOD" means each calendar quarterly period during the Principal Term and during any other term. K. "ADVANCE" means the following sum(s) payable by the following date(s) as an advance on Royalties to accrue in the following period(s): $87,500.00 payable upon your signing of this Agreement for the period commencing July 3, 1995, and ending December 31, 1997. L. "GUARANTEE" means the following sum(s) which you guarantee to pay as minimum Royalties on your cumulative sales in the following period(s): $350,000.00 for the period commencing July 3, 1995, and ending December 31, 1997. M. "SAMPLES" means six (6) samples of each stock keeping unit ("SKU") of each Article, from the first production run of each supplier of each SKU of each Article. N. "PROMOTION COMMITMENT" means the following sum(s) which you agree to spend in the following way(s): You agree to promote the Articles with in-store signage, promotional programs, and trade and consumer advertising during the Principal Term of this Agreement. You further agree to spend an amount equal to no less that $20,000.00 on the in-store signage and promotional programs and an amount equal to no less than $25,000.00 on the trade and consumer advertising. The in-store signage, promotional programs, trade and consumer advertising shall be devoted exclusively to the Articles. O. "MARKETING DATE" means the following date(s) by which the following Article(s) shall be available for purchase by the public at retail outlets authorized pursuant to Subparagraph 2.A.: (1) By release date of the film, currently estimated to be June 1996, for all Articles; provided, however, that you are responsible for assuring that no Articles shall be displayed to the general public, either by you or by anyone else, or available for consumer purchase prior to two (2) weeks before the release date, and you agree that you shall be liable to us for any damages which occur due to earlier display or availability of Articles. In the event that any of the Articles are displayed or available prior to two (2) weeks before the release date of the film, we may, in our absolute discretion, require that you recall such Articles, and you shall be responsible for 47 5 accomplishing such recall and shall bear all costs and expenses relating thereto. (2) When the actual release date of the film is determined, you shall be advised in writing of the shipping date for Articles, and you may not ship any Articles to any customer before the shipping date. In the event you ship any Articles before the shipping date, and any retailers display or make the Articles available for consumer purchase prior to two (2) weeks before the film release date, you shall immediately pay us liquidated damages in the amount of $50,000.00 for each such retailer. (3) The remedies set forth in this Paragraph 1.0 are in addition to any other remedies available to us. P. "AFFILIATE" means, with regard to you, any corporation or other entity which directly or indirectly controls, is controlled by, or is under common control with you; with regard to us, "Affiliate: means any corporation or other entity which directly or indirectly controls, is controlled by, or is under common control with us. "Control" of an entity shall mean possession, directly or indirectly, of power to direct or cause the direction of management or policies of such entity, whether through ownership of voting securities, by contract or otherwise. 2. RIGHTS GRANTED A. In consideration for your promise to pay and your payment of all Royalties, Advances and Guarantees required hereunder, we grant you the non-exclusive right, during the Principal Term and any extension thereof, and only within the Territory, to reproduce the Licensed Material only on or in connection with the Articles, to use the Trademarks, but only such Trademarks and uses thereof as may be approved when the Articles are approved and only on or in connection with the Articles, and to manufacture, distribute for sale and sell the Articles (other than by direct marketing methods, including but not limited to direct mail and door-to-door solicitation). You will sell the Articles only to mass market retailers (including such retailers as Target, Toys R Us, WalMart and Kmart), value-oriented department stores (including such retailers as J.C. Penney Co., Inc., Sears, Montgomery Ward and Mervyn's) and value-oriented specialty stores (including such retailers as Kids R Us and Baby Superstores) in the Territory for resale to the public in the Territory. You will not sell the Articles to supermarkets, drug chains, food chains, other retailers or to wholesalers. If there is a question as to whether a particular customer falls within any of the categories specified above, our determination shall be binding. If you wish to sell the Articles to wholesalers for resale to authorized retailers, you must notify us and negotiate the applicable royalty rate for such sales, which you acknowledge shall be higher royalty rate than 48 6 the rate set forth in Subparagraphs 1.G.(1)(a) and (b) for sales to retailers. B. Unless we consent in writing, you shall not sell or otherwise provide Articles for use as premiums (including those in purchase-with-purchase promotions), promotions, give-aways, fund-raisers, or entries in sweepstakes, or to customers for resale by direct mail or other direct marketing methods, including, without limitation, home shopping television programs, or to customers for inclusion in another product, unless such product has been licensed by us. However, nothing contained herein shall preclude you from soliciting orders by mail from those retailers authorized pursuant to Subparagraph 2.A. above, nor from selling to such authorized retailers which sell predominantly at retail, but which include the Articles in their mail order catalogs or otherwise sell Articles by direct marketing methods as well as at retail. If you wish to sell the Articles to other customers for resale through mail order catalogs, you must obtain our prior written consent in each instance. C. Unless we consent in writing, you shall not give away or donate Articles, except minor quantities of samples, not for onward distribution, to your accounts or other persons for the purpose of promoting Article sales. D. Nothing contained herein shall preclude you from selling Articles to us or to any Affiliate of ours, or to your or our employees, subject to the payment to us of Royalties on such sales. E. We further grant you the right to reproduce the Licensed Material and to use the Trademarks, only within the Territory, on containers, packaging and display material for the Articles, and in advertising for the Articles. F. Nothing contained in this Agreement shall be deemed to imply any restriction on your freedom and that of your customers to sell the Articles at such prices as you or they shall determine. G. You recognize and acknowledge the vital importance to us of the characters and other proprietary material we own and create, and the association of the Disney name with them. In order to prevent the denigration of our products and the value of their association with the Disney name, and in order to ensure the dedication of your best efforts to preserve and maintain that value, you agree that, during the Principal Term and any extension hereof, you will not manufacture or distribute any merchandise embodying or bearing any artwork or other representation which we determine, in our reasonable discretion, is confusingly similar to our Disney characters or other proprietary material. 49 7 3. ADVANCE A. You agree to pay the Advance, which shall be on account of Royalties to accrue during the Principal Term only, and only with respect to sales in the Territory; provided, however, that if any part of the Advance is specified hereinabove as applying to any period less than the Principal Term, such part shall be on account of Royalties to accrue during such lesser period only. If said Royalties should be less than the Advance, no part of the Advance shall be repayable. B. Royalties accruing during any sell-off period or extension of the Principal Term shall not be offset against the Advance unless otherwise agreed in writing. Royalties accruing during any extension of the Principal Term or any other term shall be offset only against an advance paid with respect to such extended term. C. In no event shall Royalties accruing by reason of any sales to us or an Affiliate of ours or by reason of sales outside the Territory pursuant to a distribution permission be offset against the Advance or any subsequent advance. 4. GUARANTEE A. You shall, with your statement for each Royalty Payment Period ending on a date indicated in Subparagraph 1.L. hereof defining "Guarantee," or upon termination if the Agreement is terminated prior to the end of the Principal Term, pay us the amount, if any, by which cumulative Royalties paid with respect to sales in the Territory during any period or periods covered by the Guarantee provision, or any Guarantee provision contained in any agreement extending the term hereof, fall short of the amount of the Guarantee for such period. B. Advances applicable to Royalties due on sales in the period to which the Guarantee relates apply towards meeting the Guarantee. C. In no event shall Royalties paid with respect of sales to us or to any Affiliate of ours, or with respect to sales outside the Territory pursuant to a distribution permission, apply towards the meeting of the Guarantee of any subsequent guarantee. 5. PRE-PRODUCTION APPROVALS A. As early as possible, and in any case before commercial production of any Article, you shall submit to us for our review and written approval (to utilize such materials in preparing a pre-production sample) all concepts, all preliminary and proposed final artwork, and all three- dimensional models which are to appear on or in the Article. Thereafter, you shall submit to us for our written approval a pre-production sample of each Article. We shall endeavor to respond to such requests within a reasonable time, but such approvals should be 50 8 sought as early as possible in case of delays. In addition to the foregoing, as early as possible, and in any case no later than sixty (60) days following written conceptual approval, you shall supply to us for our use for internal purposes, a mock-up, prototype or pre-production sample of each style of each Article on or in connection with which the Licensed Material is used. You acknowledge that we may not approve concepts or artwork submitted near the end of the Principal Term. B. Approval or disapproval shall lie solely in our discretion, and any Article not so approved in writing shall be deemed unlicensed and shall not be manufactured or sold. If any unapproved Article is being sold, we may, together with other remedies available to us, including but not limited to, immediate termination of this Agreement, by written notice require such Article to be immediately withdrawn from the market. Any modification of an Article, including, but not limited to, change of materials, color, design or size of the representation of Licensed Material must be submitted in advance for our written approval as if it were a new Article. Approval of an Article which uses particular artwork does not imply approval of such artwork for use with a different Article. The fact that artwork has been taken from a Disney publication or a previously approved Article does not mean that its use will necessarily be approved in connection with an Article licensed hereunder. C. If you submit for approval artwork from an article or book manufactured or published by another licensee of ours or of any subsidiary of ours, you must advise us in writing of the source of such artwork. If you fail to do so, any approval which we may give for use by you of such artwork may be withdrawn by giving you written notice thereof, and you may be required by us not to sell Articles using such artwork. D. Notwithstanding the above, as we rely primarily on you for the consistent quality and safety of the Articles and their compliance with applicable laws and standards, we will not unreasonably object to any change in the design of an Article or in the materials used in the manufacture of the Article or in the process of manufacturing the Articles which you advise us in writing is intended to make the Article safer or more durable. E. If we have supplied you with forms for use in applying for approval of artwork, models, pre-production and production samples of Articles, you shall use such forms when submitting anything for our approval. 6. APPROVAL OF PRODUCTION SAMPLES A. Before shipping an Article to any customer, you agree to furnish to us, from the first production run of each supplier of each of the Articles, for our approval of all aspects of the Article in question, the number of Samples with packaging which is hereinabove set forth, which shall conform to the approved artwork, three-dimensional models and 51 9 pre-production sample. Approval or disapproval of the artwork as it appears on the Article, as well as of the quality of the Article, shall lie in our sole discretion and may, among other things, be based on unacceptable quality of the artwork or of the Article as manufactured. Any Article not so approved shall be deemed unlicensed, shall not be sold and, unless otherwise agreed by us in writing, shall be destroyed. Such destruction shall be attested to in a certificate signed by one of your officers. Production samples of Articles for which we have approved a pre-production sample shall be deemed approved, unless within twenty (20) days of our receipt of such production sample we notify you to the contrary. B. You agree to make available at no charge a reasonable number of additional samples of each Article as we may from time to time reasonably request for the purpose of comparison with earlier samples, or to test for compliance with applicable laws, regulations and standards, and to permit us upon reasonable request to inspect your manufacturing operations and testing records (and those of your suppliers) for the Articles. C. It is specifically understood that we may disapprove an Article or a production run of an Article because the quality is unacceptable to us, and accordingly, we recommend that you submit production samples to us for approval before committing to a large original production run or to purchase a large shipment from a new supplier. D. No modification of an approved production sample shall be made without our further prior written approval. Articles being sold must conform in all respects to the approved production sample. It is understood that if in our reasonable judgment the quality of an Article originally approved has deteriorated in later production runs, or if the Article has otherwise been altered, we may, in addition to other remedies available to us, by written notice require such Article to be immediately withdrawn from the market. E. The rights granted hereunder do not permit the sale of "seconds" or "irregulars". All Articles not meeting the standard of approved samples shall be destroyed or all Licensed Material and Trademarks shall be removed or obliterated therefrom. F. Notwithstanding the above, as we rely primarily on you for the consistent quality and safety of the Articles and their compliance with applicable laws and standards, we will not unreasonably object to any change in the design of an Article or in the materials used in the manufacture of the Article or in the process of manufacturing the Articles which you advise us in writing is intended to make the Article safer or more durable. G. We shall have the right, by written notice to you, to require modification of any Article approved by us under any previous agreement between us 52 10 pertaining to Licensed Material. Likewise, if the Principal Term of this Agreement is extended by mutual agreement, we shall have the right, by written notice to you, to require modification of any Article approved by us under this Agreement. It is understood that there is no obligation upon either party to extend the Agreement. H. If we notify you of a required modification under Subparagraph 6.G. with respect to a particular Article, such notification shall advise you of the nature of the changes required, and you shall not accept any order for any such Article until the Article has been resubmitted to us with such changes and you have received our written approval of the Article as modified. However, you may continue to distribute your inventory of the previously approved Articles until such inventory is exhausted (unless such Articles are dangerously defective, as determined by us). I. Upon our request, you agree to give us written notice of the first ship date for each Article. 7. APPROVAL OF PACKAGING, PROMOTIONAL MATERIAL AND ADVERTISING A. All containers, packaging, display material, promotional material, catalogs, and all advertising, including, but not limited to, television advertising and press releases, for Articles must be submitted to us and receive our written approval before use. To avoid unnecessary expense if changes are required, our approval thereof should be procured when such is still in rough or storyboard format. We shall endeavor to respond to requests for approval within a reasonable time. Approval or disapproval shall lie in our sole discretion, and the use of unapproved containers, packaging, display material, promotional material, catalogs or advertising is prohibited. Whenever you shall prepare catalog sheets or other printed matter containing illustrations of Articles, you will furnish to us five (5) copies thereof when they are published. B. If we have supplied you with forms for use in applying for approval of artwork, models, pre-production and production samples of Articles, you shall use such forms when submitting anything for our approval. C. We have designed character artwork to be used by all licensees in connection with the packaging of all merchandise using the Licensed Material, and on hang tags and garment labels or such merchandise. We will supply you with reproduction artwork thereof, and you agree to use such artwork on the packaging of the Articles, and on hang tags and garment labels which you will have printed and attached to each Article at your cost. We recommend that you source the hang tags and garment labels from our authorized manufacturer of pre-approved hang tags and garment labels, the name of which will be provided to you upon request However, you may use another manufacturer for the required hang tags and garment labels if the hang tags and garment labels manufactured are 53 11 of equivalent quality and are approved by us in accordance with our usual approval process. 8. ARTWORK You shall pay us, within thirty (30) days of receiving an invoice therefor, for artwork done at your request by us or third parties under contract to us in the development and creation of Articles, display, packaging or promotional material (including any artwork which in our opinion is necessary to modify artwork initially prepared by you and submitted to us for approval, subject to your prior written approval) at our then prevailing commercial art rates. Estimates of artwork charges are available upon request. While you are not obligated to utilize the services of our Art Department, you are encouraged to do so in order to minimize delays which may occur if outside artists do renditions of Licensed Material which we cannot approve and to maximize the attractiveness of the Articles. 9. PRINT, RADIO OR TV ADVERTISING You will obtain all approvals necessary in connection with print, radio or television advertising, if any, which we may authorize. You represent and warrant that all advertising and promotional materials shall comply with all applicable laws and regulations. Our approval of copy or storyboards for such advertising will not imply a representation or belief by us that such copy or storyboards are sufficient to meet any applicable code, standard, or other obligation. This Agreement does not grant you any rights to use the Licensed Material in animation. You may not use any animation or live action footage from the motion picture from which the Licensed Material comes without our prior written approval in each instance. In the event we approve the use of film clips of the motion picture from which the Licensed Material comes, for use in a television commercial, you shall be responsible for any re-use fees which may be applicable, including SAG payments for talent. No reproduction of the film clip footage shall be made except for inclusion, as approved by us, in such commercial and there shall be no modifications of the film clip footage. All film clip footage shall be returned to us immediately after its inclusion in such commercial. We shall have the right to prohibit you from advertising the Articles by means of television and/or billboards. Such right shall be exercised within our absolute discretion, including without limitation for reasons of overexposure of the Licensed Material. 10. LICENSEE NAME AND ADDRESS ON ARTICLES A. Your name, trade name (or a trademark of yours which you have advised us in writing that you are using) and your address (at least city and state) will appear on permanently affixed labeling on each Article or, if the Article is sold to the public in packaging or a container, printed on such packaging or a container so that the public can identify the supplier of the Article. On soft goods "permanently affixed" shall mean sewn on. RN numbers do not constitute a sufficient label under this paragraph. 54 12 B. You shall advise us in writing of all trade names or trademarks you wish to use on Articles being sold under this license. You may sell the Articles only under mutually agreed upon trade names or trademarks. 11. COMPLIANCE WITH APPROVED SAMPLES AND APPLICABLE LAWS AND STANDARDS Each Article and component thereof distributed hereunder shall be of good quality and free of defects in design, materials and workmanship, and shall comply with all applicable laws, regulations and voluntary industry standards and such specifications, if any, as may have been specified in this Agreement, and shall conform to the Sample thereof approved by us. Both before and after you put Articles on the market, you shall follow reasonable and proper procedures for testing that Articles comply with such laws, regulations, and standards, and shall, upon reasonable notice, permit our designees to inspect testing, manufacturing and quality control records and procedures and to test the Articles for compliance. You shall also give due consideration to any recommendations of ours that Articles exceed the requirements of applicable laws, regulations and standards. Articles not complying with applicable laws, regulations and voluntary standards shall be deemed unapproved, even if previously approved by us, and shall not be shipped unless and until they have been brought into full compliance therewith. 12. DISNEY OWNERSHIP OF ALL RIGHTS IN LICENSED MATERIAL You acknowledge that the copyrights and all other proprietary rights in and to Licensed Material are exclusively owned by and reserved to us. You shall neither acquire nor assert copyright ownership or any other proprietary rights in Licensed Material or in any derivation, adaptation, variation or name thereof. Without limiting the foregoing, you hereby assign to us all your worldwide right, title and interest in the Licensed Material and in any material objects consisting of or incorporating drawings, paintings, animation cels, or sculptures of Licensed Material, or other derivations, adaptations, compilations, collective works, variations or names of Licensed Material, heretofore or hereafter created by or for you or any Affiliate of yours. All such new materials shall be included in the definition of "Licensed Material" under this Agreement. If any third party makes or has made any contribution to the creation of any new materials which are included in the definition of Licensed Material under this Paragraph 12, you agree to obtain from such party a full assignment of rights so that the foregoing assignment by you shall vest full rights to such new materials in us. The foregoing assignment to us of material objects shall not include that portion of your displays, catalogs or promotional material not containing Licensed Material, or the physical items constituting the Articles, unless such items are in the shape of the Licensed Material. 13. COPYRIGHT NOTICE As a condition to the grant of rights hereunder, each Article and any other matter containing Licensed Material shall bear a properly located permanently 55 13 affixed copyright notice in our name (e.g., "(C)Disney"), or such other notice as we may notify to you in writing. You will comply with such instructions as to form, location and content of the notice as we may give from time to time. You will not, without our prior written consent, affix to any Article or any other matter containing Licensed Material a copyright notice in any other name. If through inadvertence or otherwise a copyright notice on any Article or other such matter should appear in your name or the name of a third party, you hereby agree to assign to us the copyright represented by any such copyright notice in your name and, upon request, cause the execution and delivery to us of whatever documents are necessary to convey to us that copyright represented by any such copyright notice. If by inadvertence a proper copyright notice is omitted from any Article or other matter containing Licensed Material, you agree at your expense to use all reasonable efforts to correct the omission on all such Articles or other matter in process of manufacture or in distribution. You agree to advise us promptly and in writing of the steps being taken to correct any such omission and to make the corrections on existing Articles which can be located. 14. NON-ASSOCIATION OF OTHER FANCIFUL CHARACTERS WITH LICENSED MATERIAL To preserve our identification with our characters and to avoid confusion of the public, you agree not to associate other characters (other than such as constitute a trademark of yours) or licensed properties with the Licensed Material or the Trademarks either on the Articles or in their packaging, or, without our written permission, on advertising, promotional or display materials. 15. ACTIVE MARKETING OF ARTICLES You agree to manufacture (or have manufactured for you) and offer for sale all the Articles and to exercise the rights granted herein. You agree that by the Marketing Date applicable to a particular Article or, in the absence of such a date being specified in Subparagraph 1.O., by six (6) months from the commencement of the Principal Term, shipments to customers of such Article will have taken place in sufficient time that such Article shall be available for purchase by the public at the retail outlets authorized pursuant to Subparagraph 2.A. In any case in which such sales have not taken place or when the Article is not then and thereafter available for purchase by the public, we may either invoke our remedies under Paragraph 28, or withdraw such Article from the list of Articles licensed in this Agreement without obligation to you other than to give you written notice thereof. 16. PROMOTION COMMITMENT You agree to carry out the Promotion Commitment, if any, as defined in Subparagraph 1.N. 56 14 17. TRADEMARK RIGHTS AND OBLIGATIONS A. All uses of the Trademarks by you hereunder shall inure to our benefit You acknowledge that we are the exclusive owner of all the Trademarks, and of any trademark incorporating all or any part of a Trademark or any Licensed Material, and the trademark rights created by such uses. Without limiting the foregoing, you hereby assign to us all the Trademarks, and any trademark incorporating all or any part of a Trademark or any Licensed Material, and the trademark rights created by such uses, together with the goodwill attaching to that part of the business in connection with which such Trademarks or trademarks are used. You agree to execute and deliver to us such documents as we require to register you as a Registered User or Permitted User of the Trademarks or such trademarks and to follow our instructions for proper use thereof in order that protection and/or registrations for the Trademarks and such trademarks may be obtained or maintained. B. You agree not to use any Licensed Material or Trademarks, or any trademark incorporating all or any part of a Trademark or of any Licensed Material, on any business sign, business cards, stationery or forms (except as licensed herein), or to use any Licensed Material or Trademark as the name of your business or any division thereof, unless otherwise agreed by us in writing. C. Nothing contained herein shall prohibit you from using your own trademarks on the Articles or your copyright notice on the Articles when the Articles contain independent material which is your property. Nothing contained herein is intended to give us any rights to, and we shall not use, any trademark, copyright or patent used by you in connection with the Articles which is not derived or adapted from Licensed Material, Trademarks, or other materials owned by us. 18. REGISTRATIONS Except with our written consent, neither you nor any Affiliate of yours will register or attempt in any country to register copyrights in, or to register as a trademark, service mark, design patent or industrial design, or business designation, any of the Licensed Material, Trademarks or derivations or adaptations thereof, or any word, symbol or design which is so similar thereto as to suggest association with or sponsorship by us or any Affiliate of ours. In the event of breach of the foregoing, you agree, at your expense and at our request, immediately to terminate the unauthorized registration activity and promptly to execute and deliver, or cause to be delivered, to us such assignments and other documents as we may require to transfer to us all rights to the registrations, patents or applications involved. 19. UNLICENSED USE OF LICENSED MATERIALS A. You agree that you will not use the Licensed Material, or the Trademarks, or any other material the copyright to which is owned by us 57 15 in any way other than as herein authorized (or as is authorized in any other written contract in effect between us). In addition to any other remedy we may have, you agree that the profits from any use thereof on products other than the Articles (unless authorized by us in writing), and all profits from the use of any other copyrighted material of ours without written authorization, shall be payable to us. B. You agree to give us prompt written notice of any unlicensed use by third parties of Licensed Material or Trademarks, and that you will not, without our written consent, bring or cause to be brought any criminal prosecution, lawsuit or administrative action for infringement, interference with or violation of any rights to Licensed Material or Trademarks. Because of the need for and the high costs of an effective anti-piracy enforcement program, you agree to cooperate with us, and, if necessary, to be named by us as a sole complainant or co-complainant in any action against an infringer of the Licensed Material or Trademarks and, notwithstanding any right of yours to recover same, legal or otherwise, you agree to pay to us, and hereby waive all claims to, all damages or other monetary relief recovered in such action by reason of a judgment or settlement whether or not such damages or other monetary relief, or any part thereof, represent or are intended to represent injury sustained by you as a licensee hereunder; in any such action against an infringer, we agree to reimburse you for reasonable expenses incurred at our request, including reasonable attorney's fees if we have requested you to retain separate counsel. 20. STATEMENTS AND PAYMENTS OF ROYALTIES A. You agree to furnish to us by the 30th day after each Royalty Payment Period full and accurate statements on statement forms we designate for your use, showing all information requested by such forms, including but not limited to, the quantities, Net Invoiced Billings and applicable Royalty rate(s) of Articles invoiced during the preceding Royalty Payment Period, and the quantities and invoice value of Articles returned for credit or refund in such period. At the same time you will pay us all Royalties due on billings shown by such statement. To the extent that any Royalties are not paid, you authorize us to offset Royalties due against any sums which we or any Affiliate of ours may owe to you or any Affiliate of yours. No deduction or withholding from Royalties payable to us shall be made by reason of any tax. Any applicable tax on the manufacture, distribution and sale of the Articles shall be borne by you. B. The statement forms we designate for our use may be changed from time to time, and you agree to use the most current form we provide to you. You agree to fully comply with all instructions supplied by us for completing such forms. C. In addition to the other information requested by the statement forms, your statement shall with respect to all Articles report separately: 58 16 (1) F.O.B. In Sales; (2) F.O.B. Out Sales; (3) sales of Articles outside the Territory pursuant to a distribution permission (indicating the country involved); (4) your sales of Articles as a supplier to any of our or our licensees or our Affiliates' licensees for the Articles (which sales shall not generate Royalties payable to us so long as such licensees are reselling the Articles and paying us royalties on such resales); (5) sales of Articles to us or any Affiliate of ours; (6) sales of Articles to your or our employees; (7) sales of Articles under any brand or program identified in Subparagraph 1.B. hereinabove. D. Sales of items licensed under contracts with us other than this Agreement shall not be reported on the same statement as sales of Articles under this Agreement. E. Your statements and payments shall be delivered to The Walt Disney Company, P.O. Box 101947, Atlanta, Georgia 30392. However, Advances should be mailed directly to the Contract Administrator at 500 South Buena Vista Street, Burbank, California 91521-6771. A copy of each statement must be sent to us at 500 South Buena Vista Street, Burbank, California 91521-6771, to the attention of the Contract Administrator, Consumer Products Division. If you wish to send statements and payments by overnight courier, please use the following address: The Walt Disney Company, Wachovia South Metro Center, 3585 Atlanta Avenue, Hapeville, GA 30354, Attention Peggy Morris, Reference Lock Box 101947. 