-----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, J8zDsaWrIxllaKZSJjtiUscz6yVrL08naQbay5U/vfqWuYL81JgQT5GdgEmNqNkx a9HwvII0fuPwC2Wvhf7UsA== 0000950137-97-002679.txt : 19970812 0000950137-97-002679.hdr.sgml : 19970812 ACCESSION NUMBER: 0000950137-97-002679 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 13 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970811 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: DECORATIVE HOME ACCENTS INC CENTRAL INDEX KEY: 0001000453 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS FABRICATED TEXTILE PRODUCTS [2390] IRS NUMBER: 570998387 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 033-96794 FILM NUMBER: 97656064 BUSINESS ADDRESS: STREET 1: INDUSTRIAL PARK DR STREET 2: P.O. BOX 11877 CITY: ABBEVILLE STATE: SC ZIP: 29620 BUSINESS PHONE: 8644462123 MAIL ADDRESS: STREET 1: P.O. BOX 1187 CITY: ABBEVILLE STATE: SC ZIP: 29620 10-K405 1 FORM 10-K 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------------------------- FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1996 Commission File Number 33-96794 -------------------------------------- DECORATIVE HOME ACCENTS, INC. (Exact name of registrant as specified in its charter) Delaware 57-0998387 (State of Incorporation) (I.R.S. Employer ID No.) Industrial Park Drive, Abbeville, South Carolina 29620 (Address of principal executive offices) (Zip Code) (803) 446-3163 (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ ] No [X] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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 May 15, 1997, there were 109,737 shares outstanding of the Registrant's Class A Common Stock ($0.01 par value), 1,756,126 shares outstanding of the Registrant's Class B Non-Voting Common Stock ($0.01 par value), 386,040 shares outstanding of the Registrant's Class C Common Stock ($0.01 par value), 808,333 shares outstanding of the Registrant's Class D Common Stock ($0.01 par value), 118,100 shares outstanding of the Registrant's Class F Common Stock and 50,000 shares outstanding of the Registrant's 14% Cumulative Redeemable Preferred Stock ($0.01 par value). DOCUMENTS INCORPORATED BY REFERENCE: None No annual report or proxy material have been sent to security holders during the last fiscal year. ================================================================================ 2 PART I ITEM 1. BUSINESS GENERAL Decorative Home Accents, Inc. (the "Company") through its direct wholly owned subsidiaries, The Rug Barn, Inc. (the "Rug Barn") and Home Innovations, Inc. ("HII" or "Home Innovations"), designs, manufactures and markets an extensive line of decorative home accessories. The Rug Barn's products include decorative throws, pillows, table runners, placemats, rugs and golf towels. HII manufactures accessories in four major product areas: bath furnishings, window treatments, bedding products, and the Calvin Klein Home Collection, a line of designer home products launched in September 1995 under the "Calvin Klein" trademark. The Company competes in selected niches of the home accessories industry under the Home Innovations, R.A. Briggs, Calvin Klein Home, The Rug Barn, QTI Sports and Hedges & Ivy labels. The Company's products are marketed worldwide to distributors and retailers. All of the Company's manufacturing facilities are located in the United States. In 1994, the Company was formed as a holding company to purchase certain assets and assume certain liabilities from a group of commonly controlled companies known as International Textile Fabrics, Inc. ("ITF") and to acquire certain other assets from the principal shareholder of ITF. The primary products of ITF were decorative throws, pillows, table runners, placemats, rugs and golf towels. Substantially all products were marketed under the names The Rug Barn and QTI Sports. In July 1995, the Company acquired HII in a merger transaction for total cash consideration of approximately $95.1 million, after a $6.7 million adjustment to the purchase price, including acquisition related costs of approximately $2.0 million. The Company also assumed approximately $35.0 million in liabilities of HII. Concurrent with the merger, the Company completed the offering and sale of (i) 125,000 units (the "Units"), each unit consisting of one $1,000 principal amount Series A note and one share (a "Share") of the Company's Class F common stock, par value $0.01 per share (the "Class F Common Stock"), and (ii) 50,000 shares of 14% cumulative redeemable preferred stock (the "Preferred Stock"), 808,333 shares of Class D common stock (the "Class D Common Stock") and warrants to purchase shares of Class D Common Stock. In addition to using the net proceeds from these offerings to pay the merger consideration, the Company refinanced certain existing indebtedness of the Rug Barn in an aggregate principal amount of approximately $66.9 million with the proceeds from the sale of the Units. Subsequently, the Units were separated and the Series A Notes were exchanged for Series B Notes pursuant to an exchange offer effective December 26, 1995. The Series B Notes (the "Senior Notes") issued pursuant to the exchange offering may be offered for resale, resold or otherwise transferred by holders thereof, subject to the transfer restrictions under the federal securities laws. The Notes bear interest at 13% per annum payable semi-annually on June 30 and December 31 of each year. The principal amount of the Notes is non amortizing with final maturity in June of 2002. The Notes are unconditionally, jointly and severally guaranteed by each of the Rug Barn and HII and each of HII's subsidiaries. The Preferred Stock has a dividend rate of 14% which is payable quarterly. Dividends on the Preferred Stock must be paid in cash unless prohibited by the terms of the indenture agreement governing the Senior Notes (the "Indenture") or the revolving credit facility (the "Revolving Credit Facility") available to the Rug Barn, HII and each of HII's subsidiaries, in which case dividends must be paid, in lieu of cash, by the issuance of additional Preferred Stock in an amount based upon a 15% annual dividend rate on the Preferred Stock. The Preferred Stock is redeemable at any time, in whole or part without penalty at the option of the Company and, subject to certain conditions, at the option of the holders of the Preferred Stock. Since the Company's acquisition of HII, the Company's strategy has been to upgrade the product lines, integrate HII with the Rug Barn, realize certain expense and sales synergies and establish the Calvin Klein Home Collection as the leader in designer home accessories. During 1996 the Company integrated certain overhead functions and eliminated certain duplicative functions through cost and headcount reduction programs. During 1996 the Company had not implemented a marketing plan to achieve any sales synergies related to the gift division. In April 1997, the Company introduced the gift division's product line to mass merchandisers. Through the HII merger 2 3 transaction the Company positioned itself to serve all major channels of distribution in the home accessories market from large mass merchandisers to small individual gift shops with niche oriented products. These niche markets include the jacquard woven throw, coordinated bath and bedding accessories, window treatment and fashion bedding markets. The introduction of the Calvin Klein Home Collection further enhances the Company's niche orientation. The Company is the exclusive master licensee of all Calvin Klein home accessories, including soft home products such as bedding, sheets, towels and curtains, as well as non-soft home goods such as flatware, glassware and furniture, and has a right of negotiation to license the "CK" trademark in connection with such products. CAPITAL RESTRUCTURING PLAN On May 15, 1997, the Company reached an agreement in principle with certain of the Company's bond holders and equity holders providing for a comprehensive capital restructuring plan that, among other things, (i) converts the outstanding principal amount and accrued interest on its 13% Senior Notes into common equity, (ii) provided $20 million in the form of a secured term loan for working capital purposes and (iii) makes provision for a subsequent rights offering to raise permanent equity capital of up to $20 million. The restructuring agreement was entered into by the Company's preferred stockholder TCW Special Credits Fund V - The Principal Fund ("Fund V") and the beneficial owners of approximately 76% of the principal amount of the Senior Notes, Magten Asset Management Corp., solely as agent for various of its investment advisory clients in their respective accounts at Magten ("Magten"), and CIGNA. The restructuring plan will, among other things, (i) convert the outstanding $118.1 million principal plus all accrued and unpaid interest on the Senior Notes into 92.5% of the Company's common equity, (ii) exchange all the Company's 14% cumulative preferred stock outstanding into 7.5% of the common equity and a 5 year warrant to purchase up to 7.5% of the fully diluted common equity, and (iii) exchange all of the classes of common stock into a 5 year warrant to purchase up to 2.5% of the fully diluted equity. In connection with the Company's capital restructuring plan, the Company did not pay interest on the Senior Notes due June 30, 1997. Pursuant to the restructuring, Magten provided the Company with a secured term loan facility of up to $20 million (the "Term Loan Facility"). As of the date of this filing, the entire $20 million has been borrowed under the Term Loan Facility. Additionally, the Indenture was modified to permit the Company to incur the Term Loan Facility. It is contemplated that the Term Loan Facility will be repaid with the proceeds of a rights offering to purchase additional shares of the Company's common stock upon a consummation of the restructuring. The proposed restructuring plan also provides that Magten and Fund V will each agree to exercise all rights and/or oversubscription options issued to them in the rights offering so that the Company will receive sufficient proceeds from the rights offering to pay in full in cash all of the indebtedness under the Term Loan Facility. The proposed restructuring plan and Magten's and Fund V's related commitments are subject to various conditions, including due diligence by Magten and the parties entering into definitive documents. If the above described restructuring is consummated, management believes that the transactions contemplated thereby will generate additional proceeds that will be adequate to finance anticipated operational needs, planned capital expenditures and meet debt service obligations for the remainder of 1997. Management of the Company expects that a pre-negotiated filing under the provisions of Chapter 11 of the United States Bankruptcy Code will be necessary to effect the restructuring. The Company intends to present its plan of reorganization simultaneously with its bankruptcy filing, and seek confirmation thereof at the earliest possible opportunity. The Company expects that a pre-negotiated filing under the provisions of Chapter 11 of the United States Bankruptcy Code will occur in mid August, 1997, although no assurance can be given in that regard. See Management's Discussion and Analysis of Financial Condition and Results of Operations for a discussion of the significant liquidity shortage which impacted the Company during 1996 and 1997. INDUSTRY The Company competes in the domestic and foreign decorative home accessories market which is characterized by a variety of product niches and distribution channels. The Company's specific market encompasses 3 4 the decorative home accessories segments of both the fragmented giftware market and the more traditional home textile market. PRODUCTS The Company has five major product divisions: gift division, bath furnishings, window treatments, bedding products, and Calvin Klein Home Collection. General descriptions are included below. Gift Division. The gift division's products include decorative throws, pillows, table runners, placemats, rugs and golf towels. The gift division utilizes the jacquard weaving process to produce decorative home products manufactured in complementary colors and designs. The gift division's products are primarily marketed under The Rug Barn, Hedges & Ivy and QTI Sports labels. General descriptions of the gift division's product lines are included below. Throws. Throws represent the largest segment of the gift division's product mix. The throws are woven in 2-layer, 3-layer and tapestry versions (typically referred to as 2-ply, 3-ply and picturesque). Adding a third layer to a throw adds weight and enables the throw to be produced with additional colors and designs. The designs, styles, and colors of the Company's throw product line are generated either from the Company's internal design staff or external designers or licensers. The Company has affiliations with outside designers including Warren Kimble, Laurel Burch, Oliveria Brandewein, The Fraser Collection, Sanderson, Guy Harvey, Sony Signatures, Tracy Porter and Sam Butcher, designer of the popular line Precious Moments. Additionally, the Company has product licensing arrangements with 125 NCAA colleges and universities as well as the Professional Golf Association and Major League Baseball. The Company also has developed a custom throw business which enables customers to customize the design and coloration of the throw. Also, the gift division offers rayon and acrylic chenille throws in a broad range of decorative colors. Pillows. The gift division introduced its line of decorative pillows in June 1993, and currently offers an assortment of pillows many of which coordinate with the best selling throws. Pillows are available in approximately 30 different designs. Placemats and Table Runners. The gift division began producing its "tabletop" collection of jacquard woven cotton placemats and table runners in January 1993 and currently offers a broad assortment of designs. In most cases, the placemats and table runners are available as matching sets. Rugs. The gift division currently offers a limited selection of jacquard woven cotton throw rugs. The rugs are made using the same manufacturing process as the Company's other jacquard woven products, but are distinguished from other product categories in that they are woven with heavier yarn to be more durable for day to day use. The gift division is currently expanding its rug offerings through both printed and hand-hooked wool rugs. Golf and Sport Towels. The gift division also produces terry cloth golf and locker towels which display the logos of golf courses, country clubs and resorts. These products are marketed and produced on a custom basis. Bath Furnishings. The bath furnishings division product offering consists of shower curtains, embellished towels and coordinated accessories. These products are marketed under two brands: the Accents by Home Innovations line for mass merchandisers and national chains and the Home Innovations line for department and specialty stores. HII uses various techniques in manufacturing its towels such as printing, embellishing and embroidering, thus enabling the Company to supply a wide variety of product types and styles. Window Treatments. The window treatment division produces a wide variety of window treatments and coordinates such as wallpaper borders, placemats, chairpads and fabric by the yard. The Company has diversified from the marketing of traditional bedroom and living room window treatments to other areas such as the kitchen and 4 5 bathroom environments. These products are marketed under two brands: the Accents by Home Innovations line for mass merchandisers and national chains and the Home Innovations line for department and specialty stores. Bedding Products. The Company's bedding products division is organized around two brands: the Home Innovations line, consisting of jacquard-woven, 200-thread count, 50/50 cotton/polyester blend sheets and accessories targeted at department stores and mid-market retailers; and the Marquis line, a collection of 180 thread count, 50/50 cotton/polyester blend sheets and accessories, targeted at the mass merchandise market. Bedding division products include comforters, bedspreads, pillow shams, decorative pillows, dust ruffles and other accessories. Calvin Klein Home Collection. In May 1994, HII, through its wholly owned subsidiary, Calvin Klein Home, Inc.