21. ARTICLES RETURNED FOR CREDIT OR REFUND Royalties reported on sales of Articles which have been returned to you for credit or refund and on which a refund has been made or credit memo issued may be credited against Royalties due. The credit shall be taken in the Royalty Payment Period in which the refund is given or credit memo issued. Unused credits may be carried forward, but in no event shall you be entitled to a refund of Royalties. 59 17 22. INTEREST Royalties or any other payments due to us hereunder which are received after the due date shall bear interest at the rate of 10% per annum from the due date (or the maximum permissible by law if less than 10%) 23. AUDITS AND MAINTAINING RECORDS You agree to keep accurate records of all transactions relating to this Agreement and any prior agreement with us, including, without limitation, shipments to you of Articles and components thereof, inventory records, records of sales and shipments by you, and records of returns, and to preserve such records for the lesser of seven (7) years or two (2) years after the expiration or termination of this Agreement. We or our representatives, shall have the right from time to time, during your normal business hours, but only for the purpose of confirming your performance hereunder, to examine and make extracts from all such records, including the general ledger, invoices and any other records which we reasonably deem appropriate to verify the accuracy of your statements or your performance hereunder, including records of your Affiliates if they are involved in activities which are the subject of this Agreement. In particular, your invoices shall identify the Articles separately from goods which are not licensed hereunder. If in an audit of your records it is determined that there is a short fall of five percent (5%) or more in Royalties reported for any Royalty Payment Period, you shall upon request from us reimburse us for the full out-of-pocket costs of the audit, including the costs of employee auditors calculated at $60 per hour per person for travel time during normal working hours and actual working time. 24. MANUFACTURE OF ARTICLES BY THIRD PARTY MANUFACTURERS A. If you at any time desire to have Articles or components thereof containing Licensed Material manufactured by a third party, you must, as a condition to the continuation of this Agreement, notify us of the name and address of such manufacturer and the Articles or components involved and obtain our prior written permission to do so. If we are prepared to grant permission, we will do so if: (1) In the case of manufacture outside the Territory: (a) you and each of your manufacturers and any submanufacturers sign a Consent/Manufacturer's Agreement in a form which we will furnish to you; and (b) we receive all such agreements properly signed; and (2) In the case of manufacture in the Territory: (a) upon our request, you cause each such manufacturer to sign an agreement in a form which we will furnish to you; and 60 18 (b) we receive all such agreements properly signed. (A SAMPLE OF SAID AGREEMENT FORM IS AVAILABLE ON REQUEST.) B. We will not normally require agreements from suppliers of yours who are manufacturing in the Territory, but your purchase of Articles from a third party manufacturer without such agreements as are required hereunder being signed and delivered to us shall be a violation of this Agreement. It is not our policy to reveal the names of your suppliers to third parties or to any division of ours involved with buying products, except as may be necessary to enforce our contract rights or protect our trademarks and copyrights. C. If any such manufacturer utilizes Licensed Material or Trademarks for any unauthorized purpose, you shall cooperate fully in bringing such utilization to an immediate halt. If, by reason of your not having supplied the above mentioned agreements to us or not having given us the name of any supplier, we make any representation or take any action and are thereby subjected to any penalty or expense, you will fully compensate us for any cost or loss we sustain. 25. INDEMNITY A. You shall indemnify us during and after the term hereof against all claims, liabilities (including settlements entered into in good faith with your consent, not to be unreasonably withheld) and expenses (including reasonable attorneys' fees) arising out of your activities hereunder, or out of any defect (whether obvious or hidden and whether or not present in any sample approved by us) in an Article, or arising from personal injury or any infringement of any rights of any other person by the manufacture, sale, possession or use of Articles, or their failure to comply with applicable laws, regulations and standards. The parties indemnified hereunder shall include The Walt Disney Company and its subsidiaries, and their officers, directors, employees and agents. The indemnity shall not apply to any claim or liability relating to any infringement of the copyright of a third party caused by your utilization of the Licensed Material and the Trademarks in accordance with the provisions hereof. B. We shall indemnify you during and after the term hereof against all claims, liabilities (including settlements entered into in good faith with our consent, not to be unreasonably withheld) and expenses (including reasonable attorneys' fees) arising out of any claim that your use of any representation of the Licensed Material or the Trademarks approved in accordance with the provisions of this Agreement infringes the copyright of any third party or infringes any right granted by us to such third party. You shall not, however, be entitled to recover for lost profits. 61 19 C. Additionally, if by reason of any claims referred to in Subparagraph 25.B., you are precluded from selling any stock of Articles or utilizing any materials in your possession or which come into your possession by reason of any required recall, we shall be obligated to purchase such Articles and materials from you at their out-of-pocket cost to you, excluding overheads, but we shall have no other responsibility or liability with respect to such Articles or materials. D. No warranty or indemnity is given with respect to any liability or expense arising from any claim that use of the Licensed Material or the Trademarks on or in connection with the Articles hereunder or any packaging, advertising or promotional material infringes on any trademark right of any third party or otherwise constitutes unfair competition by reason of any prior rights acquired by such third party other than rights acquired from us. It is expressly agreed that it is your responsibility to carry out such investigations as you may deem appropriate to establish that Articles, packaging, promotional and advertising material which are manufactured or created hereunder, including any use made of the Licensed Material and the Trademarks therewith, do not infringe such right of any third party, and we shall not be liable to you if such infringement occurs. E. You and we agree to give each other prompt written notice of any claim or suit which may arise under the indemnity provisions set forth above. Without limiting the foregoing, you agree to give us written notice of any product liability claim made or suit with respect to any Article within seven (7) days of your receipt of the claim. 26. INSURANCE You shall maintain in full force and effect at all times while this Agreement is in effect and for three years thereafter commercial general liability insurance, including broad form coverage for contractual liability, products liability and personal injury liability (including bodily injury and death), waiving subrogation, with minimum limits of no less than two million dollars (US $2,000,000.00) per occurrence, and naming as additional insureds those indemnified in Paragraph 25 hereof. You shall deliver to us a certificate or certificates of insurance evidencing satisfactory coverage and indicating that we shall receive written notice of cancellation, non-renewal or of any material change in coverage at least thirty (30) days prior to the effective date thereof. Your insurance shall be carried by an insurer with a BEST rating of B + VII or better. Compliance herewith in no way limits your indemnity obligations, except to the extent that your insurance company actually pays us amounts which you would otherwise pay us. 27. WITHDRAWAL OF LICENSED MATERIAL You agree that we may, without obligation to you other than to give you written notice thereof, withdraw from the scope of this Agreement any Licensed Material which by the Marketing Date or, in the absence of such a date being 62 20 specified in Subparagraph 1.O., by six (6) months from the commencement of the Principal Term, is not being used on or in connection with the Articles. We may also withdraw any Licensed Material or Articles the use or sale of which under this Agreement would infringe or reasonably be claimed to infringe the rights of a third party, other than rights granted by us, in which case our obligations to you shall be limited to the purchase at cost of Articles and other materials utilizing such withdrawn Licensed Material which cannot be sold or used. In the case of any withdrawal under the preceding sentence, the Advances and Guarantees shall be adjusted to correspond to the time remaining in the Principal Term, or the number of Articles remaining under the Agreement, at the date of withdrawal. 28. TERMINATION Without prejudice to any other right or remedy available to us: A. If you fail to manufacture, sell and distribute the Articles, or to furnish statements and pay Royalties as herein provided, or if you otherwise breach the terms of this Agreement, and if any such failure is not corrected within thirty (30) days after we send you written notice thereof (or, in the case of non-payment of Royalties within fifteen (15) days), we shall have the right at any time to terminate this Agreement by giving you written notice thereof. B. We shall have the right at any time to terminate this Agreement by giving you written notice thereof: (1) if you deliver to any customer without our written authorization merchandise containing representations of Licensed Material or other material the copyright or other proprietary rights to which are owned by us other than Articles listed herein and approved in accordance with the provisions hereof; (2) if you deliver Articles outside the Territory or knowingly sell Articles to a third party for delivery outside the Territory, unless pursuant to a written distribution permission or separate written license agreement with us or any Affiliate of ours; (3) if a breach occurs which is of the same nature, and which violates the same provision of this Agreement, as a breach of which we have previously given you written notice; (4) if you breach any material term of any other license agreement between us, and we terminate such agreement for cause; (5) if you shall make any assignment for the benefit of creditors, or file a petition in bankruptcy, or are adjudged bankrupt, or become insolvent, or are placed in the hands of a receiver, or 63 21 if the equivalent of any such proceedings or acts occurs, though known by some other name or term; and/or (6) if you are not permitted or are unable to operate your business in the usual manner, or are not permitted or are unable to provide us with assurance satisfactory to us that you will so operate your business, as debtor in possession or its equivalent, or are not permitted, or are unable to otherwise meet your obligations under this Agreement or to provide us with assurance satisfactory to us that you will meet such obligations. 29. RIGHTS AND OBLIGATIONS UPON EXPIRATION OR TERMINATION A. Upon the expiration or termination of this Agreement, all rights herein granted to you shall revert to us, and we shall be entitled to retain all Royalties and other things of value paid or delivered to us. You agree that the Articles shall be manufactured during the Principal Term in quantities consistent with anticipated demand therefor so as not to result in an excessive inventory build-up immediately prior to the end of the Principal Term. You agree that from the expiration or termination of this Agreement you shall neither manufacture nor have manufactured for you any Articles, that you will deliver to us any and all artwork (including animation cels and drawings) which may have been used or created by you in connection with this Agreement, that you will at our option either sell to us at cost or destroy or efface any molds, plates and other items used to reproduce Licensed Martial or Trademarks, and that except as hereinafter provided, you will cease selling Articles. Any unauthorized distribution of Articles after the expiration or termination of this Agreement shall constitute copyright infringement. B. If you have any unsold Articles in inventory on the expiration or termination date, you shall provide us with a full statement of the kinds and numbers of such unsold Articles and shall thereupon, but only if such statement has been provided to us and if you have fully complied with the terms of this Agreement including the payment of all Royalties due and the Guarantee, have the right for a limited period of three (3) calendar months from such expiration or earlier termination date to sell off and deliver such Articles. You shall furnish us statements covering such sales and pay us Royalties in respect of such sales. Such Royalties shall not be applied against the Advance or towards meeting the Guarantee. C. In recognition of our interest in maintaining a stable and viable market for the Articles during and after the Principal Term and any sell-off period, you agree to refrain from "dumping" the Articles in the market during any sell-off period granted to you. "Dumping" shall mean the distribution of product at volume levels significantly above your prior sales practices with respect to the Articles, and at price levels so far below your prior sales practices with respect to the Articles as to 64 22 disparage the Articles; provided, however, that nothing contained herein shall be deemed to restrict your ability to set product prices at your discretion. D. Except as otherwise agreed by us in writing, any inventory of Articles in your possession or control after the expiration or termination hereof and of any sell-off period granted hereunder shall be destroyed, or all Licensed Material and Trademarks removed or obliterated therefrom. E. If we supply you with forms regarding compliance with this Paragraph 29, you agree to complete, execute and return such forms to us expeditiously. 30. WAIVERS A waiver by either of us at any time of a breach of any provision of this Agreement shall not apply to any breach of any other provision of this Agreement, or imply that a breach of the same provision at any other time has been or will be waived, or that this Agreement has been in any way amended, nor shall any failure by either party to object to conduct of the other be deemed to waive such party's right to claim that a repetition of such conduct is a breach hereof. 31. PURCHASE OF ARTICLES BY US If we wish to purchase Articles, you agree to sell such Articles to us or any Affliliate of ours at as low a price as you charge for similar quantities sold to your regular customers and to pay us Royalties on any such sales. 32. NON-ASSIGNABILITY A. You shall not voluntarily or by operation of law assign, sub-license, transfer, encumber or otherwise dispose of all or any part of your interest in this Agreement without our prior written consent, to be granted or withheld in our absolute discretion. Any attempted assignment, sub-license, transfer, encumbrance or other disposal without such consent shall be void and shall constitute a material default and breach of this Agreement. "Transfer" within the meaning of this Paragraph 32 shall include any merger or consolidation involving your company or your parent (if any); any sale or transfer of all or substantially all of your (or your parent) company's assets; any transfer of your rights hereunder to a division, business segment or other entity of yours other than the one specifically referenced on page 1 hereof (or any sale or attempted sale of Articles under a trademark or trade name of such division, business segment or other entity); and any transaction or series of related transactions resulting in the transfer of thirty-three and one-third percent (33-1/3%) or more of the voting stock of your (or your parent) company (or, if your company is a partnership, thirty-three and one-third percent (33-1/3%) or more of the profit and loss participation 65 23 in your company, or the occurrence of any of the foregoing with respect to any general partner of your company). B. Our consent to any assignment of this Agreement or other transfer as defined in Subparagraph 32.A. shall be subject to such terms and conditions as we deem appropriate, including payment of a transfer fee in the amount of ten percent (10%) of Royalties earned for the Articles in the four (4) complete calendar quarterly periods preceding the date you seek our consent, but in no event less than $100,000.00. The foregoing transfer fee shall not apply if this Agreement is assigned to one of our Affiliates as part of a corporate reorganization involving some or all of the entities existing in your corporate structure when this Agreement is signed; provided, however, that you must give us written notice of such assignment and a description of the reorganization. If you have more than one merchandise license agreement with us for the Territory, and an event occurs which would trigger the transfer fee provisions of this Paragraph 32, you need only pay to us one transfer fee, equal to the greater of $100,000.00 or ten percent (10%) of Royalties earned for all Articles in the preceding four (4) complete calendar quarterly periods under all of the merchandise license agreements for the Territory. The provisions of this Subparagraph 32.B. shall supersede any conflicting provisions on this subject in any merchandise license agreement previously entered into between you and us, including but not limited to, the determination of the applicable four (4) complete calendar quarterly periods to be used in the calculation of Royalties earned. C. Notwithstanding Subparagraphs 32.A. and B., you may, upon written notice to us, unless we have objected within thirty (30) days of receipt of such notice, sublicense your rights hereunder to your Affiliates. You hereby irrevocably and unconditionally guarantee that they will observe and perform all of your obligations hereunder, including, without limitation, the provisions governing approvals, and compliance with approved samples, applicable laws and standards, and all other provisions hereof, and that they will otherwise adhere strictly to all of the terms hereof and act in accordance with your obligations hereunder. Any involvement of an Affiliate in the activities which are the subject of this Agreement shall be deemed carried on pursuant to such a sublicense and thus covered by such guarantee, but, unless notified to us and not timely objected to, such involvement may be treated by us as a breach of this Agreement. 33. RELATIONSHIP This Agreement does not provide for a joint venture, partnership, agency or employment relationship between us. 66 24 34. CONSTRUCTION The language of all parts of this Agreement shall in all cases be construed as a whole, according to its fair meaning and not strictly for or against any of the parties. Headings of paragraphs herein are for convenience of reference only and are without substantive significance. 35. MODIFICATIONS OR EXTENSIONS OF THIS AGREEMENT Except as otherwise provided herein, this Agreement can only be extended or modified by a writing signed by both parties. 36. NOTICES All notices which either party is required or may desire to serve upon the other party shall be in writing, addressed to the party to be served at the address set forth on page 1 of this Agreement, and may be served personally or by depositing the same addressed as herein provided (unless and until otherwise notified), postage prepaid, in the United States mail. Such notice shall be deemed served upon personal delivery or upon the date of mailing; provided, however, that we shall be deemed to have been served with a notice of a request for approval of materials under this Agreement only upon our actual receipt of the request and of any required accompanying materials. Any notice sent to us hereunder shall be sent to the attention of "Vice President, Licensing", unless we advise you in writing otherwise. 37. MUSIC Music is not licensed hereunder. Any charges, fees or royalties payable for music rights or any other rights not covered by this Agreement shall be additional to the Royalties and covered by separate agreement. 38. PREVIOUS AGREEMENTS This Agreement, and any confidentiality agreement you may have signed pertaining to any of the Licensed Material, contains the entire agreement between us concerning the subject matter hereof and supersedes any pre-existing agreement and any oral or written communications between us. However, if pursuant to any such pre-existing agreement there was any agreement(s) in effect permitting you to sell or distribute Articles outside the Territory or to cause to be manufactured any Articles outside the Territory, such agreement(s) shall be deemed to remain in effect to the extent that they relate to Licensed Material and Articles licensed hereunder. 39. CHOICE OF LAW AND FORUM This Agreement shall be deemed to be entered into in California and shall be governed and interpreted according to the laws of the State of California. Any legal actions pertaining to this Agreement shall be commenced within the State of California and within either Los Angeles or Orange Counties. The prevailing 67 25 party shall be entitled to recover reasonable attorney's fees and costs incurred therein. 40. EQUITABLE RELIEF You acknowledge that we will have no adequate remedy at law if you continue to manufacture, sell advertise, promote or distribute the Articles upon the expiration or termination of this Agreement. You acknowledge and agree that, in addition to any and all other remedies available to us, we shall have the right to have any such activity by you restrained equitable relief, including, but not limited to, a temporary restraining order, a preliminary injunction, a permanent injunction, or such other alternative relief as may be appropriate, without the necessity of our posting any bond. Please sign below under the word "Agreed". When signed by both parties this shall constitute an agreement between us. THE WALT DISNEY COMPANY By: /s/ Doug Mangino ------------------- Title: VP/DMM FILM ENTERTAINMENT LICENSING ----------------------------------- Date: 9/11/95 -------- AGREED: SUN SPORTSWEAR, INC. By: /s/ Larry C. Mounger --------------------- Title: President, C.E.O. ----------------- 68 EX-10.26 4 LICENSE AGREEMENT 1 EXHIBIT 10.26 The Walt Disney Company 500 South Buena Vista Street Burbank, California 91521 October 1, 1994 Sun Sportswear, Inc. 6520 South 190th Street Kent, WA 98032 Re: WINNIE THE POOH Dear Sirs/Mesdames: We hereby agree with you as follows: 1. MEANING OF TERMS As used in this Agreement: A. "LICENSED MATERIAL" means the graphic depictions of the following: WINNIE THE POOH, CHRISTOPHER ROBIN, EEYORE, KANGA, ROO, RABBIT, PIGLET, OWL, GOPHER, AND TIGGER, ALL IN THE STYLE AS DESIGNED BY US. B. "TRADEMARKS" means "WALT DISNEY" and "DISNEY", the names for and representations of Licensed Material included in Subparagraph 1.A. above. C. "ARTICLES" means the following items on or in connections with which the Licensed Material and/or the Trademarks are reproduced or used: 1. Women's basic screen printed knit tops and bottoms in sizes S, M, L, XL, XXL, XXXL and Maternity 2. Women's basic screen printed coordinates in sizes S, M, L, XL, XXL, XXXL and Maternity 3. Girls' basic screen printed T-shirts in sizes 4 - 16 4. Girls' knit basic screen printed coordinates in sizes 7 - 16 5. Boys' basic screen printed knit tops and bottoms in sizes 4 - 20 6. Boys' basic screen printed related knit separates in sizes 4 - 20 7. Mens' basic screen printed knit tops and bottoms in sizes S, M, L, XL AND XXL D. "MINIMUM PER ARTICLE ROYALTY" means for each Article identified herein which is sold the sum indicated herein: None. E. PRINCIPAL TERM" means the period commencing October 1, 1994, and ending December 31, 1996. 69 2 F. "TERRITORY" means the United States, United States PX's wherever located, and United States territories and possessions, excluding Puerto Rico. However, if sales are made to chain stores in the United States which have stores in Puerto Rico, such chain stores may supply Articles to such stores in Puerto Rico. G. "ROYALTIES" means a copyright royalty in the amounts set forth below in Subparagraphs 1.G.(1)(a), (b), and (c) and Royalties shall be further governed by the provisions contained in Subparagraphs 1.G.(2)-(5): (1)(a) ten percent (10%) of your Net Invoiced Billings to authorized retailers for Articles shipped by you from a location in the Territory for delivery to a customer located in the Territory ("F.O.B. In Sales"); or (b) fourteen percent (14%) of your Net Invoiced Billings to authorized retailers when your customer located in the Territory bears the costs (e.g., shipping, duties, and the like) of obtaining delivery in the Territory of Articles manufactured outside the Territory ("F.O.B. Out Sales"); or (c) if a Minimum Per Article Royalty has been specified in Subparagraph 1.D. above, and it would result in a higher royalty to be paid for the Articles, you agree to pay the higher royalty amount. (2) The sums which we are paid as Royalties on any sales to Affiliates shall be no less than the sums paid on sales to customers not affiliated with you, and if such Affiliate is a reseller of the Articles, the sale to such customer shall not be counted as a sale for Royalty calculation purposes; in such case, the relevant sale for Royalty calculation purposes shall be that of such Affiliate. (3) All sales of Articles shipped to a customer outside the Territory pursuant to a distribution permission shall bear a Royalty at the rate for F.O.B. Out Sales. (4) Royalties payable shall be not less for each Article sold than the Minimum Per Article Royalty, if such a Royalty has been specified in Subparagraph 1.D. No Royalties are payable on the mere manufacture of Articles. (5) The full Royalty percentage shall be payable on close-out or other deep discount sales of Articles, including sales to employees, except that no Royalty shall be payable on Articles sold with our written permission at or below your acquisition cost or your cost of manufacture, excluding overheads. 70 3 H. "NET INVOICED BILLINGS" means the following: (1) actual invoiced billings (i.e., sales quantity multiplied by your selling price) for Articles sold, and all other receivable of any kind whatsoever, received in payment for the Articles, whether received by you or any parent, subsidiary or affiliate of yours, except as provided in Subparagraphs 1.G.(2), and 1.H.(2), less "Allowable Deductions" as hereinafter defined. (2) The following are not part of Net Invoiced Billings: invoiced charges for transportation of Articles within the Territory which are separately identified on the sales invoice, and taxes on the sale. I. "ALLOWABLE DEDUCTIONS" means the following: (1) volume discounts and other discounts separately identified on your sales invoices as being applicable to sales of Articles licensed hereunder or to combined sales of such Articles and other products not licensed by us, and post-invoice credits granted and properly documented as applicable to sales of Articles licensed hereunder or to combined sales of such Articles and other products not licensed by us; in the event that a post- invoice credit is issued for combined sales of Articles and other products not licensed by us, and you cannot document the portion of the credit applicable to the Articles, you may apply only a pro rata portion of the credit to the Articles. (2) The following are not Allowable Deductions, whether granted on sales invoices or as post-invoice credits: cash discounts granted as terms of payment; early payment discounts; allowances or discounts related to advertising; mark down allowances; costs incurred in manufacturing, importing, selling or advertising Articles; freight costs incorporated in the selling price; and uncollectible accounts. J. "ROYALTY PAYMENT PERIOD" means each calendar quarterly period during the Principal Term and during any other term. K. "ADVANCE" means the following sum(s) payable by the following date(s) as an advance on Royalties to accrue in the following period(s): $40,000.00 payable upon your signing of this Agreement for the period commencing October 1, 1994, and ending December 31, 1996. L. "GUARANTEE" means the following sum(s) which you guarantee to pay as minimum Royalties on your cumulative sales in the following period(s): $200,000.00 for the period commencing October 1, 1994, and ending December 31, 1996. 71 4 M. "SAMPLES" means six (6) samples of each stock keeping unit ("SKU") of each Article, from the first production run of each supplier of each SKU of each Article. N. "PROMOTION COMMITMENT" means the following sum(s) which you agree to spend in the following way(s): None. O. "MARKETING DATE" means the following date(s) by which the following Article(s) shall be available for purchase by the public at retail outlets: By January 1, 1995, for all Articles. P. "AFFILIATE" means any corporation or other entity which directly or indirectly controls, is controlled by or is under common control with you. "Control" of an entity shall mean possession, directly or indirectly, of power to direct or cause the direction of management or policies of such entity, whether through ownership of voting securities, by contract or otherwise. 2. RIGHTS GRANTED A. In consideration for your promise to pay and your payment of all Royalties, Advances and Guarantees required hereunder, we grant you the non-exclusive right, during the Principal Term and any extension thereof, and only within the Territory, to reproduce the Licensed Material only on or in connection with the Articles, to use the Trademarks, but only such Trademarks and uses thereof as may be approved when the Articles are approved and only on or in connection with the Articles, and to manufacture, distribute for sale and sell (other than by direct marketing methods, including buy not limited to direct mail and door-to-door solicitation) the Articles only to mass market retailers (e.g., KMart, J.C. Penney, Co., Inc., Sears, Roebuck and Co., and Target) in the Territory. You will not sell the Articles to other retailers for resale to the public in the Territory or to wholesalers. If there is a questions as to whether a particular customer falls within the category of a mass market retailer, our determination shall be binding. If you wish to sell the Articles to wholesalers or distributors for resale to retailers, you must notify us and negotiate the applicable royalty rate for such sales, which you acknowledge shall be a higher royalty rate than the rate set forth in Subparagraphs 1.G.(1)(a) and (b) for sales to retailers. B. Unless we consent in writing, you shall not sell or otherwise provide Articles for use as premiums (including those in purchase-with-purchase promotions), promotions, give-aways, fund-raisers, or entries in sweepstakes, or to customers for resale by direct mail or other direct marketing methods, including, without limitation, home shopping television programs, or to customers for inclusion in another product, unless such product has been licensed by us. However, nothing 72 5 contained herein shall preclude you from soliciting orders by mail from mass market retailers, nor from selling to mass market retailers which sell predominantly at retail, but which include the Articles in their mail order catalogs or otherwise sell Articles by direct marketing methods as well as at retail. If you wish to sell the Articles to other customers for resale through mail order catalogs, you must obtain our prior written consent in each instance. C. Unless we consent in writing, you shall not give away or donate Articles, except minor quantities of samples, not for onward distribution, to your accounts or other persons for the purpose of promoting Article sales. D. Nothing contained herein shall preclude you from selling Articles to us or to any subsidiary of ours, or to your or our employees, subject to the payment to us of Royalties on such sales. E. We further grant you the right to reproduce the Licensed Material and to use the Trademarks, only within the Territory, on containers, packaging and display material for the Articles, and in advertising for the Articles. F. Nothing contained in this Agreement shall be deemed to imply any restriction on your freedom and that of your customers to sell the Articles at such prices as you or they shall determine. G. You recognize and acknowledge the vital importance to us of the characters and other proprietary material we own and create, and the association of the Disney name with them. In order to prevent the denigration of our products and the value of their association with the Disney name, and in order to ensure the dedication of your best efforts to preserve and maintain that value, you agree that, during the Principal Term and any extension hereof, you will not manufacture or distribute any merchandise embodying or bearing any artwork or other representation which we determine, in our reasonable discretion, is confusingly similar to our Disney characters or other proprietary material. 3. ADVANCE A. You agree to pay the Advance, which shall be on account of Royalties to accrue during the Principal Term only, and only with respect to sales in the Territory; provided, however, that if any part of the Advance is specified hereinabove as applying to any period less than the Principal Term, such part shall be on account of Royalties to accrue during such lesser period only. If said Royalties should be less than the Advance, no part of the Advance shall be repayable. B. Royalties accruing during any sell-off period or extension of the Principal Term shall not be offset against the Advance unless otherwise agreed in writing. Royalties accruing during any extension of the 73 6 Principal Term or any other term shall be offset only against an advance paid with respect to such extended term. C. In no event shall Royalties accruing by reason of any sales to us or a subsidiary of ours or by reason of sales outside the Territory pursuant to a distribution permission be offset against the Advance or any subsequent advance. 4. GUARANTEE A. You shall, with your statement for each Royalty Payment Period ending on a date indicated in Subparagraph 1.L. hereof defining "Guarantee," or upon termination if the Agreement is terminated prior to the end of the Principal Term, pay us the amount, if any, by which cumulative Royalties paid with respect to sales in the Territory during any period or periods covered by the Guarantee provision, or any Guarantee provision contained in any agreement extending the term hereof, fall short of the amount of the Guarantee for such period. B. Advances applicable to Royalties due on sales in the period to which the Guarantee relates apply towards meeting the Guarantee. C. In no event shall Royalties paid with respect of sales to us or to any subsidiary or affiliate of ours, or with respect to sales outside the Territory pursuant to a distribution permission, apply towards the meeting of the Guarantee or any subsequent guarantee. 5. PRE-PRODUCTION APPROVALS A. As early as possible, and in any case before commercial production of any Article, you shall submit to us for our review and written approval (to utilize such materials in preparing a pre-production sample) all concepts, all preliminary and proposed final artwork, and all three-dimensional models which are to appear on or in the Article. Thereafter, you shall submit to us for our written approval a pre-production sample of each Article. We shall endeavor to respond to such requests within a reasonable time, but such approvals should be sought as early as possible in case of delays. In addition to the foregoing, as early as possible, and in any case no later than sixty (60) days following written conceptual approval, you shall supply to us for our use for internal purposes, a mock-up, prototype or pre-production sample of each style of each Article on or in connection with which the Licensed Material is used. You acknowledge that we may not approve concepts or artwork submitted near the end of the Principal Term. B. Approval or disapproval shall lie solely in our discretion, and any Article not so approved in writing shall be deemed unlicensed and shall not be manufactured or sold. If any unapproved Article is being sold, we may, together with other remedies available to us, including but not limited to, immediate termination of this Agreement, by written notice require such Article to be immediately withdrawn from the market. Any 74 7 modification of an Article, including, but not limited to, change of materials, color, design or size of the representation of Licensed Material must be submitted in advance for our written approval as if it were a new Article. Approval of an Article which uses particular artwork does not imply approval of such artwork for use with a different Article. The fact that artwork has been taken from a Disney publication or a previously approved Article does not mean that its use will necessarily be approved in connection with an Article licensed hereunder. C. If you submit for approval artwork from an article or book manufactured or published by another licensee of ours or of any subsidiary of ours, you must advise us in writing of the source of such artwork. If you fail to do so, any approval which we may give for use by you of such artwork may be withdrawn by giving you written notice thereof, and you may be required by us not to sell Articles using such artwork. D. Notwithstanding the above, as we rely primarily on you for the consistent quality and safety of the Articles and their compliance with applicable laws and standards, we will not unreasonably object to any change in the design of an Article or in the materials used in the manufacture of the Article or in the process of manufacturing the Articles which you advise us in writing is intended to make the Article safer or more durable. E. If we have supplied you with forms for use in applying for approval of artwork, models, pre-production and production samples of Articles, you shall use such forms when submitting anything for our approval. 6. APPROVAL OF PRODUCTION SAMPLES A. Before shipping an Article to any customer, you agree to furnish to us, from the first production run of each supplier of each of the Articles, for our approval of all aspects of the Article in question, the number of Samples with packaging which is hereinabove set forth, which shall conform to the approved artwork, three-dimensional models and pre-production sample. Approval or disapproval of the artwork as it appears on the Article, as well as of the quality of the Article, shall lie in our sole discretion and may, among other things, be based on unacceptable quality of the artwork or of the Article as manufactured. Any Article not so approved shall be deemed unlicensed, shall not be sold and, unless otherwise agreed by us in writing, shall be destroyed. Such destruction shall be attested to in a certificate signed by one of your officers. Production samples of Articles for which we have approved a pre-production sample shall be deemed approved, unless within twenty (20) days of our receipt of such production sample we notify you to the contrary. B. You agree to make available at no charge a reasonable number of additional samples of each Article as we may from time to time reasonably request for the purpose of comparison with earlier samples, 75 8 or to test for compliance with applicable laws, regulations and standards, and to permit us upon reasonable request to inspect your manufacturing operations and testing records (and those of your suppliers) for the Articles. C. It is specifically understood that we may disapprove an Article or a production run of an Article because the quality is unacceptable to us, and accordingly, we recommend that you submit production samples to us for approval before committing to a large original production run or to purchase a large shipment from a new supplier. D. No modification of an approved production sample shall be made without our further prior written approval. Articles being sold must conform in all respects to the approved production sample. It is understood that if in our reasonable judgment the quality of an Article originally approved has deteriorated in later production runs, or if the Article has otherwise been altered, we may, in addition to other remedies available to us, by written notice require such Article to be immediately withdrawn from the market. E. The rights granted hereunder do not permit the sale of "seconds" or "irregulars". All Articles not meeting the standard of approved samples shall be destroyed or all Licensed Material and Trademarks shall be removed or obliterated therefrom. F. Notwithstanding the above, as we rely primarily on you for the consistent quality and safety of the Articles and their compliance with applicable laws and standards, we will not unreasonably object to any change in the design of an Article or in the materials used in the manufacture of the Article or in the process of manufacturing the Articles which you advise us in writing is intended to make the Article safer or more durable. G. We shall have the right, by written notice to you, to require modification of any Article approved by us under any previous agreement between us pertaining to Licensed Material. Likewise, if the Principal Term of this Agreement is extended by mutual agreement, we shall have the right, by written notice to you, to require modification of any Article approved by us under this Agreement. It is understood that there is no obligation upon either party to extend the Agreement. H. If we notify you of a required modification under Subparagraph 6.G. with respect to a particular Article, such notification shall advise you of the nature of the changes required, and you shall not accept any order for any such Article until the Article has been resubmitted to us with such changes and you have received our written approval of the Article as modified. However, you may continue to distribute your inventory of the previously approved Articles until such inventory is exhausted (unless such Articles are dangerously defective, as determined by us.) I. You agree to give us written notice of the first ship date for each Article. 76 9 7. APPROVAL OF PACKAGING, PROMOTIONAL MATERIAL AND ADVERTISING A. All containers, packaging, display material, promotional material, catalogs, and all advertising, including, but not limited to, television advertising and press releases, for Articles must be submitted to us and receive our written approval before use. To avoid unnecessary expense if changes are required, our approval thereof should be procured when such is still in rough or storyboard format. We shall endeavor to respond to requests for approval within a reasonable time. Approval or disapproval shall lie in our sole discretion, and the use of unapproved containers, packaging, display material, promotional material, catalogs or advertising is prohibited. Whenever you shall prepare catalog sheets or other printed matter containing illustrations of Articles, you will furnish to us five (5) copies thereof when they are published. B. If we have supplied you with forms for use in applying for approval of artwork, models, pre-production and production samples of Articles, you shall use such forms when submitting anything for our approval. C. We have designed character artwork to be used by all licensees in connection with the hang tags and garment labels of all merchandise using the Licensed Material. We will supply you with reproduction artwork thereof, and you agree to use such artwork on the hang tags and garment labels of the Articles, which you will have printed and attached to each Article at your cost. We recommend that you source the hang tags and garment labels from our authorized manufacturer of pre-approved hang tags and garment labels, the name of which will be provided to you upon request. However, you may use another manufacturer for the required hang tags and garment labels if the hang tags and garment labels manufactured are of equivalent quality and are approved by us in accordance with our usual approval process. 8. ARTWORK You shall pay us, within thirty (30) days of receiving an invoice therefor, for artwork done at your request by us or third parties under contract to us in the development and creation of Articles, display, packaging or promotional material (including any artwork which in our opinion is necessary to modify artwork initially prepared by you and submitted to us for approval, subject to your prior written approval) at our then prevailing commercial art rates. Estimates of artwork charges are available upon request. While you are not obligated to utilize the services of our Art Department, you are encouraged to do so in order to minimize delays which may occur if outside artists do renditions of Licensed Material which we cannot approve and to maximize the attractiveness of the Articles. 77 10 9. PRINT, RADIO OR TV ADVERTISING You will obtain all approvals necessary in connection with print, radio or television advertising, if any, which we may authorize. You represent and warrant that all advertising and promotional materials shall comply with all applicable laws and regulations. Our approval of copy or storyboards for such advertising will not imply a representation or belief by us that such copy or storyboards are sufficient to meet any applicable code, standard, or other obligation. This Agreement does not grant you any rights to use the Licensed Material in animation. You may not use any animation or live action footage from the motion picture from which the Licensed Material comes without our prior written approval in each instance. In the event we approve the use of film clips of the motion picture from which the Licensed Material comes, for use in a television commercial, you shall be responsible for any re-use fees which may be applicable, including SAG payments for talent. No reproduction of the film clip footage shall be made except for inclusion, as approved by us, in such commercial and there shall be no modifications of the film clip footage. All film clip footage shall be returned to us immediately after its inclusion in such commercial. We shall have the right to prohibit you from advertising the Articles by means of television and/or billboards. Such right shall be exercised within our sole discretion, including without limitation for reasons of overexposure of the Licensed Material. 10. LICENSEE NAME AND ADDRESS ON ARTICLES A. Your name, trade name (or a trademark of yours which you have advised us in writing that you are using) and your address (at least city and state) will appear on permanently affixed labeling on each Article or, if the Article is sold to the public in packaging or a container, printed on such packaging or a container so that the public can identify the supplier of the Article. On soft goods "permanently affixed" shall mean sewn on. RN numbers do not constitute a sufficient label under this paragraph. B. You shall advise us in writing of all trade names or trademarks you wish to use on Articles being sold under this license. You may sell the Articles only under mutually agreed upon trade names or trademarks. 11. COMPLIANCE WITH APPROVED SAMPLES AND APPLICABLE LAWS AND STANDARDS Each Article and component thereof distributed hereunder shall be of good quality and free of defects in design, materials and workmanship, and shall comply with all applicable laws, regulations and voluntary industry standards and such specifications, if any, as may have been specified in this Agreement, and shall conform to the Sample thereof approved by us. Both before and after you put Articles on the market, you shall follow reasonable and proper procedures for testing that Articles comply with such laws, regulations, and standards, and shall, upon reasonable notice, permit our designees to inspect testing, manufacturing and quality control records and procedures and to test the Articles for compliance. You shall also give due consideration to any 78 11 recommendations of ours that Articles exceed the requirements of applicable laws, regulations and standards. Articles not complying with applicable laws, regulations and voluntary standards shall be deemed unapproved, even if previously approved by us, and shall not be shipped unless and until they have been brought into full compliance therewith. 12. DISNEY OWNERSHIP OF ALL RIGHTS IN LICENSED MATERIAL You acknowledge that the copyrights and all other proprietary rights in and to Licensed Material are exclusively owned by and reserved to us. You shall neither acquire nor assert copyright ownership or any other proprietary rights in Licensed Material or in any derivation, adaptation, variation or name thereof. Without limiting the foregoing, you hereby assign to us all your worldwide right, title and interest in the Licensed Material and in any material objects consisting of or incorporating drawings, paintings, animation cels, or sculptures of Licensed Material, or other derivations, adaptations, compilations, collective works, variations or names of Licensed Material, heretofore or hereafter created by or for you or any parent, subsidiary or Affiliate of yours. All such new materials shall be included in the definition of "Licensed Material" under this Agreement. If any third party makes or has made any contribution to the creation of any new materials which are included in the definition of Licensed Material under this Paragraph 12, you agree to obtain from such party a full assignment of rights so that the foregoing assignment by you shall vest full rights to such new materials in us. The foregoing assignment to us of material objects shall not include that portion of your displays, catalogs or promotional material not containing Licensed Material, or the physical items constituting the Articles, unless such items are in the shape of the Licensed Material. 13. COPYRIGHT NOTICE As a condition to the grant of rights hereunder, each Article and any other matter containing Licensed Material shall bear a properly located permanently affixed copyright notice in our name (e.g., "(C)Disney"), or such other notice as we may notify to you in writing. You will comply with such instructions as to form, location and content of the notice as we may give from time to time. You will not, without our prior written consent, affix to any Article or any other matter containing Licensed Material a copyright notice in any other name. If through inadvertence or otherwise a copyright notice on any Article or other such matter should appear in your name or the name of a third party, you hereby agree to assign to us the copyright represented by any such copyright notice in your name and, upon request, cause the execution and delivery to us of whatever documents are necessary to convey to us that copyright represented by any such copyright notice. If by inadvertence a proper copyright notice is omitted from any Article or other matter containing Licensed Material, you agree at your expense to use all reasonable efforts to correct the omission on all such Articles or other matter in process of manufacture or in distribution. You agree to advise us promptly and in writing of the steps being taken to correct any such omission and to make the corrections on existing Articles which can be located. 79 12 14. NON-ASSOCIATION OF OTHER FANCIFUL CHARACTERS WITH LICENSED MATERIAL To preserve our identification with our characters and to avoid confusion of the public, you agree not to associate other characters (other than such as constitute a trademark of yours) or licensed properties with the Licensed Material or the Trademarks either on the Articles or in their packaging, or, without our written permission, on advertising, promotional or display materials. 15. ACTIVE MARKETING OF ARTICLES You agree to manufacture (or have manufactured for you) and offer for sale all the Articles and to exercise the rights granted herein. You agree that by the Marketing Date applicable to a particular Article or, in the absence of such a date being specified in Subparagraph 1.O., by six (6) months from the commencement of the Principal Term, shipments to customers of such Article will have taken place in sufficient time that such Article shall be available for purchase by the public at the retail outlets authorized pursuant to Subparagraph 2.A. In any case in which such sales have not taken place or when the Article is not then and thereafter available for purchase by the public, we may either invoke our remedies under Paragraph 28, or withdraw such Article from the list of Articles licensed in this Agreement without obligation to you other than to give you written notice thereof. 16. PROMOTION COMMITMENT You agree to carry out the Promotion Commitment, if any, as defined in Subparagraph 1.N. 17. TRADEMARK RIGHTS AND OBLIGATIONS A. All uses of the Trademarks by you hereunder shall inure to our benefit. You acknowledge that we are the exclusive owner of all the Trademarks, and of any trademark incorporating all or any part of a Trademark or any Licensed Material, and the trademark rights created by such uses. Without limiting the foregoing, you hereby assign to us all the Trademarks, and any trademark incorporating all or any part of a Trademark or any Licensed Material, and the trademark rights created by such uses, together with the goodwill attaching to that part of the business in connection with which such Trademarks or trademarks are used. You agree to execute and deliver to us such documents as we require to register you as a Registered User or Permitted User of the Trademarks or such trademarks and to follow our instructions for proper use thereof in order that protection and/or registrations for the Trademarks and such trademarks may be obtained or maintained. B. You agree not to use any Licensed Material or Trademarks, or any trademark incorporating all or any part of a Trademark or of any Licensed Material, on any business sign, business cards, stationery or forms (except as licensed herein), or to use any Licensed Material or 80 13 Trademark as the name of your business or any division thereof, unless otherwise agreed by us in writing. C. Nothing contained herein shall prohibit you from using your own trademarks on the Articles or your copyright notice on the Articles when the Articles contain independent material which is your property. Nothing contained herein is intended to give us any rights to, and we shall not use, any trademark, copyright or patent used by you in connection with the Articles which is not derived or adapted from Licensed Material, Trademarks, or other materials owned by us. 18. REGISTRATIONS Except with our written consent, neither you, your parent, nor any subsidiary or affiliate of yours will register or attempt in any country to register copyrights in, or to register as a trademark, service mark, design patent or industrial design, or business designation, any of the Licensed Material, Trademarks or derivations or adaptations thereof, or any word, symbol or design which is so similar thereto as to suggest association with or sponsorship by us or any subsidiary of ours. In the event of breach of the foregoing, you agree, at your expense and at our request, immediately to terminate the unauthorized registration activity and promptly to execute and deliver, or cause to be delivered, to us such assignments and other documents as we may require to transfer to us all rights to the registrations, patents or applications involved. 19. UNLICENSED USE OF LICENSED MATERIALS A. You agree that you will not use the Licensed Material, or the Trademarks, or any other material the copyright to which is owned by us in any way other than as herein authorized (or as is authorized in any other written contract in effect between us). In addition to any other remedy we may have, you agree that the profits from any use thereof on products other than the Articles (unless authorized by us in writing), and all profits from the use of any other copyrighted material of ours without written authorization, shall be payable to us. B. You agree to give us prompt written notice of any unlicensed use by third parties of Licensed Material or Trademarks, and that you will not, without our written consent, bring or cause to be brought any criminal prosecution, lawsuit or administrative action for infringement, interference with or violation of any rights to Licensed Material or Trademarks. Because of the need for and the high costs of an effective anti-piracy enforcement program, you agree to cooperate with us, and, if necessary, to be named by us as a sole complainant or co-complainant in any action against an infringer of the Licensed Material or Trademarks and, notwithstanding any right of yours to recover same, legal or otherwise, you agree to pay to us, and hereby waive all claims to, all damages or other monetary relief recovered in such action by reason of a judgment or settlement whether or not such damages or other monetary relief, or any part thereof, represent or are intended to represent injury sustained by you as a licensee hereunder; in any such action against an 81 14 infringer, we agree to reimburse you for reasonable expenses incurred at our request, including reasonable attorney's fees if we have requested you to retain separate counsel. 20. STATEMENTS AND PAYMENTS OF ROYALTIES A. You agree to furnish to us by the 30th day after each Royalty Payment Period a full and accurate statement showing by Article, with stock number and item description, the quantities, Net Invoiced Billings and applicable Royalty rate(s) of Articles invoiced during the preceding Royalty Payment Period, and the quantities and invoice value of Articles returned for credit or refund in such period. At the same time you will pay us all Royalties due on billings shown by such statement. To the extent that any Royalties are not paid, you authorize us to offset Royalties due against any sums which we or any subsidiary of ours may owe to you or any parent, subsidiary or Affiliate of yours. No deduction or withholding from Royalties payable to us shall be made by reason of any tax. Any applicable tax on the manufacture, distribution and sale of the Articles shall be borne by you. B. If we at any time so request, your statements shall be made on statement forms which we shall provide, and you will fully comply with the instructions supplied by us for completing such forms. Except as otherwise agreed in writing, such statements shall separately reflect the sales and applicable Royalties for each individual Article. Apparel Articles shall be reported separately by size range (e.g., "boys'", "girls'", "men's", etc.). Your statements shall identify for each Article the character or other Licensed Material used on each such Article or the motion picture or television series from which such character derived. However, Articles which differ only in that different characters or scenes appear on them may be reported as a single Article if the characters or scenes used on such Articles are from the same motion picture or television series. C. Your statement shall with respect to all Articles report separately: (1) F.O.B. In Sales; (2) F.O.B. Out Sales; (3) sales of Articles outside the Territory pursuant to a distribution permission (indicating the country involved); (4) your sales of Articles as a supplier to any of our or our Affiliates' licensees for the Articles (which sales shall not generate Royalties payable to us so long as such licensees are reselling the Articles and paying us royalties on such resales); (5) sales of Articles to us or any subsidiary of ours; (6) sales of Articles to your or our employees; 82 15 (7) sales of Articles under any brand or program identified in Subparagraph 1.B. hereinabove. D. Sales of items licensed under contracts with us other than this Agreement shall not be reported on the same statement as sales of Articles under this Agreement. E. Your statements and payments shall be delivered to The Walt Disney Company, P.O. Box 101947, Atlanta, Georgia 30392. However, Advances should be mailed directly to the Contract Administrator at 500 South Buena Vista Street, Burbank, California 91521-6880. A copy of each statement must be sent to us at 500 South Buena Vista Street, Burbank, California 91521-6880, to the attention of the Contract Administrator, Consumer Products Division. 21. ARTICLES RETURNED FOR CREDIT OR REFUND Royalties reported on sales of Articles which have been returned to you for credit or refund and on which a refund has been made or credit memo issued may be credited against Royalties due. The credit shall be taken in the Royalty Payment Period in which the refund is given or credit memo issued. Unused credits may be carried forward, but in no event shall you be entitled to a refund of Royalties. 22. INTEREST Royalties or any other payments due to us hereunder which are received after the due date shall bear interest at the rate of 10% per annum from the due date (or the maximum permissible by law if less than 10%). 23. AUDITS AND MAINTAINING RECORDS You agree to keep accurate records of all transactions relating to this Agreement and any prior agreement with us, including, without limitation, shipments to you of Articles and components thereof, inventory records, records of sales and shipments by you, and records of returns, and to preserve such records for the lesser of seven (7) years or two (2) years after the expiration or termination of this Agreement. We or our representatives, shall have the right from time to time, during your normal business hours, but only for the purpose of confirming your performance hereunder, to examine and make extracts from all such records, including the general ledger, invoices and any other records which we reasonably deem appropriate to verify the accuracy of your statements or your performance hereunder, including records of your parent, subsidiary and affiliated companies, if they are involved in activities which are the subject of this Agreement. In particular, your invoices shall identify the Articles separately from goods which are not licensed hereunder. If in an audit of your records it is determined that there is a short fall of five percent (5%) or more in Royalties reported for any Royalty Payment Period, you shall upon request from us reimburse us for the full out-of-pocket costs of the audit, including the 83 16 costs of employee auditors calculated at $60 per hour per person for travel time during normal working hours and actual working time. 24. MANUFACTURE OF ARTICLES BY THIRD PARTY MANUFACTURERS A. If you at any time desire to have Articles or components thereof containing Licensed Material manufactured by a third party, you must, as a condition to the continuation of this Agreement, notify us of the name and address of such manufacturer and the Articles or components involved and obtain our prior written permission to do so. If we are prepared to grant permission, we will do so if: (1) In the case of manufacture outside the Territory: (a) you and each of your manufacturers and any submanufacturers sign a Consent/Manufacturer's Agreement in a form which we will furnish to you; and (b) we receive all such agreements properly signed; and (2) In the case of manufacture in the Territory: (a) upon our request, you cause each such manufacturer to sign an agreement in a form which we will furnish to you; and (b) we receive all such agreements properly signed. (A SAMPLE OF SAID AGREEMENT FORM IS AVAILABLE ON REQUEST.) B. We will not normally require agreements from suppliers of yours who are manufacturing in the Territory, but your purchase of Articles from a third party manufacturer without such agreements as are required hereunder being signed and delivered to us shall be a violation of this Agreement. It is not our policy to reveal the names of your suppliers to third parties or to any division of ours involved with buying products, except as may be necessary to enforce our contract rights or protect our trademarks and copyrights. C. If any such manufacturer utilizes Licensed Material or Trademarks for any unauthorized purpose, you shall cooperate fully in bringing such utilization to an immediate halt. If, by reason of your not having supplied the above mentioned agreements to us or not having given us the name of any supplier, we make any representation or take any action and are thereby subjected to any penalty or expense, you will fully compensate us for any cost or loss we sustain. 