("Calvin Klein Home"), became Calvin Klein Inc.'s ("Calvin Klein") exclusive master licensee to introduce the Calvin Klein Home Collection under the "Calvin Klein" trademark. The original license covered North and South America, Europe and the Caribbean (the "Licensed Territory"). This license agreement had an initial term ending December 31, 1997, with an automatic renewal period of three years commencing January 1, 1998, and one additional three-year renewal term commencing on January 1, 2001, at the sole option of Calvin Klein Home, Inc. subject to meeting certain minimum sales targets. Under the original agreement, the total term of the contract would have been nine years plus 9 months. Under the license agreement, Calvin Klein Home has guaranteed Calvin Klein certain minimum royalties in exchange for an exclusive right to use the "Calvin Klein" logo in connection with the manufacture, distribution and sale within the Licensed Territory of home products covered by the license (the "Licensed Products"). In addition to the "Calvin Klein" logo, the license agreement permits Calvin Klein Home to use the "CK/Calvin Klein" trademark in certain circumstances. The license agreement provides that, in the event that Calvin Klein receives a proposal for a license to use the "CK/Calvin Klein" trademark, including the "CK" logo on Licensed Product in the Licensed Territory, Calvin Klein will offer Calvin Klein Home the opportunity to enter into good faith negotiation regarding a license agreement for such trademark on terms that are no less favorable than such proposed license. In connection with the restructuring plan discussed elsewhere herein (See "Management's Discussion and Analysis of Financial Condition and Results of Operations") the original license described above was terminated and an interim license entered into upon similar terms and conditions. As part of the interim license agreement, the Company changed the name of Calvin Klein Home, Inc. to DHA Home, Inc. ("DHA Home"). The interim license expires on the earlier of (i) April 30, 1998, or (ii) upon the successful completion of the restructuring plan. 5 6 The collection of Licensed Products includes the following:
SOFT PRODUCTS NON-SOFT PRODUCTS ------------- ----------------- Comforters Dinnerware, including: Sheets glassware Towels woodenware Bedspreads crystal Quilts flatware Area rugs china Shams porcelain Dust ruffles cutlery Decorative pillows Window treatments Gift and accessory products, including: Fabric covered accessories picture frames Shower curtains baskets Bath rugs decorative gifts Ceramic and laminated accessories paper partyware Bath valances photo albums Duvets and duvet covers gift wrap Packaged fabric by the yard stationary products Coordinated fabric furniture Coordinated wall borders carpet Furniture covers wallpaper Napkins Placemats Chair ads Table rounds Tablecloths Bed pillows Throws Blankets Closet and storage accessories Kitchen textiles
With respect to the non-soft Licensed Products, the license provides that DHA Home shall have entered into sublicenses by January 1, 1996 in order to retain the exclusive right to manufacture, distribute and sell at wholesale such products in the Licensed Territory. Calvin Klein, Inc., however, has sole discretion in approving the selection of all sublicensees, as well as the styles, designs, packaging, components, workmanship, quality, display, merchandising, advertising and promotion of all Licensed Products. DHA Home has entered into a Sublicense Agreement with Swid Powell, Inc. as sublicensee for the production of dinnerware and selected giftware. Although the deadline to sublicense has passed, DHA Home is currently working closely with Calvin Klein, Inc. in determining appropriate sublicensees and the timing of introduction of the other non-soft Licensed Products. No assurance can be given that any additional sublicensees will be approved by Calvin Klein. Certain non-soft products sold outside of the Company's targeted distribution channels will not be sub-licensed by the Company. The Company has agreed to allow Calvin Klein, Inc. to license this sale of non-soft products directly. PRODUCT DESIGN AND DEVELOPMENT Because the demand for decorative home furnishings and home textile products is based on their fashion appeal to retailers and ultimately consumers, the success of the Company's business is highly dependent upon the 6 7 Company's ability to design and develop a wide range of attractive products and a wide array of colors and color combinations at attractive price points. The Company has made a significant investment in design automation equipment including CAD/CAM equipment. The Company employs a design staff of approximately 25 people to constantly evaluate trends in home furnishings design and to introduce new product designs and construction throughout all channels of distribution. Additionally, the Company has entered into numerous licensing agreements to facilitate further product development and enhancement. Significant time is spent by employees in activities such as meeting with stylists, designers, customers, suppliers, and machinery manufacturers as well as producing samples and running trials in order to develop new products and markets. These activities are performed at various levels and at various locations and their specifically identifiable incremental costs are not material in relation to the Company's total operating costs. MARKETING AND DISTRIBUTION The Company markets its products through most major decorative giftware and home textiles distribution channels, including gift shops, department stores, mass merchandisers and specialty stores. The Company attempts to achieve differentiation by offering products which it believes have better quality or more unique styling than competing products at equal or lower prices. In the case of The Rug Barn's throws, the Company focuses on fashionable colors and designs as well as custom and licensed designs. Home Innovations focuses on providing quality bedding, bath and window treatment products through steadfast attention to current fashionable designs and popular color schemes. The Company seeks additional differentiation through the use of coordinated presentations. The Company's manufacturing process enables Home Innovations to ship coordinated products from the same distribution center in one shipment, thereby encouraging the retailer to display the products as a set. The Rug Barn distributes its products to 15,000 - 20,000 gift accounts nationwide in orders as small as four units. The Company believes that The Rug Barn's guaranteed 48-hour turnaround time on in-stock items allows small specialty retailer or gift shop operators to minimize their inventory investments and effectively operate on a "just in time" basis. Home Innovations' distribution strategy is similar to The Rug Barn's. Home Innovations' current manufacturing process enables it to produce products in small production runs, allowing minimum print runs of approximately 2,500 yards. The Rug Barn distributes its throws and accessories primarily through a nationwide network of external regional sales representatives. Most of these representatives have salespeople who do not sell products that compete with The Rug Barn's products. In addition to its network of external sales representatives, The Rug Barn employs internal account executives who handle selected large department stores, mass merchandisers and custom accounts. International accounts are serviced by internal account executives through a network of independent agents and distributors. HII distributes its products through a team of dedicated internal account executives in addition to various external regional independent sales representatives. Mass merchandisers and large department store accounts are handled primarily by HII personnel, while small and medium size department stores and specialty stores are handled outside the company by independent sales representatives. Because department store, mass merchandiser and specialty store distribution tends to be relationship driven, HII seeks to maintain excellent relationships with most major retail purchasers, or "buyers." MANUFACTURING The Rug Barn. The Rug Barn's throws, placemats, cotton rugs, pillows and blankets/coverlets are manufactured in its 400,000 square foot manufacturing facility in Abbeville, South Carolina. Certain non-cotton throws and rug production is outsourced to independent producers in China. The Rug Barn's manufacturing facility includes computerized jacquard looms that allow the Rug Barn to transform an artist's throw design into a newly-woven throw in a matter of hours. 7 8 Home Innovations. HII manufactures window treatments and shower curtains at its Draymore facility in Mooresville, North Carolina; bedding products at its Glenn Facility in Morven, North Carolina; and bath products at its two facilities in Lake Zurich, Illinois. Management of the Company expects to relocate the manufacturing of bath products to South Carolina in 1998. Provided that the company has sufficient funds the Company plans to invest $3.4 million in new equipment related to the relocation of its bath division. DHA Home products are manufactured at HII's cut-and-sew operation in Wadesboro, North Carolina from imported printed fabric goods. Additionally, certain items are purchased from domestic or foreign manufacturers. HII does not manufacture "commodity" materials or products; instead it focuses on processes that it believes command higher margins by adding unique value. For example, HII has chosen not to weave its own towel blanks, but rather add value by embellishing pre-existing towel blanks. Management believes that the large number of greige goods providers and level of vendor competition generally enables HII to purchase its raw materials more cost-effectively than if it weaved its own fabric. See "Business - Raw Materials." HII's cut-and-sew operations are labor intensive and production lines are organized to optimize labor productivity while retaining the flexibility to adapt to ever-changing designs and styles. HII's strategy depends upon experienced operations management to integrate its design, printing, manufacturing and distribution capabilities into a competitive cost structure. Pursuant to its long-term strategy, management has begun to upgrade the Company's management information systems and share design systems used by The Rug Barn with the goal of enhancing the overall productivity of the Company's consolidated manufacturing operations. Because of the liquidity shortage faced by the Company during 1996 and early 1997, the implementation of this strategy has been delayed. CUSTOMERS During 1996, five department stores or mass merchandisers accounted for approximately 32.2% of the Company's total net sales. Of these customers, J.C. Penney accounted for approximately 15.4% of the Company's total net sales. The Company does not have a written agreement with J.C. Penney; the indicated volume was the result of purchase orders received by the Company in the ordinary course of its business. The terms and conditions of the sales to J.C. Penney are comparable to those offered to other customers. RAW MATERIALS One of the principal raw materials used in the manufacture of the Company's gift division's products is cotton yarn, a significant amount of which is purchased under fixed-price, cancellable contracts, dependent on actual delivery of goods, with terms of up to twelve months from various suppliers. Cotton yarn accounts for approximately 70% of The Rug Barn's cost of goods sold. Management of the Company believes there is an ample supply of spun yarn to service its manufacturing requirements. The Company also uses a substantial amount of greige goods material, a fabric processed from raw cotton and other raw materials, in its manufacturing process. Approximately 40% of HII's cost of goods sold are attributable to greige goods. During 1994, 1995, and 1996, each of Alice Mills, Inc., Clinton Mills, Inc. and Hamrick Mills, Inc. supplied 10% or more of the greige goods used by the Company. Management of the Company believes that the supplies purchased from these vendors could be purchased from several other readily available sources. The Company also purchases a significant amount of towel blanks for use in its bath business. Industry-wide capacity shortages for towel blanks during 1996 had a detrimental impact on the Company's sales. In order to help ensure an adequate supply of towel blanks in the future, management of the Company is diversifying the towel supplier base. COMPETITION Within the giftware market, the Company competes with thousands of manufacturers servicing over 100,000 retailers, including 70,000 gift stores, in the United States. Giftware manufacturers tend to be small operations that focus on single-product novelty items or a long-running, unique product line. Management of the Company believes that it competes in the decorative giftware market on its reputation, manufacturing capabilities and product designs. 8 9 Within the home textiles industry, the Company competes with large mills, small specialty products manufacturers and medium-sized, niche manufacturers. Large textile mills tend to be well-capitalized operations which focus on mass-produced, commodity type textiles products such as basic sheets, comforters and towels. The Company aggressively avoids competing in high-volume, commodity-oriented product areas already serviced by the large mills. Small specialty products manufacturers tend to have a limited product offering. Management believes that the Company's market presence, its manufacturing and distribution systems and the breadth of its product line allow it to compete against specialty products manufacturers. Medium-size, niche manufacturers present the greatest competition to the Company. Niche manufacturers typically focus on profitable product niches in the bedding, bath, window treatments and accessories market in a manner similar to that of the Company. Moreover, these manufacturers tend to possess the minimum required production levels to reach a level of production and marketing economies of scale not available to smaller manufacturers. Nonetheless, management believes that its distribution, design skills and manufacturing operations allow it to compete against other medium-size, niche producers. EMPLOYEES As of December 31, 1996, the Company had approximately 2,050 employees, none of whom are currently represented by a union. Management of the Company considers relations with its employees to be good. GOVERNMENTAL REGULATION The business and operations of the Company are subject to governmental regulation, including employee health and safety laws and regulations; laws and regulations governing employment practices, wages and hours, and employee benefits; and environmental laws and regulations. The Company believes that it is in compliance in all material respects with applicable laws and regulations, and that such compliance has not materially affected its business or required major capital expenditures. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 The statements contained in this Item 1 (Description of Business) and Item 7 (Management's Discussion and Analysis of Financial Condition and Results of Operations) that are not historical facts are forward-looking statements subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. The Company cautions readers of this Annual Report on Form 10-K that a number of important factors could cause the Company's actual results in 1997 and beyond to differ materially from those expressed in any such forward-looking statements. These factors include, without limitation, the general economic and business conditions affecting the retail industry, the Company's inability to receive customary credit terms from its vendors, the possible adverse impact of a Chapter 11 filing, the failure to consummate the capital restructuring plan on a timely basis, competition from a variety of firms ranging from small manufacturers to large textile mills, the seasonality of the Company's sales, the volatility of the Company's raw materials cost and availability, the Company's dependence on key personnel and the risk of loss of a material customer or a significant license. These and other factors are more fully described herein and in the Company's previous filings with the Securities and Exchange Commission including, without limitation, the Company's Prospectus dated November 10, 1995. 9 10 ITEM 2. PROPERTIES The Company owns and leases facilities in North Carolina, South Carolina, New York, Texas and Illinois. The following table lists the Company's facilities:
Approximate Floor Space Location Owned/Leased (Square Feet) Description - --------------- ----------- ------------- ---------------------------------------------- Mooresville, NC Owned 547,552 Offices, Printing, Manufacturing and Warehouse Morven, NC Owned 459,500 Manufacturing Abbeville, SC Owned 400,000 The Rug Bar Executive Offices, Manufacturing, Distribution and Showroom Lake Zurich, IL Leased(1) 199,544 Industrial Buildings/Office Space Morven, NC Leased(2) 54,000 Storage Warehouse Cheraw, SC Leased(3) 42,000 Storage Warehouse Lake Zurich, IL Leased(4) 37,689 Industrial Building/Manufacturing Lake Zurich, IL Leased(5) 27,700 General Warehouse/Manufacturing New York, NY Leased(6) 26,523 Offices, Salesroom, Showroom Wadesboro, NC Leased(7) 30,000 Manufacturing Space and Office/Administration Space Cheraw, SC Leased(8) 5,760 Metal Fabrication and Maintenance Shop Lake Zurich, IL Leased(9) 4,694 Industrial Warehouse Mooresville, NC Leased(10) 8,000 Outlet Store South Plano, TX Leased(11) 2,336 Office and Showroom
- ------------------ (1) Lease term expires May 31, 1998. (2) Lease term is month to month. (3) Lease term is month to month. (4) Lease term expires May 31, 1998. (5) Lease term expires May 31, 1998. (6) Lease term expires January 31, 1999. (7) Lease term expires November 30, 2000. (8) Lease term is month to month. (9) Lease term expires May 31, 1998. (10) Lease term expires July 31, 2001. (11) Lease term expires July 31, 1999. 10 11 ITEM 3. LEGAL PROCEEDINGS As contemplated by the Company's previously announced capital restructuring plan, the Company expects that a pre-negotiated filing under the provisions of Chapter 11 of the United States Bankruptcy Code will occur in mid August, 1997. See "Business - Capital Restructuring Plan." The Company is not a party to any litigation, and is not aware of any pending or threatened litigation except for the anticipated voluntary Chapter 11 filing previously discussed, that would have a material adverse effect on the Company or its business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 1996. 11 12 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS There is no established public trading market for the Company's common stock. As of May 15, 1997, there was one record holder of the Company's Class A Common Stock, six record holders of the Company's Class B Common Stock, one record holder of the Company's Class C Common Stock and two record holders of the Company's Class D Common Stock. The Company did not declare any dividends on outstanding common stock during 1994, 1995 or 1996. Certain of the Company's contracts restrict its (or The Rug Barn's or HII's) ability to pay dividends. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity." 12 13 ITEM 6. SELECTED CONSOLIDATED/COMBINED FINANCIAL DATA
SUCCESSOR COMPANY(1) PREDECESSOR COMPANY(1) ------------------------------------------- -------------------------------------- YEARS ENDED EIGHT MONTHS FOUR MONTHS YEARS ENDED DECEMBER 31, ENDED ENDED DECEMBER 31, -------------------------- DECEMBER 31, APRIL 30, ---------------------- 1996 1995(3) 1994 1994 1993 1992 --------- --------- ------------ --------- -------- -------- STATEMENT OF OPERATIONS DATA: Net sales $ 176,733 $ 128,031 $ 50,102 $ 14,609 $ 49,002 $ 32,862 Income (loss) from operations (93,693) 10,268 12,452 2,731 11,706 5,027 Net income (loss) (115,241) (4) (3,362) 4,841 2,691 11,783 4,694 OTHER FINANCIAL DATA: Depreciation and amortization 10,051 6,552 2,404 465 1,228 726 Capital expenditures 4,019 4,106 3,665 3,575 2,406 4,588 Ratio of earnings to fixed charges(2) - - 2.63x 13.66x 18.35x 10.16x BALANCE SHEET DATA: Total assets 116,046 215,853 81,118 25,432 25,838 16,716 Total long-term debt, including current portion 158,930 131,452 68,400 5,465 5,383 5,667 Redeemable common stock 2,476 1,639 762 - - - Redeemable preferred stock 49,351 41,059 - - - -
- ---------- (1) Effective May 1, 1994, DHA purchased, through its wholly owned subsidiary The Rug Barn (successor in interest to International Textiles, Inc.), certain assets and assumed certain liabilities from a group of commonly controlled companies known collectively as International Textile Fabrics, Inc. ("ITF" or the "Predecessor Companies") and acquired certain other assets from the principal shareholders of ITF (collectively, the "DHA 1994 Recapitalization"). Financial data as of and for the twelve months ended December 31, 1992 and 1993 and as of and for the four months ended April 30, 1994 were derived from historical combined financial statements of ITF. Financial data as of and for the eight months ended December 31, 1994 and as of and for the twelve months ended December 31, 1995 and 1996 were derived from historical consolidated financial statements of DHA. (2) The ratio of earnings to fixed charges is expressed as the ratio of pre-tax income plus fixed charges to fixed charges. Fixed charges consist of interest expense and the interest component of rental expense, assumed to be approximately one-third of rental expense. (3) On July 13, 1995, DHA purchased Home Innovations, Inc. for a cash purchase price of approximately $95.1 million, after a $6.7 million adjustment to the purchase price, including acquisition related costs of approximately $2.0 million. The Company also assumed approximately $35.0 million in liabilities consisting principally of trade payables and accruals and $2.3 million of junior subordinated notes. The acquisition was accounted for using the purchase method of accounting. Accordingly, the Company allocated the purchase price of the assets acquired and liabilities assumed based on their respective fair values. (4) Includes a non-cash charge of approximately $79.7 million for goodwill impairment. 13 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION. The following discussion provides management's assessment of the results of operations and liquidity and capital resources of DHA and should be read in conjunction with the respective financial statements of DHA and the notes thereto included elsewhere in this Form 10-K. The following table includes unaudited pro forma financial information as if the 1994 acquisition and recapitalization of DHA and the July 1995 purchase of Home Innovations, Inc. occurred as of January 1, 1994. Such adjustments to the pro forma financial information consist principally of the following: Net adjustments to cost of goods sold and selling, general and administrative ("SG&A") expenses relating to adjusting depreciation expense for the new basis of accounting resulting from the DHA and HII acquisitions; increases in SG&A expenses to account for the amortization of goodwill and the identifiable intangible assets resulting from the DHA and HII acquisitions; increases in SG&A expenses to account for compensation expense resulting from granting stock options at less than fair market value; increases in SG&A expenses related to management fees; net adjustments to interest expense resulting from the issuance of 13% Senior Notes due 2002; extinguishment of prior debt; and amortization of debt issuance costs and accretion of discount on the Senior Notes. Depreciation and amortization totaled approximately $10.0 million for 1996 and pro forma depreciation totaled approximately $9.1 million and $8.3 million for 1995 and 1994, respectively. Pro forma depreciation was approximately $1.1 million less than historical combined depreciation due to the new basis of the assets resulting from the acquisition of HII. Stock option expense included in pro forma SG&A expenses totaled pproximately $348,000 for 1995. Management's discussion and analysis of the results of operations for the items presented below should be read using the following actual and pro forma financial information (in thousands):
ACTUAL PRO FORMA ----------- -------------------------- DECEMBER 31, DECEMBER 31, DECEMBER 31, 1996 1995 1994 ----------- ---------- ----------- Sales $ 176,733 $ 206,679 $ 223,641 Cost of Goods Sold 138,633 149,580 153,717 ----------- ---------- ----------- Gross Profit 38,100 57,099 69,924 SG&A Expenses 52,076 47,816 49,080 Charge for Goodwill Impairment 79,717 -- -- ----------- ---------- ----------- Income (Loss) from Operations (93,693) 9,283 20,844 ----------- ---------- ----------- Interest Income (Expense): - Interest Expense (19,985) (17,780) (17,582) - Interest Income 69 322 164 ----------- ---------- ----------- (19,916) (17,458) (17,418) ----------- ---------- ----------- Income (Loss) Before Income Taxes $ (113,609) $ (8,175) $ 3,426 =========== ========== ===========
14 15 IMPACT OF THE PURCHASE OF HOME INNOVATIONS, INC. On July 13, 1995, DHA acquired HII, a manufacturer of niche oriented home accessories with five major product areas: bath furnishings, window treatments, furniture covers, bedding products and the Calvin Klein Home Collection, a new line of designer home products launched in September 1995 under the Calvin Klein trademark. The cash purchase price of HII was approximately $95.1 million, after a $6.7 million adjustment to the purchase price, including acquisition related costs of approximately $2.0 million. The Company also assumed approximately $35.0 million in liabilities consisting principally of trade payables and accruals and $2.3 million of junior subordinated notes. The acquisition was accounted for using the purchase method of accounting. Accordingly, the Company allocated the purchase price to the assets acquired and liabilities assumed based upon their respective fair values. The $6.7 million adjustment to the purchase price was determined as a result of the difference between the net assets specified in the purchase agreement and the actual net assets received as of the closing date and certain indemnifications from the sellers. The $6.7 million was received from the sellers in December 1995. RESULTS OF OPERATIONS As described above, the results of operations for 1995 and 1994 reflect pro forma adjustments related to the acquisition of HII in July 1995. Additionally, the results of operations for 1994 reflect pro forma adjustments related to the acquisition and recapitalization of DHA in May 1994. ACTUAL YEAR ENDED 1996 COMPARED TO PRO FORMA YEAR ENDED 1995 NET SALES Net sales for the year ended December 31, 1996 decreased $29.9 million or 14.5%, to $176.7 million compared to pro forma net sales of $206.7 million for the year ended December 31, 1995. The liquidity shortages faced by the Company in 1996 significantly impacted the Company's ability to service its customer base. Given the limited resources, the Company attempted to service its most significant customers. Sales for the year ended December 31, 1996 were negatively impacted by weak consumer demand and conservative inventory management by retailers serviced by the Company in the first six months of 1996. During the fourth quarter of 1996, sales were negatively impacted in the Company's window and bedding businesses as a result of a significant changeover in the styling and merchandising of these product lines. The anticipated introduction of the re-merchandised product lines resulted in weak fourth quarter demand for the existing product lines. The new lines were not targeted to impact sales until the first quarter of 1997. Sales in the Company's bath business were negatively impacted by delivery shortages for towel blanks as a result of an industry-wide capacity shortage. Sales in the Company's gift division (primarily cotton throws) also fell below expectations as a result of continued weakening in the jacquard woven throw business. Finally, 1996 sales were negatively impacted from the decline in furniture cover sales, resulting from the Company's decision to exit this business. The growth in DHA Home sales partially offset the 1996 declines. GROSS PROFIT Gross profit decreased $19.0 million or 33.3% to $38.1 million in 1996 from pro forma gross profit of $57.1 million in 1995. Gross profit margin decreased to 21.6% in 1996 from a pro forma gross profit margin of 27.6% in 1995. Through the use of fixed price contracts with multiple vendors, the Company was able to satisfy all of its raw material needs and accordingly, raw material costs in 1996 were not significantly changed from 1995 levels. Gross profit margin in 1996 was negatively impacted by increases in inventory cost adjustments totaling approximately $3 million to provide for slow moving and obsolete inventory. The majority of these adjustments related to inventory associated with specific marketing and merchandising programs that were changed or discontinued following the change over in senior management during the later part of 1996. Additionally, charges totaling $1.3 million were recorded in the fourth quarter to write-off inventory and fixturing associated with these programs. The gross profit margin for 1996 was also negatively impacted by a revaluation of the inventory costing standards performed during the fourth quarter of 1996. Standards are based on volume and efficiency levels and plant infrastructures which had been significantly adjusted by the new management team at the Company during 1996 as a result of the present demand for the Company's products. The standard cost revaluation resulted in charges to the 1996 statement of operations totaling $2.5. Finally, gross margin was negatively impacted by the Company's decision to expanded its 15 16 giftware product offerings to include items sourced from other manufacturers. The margins realized on these products are below those realized on items manufactured by the Company. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative ("SG&A") expenses increased $4.3 million, or 8.9% to $52.1 million for the year ended December 31, 1996, from $47.8 million for the pro forma year ended December 31, 1995. SG&A expense, as a percentage of sales, increased to 29.5% for 1996 from 23.1% for 1995. The year-to-year decline in sales volume resulted in higher relative SG&A costs primarily as a result of the fixed salary structure of the Company's sales and marketing functions. Positively impacting the 1996 expenses were ongoing cost and headcount reduction programs related to DHA's acquisition of HII. Duplicate functions were eliminated and cost reductions of approximately $1.2 million achieved from consolidating certain marketing, sales, design and support services. Negatively impacting the 1996 SG&A amounts were charges totaling approximately $1 million related to the discontinuation of certain marketing and merchandising programs following the change in senior management during the later part of 1996. Also negatively impacting the 1996 expenses were an increase in charges and the allowance for uncollectable accounts specifically related to customer chargebacks for pricing discounts and allowances and returns of approximately $5.0 million. Finally, 1996 SG&A expenses were negatively impacted by approximately $1.0 million for costs associated with DHA Home. Advertising and overhead expenses associated with DHA Home, as a percentage of sales, exceeded the level of such costs for the Company's more mature businesses. This investment in the growth of DHA Home is part of the Company's long term plan and management of the Company expects that SG&A expenses as a percentage of sales for DHA Home will continue to exceed those of its other mature businesses for the next 12 - 24 months. FOURTH QUARTER OPERATING RESULTS During the fourth quarter, there were several significant events which significantly impacted the results of operations and the ability of the Company to service its working capital needs and debt obligations: - On October 18, 1996, the Company's CEO and Executive Vice President of Operations resigned their positions with the Company at the request of the board of directors. In order to settle certain disputes between the Company and the former CEO and Executive Vice President of Operations, these officers paid the Company $448,500, and transferred $6.9 million principal amount of the Company's Senior Notes, 6,900 shares of Class F Common Stock, and 965,100 shares of Class A Common Stock to the Company. See Item 13 "Certain Relationships and Related Transactions." - Following the departure of the former CEO and Executive Vice President of Operations, a critical analysis of many of the Company's marketing, merchandising and inventory realization plans was performed by the newly installed management team. This analysis led to significant write-offs of inventory, fixturing and printed advertising materials. - During October, 1996 the Company introduced substantially upgraded product lines for all of its business units. These introductions were necessary in order for the Company to remain competitive in its markets. The transition period between the existing product lines and sales of the new product lines contributed to a significant variance in sales below previous projections for the fourth quarter of 1996. - Because of poor fourth quarter operating results, the majority of the Company's significant vendors tightened credit limits and placed the Company on cash on delivery or cash before delivery terms. The lack of trade credit significantly impacted the Company's ability to service its working capital needs specifically related to the purchase of raw materials. The liquidity shortage also negatively impacted the Company's ability to service customer orders during the first half of 1997. - The continued softening of the cotton woven throw market in giftware had a larger than expected negative impact on 1996 sales performance. Historically, the third and fourth quarters are critical sales periods for this product line. The Company continued to experience a substantially lower demand for its cotton woven throws in the first half of 1997. 16 17 ACCOUNTING CHANGE - GOODWILL WRITE-OFF Prior to the fourth quarter of 1996, the Company evaluated the recoverability of goodwill by determining whether the amortization of the goodwill balance over its remaining amortization period could be recovered through undiscounted future operating cash flows of the acquired operations. In the fourth quarter of 1996, the Company changed its method for evaluating the recoverabilty of goodwill to a method whereby the carrying amount is compared to its estimated fair value, and any excess carrying amount is determined to be impaired. The fair value of goodwill is estimated by subtracting the estimated fair value of the Company's identifiable net assets from the fair value of the Company in its entirety, which is estimated using a discounted cash flow approach. The Company believes fair value is a preferable method to assess goodwill for recoverability as it believes that the value at which the Company could be bought and sold in an arms length transaction between a willing buyer and seller is the most objective evidence and, therefore, the most relevant measure of its value. Based on an evaluation of the recoverability of goodwill at December 31, 1996, the Company concluded that its unamortized balance of goodwill, $79.7 million, was impaired and has recorded a pre-tax charge for such amount in the accompanying 1996 consolidated statement of operations. PRO FORMA YEAR ENDED 1995 COMPARED TO PRO FORMA YEAR ENDED 1994 NET SALES (PRO FORMA) Pro forma net sales for 1995 decreased $16.9 million or 7.6%, from $223.6 million for 1994 to $206.7 million in 1995. Sales in several of the Company's major product categories declined principally as a result of soft retail conditions in the major markets served by the Company, most noticeably during the second half of the year. All distribution channels served were affected by the difficult retail environment including the giftware trade. These declines were partially offset by sales growth in the DHA Home business introduced in September 1995. GROSS PROFIT (PRO FORMA) Pro forma gross profit decreased $12.8 million or 18.3% from $69.9 million in 1994 to $57.1 million in 1995. Pro forma gross profit margin decreased from 31.3% in 1994 to 27.6% in 1995. During the first half of 1995, the spot price of cotton, the Company's principal raw material, increased significantly over the same period in 1994. The Company was able to substantially mitigate the impact of these price increases on its operating performance through the use of fixed price contracts with multiple vendors to satisfy its raw material needs. Accordingly, raw material costs in 1995 were not significantly changed from 1994 levels. Gross profit margin in 1995 was positively impacted by a strategic change in the Company's sales mix but was offset by changes in marketing and manufacturing strategy made by management intended to improve future performance. Gross profit margin in 1995 was negatively impacted by increases in inventory cost adjustments totaling approximately $2.5 million to provide for slow moving and obsolete inventory at HII in its closing acquisition date balance sheet. (A portion of the charges for these cost adjustments were included in the $3.4 million earnings charge recorded in connection with the $6.7 million purchase price adjustment previously discussed.) Additionally, losses totaling approximately $2 million were recorded on sales of slow moving, closeout and obsolete inventories disposed of during 1995. The earnings charges related to inventory resulted from an inventory reduction plan implemented in the third quarter of 1995. Reduced efficiencies in the cut-and-sew and printing plants also reduced gross profit margins in 1995. In implementing management's goal of improving operations, inventory controls were tightened and several of the operating schedules of the Company's plants were reduced during the third and fourth quarters of 1995. This resulted in substantial unabsorbed fixed overhead and lower overall margins. SELLING, GENERAL AND ADMINISTRATIVE (SG&A) EXPENSES (PROFORMA) Pro forma SG&A expenses decreased from $49.1 million in 1994 to $47.8 million in 1995 primarily due to a reduction in the Company's variable selling and distribution costs, principally commissions, resulting from the decline in sales in 1995. Offsetting these reductions were increased SG&A expenses in 1995 of approximately $1.5 million related to the introduction of the Calvin Klein Home line and the associated promotional expenses. The initial shipments for the Calvin Klein Home line commenced in September 1995. 1995 SG&A expenses also increased due to the addition in the allowance for uncollectible accounts specifically related to customer chargebacks 17 18 and returns of approximately $1 million. This charge was included in the $3.4 million earnings charge recorded in connection with the purchase price adjustment discussed above. Increased employee benefit costs of approximately $0.5 million also increased SG&A expenses. These costs resulted from HII's former self-insured medical plans. Finally, SG&A expenses increased in the areas of international sales and mass merchandiser marketing as well as the expansion of the design function to facilitate the Company's expansion into mass merchandiser and custom products markets for its jacquard woven throws. These expenditures were made to invest in the Company's capability to better service these markets. LIQUIDITY AND CAPITAL RESOURCES The Company's principal sources of liquidity for operations and expansions are funds generated internally and borrowings under its revolving credit facility ("Revolving Credit Facility") with Congress Financial Corporation ("Congress"). The Revolving Credit Facility provides for a revolving loan facility and letters of credit based on specified levels of underlying collateral with a maximum principal amount equal to the lesser of (a) $50 million or (b) a specified borrowing base, which is based on eligible receivables and inventory of the Company and its operating subsidiaries ("Borrowing Subsidiaries"). The Revolving Credit Facility (or a similar credit facility) is essential for the Company's working capital needs. On December 31, 1996, the Company had $3.8 million available for borrowing under the Revolving Credit Facility borrowing base formula based on underlying collateral (net of $30.8 million of outstanding borrowings and $418,000 in outstanding letters of credit). Borrowings under the Revolving Credit Facility are made on a daily basis for requirements for that business day and repayments are made on a daily basis by cash collections from trade accounts receivables. The Company is required to maintain a minimum adjusted tangible net worth, as defined, and the payment of cash dividends on the Company's common stock is prohibited in accordance with the Revolving Credit Facility. Further, there are limitations on the Company's ability to incur additional indebtedness and make loans, advances and investments. On May 23, 1997, the Revolving Credit Facility was amended for, among other things, changes in certain covenants including the tangible net worth calculation. There were no Events of Default (as defined) under the Revolving Credit Facility, as amended, at December 31, 1996. On March 1, 1997, the Revolving Credit Facility was amended to provide for a line of credit ("Supplemental Facility") pursuant to which Congress agreed to make supplemental loans ("Supplemental Loans") up to an aggregate principal amount of $5.0 million. The Supplemental Loans were guaranteed by Fund V. The guarantee was limited to the cash collateral amount of $2.5 million. The Supplemental Loans under the Supplemental Facility were repaid in full on May 27, 1997, the guarantee was terminated and cash collateral returned. In connection with the capital restructuring plan, Magten arranged for a $20 million secured term loan facility. See "Business-Capital Restructuring Plan." In late May, the Company borrowed $15 million under the Term Loan Facility and the remaining $5 million was borrowed in July. Proceeds from the Term Loan Facility were used to repay the Supplemental Loans, to reduce trade payables and to purchase inventory. The Company continues to receive little or no trade credit, which adversely impacts its liquidity position. As of the date of this filling, sources of liquidity are approximately $2.5 million of availability under its Revolving Credit Facility and approximately $678,000 of cash. Cash flows used in operating activities were approximately $18.6 million in 1996 compared to cash used in operating activities of $6.7 million in 1995 and $12.3 million provided by operating activities in 1994. The principal reason for the change in cash flow from operating activities between 1996 and 1995 was an increase in the net loss and a $7.6 million decrease in accrued interest in 1996. The decrease in accrued interest resulted from the timing of the interest payment on the Company's Senior Notes offset by an $11.1 million decline in inventories. The Company sells its products almost entirely on credit. The Company performs ongoing credit evaluations of its customers' financial condition but does not require collateral to support customer receivables. The Company 18 19 maintains an allowance for doubtful accounts, determined based on management's estimates of collectibility of past due accounts and prior experience, that is deemed sufficient to provide for estimated credit losses. Management believes the DHA Home division has increased the Company's working capital needs in 1996 by approximately $8 to $12 million from 1995 levels. Management believes that the 1996 working capital requirements related to DHA Home peaked in April 1996. Management expects that the working capital requirements for supporting the DHA Home lines should be approximately $5 to $7 million for the next 12 to 15 months. Cash flows used in investing activities were approximately $2.8 million in 1996 compared to cash used in investing activities of $100.3 million in 1995. Approximately $95.1 million was used to purchase HII in July 1995. Capital expenditures were approximately $4.0 million in 1996, $4.1 million in 1995 and $7.2 million on a pro forma combined basis in 1994. The Company currently has no material commitments for capital expenditures. However, the Company plans to invest $3.4 million during 1997 and the first quarter of 1998 in new equipment if sufficient funds are available. Cash flows provided by financing activities were approximately $23.2 million in 1996 compared to $98.8 million in 1995 and cash used in financing activities of $4.1 million on a pro forma combined basis in 1994. In July 1995, the Company consummated its sale of 13% Senior Notes due 2002 and Class F common stock with gross proceeds of $125 million (approximately $117.5 million net of issuance costs) and its sale of redeemable Preferred Stock, Class D common stock and warrants with gross proceeds of $50 million (approximately $46.5 million net of issuance costs). The proceeds of these offerings were used to purchase HII, as previously described and to repay certain indebtedness with principal outstanding of $46.3 million. Borrowings under the Company's line of credit increased by approximately $25.9 million during the year ended December 31, 1996, the majority of which was used to fund the operating activities, primarily due to the net loss in 1996. Additionally, the Company paid dividends totaling $1.75 million on its redeemable preferred stock in January 1996. The Senior Notes outstanding as of December 31, 1996 of $124.1 million have been reclassified as a current liability due to the agreement reached in principle with certain of the Company's bond holders and equity holders (described below) and as a result of the Company's decision to not make the interest payment on the Senior Notes due on June 30, 1997. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of the assets and the settlement of liabilities and commitments in the normal course of business. Due to a net shareholders deficiency at December 31, 1996 and the Company's limited liquidity, the Company engaged Houlihan, Lokey, Howard and Zukin as financial advisors for a potential financial restructuring of the Company's obligations. On May 15, 1997, the Company reached an agreement in principle with certain of the Company's bond holders and equity holders providing for a comprehensive capital restructuring plan that, among other things, (i) converts the outstanding principal amount and accrued interest on its 13% Senior Notes and all of the Redeemable Preferred Stock into common equity, (ii) provided $20 million in the form of a secured term loan for working capital purposes and (iii) makes provision for a subsequent rights offering to raise permanent equity capital of up to $20 million. See "Business- Capital Restructuring Plan." INFLATION AND TAX MATTERS Although the operations of the Company are generally influenced by economic conditions, the Company does not believe that inflation had a material effect on the results of operations in 1996, 1995 or 1994. The Company has approximately $48.0 million of net operating loss carryforwards available for Federal income tax purposes, which begin to expire in 2007, Federal general business and alternative minimum tax credits which begin to expire in 2009, state net operating losses totaling $60.9 million which begin to expire in 1997 and state tax credits which begin to expire in 2002. The deferred tax assets resulting from the aforementioned carryforwards contribute to a net deferred tax asset of $30.8 million as of December 31, 1996. However, management cannot be assured that this net deferred income tax asset will be realized and accordingly, a 100% valuation allowance has been established for such net deferred income tax asset. 