84 17 25. INDEMNITY A. You shall indemnify us during and after the term hereof against all claims, liabilities (including settlements entered into in good faith with your consent, not to be unreasonably withheld) and expenses (including reasonable attorneys' fees) arising out of your activities hereunder, or out of any defect (whether obvious or hidden and whether or not present in any sample approved by us) in an Article, or arising from personal injury or any infringement of any rights of any other person by the manufacture, sale, possession or use of Articles, or their failure to comply with applicable laws, regulations and standards. The parties indemnified hereunder shall include The Walt Disney Company and its subsidiaries, and their officers, directors, employees and agents. The indemnity shall not apply to any claim or liability relating to any infringement of the copyright of a third party caused by your utilization of the Licensed Material and the Trademarks in accordance with the provisions hereof. B. We shall indemnify you during and after the term hereof against all claims, liabilities (including settlements entered into in good faith with our consent, not to be unreasonably withheld) and expenses (including reasonable attorneys' fees) arising out of any claim that your use of any representation of the Licensed Material or the Trademarks approved in accordance with the provisions of this Agreement infringes the copyright of any third party or infringes any right granted by us to such third party. You shall not, however, be entitled to recover for lost profits. C. Additionally, if by reason of any claims referred to in Subparagraph 25.B., you are precluded from selling any stock of Articles or utilizing any materials in your possession or which come into your possession by reason of any required recall, we shall be obligated to purchase such Articles and materials from you at their out-of-pocket cost to you, excluding overheads, but we shall have no other responsibility or liability with respect to such Articles or materials. D. No warranty or indemnity is given with respect to any liability or expense arising from any claim that use of the Licensed Material or the Trademarks on or in connection with the Articles hereunder or any packaging, advertising or promotional material infringes on any trademark right of any third party or otherwise constitutes unfair competition by reason of any prior rights acquired by such third party other than rights acquired from us. It is expressly agreed that it is your responsibility to carry out such investigations as you may deem appropriate to establish that Articles, packaging, promotional and advertising material which are manufactured or created hereunder, including any use made of the Licensed Material and the Trademarks therewith, do not infringe such right of any third party, and we shall not be liable to you if such infringement occurs. E. You and we agree to give each other prompt written notice of any claim or suit which may arise under the indemnity provisions set forth above. 85 18 Without limiting the foregoing, you agree to give us written notice of any product liability claim made with respect to any Article within seven (7) days of your receipt of the claim. 26. INSURANCE You shall maintain in full force and effect at all times while this Agreement is in effect and for three years thereafter commercial general liability insurance, including broad form coverage for contractual liability, products liability and personal injury liability (including bodily injury and death), waiving subrogation, with minimum limits of no less than two million dollars (US $2,000,000.00) per occurrence, and naming as additional insureds those indemnified in Paragraph 25 hereof. You shall deliver to us a certificate or certificates of insurance evidencing satisfactory coverage and indicating that we shall receive written notice of cancellation, non-renewal or of any material change in coverage at least thirty (30) days prior to the effective date thereof. Your insurance shall be carried by an insurer with a BEST rating of B + VII or better. Compliance herewith in no way limits your indemnity obligations, except to the extent that your insurance company actually pays us amounts which you would otherwise pay us. 27. WITHDRAWAL OF LICENSED MATERIAL You agree that we may, without obligation to you other than to give you written notice thereof, withdraw from the scope of this Agreement any Licensed Material which by the Marketing Date or, in the absence of such a date being specified in Subparagraph 1.O., by six (6) months from the commencement of the Principal Term, is not being used on or in connection with the Articles. We may also withdraw any Licensed Material or Articles the use or sale of which under this Agreement would infringe or reasonably be claimed to infringe the rights of a third party, other than rights granted by us, in which case our obligations to you shall be limited to the purchase at cost of Articles and other materials utilizing such withdrawn Licensed Material which cannot be sold or used. In the case of any withdrawal under the preceding sentence, the Advances and Guarantees shall be adjusted to correspond to the time remaining in the Principal Term, or the number of Articles remaining under the Agreement, at the date of withdrawal. 28. TERMINATION Without prejudice to any other right or remedy available to us: A. If you fail to manufacture, sell and distribute the Articles, or to furnish statements and pay Royalties as herein provided, or if you otherwise breach the terms of this Agreement, and if any such failure is not corrected within thirty (30) days after we send you written notice thereof (or, in the case of non-payment of Royalties within fifteen (15) days), we shall have the right at any time to terminate this Agreement by giving you written notice thereof. 86 19 B. We shall have the right at any time to terminate this Agreement by giving you written notice thereof: (1) if you deliver to any customer without our written authorization merchandise containing representations of Licensed Material or other material the copyright or other proprietary rights to which are owned by us other than articles listed herein and approved in accordance with the provisions hereof; (2) if you deliver Articles outside the Territory or knowingly sell Articles to a third party for delivery outside the Territory, unless pursuant to a written distribution permission or separate written license agreement with us or any subsidiary of ours; (3) if a breach occurs which is of the same nature, and which violates the same provision of this Agreement, as a breach of which we have previously given you written notice; (4) if you breach any material term of any other license agreement between us, and we terminate such agreement for cause; (5) if you shall make any assignment for the benefit of creditors, or file a petition in bankruptcy, or are adjudged bankrupt, or become insolvent, or are placed in the hands of a receiver, or if the equivalent of any such proceedings or acts occurs, though known by some other name or term; and/or (6) if you are not permitted or are unable to operate your business in the usual manner, or are not permitted or are unable to provide us with assurance satisfactory to us that you will so operate your business, as debtor in possession or its equivalent, or are not permitted, or are unable to otherwise meet your obligations under this Agreement or to provide us with assurance satisfactory to us that you will meet such obligations. 29. RIGHTS AND OBLIGATIONS UPON EXPIRATION OR TERMINATION A. Upon the expiration or termination of this Agreement, all rights herein granted to you shall revert to us, and we shall be entitled to retain all Royalties and other things of value paid or delivered to us. You agree that the Articles shall be manufactured during the Principal Term in quantities consistent with anticipated demand therefor so as not to result in an excessive inventory build-up immediately prior to the end of the Principal Term. You agree that from the expiration or termination of this Agreement you shall neither manufacture nor have manufactured for you any Articles, that you will deliver to us any and all artwork (including animation cels and drawings) which may have been used or created by you in connection with this Agreement, that you will at our option either sell to us at cost or destroy or efface any molds, plates and 87 20 other items used to reproduce Licensed Martial or Trademarks, and that except as hereinafter provided, you will cease selling Articles. Any unauthorized distribution of Articles after the expiration or termination of this Agreement shall constitute copyright infringement. B. If you have any unsold Articles in inventory on the expiration or termination date, you shall provide us with a full statement of the kinds and numbers of such unsold Articles and shall thereupon, but only if such statement has been provided to us and if you have fully complied with the terms of this Agreement including the payment of all Royalties due and the Guarantee, have the right for a limited period of ninety (90) days from such expiration or earlier termination date to sell off and deliver such Articles. You shall furnish us statements covering such sales and pay us Royalties in respect of such sales. Such Royalties shall not be applied against the Advance or towards meeting the Guarantee. C. In recognition of our interest in maintaining a stable and viable market for the Articles during and after the Principal Term and any sell-off period, you agree to refrain from "dumping" the Articles in the market during any sell-off period granted to you. "Dumping" shall mean the distribution of product at volume levels significantly above your prior sales practices with respect to the Articles, and at price levels so far below your prior sales practices with respect to the Articles as to disparage the Articles; provided, however, that nothing contained herein shall be deemed to restrict your ability to set product prices at your discretion. D. Except as otherwise agreed by us in writing, any inventory of Articles in your possession or control after the expiration or termination hereof and of any sell-off period granted hereunder shall be destroyed, or all Licensed Material and Trademarks removed or obliterated therefrom. E. If we supply you with forms regarding compliance with this Paragraph 29, you agree to complete, execute and return such forms to us expeditiously. 30. WAIVERS A waiver by either of us at any time of a breach of any provision of this Agreement shall not apply to any breach of any other provision of this Agreement, or imply that a breach of the same provision at any other time has been or will be waived, or that this Agreement has been in any way amended, nor shall any failure by either party to object to conduct of the other be deemed to waive such party's right to claim that a repetition of such conduct is a breach hereof. 31. PURCHASE OF ARTICLES BY US If we wish to purchase Articles, you agree to sell such Articles to us or any subsidiary of ours at as low a price as you charge for similar quantities sold to your regular customers and to pay us Royalties on any such sales. 88 21 32. NON-ASSIGNABILITY A. You shall not voluntarily or by operation of law assign, sub-license, transfer, encumber or otherwise dispose of all or any part of your interest in this Agreement without our prior written consent. Any attempted assignment, sub-license, transfer, encumbrance or other disposal without such consent shall be void and shall constitute a material default and breach of this Agreement. "Transfer" within the meaning of this Paragraph 32 shall include any merger or consolidation involving your company or your parent (if any); any sale or transfer of all or substantially all of your (or your parent) company's assets; any transfer of your rights hereunder to a division, business segment or other entity of yours other than the one specifically referenced on page 1 hereof (or any sale or attempted sale of Articles under a trademark or trade name of such division, business segment or other entity); and any transaction or series of related transactions resulting in the transfer of thirty-three and one-third percent (33-1/3%) or more of the voting stock of your (or your parent) company (or, if your company is a partnership, thirty-three and one-third percent (33-1/3%) or more of the profit and loss participation in your company, or the occurrence of any of the foregoing with respect to any general partner of your company). B. However, you may, upon written notice to us, unless we have objected within thirty (30) days of receipt of such notice, sublicense your rights hereunder to your parent, subsidiary and Affiliated companies. You hereby irrevocably and unconditionally guarantee that they will observe and perform all of your obligations hereunder, including, without limitation, the provisions governing approvals, and compliance with approved samples, applicable laws and standards, and all other provisions hereof, and that they will otherwise adhere strictly to all of the terms hereof and act in accordance with your obligations hereunder. Any involvement of a parent, subsidiary or Affiliate in the activities which are the subject of this Agreement shall be deemed carried on pursuant to such a sublicense and thus covered by such guarantee, but, unless notified to us and not timely objected to, such involvement may be treated by us as a breach of this Agreement. 33. RELATIONSHIP This Agreement does not provide for a joint venture, partnership, agency or employment relationship between us. 34. CONSTRUCTION The language of all parts of this Agreement shall in all cases be construed as a whole, according to its fair meaning and not strictly for or against any of the parties. Headings of paragraphs herein are for convenience of reference only and are without substantive significance. 89 22 35. MODIFICATIONS OR EXTENSIONS OF THIS AGREEMENT Except as otherwise provided herein, this Agreement can only be extended or modified by a writing signed by both parties. 36. NOTICES All notices which either party is required or may desire to serve upon the other party shall be in writing, addressed to the party to be served at the address set forth on page 1 of this Agreement, and may be served personally or by depositing the same addressed as herein provided (unless and until otherwise notified), postage prepaid, in the United States mail. Such notice shall be deemed served upon personal delivery or upon the date of mailing; provided, however, that we shall be deemed to have been served with a notice of a request for approval of materials under this Agreement only upon our actual receipt of the request and of any required accompanying materials. Any notice sent to us hereunder shall be sent to the attention of "Vice President, Licensing", unless we advise you in writing otherwise. 37. MUSIC Music is not licensed hereunder. Any charges, fees or royalties payable for music rights or any other rights not covered by this Agreement shall be additional to the Royalties and covered by separate agreement. 38. PREVIOUS AGREEMENTS This Agreement, and any confidentiality agreement you may have signed pertaining to any of the Licensed Material, contains the entire agreement between us concerning the subject matter hereof and supersedes any pre-existing agreement and any oral or written communications between us. However, if pursuant to any such pre-existing agreement there was any agreement(s) in effect permitting you to sell or distribute Articles outside the Territory or to cause to be manufactured any Articles outside the Territory, such agreement(s) shall be deemed to remain in effect to the extent that they relate to Licensed Material and Articles licensed hereunder. 39. CHOICE OF LAW AND FORUM This Agreement shall be deemed to be entered into in California and shall be governed and interpreted according to the laws of the State of California. Any legal actions pertaining to this Agreement shall be commenced within the State of California and within either Los Angeles or Orange Counties. The prevailing party shall be entitled to recover reasonable attorney's fees and costs incurred therein. 40. EQUITABLE RELIEF You acknowledge that we will have no adequate remedy at law for your failure to comply with the terms herewith, including your obligation to cease the manufacture, sale, advertisement, promotion or distribution of the Articles upon 90 23 termination. Accordingly, in the event you fail to comply with the terms of this Agreement, you acknowledge and agree that, in addition to any and all other remedies available to us, we shall have the right to have any breach by you of this Agreement remedied by equitable relief, including, but not limited to, a temporary restraining order, a preliminary injunction, a permanent injunction, or such other alternative relief as may be appropriate without the necessity of our posting any bond or proving any damages. Please sign below under the word "Agreed". When signed by both parties this shall constitute an agreement between us. THE WALT DISNEY COMPANY By: /s/ Doug Mangino ------------------- Title: VP/DMM ----------------- Date: 10/27/94 ----------------- AGREED: SUN SPORTSWEAR, INC. By: /s/ L. Kaye Counts ------------------- Title: Executive Vice. Pres., COO -------------------------- 91 EX-10.27 5 LOAN AND SECURITY AGREEMENT 1 EXHIBIT 10.27 LOAN AND SECURITY AGREEMENT DATED AS OF FEBRUARY 13, 1996 between SUN SPORTSWEAR, INC., as Borrower, and HELLER FINANCIAL, INC., as Lender 92 2 LOAN AND SECURITY AGREEMENT This LOAN AND SECURITY AGREEMENT is dated as of February 13, 1996 and entered into by and between SUN SPORTSWEAR, INC., a Washington corporation ("Borrower"), with its principal place of business at 6520 South 190th Street, Kent, Washington 98032, and HELLER FINANCIAL, INC., a Delaware corporation ("Lender"), with offices at 505 North Brand Boulevard, Suite 1100, Glendale, California 91203. All capitalized terms used herein are defined in Section 1 of this Agreement. WHEREAS, Borrower and Lender are parties to that certain Inter-Credit Agreement dated December 31, 1992, as amended; WHEREAS, Borrower now desires that Lender extend a credit facility to provide working capital financing and to provide funds for other general corporate purposes; and WHEREAS, Borrower desires to secure its obligations under the Loan Documents by granting to Lender a security interest in and lien upon certain of Borrower's property; NOW, THEREFORE, in consideration of the premises and the agreements, provisions and covenants herein contained, Borrower and Lender agree as follows: SECTION 1 DEFINITIONS 1.1 Certain Defined Terms. The following terms used in this Agreement shall have the following meanings: "Accounts" means all presently existing and hereafter created accounts, contract rights and general intangibles relating thereto, notes, drafts and other forms of obligations owed to or owned by Borrower arising or resulting from the sale of goods or the rendering of services, all proceeds thereof, all guaranties and security therefor, and all goods and rights represented thereby or arising therefrom including, but not limited to, the right of stoppage in transit, replevin and reclamation. "Affiliate" means any Person (other than Lender): (a) directly or indirectly controlling, controlled by, or under common control with, Borrower; (b) directly or indirectly owning or holding ten percent (10%) or more of any equity interest in Borrower; or (c) ten percent (10%) or more of whose voting stock or other equity interest is directly or indirectly owned or held by Borrower. For purposes of this definition, "control" (including with correlative meanings, the terms "controlling", "controlled by" and "under common control with") means the possession directly or indirectly of the power to direct or cause the direction of the management and policies of a Person, whether through the ownership of voting securities or by contract or otherwise. 1 93 3 "Agreement" means this Loan and Security Agreement as it may be amended, supplemented or otherwise modified from time to time. "Approved Account" has the meaning set forth in the Inter-Credit Agreement. "Asset Disposition" means the disposition, whether by sale, lease, transfer, loss, damage, destruction, condemnation or otherwise, of any or all of the assets of Borrower or any of its Subsidiaries other than sales of Inventory in the ordinary course of business. "Assignment of Monies Agreement" means that certain Assignment of Monies Due under Inter-Credit Agreement dated as of even date herewith among Borrower, Heller and Lender and all other instruments, documents and agreements executed in connection with the transactions contemplated thereby, all as amended, restated, supplemented or modified from time to time. "Bank Letters of Credit" means letters of credit issued by a bank acceptable to Lender for the account of Borrower and supported by a Risk Participation Agreement. "Base Rate" means the variable rate of interest per annum equal to the "reference rate", "prime rate", or other similar rate announced from time to time by Bank of America National Trust and Savings Association (with the understanding that any such rate may merely be a reference rate and may not necessarily represent the lowest or best rate actually charged to any customer by such bank). "Borrower" has the meaning assigned to that term in the preamble to this Agreement. "Borrowing Base" has the meaning assigned to that term in subsection 2.1(A). "Borrowing Base Certificate" means a certificate and assignment schedule duly executed by an officer of Borrower appropriately completed and in substantially the form of Exhibit A. "Business Day" means any day excluding Saturday, Sunday and any day which is a legal holiday under the laws of the States of Illinois, Pennsylvania, California or Washington or is a day on which banking institutions located in any such state are closed. "Capital Expenditures" means all expenditures (including deposits) for, or contracts for expenditures (excluding contracts for expenditures under or with respect to Capital Leases, but including cash down payments for assets acquired under Capital Leases) with respect to any fixed assets or improvements, or for replacements, substitutions or additions thereto, which have a useful life of more than one year, including the direct or indirect acquisition of such assets by way of increased product or service charges, offset items or otherwise. "Capital Lease" means any lease of any property (whether real, personal or mixed) that, in conformity with GAAP, should be accounted for as a capital lease. 2 94 4 "Cash Equivalents" means: (a) marketable direct obligations issued or unconditionally guarantied 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 six (6) months from the date of acquisition thereof; (b) commercial paper maturing no more than six (6) months from the date issued and, at the time of acquisition, having a rating of at least A-1 from Standard & Poor's Corporation or at least P-1 from Moody's Investors Service, Inc.; and (c) certificates of deposit or bankers' acceptances maturing within six (6) months from the date of issuance thereof issued by, or overnight reverse repurchase agreements from, any commercial bank organized under the laws of the United States of America or any state thereof or the District of Columbia having combined capital and surplus of not less than $250,000,000 and not subject to setoff rights in favor of such bank. "Chargeback Interest" means interest owing by Borrower to Heller on Accounts charged back to Borrower under the terms of the Inter-Credit Agreement. "Closing Certificate" means a certificate duly executed by the chief executive officer or chief financial officer of Borrower in a form reasonably acceptable to Lender "Closing Date" means February 14, 1996. "Collateral" has the meaning assigned to that term in subsection 2.7. "Commitment" or "Commitments" means the commitment or commitments of Lender to make Loans as set forth in subsection 2.l(A) and to provide Lender Letters of Credit as set forth in subsection 2.1(E). "Compliance Certificate" means a certificate duly executed by the chief executive officer or chief financial officer of Borrower appropriately completed and in substantially the form of Exhibit B. "Default" means a condition or event that, after notice or lapse of time or both, would constitute an Event of Default if that condition or event were not cured or removed within any applicable grace or cure period. "Default Rate" has the meaning assigned to that term in subsection 2.2. "Determination Period" means, (i) for the Fiscal Year ending in 1996, the period commencing on January 1, 1996 and ending on the last day of the applicable fiscal quarter and (ii) for the Fiscal Year ending in 1997, the four-quarter period ending on the last day of the applicable fiscal quarter. "EBITDA" means, for any period, without duplication, the total of the following for Borrower and its Subsidiaries on a consolidated basis, each calculated for such period: (1) net income determined in accordance with GAAP; plus, to the extent included in the calculation of 3 95 5 net income, (2) the sum of (a) income and franchise taxes paid or accrued; (b) Interest Expenses, net of interest income, paid or accrued; (c) interest paid in kind; (d) amortization and depreciation and (e) other non-cash charges (excluding accruals for cash expenses made in the ordinary course of business); less, to the extent included in the calculation of net income, (3) the sum of (a) the income of any Person other than wholly-owned Subsidiaries of Borrower in which Borrower or a wholly owned Subsidiary of Borrower has an ownership interest unless such income is received by Borrower or such wholly-owned Subsidiary in a cash distribution; (b) gains or losses from sales or other dispositions of assets (other than Inventory in the normal course of business); and (c) extraordinary or non-recurring gains, but not net of extraordinary or non-recurring "cash" losses. "Eligible Accounts" has the meaning assigned to that term in subsection 2.1 (B). "Eligible Inventory" has the meaning assigned to that term in subsection 2.1 (B). "Employee Benefit Plan" means any employee benefit plan within the meaning of Section 3(3) of ERISA which (a) is maintained for employees of any Loan Party or any ERISA Affiliate or (b) has at any time within the preceding six (6) years been maintained for the employees of any Loan Party or any current or former ERISA Affiliate. "Environmental Claims" means claims, liabilities, investigations, litigation, administrative proceedings, judgments or orders relating to Hazardous Materials. "Environmental Laws" means any present or future federal, state or local law, rule, regulation or order relating to pollution, waste, disposal or the protection of human health or safety, plant life or animal life, natural resources or the environment. "Equipment" means all "equipment" (as defined in the UCC), wherever located, including, without limitation, all machinery, motor vehicles, trucks, trailers, vessels, aircraft and rolling stock and all parts thereof and all additions and accessions thereto and replacements therefor. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time, and any successor statute and all rules and regulations promulgated thereunder. "ERISA Affiliate", as applied to any Loan Party, means any Person who is a member of a group which is under common control with any Loan Party, who together with any Loan Party is treated as a single employer within the meaning of Section 414(b) and (c) of the IRC. "Event of Default" means each of the events set forth in subsection 8.1. "Facility Documents" means, collectively, the Loan Documents and the Inter-Credit Agreement. 4 96 6 "Fiscal Year" means each twelve month period ending on the last day of December in each year. "Funding Date" means the date of each funding of a Loan or issuance of a Lender Letter of Credit. "GAAP" means generally accepted accounting principles set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board that are applicable to the circumstances as of the date of determination. "Hazardous Material" means all or any of the following: (a) substances that are defined or listed in, or otherwise classified pursuant to, any Environmental Laws or regulations as "hazardous substances", "hazardous materials", "hazardous wastes", "toxic substances" or any other formulation intended to define, list or classify substances by reason of deleterious properties such as ignitability, corrosivity, reactivity, carcinogenicity, reproductive toxicity or "EP toxicity"; (b) oil, petroleum or petroleum derived substances, natural gas, natural gas liquids or synthetic gas and drilling fluids, produced waters and other wastes associated with the exploration, development or production of crude oil, natural gas or geothermal resources; (c) any flammable substances or explosives or any radioactive materials; and (d) asbestos in any form or electrical equipment which contains any oil or dielectric fluid containing levels of polychlorinated biphenyls in excess of fifty parts per million. "Heller" means Heller Financial, Inc., in its capacity as a party to the Inter-Credit Agreement. "Heller Factoring Clients" means Persons (other than Borrower) who have entered into factoring or inter-credit agreements with any of Heller's offices. "Indebtedness", as applied to any Person, means without duplication: (a) all indebtedness for borrowed money; (b) obligations under leases which in accordance with GAAP constitute Capital Leases; (c) notes payable and drafts accepted representing extensions of credit whether or not representing obligations for borrowed money; (d) any obligation owed for all or any part of the deferred purchase price of property or services if the purchase price is due more than six months from the date the obligation is incurred or is evidenced by a note or similar written instrument; and (e) all indebtedness secured by any Lien on any property or asset owned or held by that Person regardless of whether the indebtedness secured thereby shall have been assumed by that Person or is nonrecourse to the credit of that Person. Indebtedness shall not include Borrower's guarantied royalty payments under licenses for Intellectual Property. "Intangible Assets" means all intangible assets (determined in conformity with GAAP) including, without limitation, goodwill, trademarks, trade names, licenses, organizational costs, deferred amounts, covenants not to compete, unearned income and restricted funds. 5 97 7 "Intellectual Property" means all present and future designs, art designs, patents, patent rights and applications therefor, trademarks and registrations or applications therefor, trade names, inventions, copyrights and all applications and registrations therefor, software or computer programs, license rights (except to the extent that the grant of a security interest thereon would violate the terms of any license), trade secrets, methods, processes, know-how, drawings, specifications, descriptions, and all memoranda, notes and records with respect to any research and development, whether now owned or hereafter acquired, all goodwill associated with any of the foregoing, and proceeds of all of the foregoing, including, without limitation, proceeds of insurance policies thereon. "Inter-Credit Agreement" means that certain Inter-Credit Agreement dated December 31, 1992 between Heller and Borrower, as it may have been, or may hereafter be, amended, supplemented or otherwise modified, and all other instruments, documents and agreements executed by or on behalf of any Loan Party and delivered to or for the benefit of Heller in connection therewith. "Interest Coverage Ratio" means, for any period, the ratio of Operating Cash Flow to Interest Expenses. "Interest Expenses" means, without duplication, for any period, the following, for Borrower and its Subsidiaries each calculated for such period: interest expenses deducted in the determination of net income (excluding (i) the amortization of fees and costs with respect to the transactions contemplated hereunder on the Closing Date which have been capitalized as transaction costs; and (ii) interest paid in kind). "Interest Rate" has the meaning assigned to that term in subsection 2.2(A). "Inventory" means all "inventory" (as defined in the UCC) now owned or hereafter acquired by Borrower including, without limitation, finished goods, raw materials, work in process and other materials and supplies used or consumed in Borrower's business, and goods which are returned or repossessed. "Inventory Report" means a report duly executed by an officer of Borrower appropriately completed and in substantially the form of Exhibit C. "IRC" means the Internal Revenue Code of 1986, as amended from time to time, and any successor statute and all rules and regulations promulgated thereunder. "Ledger Debt" means indebtedness owing by Borrower to Heller as a result of Heller's purchase of invoices evidencing sales to Borrower by Heller Factoring Clients. "Ledger Debt Interest" means interest owing by Borrower to Heller with respect to any Ledger Debt under the terms of the Inter-Credit Agreement. 6 98 8 "Lender" means Heller Financial, Inc. together with its successors and permitted assigns pursuant to subsection 9.1. "Lender Letter of Credit" has the meaning assigned to that term in subsection 2.1 (E). "Lender's Account" means ABA No. 0710-0001-3, Account No. 51-19618 at First National Bank of Chicago, One First National Plaza, Chicago, IL 60670, Reference: Heller Financial, Inc. -- Western CAMG -- Sun Sportswear, Inc. "Lender's Depository Account" has the meaning assigned to that term in subsection 5.6. "Letter of Credit Liability" means, all reimbursement and other liabilities of Borrower or any of its Subsidiaries with respect to each Lender Letter of Credit, whether contingent or otherwise, including: (a) the amount available to be drawn or which may become available to be drawn; (b) all amounts which have been paid or made available by the issuing bank to the extent not reimbursed; and (c) all unpaid interest, fees and expenses. "Letter of Credit Reserve" means, at any time, an amount equal to (a) the aggregate amount of Letter of Credit Liability with respect to all Lender Letters of Credit outstanding at such time plus (b) the aggregate amount theretofore paid by Lender under Lender Letters of Credit and not debited to the Loan Account pursuant to subsection 2.1(E)(2) or otherwise reimbursed by Borrower. "Liabilities" shall have the meaning given that term in accordance with GAAP and shall include Indebtedness. "Lien" means any lien, mortgage, pledge, security interest, charge or encumbrance of any kind, whether voluntary or involuntary, (including any conditional sale or other title retention agreement, any lease in the nature thereof, and any agreement to give any security interest). "Loan" or "Loans" means an advance or advances under the Revolving Loan Commitment. "Loan Documents" means this Agreement, the Assignment of Monies Agreement, and all other instruments, documents and agreements executed by or on behalf of Borrower and delivered concurrently herewith or at any time hereafter to or for Lender in connection with the Loans and other transactions contemplated by this Agreement, all as amended, restated, supplemented or modified from time to time. "Loan Party" means, collectively, Borrower, Borrower's Subsidiaries, and any other Person (other than Lender or Heller) which is or becomes a party to any Loan Document. "Loan Year" means each period of twelve (12) consecutive months commencing on the Closing Date and on each anniversary thereof. 7 99 9 "Material Adverse Effect" means a material adverse effect upon (a) the business, operations, prospects, properties, assets or condition (financial or otherwise) of any Loan Party on an individual basis or taken as a whole or (b) the ability of any Loan Party to perform its obligations under any Facility Document to which it is a party or Lender to enforce or collect any of the Obligations. "Maximum Revolving Loan Amount" has the meaning assigned to that term in subsection 2.1(A). "Net Worth" means, as of any date, the sum of the capital stock and additional paid-in capital plus retained earnings (or minus accumulated deficit) calculated in conformity with GAAP. "Obligations" means all obligations, liabilities and indebtedness of every nature of each Loan Party from time to time owed to Lender under the Loan Documents including the principal amount of all debts, claims and indebtedness (whether incurred before or after the Termination Date), accrued and unpaid interest and all fees, costs and expenses, whether primary, secondary, direct, contingent, fixed or otherwise, heretofore, now and/or from time to time hereafter owing, due or payable. "Operating Cash Flow" means, for any period, (a) EBITDA; less (b) Capital Expenditures. "Permitted Encumbrances" means the following types of Liens: (a) Liens (other than Liens relating to Environmental Claims or ERISA) for taxes, assessments or other governmental charges not yet due and payable; (b) statutory Liens of landlords, carriers, warehousemen, mechanics, materialmen and other similar liens imposed by law, which are incurred in the ordinary course of business for sums not more than thirty (30) days delinquent; (c) Liens (other than any Lien imposed by ERISA) incurred or deposits made in the ordinary course of business in connection with workers' compensation, unemployment insurance and other types of social security, statutory obligations, surety and appeal bonds, bids, leases, government contracts, trade contracts, performance and return-of-money bonds and other similar obligations (exclusive of obligations for the payment of borrowed money); (d) easements, rights-of-way, restrictions, and other similar charges or encumbrances not interfering in any material respect with the ordinary conduct of the business of any Loan Party or any of its Subsidiaries; (e) Liens for purchase money obligations, provided that (i) the purchase of the asset subject to any such Lien is permitted under subsection 6.5, (ii) the Indebtedness secured by any such Lien is permitted under subsection 7.1, and (iii) such Lien encumbers only the asset so purchased; (f) Liens in favor of Lender; (g) Liens in favor of Heller to secure Borrower's obligations under the Inter-Credit Agreement; and (h) Liens set forth on Schedule 1.1 (A). "Person" means and includes natural persons, corporations, limited partnerships, general partnerships, limited liability companies, joint stock companies, joint ventures, associations, companies, trusts, banks, trust companies, land trusts, business trusts or other organizations, whether or not legal entities, and governments and agencies and political subdivisions thereof. 8 100 10 "Projections" means Borrower's forecasted consolidated and consolidating: (a) balance sheets; (b) profit and loss statements; (c) cash flow statements; and (d) capitalization statements, all prepared on a division by division and Subsidiary by Subsidiary basis and otherwise consistent with Borrower's historical financial statements, together with appropriate supporting details and a statement of underlying assumptions. "Restricted Junior Payment" means: (a) any dividend or other distribution, direct or indirect, on account of any shares of any class of stock of Borrower or any of its Subsidiaries now or hereafter outstanding, except a stock dividend; (b) any payment or prepayment of principal of, premium, if any, or interest on, or any redemption, conversion, exchange, retirement, defeasance, sinking fund or similar payment, purchase or other acquisition for value, direct or indirect, of any shares of any class of stock of Borrower or any of its Subsidiaries now or hereafter outstanding; (c) any payment made to retire, or to obtain the surrender of, any outstanding warrants, options or other rights to acquire shares of any class of stock of Borrower or any of its Subsidiaries now or hereafter outstanding; and (d) any payment by Borrower or any of its Subsidiaries of any management fees or similar fees to any Affiliate, whether pursuant to a management agreement or otherwise. "Revolving Loan" means all advances made by Lender pursuant to subsection 2.1(A) and any amounts added to the principal balance of the Revolving Loan pursuant to this Agreement. "Revolving Loan Commitment" means the commitment of Lender to make the Revolving Loan and issue Lender Letters of Credit pursuant to subsection 2.1(E), in the aggregate not to exceed at anytime $24,000,000.00. "Risk Participation Agreement" has the meaning assigned to that term in subsection 2.1(E). "Subsidiary" means, with respect to any Person, any corporation, association or other business entity of which more than fifty percent (50%) of the total voting power of shares of stock (or equivalent ownership or controlling interest) entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof is at the time owned or controlled, directly or indirectly, by that Person or one or more of the other subsidiaries of that Person or a combination thereof. "Tangible Net Worth" means, as of the date of determination, an amount equal to: (a) Net Worth; less (b) Intangible Assets; less (c) prepaid expenses; less (d) all obligations owed to such Person or any of its Subsidiaries by any Affiliate of such Person or any of its Subsidiaries; and less (e) all loans by such Person to its officers, stockholders or employees. "Termination Date" means the date this Agreement is terminated as set forth in subsection 2.5. 9 101 11 "UCC" means the Uniform Commercial Code as in effect on the date hereof in the State of California, as amended from time to time, and any successor statute. "Working Capital" means, for Borrower and its Subsidiaries on a consolidated basis: (a) current assets; less (b) current liabilities; and less (c) the amount of any obligations owed to Borrower or any of its Subsidiaries by any Affiliate of Borrower or any of its Subsidiaries. 1.2 Accounting Terms. For purposes of this Agreement, all accounting terms not otherwise defined herein shall have the meanings assigned to such terms in conformity with GAAP. Financial statements and other information furnished to Lender pursuant to subsection 5.1 shall be prepared in accordance with GAAP (as in effect at the time of such preparation) on a consistent basis. In the event any "Accounting Changes" (as defined below) shall occur and such changes affect financial covenants, standards or terms in this Agreement, then Borrower and Lender agree to enter into negotiations in order to amend such provisions of this Agreement so as to equitably reflect such Accounting Changes with the desired result that the criteria for evaluating the financial condition of Borrower shall be the same after such Accounting Changes as if such Accounting Changes had not been made, and until such time as such an amendment shall have been executed and delivered by Borrower and Lender, (A) all financial covenants, standards and terms in this Agreement shall be calculated and/or construed as if such Accounting Changes had not been made, and (B) Borrower shall prepare footnotes to each Compliance Certificate and the financial statements required to be delivered hereunder that show the differences between the financial statements delivered (which reflect such Accounting Changes) and the basis for calculating financial covenant compliance (without reflecting such Accounting Changes). "Accounting Changes" means: (a) changes in accounting principles required by GAAP and implemented by Borrower; and (b) changes in accounting principles recommended by Borrower's certified public accountants. 1.3 Other Definitional Provisions. References to "Sections", "subsections", "Exhibits" and "Schedules" shall be to Sections, subsections, Exhibits and Schedules, respectively, of this Agreement unless otherwise specifically provided. Any of the terms defined in subsection 1.1 may, unless the context otherwise requires, be used in the singular or the plural depending on the reference. In this Agreement, words importing any gender include the other genders; the words "including," "includes" and "include" shall be deemed to be followed by the words "without limitation"; references to agreements and other contractual instruments shall be deemed to include subsequent amendments, assignments, and other modifications thereto, but only to the extent such amendments, assignments and other modifications are not prohibited by the terms of this Agreement or any other Loan Document; references to Persons include their respective permitted successors and assigns or, in the case of governmental Persons, Persons succeeding to the relevant functions of such Persons; and all references to statutes and related regulations shall include any amendments of same and any successor statutes and regulations. 10 102 12 SECTION 2 LOANS AND COLLATERAL 2.1 Loans. (A) Revolving Loan. Subject to the terms and conditions of this Agreement and in reliance upon the representations and warranties of Borrower herein set forth, Lender agrees to lend to Borrower from time to time an aggregate amount not to exceed at any time $24,000,000.00 as reduced by Section 2.4(B). Amounts borrowed under this subsection 2.1(A) may be repaid and reborrowed at any time prior to the earlier of (i) the termination of the Revolving Loan Commitment pursuant to subsection 8.3 or (ii) the Termination Date. Lender shall have no obligation to make advances under this subsection 2.1(A) to the extent any requested advance would cause the balance of the Revolving Loan then outstanding (after giving effect to any immediate application of the proceeds thereof) to exceed the Maximum Revolving Loan Amount; provided that Lender may, in its sole discretion, elect from time to time to make Loans in excess of the Maximum Revolving Loan Amount or the Revolving Loan Commitment. (1) "Maximum Revolving Loan Amount" means, as of any date of determination, the lesser of (a) the Revolving Loan Commitment minus the Letter of Credit Reserve and (b) the Borrowing Base minus the Letter of Credit Reserve. (2) "Borrowing Base" means, as of any date of determination, an amount equal to the sum of (a) eighty-five percent (85%) of Eligible Accounts plus (b) the lesser of (i) $8,500,000, and (ii) sixty percent (60%) of Eligible Inventory less in each case such reserves as Lender in its reasonable discretion elects to establish. (B) Eligible Accounts and Eligible Inventory. "Eligible Accounts" means, as at any date of determination, the aggregate of all Accounts that Lender, in its reasonable judgment, deems to be eligible for borrowing purposes. Without limiting the generality of the foregoing, unless otherwise agreed by Lender, the following Accounts are not Eligible Accounts: (1) Accounts which, at the date of issuance of the respective invoice therefor, were payable more than sixty (60) days after the date of issuance of such invoice; (2) Accounts which remain unpaid for more than sixty (60) days after the due date specified in the original invoice or for more than ninety (90) days after invoice date if no due date was specified; (3) Accounts which are otherwise eligible with respect to which the account debtor is owed a credit by Borrower, but only to the extent of such credit; (4) Accounts due from a customer whose principal place of business is located outside the United States of America unless such Account is backed by a letter of credit, in form and substance acceptable to Lender, and issued or confirmed by a bank that is 11 103 13 organized under the laws of the United States of America or a State thereof, that is acceptable to Lender, provided that such letter of credit has been issued for the benefit of Lender or is assignable and has been duly assigned and delivered to Lender as additional collateral; (5) Accounts due from a customer which Lender has notified Borrower does not have a satisfactory credit standing; (6) Accounts with respect to which the customer is the United States of America, any state or any municipality, or any department, agency or instrumentality thereof, unless Borrower has, with respect to such Accounts, complied with the Federal Assignment of Claims Act (31 U.S.C. Section 3727) or any applicable statute or municipal ordinance of similar purpose and effect; (7) Accounts with respect to which the customer is an Affiliate of Borrower or a director, officer, agent, stockholder or employee of Borrower or any of its Affiliates; (8) Accounts due from a customer if more than twenty-five percent (25%) of the aggregate amount of Accounts of such customer have at the time remained unpaid for more than sixty (60) days after the due date or ninety (90) days after the invoice date if no due date was specified; (9) Accounts with respect to which there is any unresolved dispute with the respective customer (but only to the extent of such dispute); (10) Accounts evidenced by an "instrument" or "chattel paper" (as defined in the UCC) not in the possession of Lender; (11) Accounts with respect to which Lender does not have a valid, first priority and fully perfected security interest; (12) Accounts subject to any Lien except those in favor of Lender; (13) Accounts (other than Accounts purchased under the Inter-Credit Agreement) with respect to which the customer is the subject of any bankruptcy or other insolvency proceeding; (14) Accounts due from (a) Wal-Mart Stores, Inc. its Subsidiaries to the extent that such Accounts exceed in the aggregate an amount equal to seventy percent (70%) of the aggregate of all Accounts at said date; or (b) Dayton Hudson Corporation and its operating divisions and Subsidiaries (including Target, Mervyn's, Dayton's, Hudson's, and Marshall Field's) to the extent that such Accounts exceed in the aggregate an amount equal to fifty percent (50%) of the aggregate of all Accounts at said date; (c) Kmart Corporation and its Subsidiaries to the extent that such Accounts exceed in the aggregate an amount equal to thirty percent (30%) of the aggregate of all Accounts at such date; or (d) any other customer to the extent that 12 104 14 such Accounts exceed in the aggregate an amount equal to twenty percent (20%) of the aggregate of all Accounts at said date; (15) Accounts with respect to which the customer's obligation to pay is conditional or subject to a repurchase obligation or right to return or with respect to which the goods or services giving rise to such Account have not been delivered (or performed, as applicable) and accepted by such account debtor, including progress billings, bill and hold sales, guarantied sales, sale or return transactions, sales on approval or consignment sales; (16) Accounts with respect to which the customer is located in Indiana, New Jersey, Minnesota, or any other state denying creditors access to its courts in the absence of a Notice of Business Activities Report or other similar filing, unless Borrower has either qualified as a foreign corporation authorized to transact business in such state or has filed a Notice of Business Activities Report or similar filing with the applicable state agency for the then current year no later than sixty (60) days after the Closing Date and provided to Lender evidence of such qualification or filing; and (17) Accounts with respect to which the customer is a creditor of Borrower, provided, however, that any such Account shall only be ineligible as to that portion of such Account which is less than or equal to the amount owed by Borrower to such Person. "Eligible Inventory" means, as at any date of determination, the value (determined at the lower of cost or market on a first-in, first- out basis) of all unprinted finished goods Inventory owned by and in the possession of Borrower and located in the United States of America that Lender, in its reasonable credit judgment, deems to be eligible for borrowing purposes. Without limiting the generality of the foregoing, unless otherwise agreed by Lender, the following is not Eligible Inventory: (a) work-in-process; (b) printed finished goods; (c) Inventory which Lender determines is unacceptable for borrowing purposes due to age, quality, type, category and/or quantity, including any Inventory for which at least twelve (12) months have elapsed since Borrower's receipt of such Inventory; (d) Inventory with respect to which Lender does not have a valid, first priority and fully perfected security interest; (e) Inventory with respect to which there exists any Lien in favor of any Person other than Lender; (f) Inventory produced in violation of the Fair Labor Standards Act and subject to the so-called "hot goods" provisions contained in Title 29 U.S.C. 215 (a)(i); and (g) Inventory located at any location other than Borrower's principal location and its warehouse in Kent, Washington. (C) Borrowing Mechanics. On any day when Borrower desires to borrow under this subsection 2.1, Borrower shall give Lender telephonic notice of the proposed borrowing by 11:00 a.m. (Los Angeles time). Lender shall not incur any liability to Borrower for acting upon any telephonic notice Lender believes in good faith to have been given by a duly authorized officer or other person authorized to borrow on behalf of Borrower or for otherwise acting in good faith under this subsection 2.1 (C). Lender will not make any advance pursuant to any telephonic notice unless Lender has also received the most recent Borrowing Base Certificate and all other documents required under subsection 5.1 (F) by 11:00 a.m. (Los Angeles time). Each advance made to Borrower under the Revolving Loan shall be deposited 13 105 15 by wire transfer in immediately available funds in such account as Borrower may from time to time designate to Lender in writing. Unless payment is otherwise timely made by Borrower, the becoming due of any amount required to be paid under this Agreement or any of the other Loan Documents as principal, accrued interest and fees shall be deemed irrevocably to be a request by Borrower for a Revolving Loan on the due date of, and in the amount required to pay, such principal, accrued interest and fees, and the proceeds of each such Revolving Loan if made by Lender shall be disbursed by Lender by way of direct payment of the relevant obligation. (D) Evidence of Revolving Loan Obligations. The advances constituting the Revolving Loan shall be evidenced by this Agreement and notations made from time to time by Lender in its books and records, including computer records. Lender's books and records shall constitute presumptive evidence, absent manifest error, of the accuracy of the information contained therein. Failure by the Lender to make any such notation or record shall not affect the obligations of Borrower to Lender with respect to the Revolving Loans. (E) Letters of Credit. Subject to the terms and conditions of this Agreement and in reliance upon the representations and warranties of Borrower herein set forth, the Revolving Loan Commitment may, in addition to advances under the Revolving Loan, be utilized, upon the request of Borrower, for (i) the issuance of letters of credit by Lender or (ii) the issuance by Lender of a risk participation agreement (a "Risk Participation Agreement") to a bank acceptable to Lender to induce the bank to issue Bank Letters of Credit for the account of Borrower (each of (i) and (ii) above, a "Lender Letter of Credit"). In no event shall any Lender Letter of Credit be issued to the extent that the issuance of such Lender Letter of Credit would cause the sum of the Letter of Credit Reserve (after giving effect to such issuance) plus the outstanding principal balance of the Revolving Loan to exceed the lesser of (x) the Borrowing Base and (y) the Revolving Loan Commitment. (1) Maximum Amount. The aggregate amount of Letter of Credit Liability with respect to all Lender Letters of Credit outstanding at any time shall not exceed $8,000,000. (2) Reimbursement. Borrower shall be irrevocably and unconditionally obligated forthwith without presentment, demand, protest or other formalities of any kind, to reimburse Lender for any amounts paid by Lender with respect to a Lender Letter of Credit including all fees, costs and expenses paid by Lender to any bank that issues Bank Letters of Credit. Borrower hereby authorizes and directs Lender, at Lender's option, to debit Borrower's account (by increasing the principal balance of the Revolving Loan) in the amount of any payment made by Lender with respect to any Lender Letter of Credit. All amounts paid with respect to any Lender Letter of Credit that are not immediately repaid by Borrower with the proceeds of a Revolving Loan or otherwise shall bear interest at the Default Rate applicable to Revolving Loans. (3) Conditions of Issuance. In addition to all other terms and conditions set forth in this Agreement, the issuance of any Lender Letter of Credit shall be 14 106 16 subject to the conditions precedent that the letter of credit which Borrower requests be in such form, be for such amount, contain such terms and support such transactions as are reasonably satisfactory to Lender. The expiration date of each Lender Letter of Credit shall be on a date which is at least thirty (30) days prior to the Termination Date. (4) Request for Letters of Credit. Borrower shall give Lender at least two (2) Business Days (or such lesser time as acceptable to Lender) prior notice specifying the date a Lender Letter of Credit is to be issued, identifying the beneficiary and describing the nature of the transactions proposed to be supported thereby. The notice shall be accompanied by the form of the letter of credit being requested. (F) Other Letter of Credit Provisions. (1) Obligations Absolute. The obligation of Borrower to reimburse Lender for payments made under any Lender Letter of Credit shall be unconditional and irrevocable and shall be paid strictly in accordance with the terms of this Agreement under all circumstances including the following circumstances: (a) any lack of validity or enforceability of any Lender Letter of Credit or Bank Letter of Credit or any other agreement; (b) the existence of any claim, set-off, defense or other right which Borrower, any of its Affiliates, or Lender, on the one hand, may at any time have against any beneficiary or transferee of any Lender Letter of Credit or Bank Letter of Credit (or any Persons for whom any such transferee may be acting), Lender or any other Person, on the other hand, whether in connection with this Agreement, the transactions contemplated herein or any unrelated transaction (including any underlying transaction between Borrower or any of its Affiliates and the beneficiary of the letter of credit); (c) any draft, demand, certificate or any other document presented under any Lender Letter of Credit or Bank Letter of Credit which is forged, fraudulent, invalid or insufficient in any respect or any statement therein being untrue or inaccurate in any respect; (d) payment under any Lender Letter of Credit or Bank Letter of Credit against presentation of a demand, draft or certificate or other document which does not comply with the terms of such Lender Letter of Credit provided that, in the case of any payment by Lender under any Lender Letter of Credit, Lender has not acted with gross negligence or willful misconduct (as determined by a court of competent jurisdiction) in determining that the demand for payment under such Lender Letter of Credit complies on its face with any applicable requirements for a demand for payment under such Lender Letter of Credit; (e) any other circumstance or happening whatsoever, which is similar to any of the foregoing; or 15 107 17 (f) the fact that a Default or an Event of Default shall have occurred and be continuing. (2) Nature of Duties. As between Lender and Borrower, Borrower assumes all risks of the acts and omissions of, or misuse of any Lender Letter of Credit or Bank Letter of Credit by the beneficiary thereof. In furtherance and not in limitation of the foregoing, Lender shall not be responsible: (a) for the form, validity, sufficiency, accuracy, genuineness or legal effect of any document by any party in connection with the application for and issuance of any Lender Letter of Credit or Bank Letter of Credit, even if it should in fact prove to be in any or all respects invalid, insufficient, inaccurate, fraudulent or forged; provided that, in the case of any payment by Lender under any Lender Letter of Credit, Lender has not acted with gross negligence or willful misconduct (as determined by a court of competent jurisdiction) in determining that the demand for payment under such Lender Letter of Credit complies on its face with any applicable requirements for a demand for payment thereunder; (b) for the validity or sufficiency of any instrument transferring or assigning or purporting to transfer or assign any Lender Letter of Credit or Bank Letter of Credit or the rights or benefits thereunder or proceeds thereof, in whole or in part, which may prove to be invalid or ineffective for any reason; provided that, in the case of any payment by Lender under any Lender Letter of Credit, Lender has not acted with gross negligence or willful misconduct (as determined by a court of competent jurisdiction) in determining that the demand for payment under such Lender Letter of Credit complies on its face with any applicable requirements for a demand for payment thereunder; (c) for failure of the beneficiary of any Lender Letter of Credit or Bank Letter of Credit to comply fully with conditions required in order to demand payment thereunder; provided that, in the case of any payment by Lender under any Lender Letter of Credit, Lender has not acted with gross negligence or willful misconduct (as determined by a court of competent jurisdiction) in determining that the demand for payment under such Lender Letter of Credit complies on its face with any applicable requirements for a demand for payment thereunder; (d) for errors, omissions, interruptions or delays in transmission or delivery of any messages, by mail, cable, telegraph, telex or otherwise, whether or not they be in cipher; (e) for errors in interpretation of technical terms; (f) for any loss or delay in the transmission or otherwise of any document required in order to make a payment under any Lender Letter of Credit or Bank Letter of Credit; (g) for the credit of the proceeds of any drawing under any Lender Letter of Credit or Bank Letter of Credit; and (h) for any consequences arising from causes beyond the control of Lender. None of the above shall affect, impair, or prevent the vesting of any of Lender's rights or powers hereunder. (3) Liability. In furtherance and extension of and not in limitation of, the specific provisions herein above set forth, any action taken or omitted by Lender under or in connection with any Lender Letter of Credit, if taken or omitted in good faith, shall not put Lender under any resulting liability to Borrower. (G) Ledger Debt and Chargebacks. To the extent Borrower does not pay (a) any Ledger Debt within five days (5) from its due date, unless Lender has been notified that Borrower has alleged a dispute with respect thereto or (b) any Chargeback Interest or (c) Ledger Debt Interest, upon demand by Heller to Lender, Lender may, in its sole discretion, pay an 16 108 18 amount equal to the amount of such Ledger Debt, Ledger Debt Interest or Chargeback Interest to Heller or establish an additional reserve against the Borrowing Base or the Maximum Loan Amount for any such unpaid Ledger Debt, Ledger Debt Interest or Chargeback Interest. Borrower hereby authorizes and directs Lender, at Lender's option, to debit Borrower's account (by increasing the principal balance of the Revolving Loan) for any Ledger Debt, Ledger Debt Interest or Chargeback Interest then due and payable, or to establish a reserve against the Borrowing Base or the Maximum Loan Amount for any unpaid Ledger Debt, Ledger Debt Interest or Chargeback Interest, all as set forth on Heller's books and records. Such paid amounts shall, in the absence of manifest or demonstrable error, be final and conclusive and binding on all of the parties hereto. All amounts paid by Lender to Heller with respect to any Ledger Debt, Ledger Debt Interest or Chargeback Interest that are not immediately repaid by Borrower with the proceeds of a Revolving Loan or otherwise shall bear interest at the Default Rate. 2.2 Interest (A) Rate of Interest. The Loans and all other Obligations shall bear interest from the date such Loans are made or such other Obligations become due to the date paid at a rate per annum equal to the Base Rate. After the occurrence and during the continuance of an Event of Default, the Loans and all other Obligations shall, at Lender's option, bear interest at a rate per annum equal to two percent (2.0%) plus the Base Rate (the "Default Rate"). (B) Computation and Payment of Interest. Interest on the Loans and all other Obligations shall be computed on the daily principal balance on the basis of a 360 day year for the actual number of days elapsed in the period during which it accrues and shall be payable monthly in arrears on the first day of each month. Any publicly announced change in the Base Rate shall result in an adjustment to the Base Rate on the day such change takes effect. (C) Interest Laws. Notwithstanding any provision to the contrary contained in this Agreement or any other Loan Document, Borrower shall not be required to pay, and Lender shall not be permitted to collect, any amount of interest in excess of the maximum amount of interest permitted by law ("Excess Interest"). If any Excess Interest is provided for or determined by a court of competent jurisdiction to have been provided for in this Agreement or in any other Loan Document, then in such event: (1) the provisions of this subsection shall govern and control; (2) neither Borrower nor any Loan Party shall be obligated to pay any Excess Interest; (3) any Excess Interest that Lender may have received hereunder shall be, at Lender's option, (a) applied as a credit against the outstanding principal balance of the Obligations or accrued and unpaid interest (not to exceed the maximum amount permitted by law), (b) refunded to the payor thereof, or (c) any combination of the foregoing; (4) the interest rate(s) provided for herein shall be automatically reduced to the maximum lawful rate allowed from time to time under applicable law (the "Maximum Rate"), and this Agreement and the other Loan Documents shall be deemed to have been and shall be, reformed and modified to reflect such reduction; and (5) neither Borrower nor any Loan Party shall have any action against Lender for any damages arising out of the payment or collection of any Excess Interest. Notwithstanding the foregoing, if for any period of time interest on any Obligations is calculated 17 109 19 at the Maximum Rate rather than the applicable rate under this Agreement, and thereafter such applicable rate becomes less than the Maximum Rate, the rate of interest payable on such Obligations shall remain at the Maximum Rate until Lender shall have received the amount of interest which Lender would have received during such period on such Obligations had the rate of interest not been limited to the Maximum Rate during such period. 