19 20 EFFECT OF COMPLIANCE WITH ENVIRONMENTAL PROVISIONS Compliance with Federal, State and local provisions that have been enacted or adopted regulating the discharge of materials in the environment, or otherwise relating to protection of the environment, has not had, and is not expected to have, a material adverse effect on the capital expenditures, future operating results or competitive position of the Company. OTHER MATTERS In connection with the Company's capital restructuring plan, on June 30, 1997 the Company did not make the interest payment on the Senior Notes due on such date. The Company expects to file a pre-negotiated Chapter 11 bankruptcy case to effect the restructuring. See "Business - Capital Restructuring Plan." In connection with the restructuring and the poor financial performance in 1996 by the Company, Calvin Klein, Inc. informed the Company that it had terminated the license agreement between Calvin Klein, Inc. and Calvin Klein Home, Inc. On April 27, 1997, a new interim license agreement on similar terms and conditions was entered into to replace the terminated agreement. In connection with the interim license agreement, the name of Calvin Klein Home, Inc. was changed to DHA Home, Inc. The interim license agreement will expire on April 30, 1998, or upon the completion of the restructuring plan. Upon the consummation of the above described restructuring, Calvin Klein, Inc. has committed to enter into a new multi-year license agreement on similar terms and conditions that will extend through the year 2004. If the above described restructuring is not completed, Calvin Klein, Inc. may not enter into a new multi-year license agreement with the Company. Failure to renew the license agreement on a long-term basis would result in a charge to earnings for the unamortized balance of the license agreement and may otherwise have a material adverse effect on the Company's future results of operations. On October 18, 1996, at the request of the Board of Directors, two of the Company's officers and members of the Board of Directors, Mr. Henry E. Scharling, II and Mrs. Barbara Scharling resigned as members of the Board of Directors as well as their positions as Chief Executive Officer and Executive Vice President - Operations, respectively. Subsequent to their resignation, certain allegations concerning wrongful acts of Henry and/or Barbara Scharling were made by the Company and certain stockholders. The allegations included, but are not limited to, improper self dealing transactions, negligence in managing and overseeing the business and affairs of the Company, and failure to disclose material information regarding the financial condition and business plan of the Company. In consideration of the release and discharge of Mr. and Mrs. Scharling by the Company and certain stockholders from all claims, damages, and causes of action, Mr. and Mrs. Scharling paid the Company $448,500 and assigned to the Company 965,101 shares of the Company's Class A Common Stock, 6,900 shares of the Company's Class F Common Stock, and $6.9 million of the Company's Senior Notes. 20 21 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following consolidated financial statements and report of independent auditors are included at pages F-1 through F-24. Independent Auditors' Report Decorative Home Accents, Inc. Consolidated Balance Sheets Decorative Home Accents, Inc. Consolidated/Combined Statements of Operations Decorative Home Accents, Inc. Consolidated/Combined Statements of Stockholders' (Deficiency) Equity Decorative Home Accents, Inc. Consolidated/Combined Statements of Cash Flows Notes to Consolidated/Combined Financial Statements. 21 22 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 22 23 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information with respect to the directors and executive officers of DHA.
NAME AGE POSITION - ------------------ ------- ------------------------------------- Peter H. Howard(1) 38 Chairman and Director Murphy L. Fontenot 53 President, Chief Executive Officer Fontenot and Director Jay N. Baker 36 Executive Vice President, Chief Financial Officer David M. Tracy 72 Vice Chairman and Director Stephen A. Kaplan(1) 38 Director Vincent J. Cebula 33 Director Richard J. Goldstein 31 Director
- ------------ (1) Member of the Compensation Committee. Peter Howard has been Chairman and a Director of the Company since April 1994, has been Chairman of The Rug Barn since May 1994 and is the founder of Howard Industries, Inc., a private investment firm. Prior to founding Howard Industries in 1993, Mr. Howard was a Managing Partner at Dubin Clark and Company, a private investment firm. From 1984 to 1988, Mr. Howard was a Manager at Arthur Young and Company where he performed strategic and due diligence consulting. Mr. Howard serves on the Boards of Directors of Jakel, Incorporated, Comair Rotron, Inc. and Howard Industries, Inc. Mr. Howard also serves as a Director of DHA Home, Inc. and as the sole Director on all of the Boards of Directors of all of the other direct and indirect subsidiaries of the Company. Murphy Fontenot has been a Director of the Company since February 1996 and Chief Executive Officer since October 21, 1996. Mr. Fontenot previously served as President, Chief Operating Officer and a Director of the Company, as well as President and Chief Executive Officer of HII, since February 1996. Prior to joining the Company, Mr. Fontenot was President and Chief Executive Officer of Perfect Fit Industries, a home textiles manufacturer, from May 1989 to February 1996. Prior to May 1989, Mr. Fontenot was Executive Vice President of Springs Industries where he was employed for 21 years in various management positions. Jay Baker has been Executive Vice President and Chief Financial Officer of the Company since July 1995 and has been the Chief Financial Officer of The Rug Barn since July 1993. Mr. Baker is responsible for the Company's finance and accounting operations. Prior to joining The Rug Barn, Mr. Baker was employed at Esmark Marine Sports, Inc. as its chief financial officer for approximately one year beginning in 1992 and, prior to that, was a senior manager at Arthur Andersen & Company where he was employed for almost 10 years. Mr. Baker is a Certified Public Accountant. David Tracy has been a Director and Vice Chairman of the Company since September 1995, has been affiliated with HII since 1990, acting as its interim President from September 1995 through January 1996, and has been Chairman of HII's wholly owned subsidiary, Calvin Klein Home, Inc., since May 1994. Mr. Tracy has over 47 years of home furnishings industry experience. Prior to joining HII, Mr. Tracy was associated with J. P. Stevens & Co. as Vice Chairman of the Board and Senior Marketing Executive where he was responsible for the introduction and building of the Ralph Lauren Home Collection. Mr. Tracy also held various positions with Fieldcrest Mills where he was President from 1971 to 1981. Mr. Tracy has served as the Chairman of the Executive Committee of the Board of Directors of HII and Vice Chairman of the Board of Directors of HII. Mr. Tracy is a member of the Board of Directors of Royal International Optical Company. Mr. Tracy also serves as a Director of DHA, Inc. 23 24 Stephen Kaplan has been a Director of the Company since December 1995 and is a Principal of Oaktree Capital Management, LLC where he has worked since 1995. Pursuant to a subadvisory agreement with TCW Asset Management Company, the general partner of TCW Special Credits Fund V The Principal Fund (the "Principal Fund"), Oaktree Capital Management, LLC provides investment management services to the Principal Fund, which is a holder of the Preferred Stock and Class D Common Stock. See Item 12, "Security Ownership of Certain Beneficial Owners and Management." Mr. Kaplan was a Managing Director of Trust Company of the West and TCW Asset Management Company from 1993 to 1995. Prior thereto, Mr. Kaplan was employed by the law firm of Gibson, Dunn & Crutcher, where he was elected partner in 1990. Mr. Kaplan currently serves as a member of the Board of Directors of Acorn Products, Inc., Chief Auto Parts, Inc., KinderCare Learning Centers, Inc. and Roller Bearing Holding Company, Inc. Vincent Cebula has been a Director of the Company since December 1995 and is a Managing Director of Oaktree Capital Management, LLC where he has worked since 1995. Pursuant to a subadvisory agreement with TCW Asset Management Company, the general partner of the Principal Fund, Oaktree Capital Management, LLC provides investment management services to the Principal Fund. Mr. Cebula was a Senior Vice President of Trust Company of the West and TCW Asset Management Company from 1994 to 1995. Prior thereto, Mr. Cebula was executive assistant to the Vice Chairman of Brooke Group Ltd. from 1990 through 1993, where he was responsible for the coordination of financing and investment banking activities. Richard Goldstein has been a Director of the Company since December 1995 and is a Senior Vice President of Oaktree Capital Management, LLC where he has worked since 1995. Pursuant to a subadvisory agreement with TCW Asset Management Company, the general partner of the Principal Fund, Oaktree Capital Management, LLC provides investment management services to the Principal Fund. Mr. Goldstein was an Assistant Vice President of Trust Company of the West and TCW Asset Management Company from 1994 to 1995. Prior thereto, Mr. Goldstein was an Associate in the Corporate Finance Department of Jefferies & Company, Inc. from 1992 to 1994. Prior to being employed by Jefferies & Company, Inc., Mr. Goldstein was a Senior Consultant with Deloitte & Touche Management Consulting from 1991 to 1992. On October 18, 1996, two of the Company's Directors, Mr. Henry E. Scharling, II and Mrs. Barbara Scharling resigned at the Board of Director's request as members of the Board of Directors as well as their positions as Chief Executive Officer and Executive Vice President - Operations, respectively. Subsequent to their resignation, certain allegations concerning wrongful acts of Henry and/or Barbara Scharling were made by the Company and certain stockholders. The allegations included, but are not limited to, improper self dealing transactions, negligence in managing and overseeing the business and affairs of the Company, and failure to disclose material information regarding the financial condition and business plan of the Company. In consideration for the release by the Company and certain stockholders of Mr. and Mrs. Scharling from all claims, damages and causes of action, Mr. and Mrs. Scharling paid the Company $448,500 and assigned to the Company 965,101 shares of the Company's Class A Common Stock, 6,900 shares of the Company's Class F Common Stock, and $6.9 million of the Company's Senior Notes. All directors of the Company hold office until the election and qualification of their successors. Executive officers of the Company are chosen by the Board of Directors and serve at its discretion. The Company and certain of its stockholders have entered into an Amended and Restated Stockholders' Agreement, pursuant to which each party thereto has agreed to vote all shares of Common Stock held by it (i) so long as CIGNA Mezzanine Partners III, L.P. holds any Class B Non-Voting Common Stock (or shares of Class A Common Stock issued upon conversion of shares of Class B Non-Voting Common Stock), to nominate and elect as a Common Stock Director one person designated by CIGNA Mezzanine Partners III, L.P., (ii) so long as he is employed by the Company, to nominate and elect as a Common Stock Director David Tracy, (iii) to nominate and elect as the Class D Directors those persons designated by the Principal Fund V and (iv) so long as the Class C Director has eight votes, to nominate and elect Peter Howard as the Class C Director. 24 25 ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table sets forth information with respect to the annual compensation for 1996, 1995 and 1994 of the Company's Chief Executive Officer and each of the other most highly compensated executive officers of the Company whose total compensation exceeded $100,000 for the fiscal year ended December 31, 1996 (collectively, the "Named Officers"). grants
ANNUAL LONG-TERM COMPENSATION COMPENSATION - ------------------------------------ ------ ---------------- ---------------------------- NAME AND YEAR SALARY BONUS SECURITIES ALL OTHER PRINCIPAL POSITION ($) ($) UNDERLYING (COMPENSATION OPTIONS/SAR(#) ($)(4) - ------------------------------------ ------ --------- ------ ----------- ------------- Henry E. Scharling II, Chief 1996 $203,125 $ -- -- $7,675 Executive Officer(1)(2).......... 1995 250,000 -- -- 7,675 1994 166,667 86,880 -- 7,675 Barbara Scharling, Executive Vice 1996 203,125 -- -- $1,922 President-Operations(1)(2)....... 1995 250,000 -- -- 1,922 1994 166,667 86,880 -- 1,422 Murphy L. Fontenot, Chief 1996 272,845 -- 180,000(5) $35,000 Executive Officer................ Jay N. Baker, Chief Financial 1996 208,838 -- 45,000(5) $1,660 Officer(1)....................... 1995 165,000 15,000 355,093(5) 1,577 1994 93,333 43,440 -- 1,577 David M. Tracy, Vice-Chairman(3)... 1996 232,163 130,000 -- -- 1995 112,500 380,390 45,000(5) -- - ------------------
(1) Salary figures for 1994 are based on compensation for the period of May 4, 1994 to December 31, 1994. Prior to May 4, 1994, none of the Named Officers received any compensation from the Company, as Henry E. Scharling II, Barbara Scharling and Jay N. Baker were executives of ITF, which had not yet been acquired by the Company. (2) Henry E. Scharling, II and Barbara Scharling resigned their positions on October 18, 1996. See "Certain Relationships and Related Transactions." Their salary figures for 1996 are based on compensation from January 1, 1996 through October 18, 1996. (3) Salary figures for 1995 are based on compensation for the period from July 13, 1995 to December 31, 1995. Prior to July 13, 1995, Mr. Tracy did not receive any compensation from the Company, as he was an executive of HII which had not yet been acquired by the Company. (4) "All Other Compensation" includes payments of $7,675 for each of 1996, 1995 and 1994 on behalf of Mr. Scharling for supplemental life and accident insurance, payments of $1,922 in 1996 and 1995, and $1,422 in 1994 on behalf of Mrs. Scharling for supplemental life and accident insurance and $1,660 in 1996, and $1,577 for each of 1995 and 1994 on behalf of Mr. Baker for long-term disability insurance. (5) Mr. Fontenot was granted options to purchase 180,000 shares of Common Stock in 1996. Mr. Baker was granted options to purchase 45,000 and 355,093 shares of Common Stock in 1996 and 1995, respectively. Mr. Tracy was granted options to purchase 45,000 shares of Common Stock and was also granted certain stock appreciation rights. See "Executive Compensation - Options and Stock Appreciation Rights." 25 26 OPTIONS AND STOCK APPRECIATION RIGHTS The following tables summarize grants of stock options and stock appreciation rights ("SARs") in 1996 to the Named Officers and unexercised options and SARs at December 31, 1996. No Named Officer exercised any options or SARs during 1996.