2.3 Fees. (A) Closing Fee. Borrower shall pay to Lender on the Closing Date a closing fee in the amount of $25,000, which shall be fully earned and non-refundable on such Closing Date. (B) Letter of Credit Fees. Borrower shall reimburse Lender for any and all fees and expenses, if any, paid by Lender to the issuer of Bank Letters of Credit relating to Bank Letters of Credit. (C) Prepayment Fees. If Borrower voluntarily prepays the Obligations in full (other than voluntary prepayments of the Revolving Loan which do not terminate the Revolving Loan Commitment) prior to the Termination Date, Borrower at the time of prepayment shall pay to Lender, as compensation for the costs of being prepared to make funds available to Borrower under this Agreement, and not as a penalty, an amount equal to $75,000.00 upon a prepayment during the first Loan Year and $37,500.00 upon a prepayment during the second Loan Year. (D) Audit and Appraisal Fees. Borrower agrees to pay Lender an audit fee for each inspection equal to $500.00 per auditor per day or any portion thereof, excluding all full days spent by Lender traveling to or from Borrower's locations, and costs for appraisals required under subsection 5.1(I), together in each case with out-of-pocket expenses (provided, that unless a Default or Event of Default has occurred and is continuing, such fees, costs and expenses shall not exceed $7,500 in any Loan Year). (E) Other Fees and Expenses. Borrower shall pay to Lender, for its own account, all charges for returned items and all other bank charges incurred by Lender, as well as Lender's standard wire transfer charges for each wire transfer made under this Agreement. 2.4 Payments and Prepayments. (A) Manner and Time of Payment. In its sole discretion, Lender may charge interest and other amounts payable hereunder to the Revolving Loan, all as set forth on Lender's books and records. If Lender elects to bill Borrower for any amount due hereunder, such amount shall be immediately due and payable with interest thereon as provided herein. All payments made by Borrower with respect to the Obligations shall be made without deduction, defense, setoff or counterclaim. All payments to Lender hereunder shall, unless otherwise directed by Lender, be made in accordance with subsection 5.6. Proceeds remitted to any Lender's Depository Account shall be credited to the Obligations on the first Business Day following the day such proceeds were received in Lender's Depository Account; provided, 18 110 20 however, for the purpose of calculating interest on the Obligations, such funds shall be deemed received on the date such funds were received in such account. Proceeds remitted to Lender's Account by wire transfer shall be credited to the Obligations on the Business Day received. To compensate Lender for collection clearance on all checks and other payments remitted with respect to Accounts, Borrower shall pay to Lender each month, in addition to interest, a collection clearance charge computed as follows: (a) total collections on Accounts for the month, multiplied by (b) two (2) days, multiplied by (c) the Base Rate, divided by (d) two hundred fifty (250) days. (B) Mandatory Prepayments. (1) Overadvance. At any time that the principal balance of the Revolving Loan exceeds the Maximum Revolving Loan Amount, Borrower shall, upon demand by Lender, immediately repay the Revolving Loan to the extent necessary to reduce the principal balance to an amount that is equal to or less than the Maximum Revolving Loan Amount. (2) Proceeds of Asset Dispositions. Immediately upon receipt by Borrower or any of its Subsidiaries of proceeds of any Asset Disposition (in one or a series of related transactions), which proceeds exceed $10,000 (it being understood that if the proceeds exceed $10,000, the entire amount and not just the portion above $10,000 shall be subject to this subsection 2.4(B)(2)), Borrower shall prepay the Obligations in an amount equal to such proceeds. (C) Voluntary Prepayments and Repayments. Borrower may, at any time upon not less than three (3) Business Days' prior notice to Lender and payment of any fee required under subsection 2.3(C) terminate the Revolving Loan Commitment. Upon termination of the Revolving Loan Commitment, Borrower shall cause Lender to be released from all liability under any Lender Letters of Credit, or, at Lender's option, Borrower will deposit cash collateral with Lender in an amount equal to one hundred five percent (105%) of the Letter of Credit Liability that will remain outstanding after prepayment or repayment. (D) Payments on Business Days. Whenever any payment to be made hereunder shall be stated to be due on a day that is not a Business Day, the payment may be made on the next succeeding Business Day and such extension of time shall be included in the computation of the amount of interest or fees due hereunder. 2.5 Term of this Agreement. This Agreement shall be effective until the second anniversary of the Closing Date (the "Termination Date"). The Commitments shall (unless earlier terminated) terminate upon the earlier of (i) the occurrence of an event specified in subsection 8.3 or (ii) the Termination Date. Upon termination in accordance with subsection 8.3 or on the Termination Date, all Obligations shall become immediately due and payable without notice or demand. Notwithstanding any termination, until all Obligations (other than contingent indemnification obligations as to which no claim has been made) have been fully paid and satisfied, Lender shall be entitled to retain security interests in and liens upon all Collateral. 19 111 21 Even after payment of all Obligations hereunder, Borrower's obligation to indemnify Lender in accordance with the terms hereof shall continue. 2.6 Statements. Lender shall render a monthly statement of account to Borrower within twenty (20) days after the end of each month. Such statement of account shall constitute an account stated unless Borrower makes written objection thereto within thirty (30) days from the date such statement is mailed to Borrower. Borrower promises to pay all of its Obligations as such amounts become due or are declared due pursuant to the terms of this Agreement. 2.7 Grant of Security Interest. To secure the payment and performance of the Obligations, including all renewals, extensions, restructurings and refinancings of any or all of the Obligations, Borrower hereby grants to Lender a continuing security interest, lien and mortgage in and to all right, title and interest of Borrower in the following property of Borrower, whether now owned or existing or hereafter acquired or arising and regardless of where located (all being collectively referred to as the "Collateral"): (A) Accounts, and all guaranties and security therefor, and all goods and rights represented thereby or arising therefrom including the right of stoppage in transit, replevin and reclamation; (B) Inventory; (C) general intangibles (as defined in the UCC) (including rights to payments under the Assignment of Monies Agreement); (D) documents (as defined in the UCC) or other receipts covering, evidencing or representing goods; (E) instruments (as defined in the UCC); (F) chattel paper (as defined in the UCC); (G) Equipment; (H) Intellectual Property, including that listed on Schedule 4.14; (I) all deposit accounts of Borrower maintained with any bank or financial institution; (J) all cash and other monies and property of Borrower in the possession or under the control of Lender or any participant; (K) all books, records, ledger cards, files, correspondence, computer programs, tapes, disks and related data processing software that at any time evidence or contain information relating to any of the property described above or are otherwise necessary or helpful in the collection thereof or realization thereon; and (L) proceeds of all or any of the property described above, including, without limitation, the proceeds of any insurance policies covering any of the above described property. 2.8 Capital Adequacy and Other Adjustments. In the event Lender shall have determined that the adoption after the date hereof of any law, treaty, governmental (or quasi-governmental) rule, regulation, guideline or order regarding capital adequacy, reserve requirements or similar requirements or compliance by Lender or any corporation controlling Lender with any request or directive regarding capital adequacy, reserve requirements or similar requirements (whether or not having the force of law and whether or not failure to comply therewith would be unlawful) from any central bank or governmental agency or body having jurisdiction does or shall have the effect of increasing the amount of capital, reserves or other funds required to be maintained by Lender or any corporation controlling Lender and thereby reducing the rate of return on Lender's or such corporation's capital as a consequence of its obligations hereunder, then Borrower shall from time to time within fifteen (15) days after notice and demand from Lender (together with the certificate referred to in the next sentence) pay to Lender additional amounts sufficient to compensate such Lender for such reduction. A certificate as to the amount of such cost and showing the basis of the computation of such cost 20 112 22 submitted by Lender to Borrower shall, absent manifest error, be final, conclusive and binding for all purposes. 2.9 Taxes. (A) No Deductions. Any and all payments or reimbursements made hereunder shall be made free and clear of and without deduction for any and all taxes, levies, imposts, deductions, charges or withholdings, and all liabilities with respect thereto; excluding, however, the following: taxes imposed on the net income of Lender by the jurisdiction under the laws of which Lender is organized or doing business or any political subdivision thereof and taxes imposed on its net income by the jurisdiction of Lender's applicable lending office or any political subdivision thereof (all such taxes, levies, imposts, deductions, charges or withholdings and all liabilities with respect thereto excluding such taxes imposed on net income, herein "Tax Liabilities"). If Borrower shall be required by law to deduct any such Tax Liabilities from or in respect of any sum payable hereunder to Lender, then the sum payable hereunder shall be increased as may be necessary so that, after making all required deductions, Lender receives an amount equal to the sum it would have received had no such deductions been made. (B) Changes in Tax Laws. In the event that, subsequent to the Closing Date, (i) any changes in any existing law, regulation, treaty or directive or in the interpretation or application thereof, (ii) any new law, regulation, treaty or directive enacted or any interpretation or application thereof, or (iii) compliance by Lender with any request or directive (whether or not having the force of law) from any governmental authority, agency or instrumentality: (1) does or shall subject Lender to any tax of any kind whatsoever with respect to this Agreement, the other Loan Documents or any Loans made or Lender Letters of Credit issued hereunder, or change the basis of taxation of payments to Lender of principal, fees, interest or any other amount payable hereunder (except for net income taxes, or franchise taxes imposed in lieu of net income taxes, imposed generally by federal, state or local taxing authorities with respect to interest or commitment or other fees payable hereunder or changes in the rate of tax on the overall net income of Lender); or (2) does or shall impose on Lender any other condition or increased cost in connection with the transactions contemplated hereby or participations herein; and the result of any of the foregoing is to increase the cost to Lender of issuing any Lender Letter of Credit or making or continuing any Loan hereunder, as the case may be, or to reduce any amount receivable hereunder, then, in any such case, Borrower shall promptly pay to Lender, upon its demand, any additional amounts necessary to compensate Lender, on an after-tax basis, for such additional cost or reduced amount receivable, as determined by Lender with respect to this Agreement or the other Loan Documents. If Lender becomes entitled to claim any additional amounts pursuant to this subsection, it shall promptly notify Borrower of the event by reason of which Lender has become so entitled. A certificate as to any additional amounts payable pursuant to the foregoing sentence submitted by Lender to Borrower shall, absent manifest error, be final, conclusive and binding for all purposes. 21 113 23 SECTION 3 CONDITIONS TO LOANS 3.1 Conditions to Loans. The obligations of Lender to make Loans and to issue Lender Letters of Credit on the Closing Date and on each Funding Date are subject to satisfaction of all of the conditions set forth below. (A) Closing Deliveries. Lender shall have received, in form and substance satisfactory to Lender, all documents, instruments and information identified on Schedule 3.1(A) and all other agreements, notes, certificates, orders, authorizations, financing statements, mortgages and other documents which Lender may at any time reasonably request. Borrower and Heller shall have executed and delivered an amendment to the Inter-Credit Agreement on terms and conditions acceptable to Heller. (B) Security Interests. Lender shall have received satisfactory evidence that all security interests and liens granted to Lender pursuant to this Agreement or the other Loan Documents have been duly perfected and constitute first priority liens on the Collateral, subject only to Permitted Encumbrances. (C) Closing Date Availability. After giving effect to the consummation of the transactions contemplated hereunder on the Closing Date and the payment by Borrower of all costs, fees and expenses relating thereto, the Maximum Revolving Loan Amount on the Closing Date shall exceed the principal balance of the Revolving Loans plus the Letter of Credit Reserve by at least $1,000,000. (D) Representations and Warranties. The representations and warranties contained herein and in the Loan Documents shall be true, correct and complete in all material respects on and as of that Funding Date to the same extent as though made on and as of that date, except for any representation or warranty limited by its terms to a specific date and taking into account any amendments to the Schedules or Exhibits as a result of any disclosures made by Borrower to Lender after the Closing Date and approved by Lender. (E) Fees. With respect to Loans or Lender Letters of Credit to be made or issued on the Closing Date, Borrower shall have paid the fees payable on the Closing Date referred to in subsection 2.3(A). (F) No Default. No event shall have occurred and be continuing or would result from the consummation of the requested borrowing or notice requesting issuance of a Lender Letter of Credit that would constitute an Event of Default or a Default. (G) Performance of Agreements. Each Loan Party shall have performed in all material respects all agreements and satisfied all conditions which any Loan Document provides shall be performed by it on or before that Funding Date. 22 114 24 (H) No Prohibition. No order, judgment or decree of any court, arbitrator or governmental authority shall purport to enjoin or restrain Lender from making any Loans or issuing any Lender Letters of Credit. (I) No Litigation. There shall not be pending or, to the knowledge of Borrower, threatened, any action, charge, claim, demand, suit, proceeding, petition, governmental investigation or arbitration by, against or affecting any Loan Party or any of its Subsidiaries or any property of any Loan Party or any of its Subsidiaries that has not been disclosed by Borrower in writing, and there shall have occurred no development in any such action, charge, claim, demand, suit, proceeding, petition, governmental investigation or arbitration that, in the opinion of Lender, would reasonably be expected to have a Material Adverse Effect. (J) No Material Adverse Change. There shall not have occurred since December 1, 1995 any event or condition which, in the sole determination of Lender, constitutes or could reasonably be expected to constitute a Material Adverse Effect. (K) Solvency. Lender shall have received, in form and substance acceptable to it, evidence that Borrower's representation and warranty in subsection 4.16 is true as of the Closing Date. (L) Audit. Lender shall have completed its audit of Borrower's business operations and Lender shall have determined that the results thereof are acceptable. (M) Consents. Lender shall have received, in form and substance acceptable to it, all consents and approvals required for Borrower to enter into and perform its obligations under the Loan Documents and the Inter-Credit Agreement, including without limitation agreements from each of Borrower's landlords permitting Lender access to the Inventory located in any leased location or warehouse. SECTION 4 BORROWER'S REPRESENTATIONS AND WARRANTIES To induce Lender to enter into this Agreement, and to make Loans and to issue Lender Letters of Credit, Borrower represents and warrants to Lender that the following statements are and will be true, correct and complete: 4.1 Organization, Powers, Capitalization. (A) Organization and Powers. Each of the Loan Parties is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation and qualified to do business in all states where such qualification is required except where failure to be so qualified could not be reasonably expected to have a Material Adverse Effect. Each of the Loan Parties has all requisite corporate power and authority to own and operate its properties, to carry on its business as now conducted and proposed to be conducted and to enter into each Facility Document. 23 115 25 (B) Capitalization. The authorized capital stock of each of the Loan Parties is as set forth on Schedule 4.1(B). All issued and outstanding shares of capital stock of each of the Loan Parties are duly authorized and validly issued, fully paid, nonassessable, free and clear of all Liens and such shares were issued in compliance with all applicable state and federal laws concerning the issuance of securities. The capital stock of each of the Loan Parties is owned by the stockholders and in the amounts set forth on Schedule 4.1(B). No shares of the capital stock of any Loan Party, other than those described above, are issued and outstanding. There are no preemptive or other outstanding rights, options, warrants, conversion rights or similar agreements or understandings for the purchase or acquisition from any Loan Party, of any shares of capital stock or other securities of any such entity, except as set forth on Schedule 4.1(B). 4.2 Authorization of Borrowing, No Conflict. Borrower has the corporate power and authority to incur the Obligations and to grant security interests in the Collateral. On the Closing Date, the execution, delivery and performance of the Facility Documents by each Loan Party signatory thereto will have been duly authorized by all necessary corporate and shareholder action. The execution, delivery and performance by each Loan Party of each Facility Document to which it is a party and the consummation of the transactions contemplated by this Agreement and the other Facility Documents by each Loan Party do not contravene and will not be in contravention of any applicable law, the corporate charter or bylaws of any Loan Party or any agreement or order by which any Loan Party or any Loan Party's property is bound. This Agreement is, and the other Facility Documents when executed and delivered will be, the legally valid and binding obligations of the applicable Loan Parties respectively, each enforceable against the Loan Parties, as applicable, in accordance with their respective terms. 4.3 Financial Condition. All financial statements concerning Borrower and its Subsidiaries which have been or will hereafter be furnished by Borrower and its Subsidiaries to Lender pursuant to this Agreement have been or will be prepared in accordance with GAAP consistently applied throughout the periods involved (except as disclosed therein) and do or will present fairly the financial condition of the corporations covered thereby as at the dates thereof and the results of their operations for the periods then ended. The Projections delivered and to be delivered have been and will be prepared by Borrower in light of the past operations of the business of Borrower and its Subsidiaries, and such Projections represent and will represent the good faith estimate of Borrower and its senior management concerning the most probable course of its business as of the date such Projections are prepared and delivered. 4.4 Indebtedness and Liabilities. As of the Closing Date, neither Borrower nor any of its Subsidiaries has (a) any Indebtedness except as reflected on the most recent financial statements delivered to Lender; or (b) any Liabilities other than as reflected on the most recent financial statements delivered to Lender or as incurred in the ordinary course of business following the date of the most recent financial statements delivered to Lender. 4.5 Account Warranties. Borrower represents, warrants and covenants as to each Account that, at the time of its creation, the Account is a valid, bona fide account, representing an undisputed indebtedness incurred by the named account debtor for goods actually sold and delivered or for services completely rendered; there are no setoffs, offsets or counterclaims, 24 116 26 genuine or otherwise, against the Account; the Account does not represent a sale to an Affiliate or a consignment, sale or return or a bill and hold transaction; no agreement exists permitting any deduction or discount (other than the discount or allowance stated on the invoice or, as to a specific customer, as set forth on Schedule 4.5); Borrower is the lawful owner of the Account and has the right to assign the same to Lender; the Account is free of all security interests, liens and encumbrances other than those in favor of Lender and in favor of Heller, and the Account is due and payable in accordance with its terms. 4.6 Names. Schedule 4.6 sets forth all names, tradenames, fictitious names and business names under which Borrower currently conducts business or has at any time during the past five years conducted business. 4.7 Locations; FEIN. Schedule 4.7 sets forth the location of Borrower's principal place of business, the location of Borrower's books and records, the location of all other offices of Borrower and all locations of Eligible Inventory, and such locations are Borrower's sole locations for its business and the Collateral, other than Inventory in an amount not in excess of $4,000,000 at any time located with contractors or subcontractors. Borrower's federal employer identification number is set forth on the signature page hereof. 4.8 Title to Properties; Liens. Borrower and each of its Subsidiaries has good, sufficient and legal title, subject to Permitted Encumbrances, to all its respective material properties and assets. Borrower owns no real property. Except for Permitted Encumbrances, all such properties and assets are free and clear of Liens. To the best knowledge of Borrower after due inquiry, there are no actual, threatened or alleged defaults with respect to any leases of real property under which Borrower or any of its Subsidiaries is lessee or lessor which would have a Material Adverse Effect. 4.9 Litigation; Adverse Facts. There are no judgments outstanding against any Loan Party or affecting any property of any Loan Party nor is there any action, charge, claim, demand, suit, proceeding, petition, governmental investigation or arbitration now pending or, to the best knowledge of Borrower after due inquiry, threatened against or affecting any Loan Party or any property of any Loan Party which could reasonably be expected to result in any Material Adverse Effect. No Loan Party has received any opinion or memorandum or legal advice from legal counsel to the effect that it is exposed to any liability which could reasonably be expected to result in any Material Adverse Effect. 4.10 Payment of Taxes. All material tax returns and reports of Borrower and each of its Subsidiaries required to be filed by any of them have been timely filed, and all taxes, assessments, fees and other governmental charges upon such Persons and upon their respective properties, assets, income and franchises which are shown on such returns as due and payable have been paid when due and payable. As of the Closing Date, none of the United States income tax returns of Borrower or any of its Subsidiaries are under audit. No tax liens have been filed and no claims (except as otherwise permitted by Section 5.9) are being asserted with respect to any such taxes. The charges, accruals and reserves on the books of Borrower and 25 117 27 each of its Subsidiaries in respect of any taxes or other governmental charges are in accordance with GAAP. 4.11 Performance of Agreements. None of the Loan Parties and none of their respective Subsidiaries is in default in the performance, observance or fulfillment of any of the obligations, covenants or conditions contained in any contractual obligation of any such Person, and no condition exists that, with the giving of notice or the lapse of time or both, would constitute such a default. 4.12 Employee Benefit Plans. Borrower, each of its Subsidiaries and each ERISA Affiliate is in compliance in all material respects with all applicable provisions of ERISA, the IRC and all other applicable laws and the regulations and interpretations thereof with respect to all Employee Benefit Plans. No material liability has been incurred by Borrower, any of its Subsidiaries or any ERISA Affiliate which remains unsatisfied for any funding obligation, taxes or penalties with respect to any Employee Benefit Plan. 4.13 Intellectual Property. Borrower and each of its Subsidiaries owns, is licensed to use or otherwise has the right to use, all Intellectual Property used in or necessary for the conduct of its business as currently conducted, and all such Intellectual Property is identified on Schedule 4.13. All licenses of Intellectual Property material to Borrower's business are in full force and effect, and, to the knowledge of Borrower, no party to such licenses is in default thereunder. 4.14 Broker's Fees. No broker's or finder's fee or commission will be payable with respect to any of the transactions contemplated hereby. 4.15 Environmental Compliance. Each Loan Party has been and is currently in compliance with all applicable Environmental Laws, including obtaining and maintaining in effect all permits, licenses or other authorizations required by applicable Environmental Laws. There are no claims, liabilities, investigations, litigation, administrative proceedings, whether pending or threatened, or judgments or orders relating to any Hazardous Materials asserted or threatened against any Loan Party or relating to any real property currently or formerly owned, leased or operated by any Loan Party. 4.16 Solvency. As of and from and after the date of this Agreement, Borrower: (a) owns and will own assets the fair salable value of which are (i) greater than the total amount of its liabilities (including contingent liabilities) and (ii) greater than the amount that will be required to pay the probable liabilities of Borrower as they mature; (b) has capital that is not unreasonably small in relation to its business as presently conducted or any contemplated or undertaken transaction; and (c) does not intend to incur and does not believe that it will incur debts beyond its ability to pay such debts as they become due. There is no material fact known to Borrower that has or could have a Material Adverse Effect and that has not been fully disclosed herein or in such other documents, certificates and statements furnished to Lender for use in connection with the transactions contemplated hereby. 26 118 28 4.17 Disclosure. No representation or warranty of Borrower, any of its Subsidiaries or any other Loan Party contained in this Agreement, the financial statements, the other Facility Documents, or any other document, certificate or written statement furnished to Lender or Heller by or on behalf of any such Person for use in connection with the Facility Documents contains any untrue statement of a material fact or omitted, omits or will omit to state a material fact necessary in order to make the statements contained herein or therein not misleading in light of the circumstances in which the same were made. The Projections and pro forma financial information contained in such materials are based upon good faith estimates and assumptions believed by such Persons to be reasonable at the time made, it being recognized by Lender that such projections as to future events are not to be viewed as facts and that actual results during the period or periods covered by any such projections may differ from the projected results. There is no material fact known to Borrower that has had or will have a Material Adverse Effect and that has not been disclosed herein or in such other documents, certificates and statements furnished to Lender for use in connection with the transactions contemplated hereby. 4.18 Insurance. Borrower and each of its Subsidiaries maintains adequate insurance policies for public liability, property damage for its business and properties, product liability, and business interruption, no notice of cancellation has been received with respect to such policies and Borrower and each of its Subsidiaries is in compliance with all conditions contained in such policies. 4.19 Compliance with Laws. Neither Borrower nor any of its Subsidiaries is in violation of any law, ordinance, rule, regulation, order, policy, guideline or other requirement of any domestic or foreign government or any instrumentality or agency thereof, having jurisdiction over the conduct of its business or the ownership of its properties, including, without limitation, any violation relating to any use, release, storage, transport or disposal of any Hazardous Material, which violation would subject Borrower or any of its Subsidiaries, or any of their respective officers to criminal liability or have a Material Adverse Effect and no such violation has been alleged. 4.20 Bank Accounts. Schedule 4.20 sets forth the account numbers and locations of all bank accounts of Borrower and its Subsidiaries. 4.21 Subsidiaries. Borrower has no Subsidiaries. 4.22 Employee Matters. Except as set forth on Schedule 4.22, (a) no Loan Party nor any of such Loan Party's employees is subject to any collective bargaining agreement, (b) no petition for certification or union election is pending with respect to the employees of any Loan Party and no union or collective bargaining unit has sought such certification or recognition with respect to the employees of any Loan Party and (c) there are no strikes, slowdowns, work stoppages or controversies pending or, to the best knowledge of Borrower after due inquiry, threatened between any Loan Party and its respective employees, other than employee grievances arising in the ordinary course of business which could reasonably be expected to have, either individually or in the aggregate, a Material Adverse Effect. Except as set forth on Schedule 4.22, neither Borrower nor any of its Subsidiaries is subject to an employment contract. 27 119 29 4.23 Governmental Regulation. None of the Loan Parties is, or after giving effect to any loan will be, subject to regulation under the Public Utility Holding Company Act of 1935, the Federal Power Act or the Investment Company Act of 1940 or to any federal or state statute or regulation limiting its ability to incur indebtedness for borrowed money. Borrower may, at any time and from time to time and subject to subsection 5.13, amend any one or more of the Schedules referred in this Section 4 and any representation or warranty contained herein which refers to any such Schedule shall from and after the date of any such amendment refer to such Schedule as so amended; provided, however, that in no event may the Borrower amend any such Schedule if such amendment would reflect or evidence a Default or Event of Default. SECTION 5 AFFIRMATIVE COVENANTS Borrower covenants and agrees that, so long as any of the Commitments hereunder shall be in effect and until payment in full of all Obligations and termination of all Lender Letters of Credit, unless Lender shall otherwise give its prior written consent, Borrower shall perform, and shall cause each of its Subsidiaries to perform, all covenants in this Section 5 applicable to such Person. 