OPTION/SAR GRANTS IN 1996 POTENTIAL REALIZABLE VALUE AT ASSUMED ANNUAL RATES OF STOCK PRICE APPRECIATION FOR INDIVIDUAL OPTION/SAR GRANTS TERMS (1) - --------------------------------------------------------------------- ----------------- NUMBER OF % OF TOTAL SECURITIES OPTIONS UNDERLYING GRANTED OPTIONS TO EXERCISE GRANTED EMPLOYEES PRICE EXPIRATION NAME (#) IN 1996 ($/SH) DATE 5% ($) 10% ($) - ---------------------- ------------------------- --------- ---------- ----------------- Jay N. Baker 45,000 (2) 14.20% $7.68 11/1/01 -- -- Murphy L. Fontenot 180,000 (3) 56.76% $7.68 12/1/01 -- --
AGGREGATE OPTION EXERCISES IN 1996 AND YEAR-END 1996 OPTION VALUES
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED UNEXERCISED IN-THE-MONEY SHARES OPTIONS AT OPTIONS AT ACQUIRED DECEMBER 31, 1996 DECEMBER 31, 1996 ON VALUE (#) ($)(4) EXERCISE REALIZE ------------------------------------------------------ NAME (#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ----------------------- --------- -------- ----------- ------------- ------------ ------------- Jay N. Baker -- -- 241,821 158,272 -- -- David M. Tracy (5) -- -- 15,000 30,000 -- -- Murphy L. Fontenot -- -- -- 180,000 -- --
- ------------------ (1) Potential realizable value is presented net of the option exercise price but before any federal or state income taxes associated with exercise. These amounts represent certain assumed rates of appreciation only. Actual gains, if any, on stock option exercise are dependent on the future performance of the Common Stock, as well as the option holder's continued employment throughout the vesting period. The amounts reflected in the table may not necessarily be achieved. (2) These options vest in three equal annual installments on each of January 1, 1997, January 1, 1998, and January 1, 1999. (3) These options vest in three equal annual installments on each of February 1, 1997, February 1, 1998, and February 1, 1999. (4) The value of the in-the-money options was based on the estimated market value of the shares after considering various factors. (5) Mr. Tracy's employment agreement also provides that he shall be given certain stock appreciation rights, one-third of which vest on each of September 19, 1996, 1997 and 1998. Except in the case of the sale of all or substantially all of the assets or common stock of Calvin Klein Home, Inc. ("CKH") to an unrelated party, Mr. Tracy is entitled to a cash bonus based upon CKH's earnings before interest income and expense, taxes, depreciation and amortization for the twelve months prior to exercise of the SARs. In the case of the sale of all or substantially all of CKH's assets or common stock, Mr. Tracy is entitled to a cash bonus based upon the net cash proceeds of such sale to CKH's common stockholders. 26 27 EMPLOYMENT AGREEMENTS The Company has an employment agreement with Mr. Fontenot which provides for his employment with the Company as Chief Executive Officer of the Company at a Base Compensation of $300,000 per year until February 28, 2000, subject to annual review by the Board of Directors, which shall be automatically extended for additional one year periods, unless the Company or Mr. Fontenot provides a written notice at least 90 days prior to the expiration of the contract that such party does not desire to extend the employment agreement. Mr. Fontenot is entitled to participate in the Company's Executive Bonus Plan. With respect to the 1997 bonus plan, Mr. Fontenot will receive (i) $150,000 on March 31, 1998 and (ii) an amount equal to the amount determined pursuant to the 1997 Executive Bonus Plan. Mr. Fontenot is also entitled to other employee benefits substantially comparable to those regularly provided for other key management employees. If the Company were to terminate Mr. Fontenot's employment without good cause (as defined in the employment agreement) prior to February 28, 2000, Mr. Fontenot is entitled to receive as severance pay (i) his base salary for a period equal to the remainder of said employment period, payable in regular installments in accordance with the Company's general payroll practices for salaried employees and (ii) any rights he may have under the Executive Bonus Plan. If Mr. Fontenot's employment is terminated within 90 days following a change of control of the Company, by (i) the Company without good cause, (ii) a successor to the Company without good cause or (iii) Mr. Fontenot, then the Company shall pay Mr. Fontenot an amount equal to $1,800,000 in a single sum in cash within 30 days after such termination of employment. Pursuant to the Agreement, the Company has also agreed to reimburse Mr. Fontenot in an amount up to $70,000 per year for a life insurance policy currently in force and owned by Mr. Fontenot and in an amount up to $10,000 per year for a disability policy currently in force and owned by Mr. Fontenot. The Company has an employment agreement with Mr. Baker which provides for his employment with the Company as Executive Vice President and Chief Financial Officer until February 28, 2000, at an annual base salary of $225,000, subject to annual review by the Board of Directors, which shall be automatically extended for additional one year periods, unless the Company or Mr. Baker provides a written notice at least 90 days prior to the expiration of the contract that such party does not desire to extend the employment agreement. Mr. Baker is entitled to participate in the Company's Executive Bonus Plan. With respect to the 1997 bonus plan, Mr. Baker will receive (i) $112,500 on March 31, 1998 and (ii) an amount equal to the amount determined pursuant to the 1997 Executive Bonus Plan. Mr. Baker is also entitled to other employee benefits substantially comparable to those regularly provided for other key management employees. If the Company terminates Mr. Baker's employment without good cause (as defined in the employment agreement) prior to February 28, 2000, Mr. Baker is entitled to receive as severance pay (i) his base salary for a period equal to the remainder of said employment period, payable in regular installments in accordance with the Company's general payroll practices for salaried employees and (ii) any rights he may have under the Executive Bonus Plan. If Mr. Baker's employment is terminated within 90 days following a change of control of the Company, by (i) the Company without good cause, (ii) a successor to the Company without good cause or (iii) Mr. Baker, then the Company shall pay Mr. Baker an amount equal to $675,000 in a single sum in cash within 30 days after such termination of employment. Pursuant to the Agreement, the Company has also agreed to reimburse Mr. Baker an amount up to $10,000 per year for a disability policy currently in force and owned by Mr. Baker. The Company has an employment agreement with Mr. Tracy which provides for his employment with the Company as Vice Chairman and Chairman of DHA Home until October 1998, and may be extended for additional one-year periods, at an annual base salary of $225,000 for the first 12-month period, $250,000 for the next 12-month period and $275,000 per annum thereafter, other employee benefits substantially comparable to those regularly provided for other key management employees, the right to participate in any pension, salary or profit sharing plan of the Company, the right to participate in the Bonus Plan and the right to participate in a Stock Appreciation Rights Plan (the "SAR Plan") for DHA Home. In addition, pursuant to such employment agreement, the Company paid Mr. Tracy a signing bonus of $175,000 and paid him a bonus for staying with the Company through December 31, 1995 of $175,390. Such employment agreement provides that so long as Mr. Tracy remains an executive of the Company, the Company agrees to cause Mr. Tracy to be elected to its Board of Directors and to the Board of Directors of DHA Home. See "Certain Relationships and Related Transactions." If the Company were to terminate Mr. Tracy's employment without good cause (as defined in the employment agreement) prior to the expiration of the employment period thereunder, Mr. Tracy is entitled to receive as severance pay (i) his base salary for a period equal to the remainder of said employment period, payable in regular installments in accordance with the Company's general 27 28 payroll practices for salaried employees and (ii) any rights he may have under the Bonus Plan, his Management Options or the SAR Plan. Upon Mr. Tracy's death or disability, Mr. Tracy (or his estate) is entitled to receive as severance pay (i) his base salary for a period equal to six months, payable in regular installments in accordance with the Company's general payroll practices for salaried employees and (ii) any rights he may have under the Bonus Plan, his Management Options or the SAR Plan. In addition, the Company has agreed to continue to provide medical and dental insurance to certain of Mr. Tracy's dependents if he should die while employed by the Company. The employment agreement also contains a broker fee agreement in the event Mr. Tracy originates acquisitions or certain licenses on behalf of the Company. See "Certain Relationships and Related Transactions." In addition, pursuant to their employment agreements, Mr. Fontenot, Mr. Baker, and Mr. Tracy were granted options to purchase shares of the Company's Class E Common Stock ("Management Options"). These Management Options are subject to one or more of the following: (i) transfer restrictions, (ii) terms that provide for the vesting of the right to exercise the options over time, (iii) terms that provide for the vesting of the right to exercise the options only upon the attainment of certain performance criteria, or (iv) an exercise price that assumes a certain valuation for the Common Stock. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Compensation Committee of the Company, currently composed of Peter H. Howard and Stephen A. Kaplan, determines the compensation of all executive officers of the Company including, Murphy L. Fontenot, the President and Chief Executive Officer of the Company, Jay Baker, Executive Vice President and Chief Financial Officer of the Company, and David M. Tracy, Vice Chairman of the Company. From July 13, 1995 to October 18, 1996, the Compensation Committee determined the compensation of Henry E. Scharling, Chief Executive Officer of the Company, and Barbara Scharling, Executive Vice President of Operations. Prior to July 13, 1995, the Board of Directors of the Company, then composed of Peter H. Howard, Henry E. Scharling II and Barbara Scharling, determined the compensation of all the executive officers of the Company including Henry E. Scharling II and Barbara Scharling. COMPENSATION OF DIRECTORS The Company does not pay any fees or remuneration to its directors for service on the Board or any Board committee, but the Company does reimburse directors for their ordinary out-of-pocket expenses incurred in connection with attending meetings of the Board. 28 29 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table furnishes certain information regarding the beneficial ownership of the Common Stock of the Company as of March 31, 1997 by (a) each person that is the beneficial owner of more than five percent of the outstanding number of shares of any class of voting securities of the Company, (b) the directors of the Company, (c) each of the Named Officers, and (d) all directors and executive officers of the Company as a group. To the knowledge of the Company, except as otherwise indicated, each named person has voting and investment power over the listed shares, and such voting and investment power is exercised solely by the named person or shared with a spouse. (See Note 14 to the accompanying consolidated/combined financial statements - Subsequent Events).