5.1 Financial Statements and Other Reports. Borrower will maintain, and cause each of its Subsidiaries to maintain, a system of accounting established and administered in accordance with sound business practices to permit preparation of financial statements in conformity with GAAP. Borrower will deliver to Lender the financial statements and other reports described below (which shall be in addition to any reports required by the Inter-Credit Agreement), and hereby authorizes Lender to deliver any of the following to Heller: (A) Monthly Financials. As soon as available and in any event within twenty (20) days after the end of each month, Borrower will deliver (1) the consolidated and consolidating balance sheet of Borrower and its Subsidiaries as at the end of such month and the related consolidated and consolidating statements of income and cash flow for such month and for the period from the beginning of the then current Fiscal Year to the end of such month; and (2) upon Lender's request, a schedule of outstanding royalties payable under Borrower's license agreements for Intellectual Property. (B) Quarterly Financials. As soon as available and in any event within forty-five (45) days after the end of each quarter of a Fiscal Year, Borrower will deliver Borrower's Form 10Q as filed or to be filed with the Securities and Exchange Commission (or any successor agency). (C) Year-End Financials. As soon as available and in any event within ninety (90) days after the end of each Fiscal Year, Borrower will deliver: (1) the consolidated balance sheet of Borrower and its Subsidiaries as at the end of such year and the related consolidated statements of income, stockholders' equity and cash flow for such Fiscal Year; (2) a schedule 28 120 30 of the outstanding Indebtedness of Borrower and its Subsidiaries describing in reasonable detail each such debt issue or loan outstanding and the principal amount and amount of accrued and unpaid interest with respect to each such debt issue or loan; and (3) a report with respect to the financial statements from a firm of independent certified public accountants selected by Borrower, and acceptable to Lender, which report shall be unqualified as to going concern and scope of audit of Borrower and its Subsidiaries and shall state that (a) such consolidated financial statements present fairly the consolidated financial position of Borrower and its Subsidiaries as at the dates indicated and the results of their operations and cash flow for the periods indicated in conformity with GAAP applied on a basis consistent with prior years and (b) that the examination by such accountants in connection with such consolidated financial statements has been made in accordance with generally accepted auditing standards ; and (4) copies of the consolidating financial statements of Borrower and its Subsidiaries, including (a) consolidating balance sheets of Borrower and its Subsidiaries as at the end of such Fiscal Year showing intercompany eliminations, if any and (b) related consolidating statements of earnings of Borrower and its Subsidiaries showing intercompany eliminations, if any. (D) Accountants' Certification and Reports. Together with each delivery of consolidated financial statements of Borrower and its Subsidiaries pursuant to subsection 5.1(C), Borrower will deliver a written statement by its independent certified public accountants (a) stating that the examination has included a review of the terms of this Agreement as same relate to accounting matters and (b) stating whether, in connection with the examination, any condition or event that constitutes a Default or an Event of Default has come to their attention and, if such a condition or event has come to their attention, specifying the nature and period of existence thereof. Promptly upon receipt thereof, Borrower will deliver copies of all significant reports submitted to Borrower by independent public accountants in connection with each annual, interim or special audit of the financial statements of Borrower made by such accountants, including the comment letter submitted by such accountants to management in connection with their annual audit. (E) Compliance Certificate. Together with the delivery of each set of financial statements referenced in subparts (A), (B) and (C) of this subsection 5.1, Borrower will deliver to Lender a Compliance Certificate, together with copies of the calculations and work-up employed to determine Borrower's compliance or noncompliance with the financial covenants set forth in Section 6. (F) Borrowing Base Certificates. On the first Business Day of each week and on each day on which Borrower makes a borrowing hereunder, Borrower shall deliver to Lender a Borrowing Base Certificate updated to reflect the most recent sales and collections of Borrower since the last Borrowing Base Certificate. (G) Reconciliation Reports, Inventory Reports and Listings and Agings. Borrower will deliver to Lender, the reports described on Exhibit C attached hereto, within the periods set forth on such Exhibit. All such reports shall be in form and substance satisfactory 29 121 31 to Lender. (H) Management Report. Together with each delivery of financial statements of Borrower and its Subsidiaries pursuant to subdivisions (A), (B) and (C) of this subsection 5.1, Borrower will deliver a management report: (1) describing the operations and financial condition of Borrower and its Subsidiaries for the month then ended and the portion of the current Fiscal Year then elapsed (or for the Fiscal Year then ended in the case of year-end financials); (2) setting forth in comparative form the corresponding figures for the corresponding periods of the previous Fiscal Year and the corresponding figures from the most recent Projections for the current Fiscal Year delivered to Lender pursuant to 5.1(P); and (3) discussing the reasons for any significant variations from Borrower's business plan and Projections. The information above shall be presented in reasonable detail and shall be certified by the chief financial officer of Borrower to the effect that such information fairly presents the results of operations and financial condition of Borrower and its Subsidiaries as at the dates and for the periods indicated. (I) Appraisals. From time to time, upon the request of Lender, Borrower will obtain and deliver to Lender, at Borrower's expense, appraisal reports in form and substance and from appraisers satisfactory to Lender, stating the then current fair market and orderly liquidation values of all or any portion of the Collateral; provided, however, so long as no Event of Default is continuing, Lender shall not request an appraisal as to any particular category of Collateral to be performed more than once every Loan Year at Borrower's expense, and subject to the limitations on fees payable under subsection 2.3(D). (J) Government Notices. Borrower will deliver to Lender within three (3) Business Days after receipt copies of all notices, requests, subpoenas, inquiries or other writings received from any governmental agency concerning any Employee Benefit Plan, the violation or alleged violation of any Environmental Laws, the storage, use or disposal of any Hazardous Material, the violation or alleged violation of the Fair Labor Standards Act or Borrower's payment or non-payment of any taxes including any tax audit. (K) Events of Default, etc. Within three (3) Business Days after any officer of Borrower obtains knowledge of any of the following events or conditions, Borrower shall deliver a certificate of Borrower's chief executive officer specifying the nature and period of existence of such condition or event and what action Borrower has taken, is taking and proposes to take with respect thereto: (1) any condition or event that constitutes an Event of Default or Default; (2) any notice of default that any Person has given to Borrower or any of its Subsidiaries or any other action taken with respect to a claimed default; (3) any Material Adverse Effect; or (4) any termination or cancellation of any material license agreement for Intellectual Property. (L) Trade Names. Borrower and each of its Subsidiaries will give Lender at least thirty (30) days advance written notice of any change of name or of any new trade name or fictitious business name. Borrower's use of any trade name or fictitious business name will be in compliance with all laws regarding the use of such names. 30 122 32 (M) Locations. Borrower will give Lender at least thirty (30) days advance written notice of any change in Borrower's principal place of business or any change in the location of its books and records or the Collateral or of any new location for its books and records or the Collateral; provided that Borrower shall only be required to update the information on Borrower's contractors and subcontractors where Inventory (other than Eligible Inventory) is located on a quarterly basis. (N) Bank Accounts. Borrower will give Lender notice of any new bank accounts Borrower intends to establish at least five (5) Business Days prior to its opening same and shall deliver to Lender such agreements with respect to such accounts as Lender may require. (O) Litigation. Within three (3) Business Days after any officer of Borrower or its Subsidiaries obtains knowledge of (1) the institution of any action, suit, proceeding, governmental investigation or arbitration against or directly affecting any Loan Party or any property of any Loan Party not previously disclosed by Borrower to Lender or (2) any material development in any action, suit, proceeding, governmental investigation or arbitration at any time pending against or affecting any Loan Party or any property of any Loan Party which is reasonably likely to have a Material Adverse Effect, Borrower will promptly give notice thereof to Lender and provide such other information as may be reasonably available to them to enable Lender and its counsel to evaluate such matter. (P) Projections. As soon as available and in any event no later than thirty (30) days prior to the end of each Fiscal Year of Borrower, Borrower will deliver consolidated and consolidating Projections of Borrower and its Subsidiaries for the forthcoming Fiscal Year, month by month. (Q) Indebtedness Notices. Within three (3) Business Days after receipt, Borrower shall deliver copies of all notices given or received by Borrower and any of its Subsidiaries with respect to noncompliance with any material term or condition related to any Indebtedness, and shall promptly notify Lender of any potential or actual event of default with respect to any Indebtedness. (R) Landlord Notices. Borrower will deliver copies of any notices received from any landlord (or give notice of any oral notice) immediately upon receipt. In addition, Borrower shall deliver to Lender each month evidence of payment of all amounts due under Borrower's lease at 6520 South 190th Street, Kent, Washington, or any other leased location for which Lender has not received a landlord agreement in form and substance acceptable to Lender. (S) Other Information. With reasonable promptness, Borrower will deliver such other information and data with respect to any Loan Party, any Subsidiary of any Loan Party or the Collateral as Lender may reasonably request from time to time. 5.2 Access to Accountants. Borrower authorizes Lender to discuss the financial condition and financial statements of Borrower and its Subsidiaries with Borrower's independent 31 123 33 public accountants upon reasonable notice to Borrower of its intention to do so, and authorizes such accountants to respond to all of Lender's inquiries. 5.3 Inspection. Borrower shall permit Lender and any authorized representatives designated by Lender to visit and inspect any of the properties of Borrower or any of its Subsidiaries, including its and their financial and accounting records, and to make copies and take extracts therefrom, and to discuss its and their affairs, finances and business with its and their officers and independent public accountants, at such reasonable times during normal business hours and as often as may be reasonably requested. Borrower acknowledges that Lender intends to make such inspections on at least a quarterly basis. 5.4 Collateral Records. Borrower shall keep full and accurate books and records relating to the Collateral and shall mark such books and records to indicate Lender's security interests in the Collateral. 5.5 Account Covenants; Verification. Borrower shall, at its own expense: (a) cause all invoices evidencing Accounts and all copies thereof to bear a notice that such invoices are payable to the lockboxes established in accordance with subsection 5.6 and (b) use its best efforts to assure prompt payment of all amounts due or to become due under the Accounts. No discounts, credits or allowances will be issued, granted or allowed by Borrower to customers except as set forth on Schedule 4.5 and no returns will be accepted without Lender's prior written consent; provided, that until Lender notifies Borrower to the contrary, Borrower may presume consent. Borrower will immediately notify Lender in the event that a customer alleges any dispute or claim with respect to an Account or of any other circumstances known to Borrower that may impair the validity or collectibility of an Account. Lender shall have the right, at any time or times hereafter, to verify the validity, amount or any other matter relating to an Account, by mail, telephone or in person. After the occurrence of a Default or an Event of Default, Borrower shall not, without the prior consent of Lender, adjust, settle or compromise the amount or payment of any Account, or release wholly or partly any customer or obligor thereof, or allow any credit or discount thereon. Lender may notify account debtors to make payments directly to Lender's Depository Account(s) or to Lender's Account; provided, however, that unless a Default or Event of Default has occurred, Lender agrees that it will not deliver such notification unless it determines in its discretion that such action is necessary in order to protect the value of the Collateral or to ensure collection of the Accounts. 5.6 Collection of Accounts and Payments. Borrower and Lender shall establish lockboxes and depository accounts ("Lender's Depository Accounts") with such banks as are acceptable to Lender to which all account debtors shall directly remit all payments on Accounts and in which Borrower will immediately deposit all payments made for Inventory or other payments constituting proceeds of Collateral in the identical form in which such payment was made, whether by cash or check. Borrower hereby agrees that all payments received by Lender, whether by cash, check, wire transfer or any other instrument, made to such Lender Depository Accounts or otherwise received by Lender and whether on the Accounts or as proceeds of other Collateral or otherwise will be the sole and exclusive property of Lender. Borrower, and any of its Affiliates, employees, agents, or other Persons acting for or in concert with Borrower, shall, acting as trustee for Lender, receive, as the sole and exclusive property of Lender, any monies, checks, notes, drafts or any other payments relating to and/or proceeds of Accounts or other Collateral which come into the possession or under the control of Borrower or any of Borrower's Affiliates, employees, 32 124 34 agents or other Persons acting for or in concert with Borrower,and immediately upon receipt thereof, Borrower or such Persons shall remit the same or cause the same to be remitted, in kind, to the Lender Depository Account or to Lender at its address set forth in subsection 9.6 below. 5.7 Endorsement. Borrower hereby constitutes and appoints Lender and all Persons designated by Lender for that purpose as Borrower's true and lawful attorney-in-fact, with power to endorse Borrower's name to any of the items of payment or proceeds described in subsection 5.6 above and all proceeds of Collateral that come into Lender's possession or under Lender's control. Both the appointment of Lender as Borrower's attorney and Lender's rights and powers are coupled with an interest and are irrevocable until payment in full and complete performance of all of the Obligations. 5.8 Corporate Existence. Borrower will, and will cause each of its Subsidiaries to, at all times preserve and keep in full force and effect its corporate existence and all rights and franchises material to its business. Borrower will promptly notify Lender of any change in its or its Subsidiaries' ownership or corporate structure. 5.9 Payment of Taxes. Borrower will, and will cause each of its Subsidiaries to, pay all taxes, assessments and other governmental charges imposed upon it or any of its properties or assets or with respect to any of its franchises, business, income or property before any penalty accrues thereon provided that no such tax need be paid if Borrower or one of its Subsidiaries is contesting same in good faith by appropriate proceedings promptly instituted and diligently conducted and if Borrower or such Subsidiary has established appropriate reserves as shall be required in conformity with GAAP. 5.10 Maintenance of Properties; Insurance. Borrower will maintain or cause to be maintained in good repair, working order and condition all material properties used in the business of Borrower and its Subsidiaries and will make or cause to be made all appropriate repairs, renewals and replacements thereof. Borrower will maintain or cause to be maintained, with financially sound and reputable insurers, public liability and property damage insurance with respect to its business and properties and the business and properties of its Subsidiaries against loss or damage of the kinds customarily carried or maintained by corporations of established reputation engaged in similar businesses and in amounts acceptable to Lender. Borrower shall cause Lender to be named as loss payee on all insurance policies relating to any Collateral and as additional insured under all liability policies, in each case pursuant to appropriate endorsements in form and substance satisfactory to Lender and shall collaterally assign to Lender as security for the payment of the Obligations all business interruption insurance of Borrower. Borrower shall apply any proceeds received from any policies of insurance relating to any Collateral to the Obligations as set forth in subsection 2.4(B). 33 125 35 5.11 Compliance with Laws. Borrower will, and will cause each of its Subsidiaries to, comply with the requirements of all applicable laws, rules, regulations and orders of any governmental authority as now in effect and which may be imposed in the future in all jurisdictions in which Borrower or any of its Subsidiaries is now doing business or may hereafter be doing business, other than those laws the noncompliance with which would not have a Material Adverse Effect. 5.12 Further Assurances. Borrower shall, and shall cause each of its Subsidiaries to, from time to time, execute such guaranties, financing or continuation statements, documents, security agreements, reports and other documents or deliver to Lender such instruments, certificates of title or other documents as Lender at any time may reasonably request to evidence, perfect or otherwise implement the guaranties and security for repayment of the Obligations provided for in the Loan Documents. At Lender's request, Borrower shall cause any Subsidiaries of Borrower promptly to guaranty the Obligations and to grant to Lender security interests in the real, personal and mixed property of such Subsidiary to secure the Obligations. 5.13 Collateral Locations. Borrower will keep the Collateral at the locations specified on Schedule 4.7; provided that Borrower may keep no more than $4,000,000 of Inventory with contractors or subcontractors. Except as permitted by the foregoing sentence, with respect to any new location (which in any event shall be within the continental United States), Borrower will execute such documents and take such actions as Lender deems necessary to perfect and protect the security interests of the Lender in the Collateral prior to the transfer or removal of any Collateral to such new location, and will obtain from the landlord of any leased location such estoppel certificates and collateral access agreements as may be requested by Lender, in form and substance acceptable to Lender. 5.14 Bailees. If any Collateral is at any time in the possession or control of any warehouseman, bailee or any of Borrower's agents or processors, Borrower shall, upon the request of Lender, notify such warehouseman, bailee, agent or processor of the security interests in favor of Lender created hereby and shall instruct such Person to hold all such Collateral for Lender's account subject to Lender's instructions. 5.15 Use of Proceeds and Margin Security. Borrower shall use the proceeds of all Loans for proper business purposes (as described in the recitals to this Agreement) consistent with all applicable laws, statutes, rules and regulations. No portion of the proceeds of any Loan shall be used by Borrower or any of its Subsidiaries for the purpose of purchasing or carrying of margin stock within the meaning of Regulation G or Regulation U, or in any manner that might cause the borrowing or the application of such proceeds to violate Regulation T or Regulation X or any other regulation of the Board of Governors of the Federal Reserve System, or to violate the Exchange Act. 34 126 36 SECTION 6 FINANCIAL COVENANTS Borrower covenants and agrees that so long as any of the Commitments remain in effect and until payment in full of all Obligations and termination of all Lender Letters of Credit, Borrower shall comply with and shall cause each of its Subsidiaries to comply with all covenants in this Section 6 applicable to such Person. 6.1 Tangible Net Worth. Borrower shall at all times maintain Tangible Net Worth of at least $24,500,000. 6.2 Working Capital. Borrower shall at all times maintain Working Capital of at least $19,000,000. 6.3 Minimum EBITDA. Borrower shall maintain EBITDA of at least the amounts set forth below for the Determination Period ending on the last day of each fiscal quarter set forth below.
Minimum EBITDA Amount for Determination Period ------------------- -------------------- 3/96 $ 300,000 6/96 $1,050,000 9/96 $1,050,000 12/96 $1,750,000 3/97 $2,000,000 6/97 $2,500,000 9/97 $2,500,000 12/97 $3,000,000
6.4 Ratio of Liabilities to Tangible Net Worth. The ratio of (a) Borrower's Liabilities, on a consolidated basis, to (b) Borrower's Tangible Net Worth shall at no time be greater than 1.15:1. 6.5 Capital Expenditure Limits. The aggregate amount of all Capital Expenditures of Borrower and its Subsidiaries (excluding trade-ins and excluding Capital Expenditures in respect of replacement assets to the extent funded with casualty insurance proceeds) will not exceed $1,300,000 in any Fiscal Year. In the event that Borrower or any of its Subsidiaries enters into a Capital Lease or other contract with respect to fixed assets, for purposes of 35 127 37 calculating Capital Expenditures under this subsection only, the amount of the Capital Lease or contract initially capitalized on Borrower's or any Subsidiary's balance sheet prepared in accordance with GAAP shall be considered expended in full on the date that Borrower or any of its Subsidiaries enters into such Capital Lease or contract. 6.6 Interest Coverage Ratio. Borrower shall not permit the Interest Coverage Ratio for each Determination Period ending on the last day of each fiscal quarter set forth below to be less than the ratio set forth below for such period.
Interest Coverage Determination Period Ratio for Fiscal Quarter Ending Date Determination Period -------------------------- -------------------- 3/96 not applicable 6/96 0.5 to 1 9/96 0.5 to 1 12/96 1.0 to 1 3/97 1.5 to 1 6/97 2.0 to 1 9/97 2.0 to 1 12/97 3.0 to 1
6.7 Minimum Net Sales to Inventory Ratio. Borrower shall not permit at the end of any month the ratio of (a) net sales of Inventory for the prior twelve (12) month period ending on such date to (b) Inventory as of such date to be less than 3.3 to 1 through and including December 31, 1996 or less than 3.6 to 1 thereafter. SECTION 7 NEGATIVE COVENANTS Borrower covenants and agrees that so long as any of the Commitments remain in effect and until payment in full of all Obligations and termination of all Lender Letters of Credit, unless Borrower has received the prior written consent of Lender, Borrower shall not and will not permit any of its Subsidiaries to: 7.1 Indebtedness and Liabilities. Directly or indirectly create, incur, assume, guaranty, or otherwise become or remain directly or indirectly liable, on a fixed or contingent basis, with respect to any Indebtedness or any agreement with respect to the factoring or sale of Accounts except: (a) the Obligations; (b) intercompany Indebtedness, not to exceed $250,000 outstanding at any time in the aggregate, among Borrower and its Subsidiaries; provided that such Indebtedness is subordinated in right of payment to the Obligations; (c) liabilities under 36 128 38 the Inter-Credit Agreement; (d) Indebtedness not to exceed $3,000,000 in the aggregate at any time outstanding secured by purchase money Liens or under capital leases. Except for Indebtedness described permitted in the preceding sentence, Borrower will not, and will not permit any of its Subsidiaries to, incur any Liabilities except for trade payables and normal accruals in the ordinary course of business not yet due and payable or with respect to which Borrower or any of its Subsidiaries is contesting in good faith the amount or validity thereof by appropriate proceedings and then only to the extent that Borrower or any of its Subsidiaries has established adequate reserves therefor, if appropriate under GAAP. 7.2 Guaranties. Except for endorsements of instruments or items of payment for collection in the ordinary course of business, guaranty, endorse, or otherwise in any way become or be responsible for any obligations of any other Person, whether directly or indirectly by agreement to purchase the indebtedness of any other Person or through the purchase of goods, supplies or services, or maintenance of working capital or other balance sheet covenants or conditions, or by way of stock purchase, capital contribution, advance or loan for the purpose of paying or discharging any indebtedness or obligation of such other Person or otherwise. 7.3 Transfers, Liens and Related Matters. (A) Transfers. Sell, assign (by operation of law or otherwise) or otherwise dispose of, or grant any option with respect to any of the Collateral or the assets of such Person, except that Borrower and its Subsidiaries may (i) sell Inventory in the ordinary course of business; (ii) sell Accounts pursuant to the Inter-Credit Agreement; and (iii) make Asset Dispositions if all of the following conditions are met: (1) the market value of assets sold or otherwise disposed of in any single transaction or series of related transactions does not exceed $500,000 and the aggregate market value of assets sold or otherwise disposed of in any Fiscal Year does not exceed $500,000; (2) the consideration received is at least equal to the fair market value of such assets; (3) the sole consideration received is cash; (4) the net proceeds of such Asset Disposition are applied as required by subsection 2.4(B); (5) after giving effect to the sale or other disposition of the assets included within the Asset Disposition and the repayment of the Obligations with the proceeds thereof, Borrower is in compliance on a pro forma basis with the covenants set forth in Section 6 recomputed for the most recently ended month for which information is available and is in compliance with all other terms and conditions contained in this Agreement; and (6) no Default or Event of Default shall then exist or result from such sale or other disposition. (B) Liens. Except for Permitted Encumbrances, directly or indirectly create, incur, assume or permit to exist any Lien on or with respect to any of the Collateral or the assets of such Person or any proceeds, income or profits therefrom. (C) No Negative Pledges. Enter into or assume any agreement (other than the Loan Documents) prohibiting the creation or assumption of any Lien upon its properties or assets, whether now owned or hereafter acquired. 37 129 39 (D) No Restrictions on Subsidiary Distributions to Borrower. Except as provided herein, directly or indirectly create or otherwise cause or suffer to exist or become effective any consensual encumbrance or restriction of any kind on the ability of any such Subsidiary to: (1) pay dividends or make any other distribution on any of such Subsidiary's capital stock owned by Borrower or any Subsidiary of Borrower; (2) subject to subordination provisions, pay any indebtedness owed to Borrower or any other Subsidiary; (3) make loans or advances to Borrower or any other Subsidiary; or (4) transfer any of its property or assets to Borrower or any other Subsidiary. 7.4 Investments and Loans. Make or permit to exist investments in or loans to any other Person, except: (a) Cash Equivalents; and (b) loans and advances to employees for moving, entertainment, travel and other similar expenses in the ordinary course of business in an aggregate outstanding amount not in excess of $200,000 at any time. 7.5 Restricted Junior Payments. Directly or indirectly declare, order, pay, make or set apart any sum for any Restricted Junior Payment, except that Subsidiaries of Borrower may make Restricted Junior Payments with respect to their common stock to the extent necessary to permit Borrower to pay the Obligations, and to permit Borrower to pay expenses incurred in the ordinary course of business. 7.6 Restriction on Fundamental Changes. (a) Enter into any transaction of merger or consolidation; provided, however, that a Subsidiary may merge into Borrower (so long as Borrower is the surviving corporation) and any wholly-owned Subsidiary may merge with another wholly-owned Subsidiary; (b) liquidate, wind-up or dissolve itself (or suffer any liquidation or dissolution); (c) convey, sell, lease, sublease, transfer or otherwise dispose of, in one transaction or a series of transactions, all or any substantial part of its business or assets, or the capital stock of any of its Subsidiaries, whether now owned or hereafter acquired; or (d) acquire by purchase or otherwise all or any substantial part of the business or assets of, or stock or other evidence of beneficial ownership of, any Person. 7.7 [intentionally omitted] 7.8 Transactions with Affiliates. Directly or indirectly, enter into or permit to exist any transaction (including the purchase, sale or exchange of property or the rendering of any service) with any Affiliate or with any officer, director or employee of any Loan Party, except for transactions in the ordinary course of and pursuant to the reasonable requirements of Borrower's business and upon fair and reasonable terms which are fully disclosed to Lender and which are no less favorable to Borrower than it would obtain in a comparable arm's length transaction with an unaffiliated Person. 7.9 Environmental Liabilities. (a) Violate any applicable Environmental Law; (b) dispose of any Hazardous Materials (except in accordance with applicable law) into or onto or from, any real property owned, leased or operated by any Loan Party; or (c) permit any Lien imposed pursuant to any Environmental Law to be imposed or to remain on any real property owned, leased or operated by any Loan Party. 38 130 40 7.10 Conduct of Business. From and after the Closing Date, engage in any business other than businesses of the type engaged in by Borrower or such Subsidiary on the Closing Date. 7.11 Compliance with ERISA. Establish any new Employee Benefit Plan or amend any existing Employee Benefit Plan if the liability or increased liability resulting from such establishment or amendment is material. Neither Borrower nor any Subsidiary shall fail to establish, maintain and operate each Employee Benefit Plan in compliance in all material respects with the provisions of ERISA, the IRC and all other applicable laws and the regulations and interpretations thereof. 7.12 Tax Consolidations. File or consent to the filing of any consolidated income tax return with any Person other than Borrower, or any of its Subsidiaries. 7.13 Subsidiaries. Establish, create or acquire any new Subsidiaries. 