PERCENTAGE OF SHARES TOTAL NAME AND ADDRESS OF TITLE OF BENEFICIAL PERCENTAGE VOTING BENEFICIAL OWNER CLASS OWNED OF CLASS POWER (10) ------------------- ------- ----------- ---------- ---------- Southern Farm Bureau Annuity Class A 109,737 48.16% 3.45% Insurance Company Common Stock P.O. Box 78 (1)(7) Jackson, Mississippi 39205 CIGNA Mezzanine Partners III, Class B 765,223 43.57% 24.08% L.P. (2) Non-Voting c/o CIGNA Investments, Inc. Common Stock Hartford, Connecticut 06152 (3)(7) Connecticut General Life Class B 387,346 22.06% 12.19% Insurance Non-Voting Company (2) Common Stock c/o CIGNA Investments, Inc. (3)(7) Hartford, Connecticut 06152 Connecticut General Life Class B 210,657 12.00% 6.63% Insurance Company, Non-Voting on behalf of one or more Common Stock separate (3)(7) accounts (2) c/o CIGNA Investments, Inc. Hartford, Connecticut 06152 Life Insurance Company of North Class B 118,556 6.75% 3.73% America (2) Non-Voting c/o CIGNA Investments, Inc. Common Stock Hartford, Connecticut 06152 (3)(7) Providian Life and Health Class B 137,172 7.81% 4.32% Insurance Company (4) Non-Voting c/o Capital Holding Common Stock Corporation (3)(7) 400 West Market Street P.O. Box 32830 Louisville, Kentucky 40202 People's Security Life Class B 137,172 7.81% 4.32% Insurance Company (4) Non-Voting c/o Capital Holding Common Stock Corporation (3)(7) 400 West Market Street P.O. Box 32830 Louisville, Kentucky 40202 Peter H. Howard Class C Common 386,040 100.00% 12.15% 136 Main Street Stock (5)(9) Westport, Connecticut 06880 TCW Special Credits Fund V-- The Class D Common 797,016 98.60% 25.08%
29 30
NAME AND ADDRESS OF BENEFICIAL OWNER TITLE OF CLASS SHARES PERCENTAGE PERCENTAGE BENEFICIAL OF CLASS OF OWNED TOTAL VOTING POWER (10) - ---------------------------- -------------- ------- ------ ------------ Principal Fund Stock c/o Oaktree Capital (1)(6)(7)(8) Management, LLC 550 South Hope Street, 22nd Floor Los Angeles, California 90071 Jay N. Baker Class E Common 285,139 79.17% 8.23% Industrial Park Drive Stock (7)(9)(11) Abbeville, South Carolina 29620 Murphy L. Fontenot Class E Common 60,000 16.66% 1.85% Industrial Park Drive Stock (7)(9)(12) Abbeville, South Carolina 29620 David M. Tracy Class E Common 15,000 4.17% 0.47% Stock (7)(9)(13) Stephen A. Kaplan(14) -- -- -- -- Vincent J. Cebula(14) -- -- -- -- Richard J. Goldstein(14) -- -- -- -- Directors and executive Class C Common 386,040 100.00% 12.15% officers as a group (9 persons) Stock (5)(9) Class E Common 360,139 100.00% 10.18% Stock (7)(9)(11)
- ------------------ (1)Holders of Class A Common Stock, Class D Common Stock, Class E Common Stock and Class F Common Stock are entitled to one vote per share and vote together as one class. The holders of Class A Common Stock and Class F Common Stock have substantially similar rights and privileges and, as such, for purposes of this "Beneficial Ownership of Securities" table are considered one class of common stock. As of March 31, 1997 there were 118,100 shares of Class F Common Stock outstanding. (2)CIGNA Mezzanine Partners III, L.P., Connecticut General Life Insurance Company, Connecticut General Life Insurance Company, on behalf of one or more separate accounts, and Life Insurance Company of North America are affiliated entities but each entity exercises independent investment authority from the other entities. (3)Holders of Class B Non-Voting Common Stock are not entitled to vote on any matters, except under certain circumstances. Each outstanding share of Class B Non-Voting Common Stock may be converted into one fully paid and non assessable share of Class A Common Stock at any time at the option of a non-affiliated transferee of the current holder thereof. (4)Providian Life and Health Insurance Company (formerly National Home Life Assurance Company) and Peoples Security Life Insurance Company (successor by merger to Durham Life Insurance Company) are affiliated entities. (5)Subject to certain conditions, holders of Class C Common Stock are entitled to (i) a majority of the votes of the common stock of the Company and (ii) elect the Class C Director, which director is entitled to cast a majority of the votes on any matter submitted to the Company's Board of Directors. Under certain circumstances, including conversion of certain shares of Class B Non-Voting Common Stock to Class A Common Stock and an initial public offering, holders of Class C Common Stock are entitled to one vote per share and the Class C Director is only entitled to one vote. Howard Industries, Inc., which is owned by Mr. Howard, is the nominal owner of all of the outstanding Class C Common Stock. (6)The directors nominated by the Principal Fund have that number of votes constituting 50% of the votes of the Company's Board of Directors. (7)Certain matters require the affirmative vote of certain classes of DHA's Common Stock, voting as a separate class or voting as a single class, including (i) certain amendments to DHA's Certificate of Incorporation or Bylaws, (ii) certain mergers or consolidations of DHA, and (iii) amendments to DHA's Certificate of Incorporation and 30 31 Bylaws affecting provisions that address the personal liability of directors and certain indemnifications. (8) Does not include the Class D Warrants exercisable for shares of Class D Common Stock held by the Principal Fund, which Class D Warrants are not exercisable earlier than December 31, 1997 except pursuant to a sale of the Company. (9) Peter Howard, an executive officer and director of the Company, owns and controls Howard Industries, Inc., which is the nominal owner of all of the outstanding Class C Common Stock. Murphy L. Fontenot, David M. Tracy and Jay N. Baker are executive officers of the Company. All directors and officers of the Company, as a group, beneficially own 746,179 shares of Common Stock, or 21.09% of the issued and outstanding shares of Common Stock (assuming the exercise of all options which are exercisable within 60 days of March 31, 1997). (10) Assumes (i) one vote per share which would occur upon the conversion of all of the Class B Non-Voting Common Stock into shares of Class A Common Stock, which conversion may occur anytime at the option of non-affiliate transferees of the current holders of the Class B Non-Voting Common Stock and (ii) the exercise of all options exercisable within 60 days of March 31, 1997. Howard Industries, Inc. otherwise has the power to vote 54.38% of the issued and outstanding Common Stock of the Company. (11) Includes 285,139 shares issuable prior to May 30, 1997 upon exercise of stock options granted to Mr. Baker. (12) Includes 60,000 shares issuable prior to May 30, 1997 upon exercise of stock options granted to Mr. Fontenot. (13) Includes 15,000 shares issuable prior to May 30, 1997 upon exercise of stock options granted to Mr. Tracy. (14) Excludes 797,016 shares of Class D Common Stock held by The Principal Fund, as to which such person shares voting and investment power and of which such person disclaims beneficial ownership. * Less than one percent. 31 32 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS DHA was formed as a holding company to effect the Company's acquisition of certain assets and assumption of certain liabilities of ITF and its acquisition of certain other assets from the principal shareholders of ITF (the "DHA 1994 Recapitalization"). In connection with the DHA 1994 Recapitalization, ITF, a group of companies owned and controlled by Mr. and Mrs. Scharling, received (i) subordinated notes totaling $8.4 million, (ii) approximately $60.3 million in cash, (iii) a warrant exercisable for 1,232 shares of DHA's Class A Common Stock and (iv) 1,723 shares of DHA's Class A Common Stock. In connection with the DHA 1994 Recapitalization, Howard Industries, Inc., a company owned and controlled by Mr. Howard, received (a) 1,182 shares of Class C Common Stock for the contribution of certain contract rights and other property to DHA and (b) a transaction fee of $400,000 for its role in the structuring, negotiation and consummation of the DHA 1994 Recapitalization. Also in connection with the DHA 1994 Recapitalization, DHA's institutional stockholders (i) purchased an aggregate of 336 shares of DHA's Class A Common Stock and an aggregate of 5,377 shares of DHA's Class B Non-Voting Common Stock for an aggregate purchase price of $8.0 million and (ii) purchased outstanding senior notes for an aggregate purchase price of $60.0 million. In May 1994, The Rug Barn entered into a management fee agreement with Howard Industries, Inc. (the "Management Fee Agreement") pursuant to which The Rug Barn agreed to make annual payments to Howard Industries, Inc. of $400,000 plus an additional amount based on certain financial thresholds in consideration of Howard Industries, Inc. providing general supervisory and business planning services which include, but are not limited to, financial management, tax, accounting, human resources and personnel advice and public relations and press relations services (the "Services"). Contemporaneously with the closing of the Company's acquisition of HII, the Management Fee Agreement was amended to provide for an annual fixed management fee to Howard Industries, Inc. of $750,000. Management fees and reimbursement for expenses totaling approximately $398,000, $603,000 and $451,000 in 1996, 1995, and 1994, respectively, were paid to Howard Industries. During 1996, the management fee was reduced to $375,000 per year. Howard Industries, Inc. is owned and managed by Mr. Howard; its employees provide management services to a number of companies controlled by Mr. Howard, including the Company, and, as such, its employees devote only a portion of their time to the Company. The Services rendered by Howard Industries, Inc. to the Company include Mr. Howard's acting as a Director of the Company as well as other financial and management advisory services, for which Mr. Howard does not receive any direct compensation. In connection with the DHA 1994 Recapitalization, ITF, a company wholly owned by Mr. Scharling, entered into a letter agreement with the Company pursuant to which ITF would make available an airplane to the Company under certain circumstances. In consideration, the Company would reimburse ITF for certain expenses related to the Company's use of the airplane, including among other expenses fuel, maintenance and engine reserve. The Company paid ITF approximately $99,000 in 1996, $266,000 in 1995 and $78,000 for the eight months ended December 31, 1994, for reimbursement of such expenses. In connection with the DHA 1994 Recapitalization, DHA issued to Mr. and Mrs. Scharling a warrant exercisable for 1,232 shares of DHA's Class A Common Stock at an aggregate exercise price of $1.5 million. In June 1995, $1.5 million of the principal amount of the subordinated notes issued to the Scharlings in connection with the DHA 1994 Recapitalization was used to pay the exercise price under such warrant. Immediately following such cancellation, the outstanding principal balance of the subordinated notes was $6.9 million, which balance was repaid in connection with the 1995 refinancing. Action Digital Color, Inc., a company wholly-owned by Mr. and Mrs. Scharling, provides certain printing services to the Company on terms that management believes are no less favorable to the Company than those that would be negotiated on an arm's-length basis. Payments made by the Company to Action Digital Color, Inc. for such printing services were approximately $987,000 in 1996, $244,000 in 1995 and $85,000 for the eight months ended December 31, 1994. Mr. and Mrs. Scharling purchased $6.9 million of the Units in connection with the sale of the Units and at the time of their resignations on October 18, 1996 still held $6.9 million in principal amount of the Series A Notes and 6,900 shares of the Class F Common Stock. Such securities were subsequently assigned to the Company as described below. 