7.14 Fiscal Year. Change its Fiscal Year. 7.15 Press Release; Public Offering Materials. Disclose the name of Lender in any press release or in any prospectus, proxy statement or other materials filed with any governmental entity relating to a public offering of the capital stock of any Loan Party except as may be required by law. 7.16 Bank Accounts. Establish any new bank accounts, or amend or terminate any Blocked Account or lockbox agreement without Lender's prior written consent. SECTION 8 DEFAULT, RIGHTS AND REMEDIES 8.1 Event of Default. "Event of Default" shall mean the occurrence or existence of any one or more of the following: (A) Payment. Failure to make payment of any of the Obligations when due and in the case of interest, such failure shall not be cured within five (5) days of the applicable due date; or (B) Default in Other Agreements. (1) Failure of Borrower or any of its Subsidiaries to pay when due any principal or interest on any Indebtedness or (2) breach or default of Borrower or any of its Subsidiaries with respect to any Indebtedness (other than the Obligations); if such failure to pay, breach or default entitles the holder to cause such Indebtedness having an individual principal amount in excess of $25,000 or having an aggregate principal amount in excess of $50,000 to become or be declared due prior to its stated maturity; or 39 131 41 (C) Breach of Certain Provisions. Failure of Borrower to perform or comply with any term or condition contained in subsections 5.1(F), (G), or (J) through (S) inclusive, 5.3, 5.5 or 5.6 or contained in Section 6 or Section 7; or (D) Breach of Warranty. Any representation, warranty, certification or other statement made by any Loan Party in any Loan Document or in any statement or certificate at any time given by such Person in writing pursuant or in connection with any Loan Document is false in any material respect on the date made; or (E) Other Defaults Under Loan Documents. Borrower or any other Loan Party defaults in the performance of or compliance with any term contained in this Agreement or the other Loan Documents and such default is not remedied or waived within ten (10) days (or solely with respect to subsections 5.1(A), (B), (C), (D), (E), (H) or (I), five (5) days) after receipt by Borrower of notice from Lender of such default (other than occurrences described in other provisions of this subsection 8.1 for which a different grace or cure period is specified or which constitute immediate Events of Default); or (F) [intentionally omitted] (G) Involuntary Bankruptcy; Appointment of Receiver, etc. (1) A court enters a decree or order for relief with respect to Borrower or any of its Subsidiaries in an involuntary case under the Bankruptcy Code or any applicable bankruptcy, insolvency or other similar law now or hereafter in effect, which decree or order is not stayed or other similar relief is not granted under any applicable federal or state law; or (2) the continuance of any of the following events for sixty (60) days unless dismissed, bonded or discharged: (a) an involuntary case is commenced against Borrower or any of its Subsidiaries, under any applicable bankruptcy, insolvency or other similar law now or hereafter in effect; or (b) a decree or order of a court for the appointment of a receiver, liquidator, sequestrator, trustee, custodian or other officer having similar powers over Borrower or any of its Subsidiaries, or over all or a substantial part of their respective property, is entered; or (c) an interim receiver, trustee or other custodian is appointed without the consent of Borrower or any of its Subsidiaries, for all or a substantial part of the property of Borrower or any such Subsidiary; or (H) Voluntary Bankruptcy; Appointment of Receiver, etc. (1) An order for relief is entered with respect to Borrower or any of its Subsidiaries or Borrower or any of its Subsidiaries commences a voluntary case under the Bankruptcy Code or any applicable bankruptcy, insolvency or other similar law now or hereafter in effect, or consents to the entry of an order for relief in an involuntary case or to the conversion of an involuntary case to a voluntary case under any such law or consents to the appointment of or taking possession by a receiver, trustee or other custodian for all or a substantial part of its property; or (2) Borrower or any of its Subsidiaries makes any assignment for the benefit of creditors; or (3) the board of directors of Borrower or any of its Subsidiaries adopts any resolution or otherwise authorizes action to approve any of the actions referred to in this subsection 8.1(H); or 40 132 42 (I) Liens. Any lien, levy or assessment is filed or recorded with respect to or otherwise imposed upon all or any part of the Collateral or the assets of Borrower or any of its Subsidiaries by the United States or any department or instrumentality thereof or by any state, county, municipality or other governmental agency (other than Permitted Encumbrances) and such lien, levy or assessment is not stayed, vacated, paid or discharged within ten (10) days; or (J) Judgment and Attachments. Any money judgment, writ or warrant of attachment, or similar process involving (1) an amount in any individual case in excess of $25,000 or (2) an amount in the aggregate at any time in excess of $50,000 (in either case not adequately covered by insurance as to which the insurance company has acknowledged coverage) is entered or filed against Borrower or any of its Subsidiaries or any of their respective assets and remains undischarged, unvacated, unbonded or unstayed for a period of thirty (30) days or in any event later than five (5) days prior to the date of any proposed sale thereunder; or (K) Dissolution. Any order, judgment or decree is entered against Borrower or any of its Subsidiaries decreeing the dissolution or split up of Borrower or that Subsidiary and such order remains undischarged or unstayed for a period in excess of twenty (20) days; or (L) Solvency. Borrower ceases to be solvent (as represented by Borrower in subsection 4.17) or admits in writing its present or prospective inability to pay its debts as they become due; or (M) Injunction. Borrower or any of its Subsidiaries is enjoined, restrained or in any way prevented by the order of any court or any administrative or regulatory agency from conducting all or any material part of its business and such order continues for more than thirty (30) days; or (N) Invalidity of Loan Documents. Any of the Loan Documents for any reason, other than a partial or full release in accordance with the terms thereof, ceases to be in full force and effect or is declared to be null and void, or any Loan Party denies that it has any further liability under any Loan Documents to which it is party, or gives notice to such effect; or (O) Failure of Security. Lender does not have or ceases to have a valid and perfected first priority security interest in the Collateral (subject to Permitted Encumbrances), in each case, for any reason other than the failure of Lender to take any action within its control or except for Inventory not in excess of $4,000,000 located at Borrower's contractors or subcontractors; or (P) Damage, Strike, Casualty. (1) Any material damage to, or loss, theft or destruction of, any Collateral, whether or not insured, and, if such damage is insured and Borrower has business interruption insurance relating to such casualty, the passage of 60 days or (2) any strike, lockout, labor dispute, embargo, condemnation, act of God or public enemy, or other casualty which causes, for more than sixty (60) consecutive days if Borrower has business interruption insurance which is applicable or fifteen (15) consecutive days if no such 41 133 43 insurance is applicable, the cessation or substantial curtailment of revenue producing activities at any facility of Borrower or any of its Subsidiaries, if any such event or circumstance described in clauses (1) or (2) could reasonably be expected to have a Material Adverse Effect. (Q) Licenses and Permits. The loss, suspension or revocation of, or failure to renew, any license or permit now held or hereafter acquired by Borrower or any of its Subsidiaries, if such loss, suspension, revocation or failure to renew could have a Material Adverse Effect. (R) Forfeiture. There is filed against Borrower any civil or criminal action, suit or proceeding under any federal or state racketeering statute (including, without limitation, the Racketeer Influenced and Corrupt Organization Act of 1970), which action, suit or proceeding (1) is not dismissed within one hundred twenty (120) days; and (2) could result in the confiscation or forfeiture of any material portion of the Collateral. (S) Breach or Default under Inter-Credit Agreement. (1) Failure of Borrower to pay when due any amounts under the Inter-Credit Agreement or (2) the material breach by Borrower of any of the terms, representations, covenants, conditions or provisions of the Inter-Credit Agreement or (3) termination of the Inter-Credit Agreement. 8.2 Suspension of Commitments. Upon the occurrence of any Default or Event of Default, notwithstanding any grace period or right to cure, Lender, without notice or demand, may immediately cease making additional Loans and the Commitments shall be suspended; provided that, in the case of a Default, if the subject condition or event is waived or cured within any applicable grace or cure period, the Commitments shall be reinstated. 8.3 Acceleration. Upon the occurrence of any Event of Default described in the foregoing subsections 8.1(G) or 8.1(H), all Obligations shall automatically become immediately due and payable, without presentment, demand, protest or other requirements of any kind, all of which are hereby expressly waived by Borrower, and the Commitments shall thereupon terminate. Upon the occurrence and during the continuance of any other Event of Default, Lender may, by written notice to Borrower, (a) declare all or any portion of the Obligations to be, and the same shall forthwith become, immediately due and payable and the Commitments shall thereupon terminate and (b) demand that Borrower immediately deposit with Lender an amount equal to one hundred five percent (105%) of the Letter of Credit Reserve to enable Lender to make payments under the Lender Letters of Credit when required and such amount shall become immediately due and payable. 8.4 Remedies. If any Event of Default shall have occurred and be continuing, in addition to and not in limitation of any rights or remedies available to Lender at law or in equity, Lender may exercise in respect of the Collateral, in addition to all other rights and remedies provided for herein or otherwise available to it, all the rights and remedies of a secured party on default under the UCC (whether or not the UCC applies to the affected Collateral) and may also (a) notify any or all obligors on the Accounts to make all payments directly to Lender; (b) require Borrower to, and Borrower hereby agrees that it will, at its expense and upon request 42 134 44 of Lender forthwith, assemble all or part of the Collateral as directed by Lender and make it available to Lender at a place to be designated by Lender which is reasonably convenient to both parties; (c) without notice or demand or legal process, enter upon any premises of Borrower and take possession of the Collateral; and (d) without notice except as specified below, sell the Collateral or any part thereof in one or more parcels at public or private sale, at any of the Lender's offices or elsewhere, at such time or times, for cash, on credit or for future delivery, and at such price or prices and upon such other terms as Lender may deem commercially reasonable. Borrower agrees that, to the extent notice of sale shall be required by law, at least ten (10) days notice to Borrower of the time and place of any public sale or the time after which any private sale is to be made shall constitute reasonable notification. At any sale of the Collateral, if permitted by law, Lender may bid (which bid may be, in whole or in part, in the form of cancellation of indebtedness) for the purchase of the Collateral or any portion thereof for the account of Lender. Lender shall not be obligated to make any sale of Collateral regardless of notice of sale having been given. Borrower shall remain liable for any deficiency. Lender may adjourn any public or private sale from time to time by announcement at the time and place fixed therefor, and such sale may, without further notice, be made at the time and place to which it was so adjourned. To the extent permitted by law, Borrower hereby specifically waives all rights of redemption, stay or appraisal which it has or may have under any law now existing or hereafter enacted. Lender shall not be required to proceed against any Collateral but may proceed against Borrower directly; 8.5 Appointment of Attorney-in-Fact. Borrower hereby constitutes and appoints Lender as Borrower's attorney-in-fact with full authority in the place and stead of Borrower and in the name of Borrower, Lender or otherwise, from time to time in Lender's discretion while an Event of Default is continuing to take any action and to execute any instrument that Lender may deem necessary or advisable to accomplish the purposes of this Agreement, including: (a) to ask, demand, collect, sue for, recover, compound, receive and give acquittance and receipts for moneys due and to become due under or in respect of any of the Collateral; (b) to adjust, settle or compromise the amount or payment of any Account, or release wholly or partly any customer or obligor thereunder or allow any credit or discount thereon; (c) to receive, endorse, and collect any drafts or other instruments, documents and chattel paper, in connection with clause (a) above; (d) to file any claims or take any action or institute any proceedings that Lender may deem necessary or desirable for the collection of any of the Collateral or otherwise to enforce the rights of Lender with respect to any of the Collateral; and (e) to sign and endorse any invoices, freight or express bills, bills of lading, storage or warehouse receipts, assignments, verifications and notices in connection with Accounts and other documents relating to the Collateral. The appointment of Lender as Borrower's attorney and Lender's rights and powers are coupled with an interest and are irrevocable until payment in full and complete performance of all of the Obligations. 8.6 Limitation on Duty of Lender with Respect to Collateral. Beyond the safe custody thereof, Lender shall have no duty with respect to any Collateral in its possession or control (or in the possession or control of any agent or bailee) or with respect to any income thereon or the preservation of rights against prior parties or any other rights pertaining thereto. Lender shall be deemed to have exercised reasonable care in the custody and preservation of the Collateral 43 135 45 in its possession if the Collateral is accorded treatment substantially equal to that which Lender accords its own property. Lender shall not be liable or responsible for any loss or damage to any of the Collateral, or for any diminution in the value thereof, by reason of the act or omission of any warehouseman, carrier, forwarding agency, consignee or other agent or bailee selected by Lender in good faith. 8.7 Application of Proceeds. Upon the occurrence and during the continuance of an Event of Default, (a) Borrower irrevocably waives the right to direct the application of any and all payments at any time or times thereafter received by Lender from or on behalf of Borrower, and Borrower hereby irrevocably agrees that Lender shall have the continuing exclusive right to apply and to reapply any and all payments received at any time or times after the occurrence and during the continuance of an Event of Default against the Obligations in such manner as Lender may deem advisable notwithstanding any previous entry by Lender upon any books and records and (b) the proceeds of any sale of, or other realization upon, all or any part of the Collateral shall be applied: first, to all fees, costs and expenses incurred by Lender with respect to this Agreement, the other Loan Documents or the Collateral; second, to all fees due and owing to Lender; third, to accrued and unpaid interest on the Obligations; fourth, to the principal amounts of the Obligations outstanding; and fifth, to any other indebtedness or obligations of Borrower owing to Lender. 8.8 License of Intellectual Property. Borrower hereby assigns, transfers and conveys to Lender, effective upon the occurrence of any Event of Default hereunder, the non-exclusive right and license to use all Intellectual Property owned or used by Borrower together with any goodwill associated therewith, all to the extent necessary to enable Lender to realize on the Collateral and any successor or assign to enjoy the benefits of the Collateral. This right and license shall inure to the benefit of all successors, assigns and transferees of Lender and its successors, assigns and transferees, whether by voluntary conveyance, operation of law, assignment, transfer, foreclosure, deed in lieu of foreclosure or otherwise. Such right and license is granted free of charge, without requirement that any monetary payment whatsoever be made to Borrower by Lender. 8.9 Waivers, Non-Exclusive Remedies. No failure on the part of Lender to exercise, and no delay in exercising and no course of dealing with respect to, any right under this Agreement or the other Loan Documents shall operate as a waiver thereof; nor shall any single or partial exercise by Lender of any right under this Agreement or any other Loan Document preclude any other or further exercise thereof or the exercise of any other right. The rights in this Agreement and the other Loan Documents are cumulative and are not exclusive of any other remedies provided by law. SECTION 9 MISCELLANEOUS 9.1 Assignments and Participations. Lender may assign its rights and delegate its obligations under this Agreement and further may assign, or sell participations in, all or any part of the Loans, the Commitments or any other interest herein to an Affiliate or to another Person. 44 136 46 In the case of an assignment authorized under this subsection 9.1, the assignee shall have, to the extent of such assignment, the same rights, benefits and obligations as it would if it were a Lender hereunder. Lender shall be relieved of its obligations hereunder with respect to the Commitments or assigned portion thereof. Borrower hereby acknowledges and agrees that any assignment will give rise to a direct obligation of Borrower to the assignee and that the assignee shall be considered to be a "Lender". Lender may furnish any information concerning Borrower and its Subsidiaries in its possession from time to time to assignees and participants (including prospective assignees and participants). 9.2 Set Off. In addition to any rights now or hereafter granted under applicable law and not by way of limitation of any such rights, upon the occurrence of any Event of Default, Lender, each assignee of Lender's interest, and each participant is hereby authorized by Borrower at any time or from time to time, without notice to Borrower or to any other Person, any such notice being hereby expressly waived, to set off and to appropriate and to apply any and all balances held by it at any of its offices for the account of Borrower or any of its Subsidiaries (regardless of whether such balances are then due to Borrower or its Subsidiaries) and any other property at any time held or owing by that Lender or assignee to or for the credit or for the account of Borrower against and on account of any of the Obligations then outstanding; provided, that no participant shall exercise such right without the prior written consent of Lender. Borrower hereby agrees, to the fullest extent permitted by law, that any Lender, assignee or participant may exercise its right of setoff with respect to amounts in excess of its pro rata share of the Obligations (or, in the case of a participant, in excess of its pro rata participation interest in the Obligations) and that such Lender, assignee or participant, as the case may be, shall be deemed to have purchased for cash in the amount of such excess, participations in each other Lender's or holder's share of the Obligations. 9.3 Expenses and Attorneys' Fees. Whether or not the transactions contemplated hereby shall be consummated, Borrower agrees to promptly pay all reasonable fees, costs and expenses incurred by Lender and Heller in connection with any matters contemplated by or arising out of this Agreement or the other Loan Documents or the Inter-Credit Agreement including the following, and all such fees, costs and expenses shall be part of the Obligations, payable on demand and secured by the Collateral: (a) fees, costs and expenses (including attorneys' fees, allocated costs of internal counsel and fees of environmental consultants, accountants and other professionals retained by Lender) incurred in connection with the examination, review, due diligence investigation, documentation and closing of the financing arrangements evidenced by the Loan Documents, subject to the limitations in Lender's proposal letter to Borrower dated November 30, 1995; (b) following the Closing Date, fees, costs and expenses (including attorneys' fees, allocated costs of internal counsel and fees of environmental consultants, accountants and other professionals retained by Lender) incurred in connection with any amendments, waivers, consents, forbearances, and other modifications relating to the Facility Documents or any subordination or intercreditor agreements or actions taken by Lender following any Default; (c) fees, costs and expenses incurred in creating, perfecting and maintaining perfection of Liens in favor of Lender not in excess of $1,000 per year unless an 45 137 47 Event of Default has occurred; (d) fees, costs and expenses incurred in connection with forwarding to Borrower the proceeds of Loans including Lender's standard wire transfer fee; (e) fees, costs, expenses and bank charges, including bank charges for returned checks, incurred by Lender in establishing, maintaining and handling lock box accounts, blocked accounts or other accounts for collection of the Collateral; (f) fees, costs, expenses (including attorneys' fees and allocated costs of internal counsel) and costs of settlement incurred in collecting upon or enforcing rights against the Collateral or incurred in any action to enforce this Agreement or the other Loan Documents or the Inter-Credit Agreement or to collect any payments due from Borrower or any other Loan Party under this Agreement or any other Loan Document or the Inter-Credit Agreement or incurred in connection with any refinancing or restructuring of the credit arrangements provided under this Agreement, whether in the nature of a "workout" or in connection with any insolvency or bankruptcy proceedings or otherwise. 9.4 Indemnity. In addition to the payment of expenses pursuant to subsection 9.3, whether or not the transactions contemplated hereby shall be consummated, Borrower agrees to indemnify, pay and hold Lender, and the officers, directors, employees, agents, consultants, auditors, persons engaged by Lender to evaluate or monitor the Collateral, affiliates and attorneys of Lender and such holders (collectively called the "Indemnitees") harmless from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, costs, expenses and disbursements of any kind or nature whatsoever (including the fees and disbursements of counsel for such Indemnitees in connection with any investigative, administrative or judicial proceeding commenced or threatened, whether or not such Indemnitee shall be designated a party thereto) that may be imposed on, incurred by, or asserted against that Indemnitee, in any manner relating to or arising out of this Agreement or the other Loan Documents, the consummation of the transactions contemplated by this Agreement, the statements contained in the commitment letters, if any, delivered by Lender, Lender's agreement to make the Loans hereunder, the use or intended use of the proceeds of any of the Loans or the exercise of any right or remedy hereunder or under the other Loan Documents (the "Indemnified Liabilities"); provided that Borrower shall have no obligation to an Indemnitee hereunder with respect to Indemnified Liabilities arising from the gross negligence or willful misconduct of that Indemnitee as determined by a court of competent jurisdiction. 9.5 Amendments and Waivers. No amendment, modification, termination or waiver of any provision of this Agreement or of the other Loan Documents, or consent to any departure by Borrower therefrom, shall be effective unless the same shall be in writing and signed by Lender and Borrower. Each amendment, modification, termination or waiver shall be effective only in the specific instance and for the specific purpose for which it was given. 9.6 Notices. Unless otherwise specifically provided herein, all notices shall be in writing addressed to the respective party as set forth below and may be personally served, telecopied or sent by overnight courier service or United States mail and shall be deemed to have been given: (a) if delivered in person, when delivered; (b) if delivered by telecopy, on the date of transmission if transmitted on a Business Day before 4:00 p.m. Los Angeles time or, if not, on the next succeeding Business Day; (c) if delivered by overnight courier, two (2) days after 46 138 48 delivery to such courier properly addressed; or (d) if by U.S. Mail, four (4) Business Days after depositing in the United States mail, with postage prepaid and properly addressed. If to Borrower: SUN SPORTSWEAR, INC. 6520 190th Street Kent, Washington 98032 Attn: Chief Financial Officer Telecopy No.: (206) 251-6133 If to Lender: HELLER FINANCIAL, INC. Attn: CAMG Portfolio Manager 505 North Brand Boulevard Glendale, California 91203 Telecopy No.: (818) 246-6380 With a copy to: HELLER FINANCIAL, INC. Attn: Legal Department 505 North Brand Boulevard Glendale, California 91203 Telecopy No.: (818) 548-4963 or to such other address as the party addressed shall have previously designated by written notice to the serving party, given in accordance with this subsection 9.6. 9.7 Survival of Warranties and Certain Agreements. All agreements, representations and warranties made herein shall survive the execution and delivery of this Agreement and the making of the Loans hereunder. Notwithstanding anything in this Agreement or implied by law to the contrary, the agreements of Borrower set forth in subsections 9.3 and 9.4 shall survive the payment of the Loans and the termination of this Agreement. 9.8 Indulgence Not Waiver. No failure or delay on the part of Lender in the exercise of any power, right or privilege shall impair such power, right or privilege or be construed to be a waiver of any default or acquiescence therein, nor shall any single or partial exercise of any such power, right or privilege preclude other or further exercise thereof or of any other right, power or privilege. 9.9 Marshaling; Payments Set Aside. Lender shall not be under any obligation to marshal any assets in favor of any Loan Party or any other party or against or in payment of any or all of the Obligations. To the extent that any Loan Party makes a payment or payments to Lender or Lender enforces its security interests or exercise its rights of setoff, and such payment or payments or the proceeds of such enforcement or setoff or any part thereof are subsequently invalidated, declared to be fraudulent or preferential, set aside and/or required to be repaid to 47 139 49 a trustee, receiver or any other party under any bankruptcy law, state or federal law, common law or equitable cause, then to the extent of such recovery, the Obligations or part thereof originally intended to be satisfied, and all Liens, rights and remedies therefor, shall be revived and continued in full force and effect as if such payment had not been made or such enforcement or setoff had not occurred. 9.10 Entire Agreement. This Agreement, and the other Loan Documents referred to herein embody the final, entire agreement among the parties hereto and supersede any and all prior commitments, agreements, representations, and understandings, whether written or oral, relating to the subject matter hereof and may not be contradicted or varied by evidence of prior, contemporaneous, or subsequent oral agreements or discussions of the parties hereto. There are no oral agreements among the parties hereto. 9.11 Independence of Covenants. All covenants hereunder shall be given independent effect so that if a particular action or condition is not permitted by any of such covenants, the fact that it would be permitted by an exception to, or be otherwise within the limitations of, another covenant shall not avoid the occurrence of a Default or an Event of Default if such action is taken or condition exists. 9.12 Severability. The invalidity, illegality or unenforceability in any jurisdiction of any provision in or obligation under this Agreement or the other Loan Documents shall not affect or impair the validity, legality or enforceability of the remaining provisions or obligations under this Agreement, or the other Loan Documents or of such provision or obligation in any other jurisdiction. 9.13 Headings. Section and subsection headings in this Agreement are included herein for convenience of reference only and shall not constitute a part of this Agreement for any other purpose or be given any substantive effect. 9.14 APPLICABLE LAW. THIS AGREEMENT SHALL BE GOVERNED BY, AND SHALL BE CONSTRUED AND ENFORCED IN ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE OF CALIFORNIA, WITHOUT REGARD TO CONFLICTS OF LAWS PRINCIPLES. 9.15 Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns except that Borrower may not assign its rights or obligations hereunder without the prior written consent of Lender. 9.16 No Fiduciary Relationship; Limitation of Liabilities. (A) No provision in this Agreement or in any of the other Facility Documents and no course of dealing between the parties shall be deemed to create any fiduciary duty by Lender to Borrower. 48 140 50 (B) Neither Lender, nor any affiliate, officer, director, shareholder, employee, attorney, or agent of Lender shall have any liability with respect to, and Borrower hereby waives, releases, and agrees not to sue any of them upon, any claim for any special, indirect, incidental, or consequential damages suffered or incurred by Borrower in connection with, arising out of, or in any way related to, this Agreement or any of the other Facility Documents, or any of the transactions contemplated by this Agreement or any of the other Facility Documents. Borrower hereby waives, releases, and agrees not to sue Lender or any of Lender's affiliates, officers, directors, employees, attorneys, or agents for punitive damages in respect of any claim in connection with, arising out of, or in any way related to, this Agreement or any of the other Facility Documents, or any of the transactions contemplated by this Agreement or any of the transactions contemplated hereby. 9.17 CONSENT TO JURISDICTION. BORROWER HEREBY CONSENTS TO THE JURISDICTION OF ANY STATE OR FEDERAL COURT LOCATED WITHIN THE COUNTY OF LOS ANGELES, STATE OF CALIFORNIA AND IRREVOCABLY AGREES THAT, SUBJECT TO LENDER'S ELECTION, ALL ACTIONS OR PROCEEDINGS ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE OTHER LOAN DOCUMENTS SHALL BE LITIGATED IN SUCH COURTS. BORROWER ACCEPTS FOR ITSELF AND IN CONNECTION WITH ITS PROPERTIES, GENERALLY AND UNCONDITIONALLY, THE NON-EXCLUSIVE JURISDICTION OF THE AFORESAID COURTS AND WAIVES ANY DEFENSE OF FORUM NON CONVENIENS, AND IRREVOCABLY AGREES TO BE BOUND BY ANY FINAL JUDGMENT RENDERED THEREBY IN CONNECTION WITH THIS AGREEMENT, THE OTHER LOAN DOCUMENTS OR THE OBLIGATIONS. 9.18 WAIVER OF JURY TRIAL. BORROWER AND LENDER HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF THIS AGREEMENT OR THE OTHER LOAN DOCUMENTS. BORROWER AND LENDER ACKNOWLEDGE THAT THIS WAIVER IS A MATERIAL INDUCEMENT TO ENTER INTO A BUSINESS RELATIONSHIP, THAT EACH HAS ALREADY RELIED ON THE WAIVER IN ENTERING INTO THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS AND THAT EACH WILL CONTINUE TO RELY ON THE WAIVER IN THEIR RELATED FUTURE DEALINGS. BORROWER AND LENDER FURTHER WARRANT AND REPRESENT THAT EACH HAS REVIEWED THIS WAIVER WITH ITS LEGAL COUNSEL, AND THAT EACH KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL. 9.19 Construction. Borrower and Lender each acknowledge that it has had the benefit of legal counsel of its own choice and has been afforded an opportunity to review this Agreement and the other Loan Documents with its legal counsel and that this Agreement and the other Loan Documents shall be construed as if jointly drafted by Borrower and Lender. 9.20 Counterparts; Effectiveness. This Agreement and any amendments, waivers, consents, or supplements may be executed in any number of counterparts and by different parties 49 141 51 hereto in separate counterparts, each of which when so executed and delivered shall be deemed an original, but all of which counterparts together shall constitute but one and the same instrument. This Agreement shall become effective upon the execution of a counterpart hereof by each of the parties hereto. 9.21 No Duty. All attorneys, accountants, appraisers, and other professional Persons and consultants retained by Lender shall have the right to act exclusively in the interest of Lender and shall have no duty of disclosure, duty of loyalty, duty of care, or other duty or obligation of any type or nature whatsoever to Borrower or any of Borrower's shareholders or any other Person. 9.22 Confidentiality. Lender shall hold all nonpublic information identified as such by Borrower, including Projections and open customer order reports, in accordance with such Person's customary procedures for handling confidential information of this nature and in accordance with safe and sound business practices and in any event may make disclosure to such of its respective Affiliates, officers, directors, employees, agents and representatives as need to know such information in connection with the Loans. If Lender is otherwise a creditor of Borrower, Lender may use the information in connection with its other credits. Lender may also make disclosure reasonably required by a bona fide offeree or assignee (or participation), or as required or requested by any Governmental Authority or representative thereof, or pursuant to legal process, or to its accountants, lawyers and other advisors, and shall require any such offeree or assignee (or participant) to agree (and require any of its offerees, assignees or participants to agree) to comply with this Section 9.22. If Lender discloses confidential information to its accountants, lawyers or other advisors, it agrees to advise such Persons that such information is confidential, but Lender shall have no responsibility for such Persons. In no event shall Lender be obligated or required to return any materials furnished by Borrower; provided, however, each offeree shall be required to agree that if it does not become a assignee (or participant) it shall return all materials furnished to it by Borrower in connection herewith. 50 142 52 Witness the due execution hereof by the respective duly authorized officers of the undersigned as of the date first written above. HELLER FINANCIAL, INC. SUN SPORTSWEAR, INC. By: /s/ David M. Reza By: /s/ Kevin James ----------------------- ------------------------ Name: David M. Reza Name: Kevin James ----------------------- ------------------------ Title: Senior Vice President Title: Senior VP & CFO ----------------------- ------------------------ FEIN: 91-1132620 ------------------------ 51 143 EX-27 6 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from Form 10-K for the year ended December 31, 1995 and is qualified in its entirety by reference to such financial statements. 0000856711 SUN SPORTSWEAR, INC. 1 U.S. DOLLARS YEAR DEC-31-1995 JAN-01-1995 DEC-31-1995 1 2,006,633 0 13,148,592 46,317 23,631,358 42,468,005 10,904,0830 6,072,089 47,315,106 21,048,691 247,996 0 0 21,618,339 4,400,080 47,315,106 93,965,325 93,965,325 84,569,855 98,533,938 1,066,461 0 1,267,442 (5,635,074) (1,898,620) (3,736,454) 0 0 0 (3,736,454) (0.65) (0.65)
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