32 33 On October 18, 1996, two of the Company's Board of Directors, Mr. Henry E. Scharling, II and Mrs. Barbara Scharling resigned at the Board of Director's request as members of the Board of Directors as well as their positions as Chief Executive Officer and Executive Vice President Operations, respectively. Subsequent to their resignation, certain allegations concerning wrongful acts of Henry and/or Barbara Scharling were made by the Company and certain stockholders. The allegations included, but are not limited to, improper self dealing transactions, negligence in managing and overseeing the business and affairs of the Company, and failure to disclose material information regarding the financial condition and business plan of the Company. In consideration for the release by the Company and certain stockholders of Mr. and Mrs. Scharling from all claims, damages and causes of actions, Mr. and Mrs. Scharling paid the Company $448,500 and assigned to the Company 965,101 shares of the Company's Class A Common Stock, 6,900 shares of the Company's Class F Common Stock, and $6.9 million of the Company's Senior Notes. In connection with the sale of Units, Connecticut General Life Insurance Company tendered $12,452,000 principal amount of 11% Senior Notes due May 31, 2004 of The Rug Barn (the "Rug Barn Notes") in exchange for 12,452 Units; Connecticut General Life Insurance Company, on behalf of one or more separate accounts, tendered $6,776,000 principal amount of Rug Barn Notes in exchange for 6,776 Units; and Life Insurance Company of North America tendered $3,811,000 principal amount of Rug Barn Notes in exchange for 3,811 Units. The Rug Barn Notes were subsequently cancelled. Pursuant to his employment agreement with the Company, Mr. Tracy would be entitled to receive a brokers fee on acquisitions or designer licenses originated by him. There were no payments made pursuant to this arrangement for the years ended December 31, 1996 and 1995. The Company believes that the terms of the above-described transactions are no less favorable to the Company than could be obtained with non-affiliated parties. Pursuant to the Amended and Restated Stockholders' Agreement, all of the holders of Common Stock entitled to vote for the election of directors have agreed to vote their shares to elect David Tracy to the Board of Directors of the Company so long as he is an executive officer of the Company. 33 34 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K DOCUMENTS FILED AS PART OF THIS FORM 10-K: (A)(1)THE FOLLOWING FINANCIAL STATEMENTS ARE INCLUDED ON PAGES F-1 THROUGH F-24 OF THIS REPORT. Decorative Home Accents, Inc. Consolidated Balance Sheets Decorative Home Accents, Inc. Consolidated/Combined Statements of Operations Decorative Home Accents, Inc. Consolidated/Combined Statements of Stockholders' Equity Decorative Home Accents, Inc. Consolidated/Combined Statements of Cash Flows (A)(2)THE FOLLOWING FINANCIAL STATEMENT SCHEDULES ARE INCLUDED (NO OTHER FINANCIAL STATEMENT SCHEDULES ARE INCLUDED BECAUSE SUCH SCHEDULES ARE NOT REQUIRED OR THE INFORMATION REQUIRED HAS BEEN PRESENTED IN THE AFOREMENTIONED FINANCIAL STATEMENTS): Schedule I - Condensed Financial Information Schedule II - Valuation and Qualifying Accounts (A)(3)EXHIBITS THE FOLLOWING EXHIBITS ARE INCORPORATED BY REFERENCE: 2.1(1)-- Agreement and Plan of Merger, dated as of June 7, 1995, by and between HII Acquisition Corp. and Home Innovations, Inc., as amended. A list identifying the exhibits and schedules to the Agreement is attached thereto. Registrant agrees to furnish supplementally to the Commission, upon request, a copy of any omitted exhibit or schedule. 2.2(1)-- Purchase Agreement, dated as of June 29, 1995, by and among Decorative Home Accents, Inc., The Rug Barn, Inc., HII Acquisition Corp. and Jefferies & Company, Inc. A list identifying the exhibits and schedules to the Agreement is attached thereto. Registrant agrees to furnish supplementally to the Commission, upon request, a copy of any omitted exhibit or schedule. 2.3(1)-- Purchase Agreement, dated as of July 13, 1995, by and among Decorative Home Accents, Inc., DHA Partners, L.P. and TCW Special Credits Fund V--The Principal Fund. A list identifying the exhibits and schedules to the Agreement is attached thereto. Registrant agrees to furnish supplementally to the Commission, upon request, a copy of any omitted exhibit or schedule. 3.1(1)-- Second Amended and Restated Certificate of Incorporation of Decorative Home Accents, Inc. 3.2(1)-- Amended and Restated Bylaws of Decorative Home Accents, Inc. 3.3(1)-- Certificate of Designation for Decorative Home Accents, Inc., as amended by the Certificate of Correction for Decorative Home Accents, Inc. 4.1(1)-- Indenture, dated as of July 13, 1995, by and among Decorative Home Accents, Inc. The Rug Barn, Inc., Home Innovations, Inc., Home Curtain Corp., Calvin Klein Home, Inc., Draymore Mfg. Corp., R.A. Briggs and Company and American Bank National Association, as Trustee, relating to $125,000,000 13% Senior Notes due 2002, Series A and Series B. 4.2(1)-- Form of Series B Notes 4.3(1)-- Registration Rights Agreement, dated as of July 13, 1995, by and among Decorative Home Accents, Inc., The Rug Barn, Inc., Home Innovations, Inc., Home Curtain Corp., Calvin Klein Home, Inc., Draymore Mfg. Corp., R.A. Briggs and Company and Jefferies & Company, Inc. 4.4(3)-- Amended and Restated Credit Agreement, dated as of July 13, 1995, by and among 34 35 LaSalle National Bank, as co-agent and lender, General Electric Capital Corporation, as co-agent and lender, The Rug Barn, Inc., Home Innovations, Inc., Home Curtain Corp., Calvin Klein Home, Inc., Draymore Mfg. Corp. and R.A. Briggs and Company, as amended 10.1(1)-- Amended and Restated Stockholders' Agreement dated as of July 13, 1995, by and among Decorative Home Accents, Inc., Howard Industries, Inc., Henry E. Scharling II, Barbara Scharling, Jay Baker, David M. Tracy, CIGNA Mezzanine Partners III, L.P., Connecticut General Life Insurance Company, Connecticut General Life Insurance Company, on behalf of one or more separate accounts, Life Insurance Company of North America, National Home Life Assurance Company, Durham Life Insurance Company, Southern Farm Bureau Annuity Insurance Company, TCW Special Credits Fund V--The Principal Fund and DHA Partners, L.P. 10.2(1)-- Class F Stockholders' Agreement, dated as of July 13, 1995, by and between Decorative Home Accents, Inc. and Jefferies & Company, Inc. 10.3(1)-- Registration Rights Agreement, dated as of July 13, 1995, by and among Decorative Home Accents, Inc. and TCW Special Credits Fund V -- The Principal Fund. 10.4(1)-- Warrant Agreement, dated as of July 13, 1995, by and between Decorative Home Accents, Inc. and American Bank National Association, as Warrant Agent. 10.5(1)-- Employment and Non-Competition Agreement, dated as of July 13, 1995, between Decorative Home Accents, Inc. and Henry E. Scharling II 10.6(1)-- Employment and Non-Competition Agreement, dated as of July 13, 1995, between Decorative Home Accents, Inc. and Barbara Scharling 10.7(1)-- Employment and Non-Competition Agreement, dated as of July 13, 1995, between Decorative Home Accents, Inc. and Jay Baker 10.8(2)-- Employment Agreement, dated as of October 25, 1995, between Decorative Home Accents, Inc. and David M. Tracy. 10.9(3)-- Employment and Non-Competition Agreement, dated as of February 1, 1996, between Decorative Home Accents, Inc. and Murphy L. Fontenot. (1) Incorporated by reference to the Company's Registration Statement on Form S-1 (File No. 33-96794). (2) Incorporated by reference to the Company's report on Form 10-Q for the quarter ended September 30, 1995. (3) Incorporated by reference to the Company's report on Form 10-K for the year ended December 31, 1995. THE FOLLOWING EXHIBITS ARE CONTAINED HEREIN: 10.1 -- Mutual Release and Settlement Agreement, dated as of March 11, 1997, between Decorative Home Accents, Inc. and Henry E. Scharling, II and Barbara Scharling. 10.2 -- Employment and Non-Competition Agreement, dated as of February 28, 1997, between Decorative Home Accents, Inc. and Jay N. Baker. 10.3 -- Employment and Non-Competition Agreement, dated as of February 28, 1997, between Decorative Home Accents, Inc. and Murphy L. Fontenot. 10.4 -- Amendment to Loan and Security Agreement, dated as of February 28, 1997, between Decorative Home Accents, Inc. and Congress Financial Corporation. 10.5 -- Amendment to Loan and Security Agreement, dated as of May 23, 1997, between Decorative Home Accents, Inc. and Congress Financial Corporation. 10.6 -- Credit Agreement, dated as of May 23, 1997, between Decorative Home Accents, Inc. and General Motors Domestic Group Pension Trust, Hughes Master Retirement Trust, Department of Pensions - City of Los Angeles, Magten Offshore Fund Ltd., Magten Partners, L.P., Magten Group Trust, Navy Exchange Service Command Retirement Trust, Western Union Pension Trust and Saturn Fund Ltd. 10.7-- Security Agreement, dated as of May 23, 1997, between Decorative Home Accents, Inc. 35 36 and General Motors Domestic Group Pension Trust, Hughes Master Retirement Trust, Department of Pensions - City of Los Angeles, Magten Offshore Fund Ltd., Magten Partners, L.P., Magten Group Trust, Navy Exchange Service Command Retirement Trust, Western Union Pension Trust and Saturn Fund Ltd. 10.8 -- License Agreement, dated as of April 27, 1997, between DHA Home Inc. and Calvin Klein, Inc. 12 -- Computation of Ratio of Earnings to Fixed Charges for Decorative Home Accents, Inc. and Predecessor Companies 18 -- Letter regarding change in accounting principle 21 -- List of Subsidiaries ------------------ (B) REPORTS ON FORM 8-K: THE COMPANY FILED THE FOLLOWING REPORT ON FORM 8-K DURING THE LAST QUARTER OF 1996. Form 8-K filed on November 6, 1996, regarding the resignation of Henry E. Scharling, II and Barbara Scharling reported under Item 5 of Form 8-K. 36 37 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 31st day of July, 1997. DECORATIVE HOME ACCENTS, INC. By: /s/ Murphy L. Fontenot --------------------------------------------- Murphy L. Fontenot, 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 capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- Chief Executive Officer, July 31, 1997 /s/ Murphy L. Fontenot President and a Director - ---------------------------- Murphy L. Fontenot Chief Financial Officer (Principal Financial and July 31, 1997 /s/ Jay N. Baker Accounting Officer) - ---------------------------- Jay N. Baker /s/ Peter H. Howard Chairman of the Board July 31, 1997 - ---------------------------- Peter H. Howard /s/ David M. Tracy Vice-Chairman and a Director July 31, 1997 - ---------------------------- David M. Tracy /s/ Stephen A. Kaplan Director July 31, 1997 - ---------------------------- Stephen A. Kaplan /s/ Vincent J. Cebula Director July 31, 1997 - ---------------------------- Vincent J. Cebula /s/ Richard J. Goldstein Director July 31, 1997 - ---------------------------- Richard J. Goldstein
37 38 INDEX TO EXHIBITS SEQUENTIAL EXHIBITS DESCRIPTION PAGE NO. - -------- ------------------------------------------------------- ---------- 10.1 -- Mutual Release and Settlement Agreement, dated as of March 11, 1997, between Decorative Home Accents, Inc. and Henry E. Scharling, II and Barbara Scharling. 10.2 -- Employment and Non-Competition Agreement, dated as of February 28, 1997, between Decorative Home Accents, Inc. and Jay N. Baker. 10.3 -- Employment and Non-Competition Agreement, dated as of February 28, 1997, between Decorative Home Accents, Inc. and Murphy L. Fontenot. 10.4 -- Amendment to Loan and Security Agreement, dated as of February 28, 1997, between Decorative Home Accents, Inc. and Congress Financial Corporation. 10.5 -- Amendment to Loan and Security Agreement, dated as of May 23, 1997, between Decorative Home Accents, Inc. and Congress Financial Corporation. 10.6 -- Credit Agreement, dated as of May 23, 1997, between Decorative Home Accents, Inc. and General Motors Domestic Group Pension Trust, Hughes Master Retirement Trust, Department of Pensions - City of Los Angeles, Magten Offshore Fund Ltd., Magten Partners, L.P., Magten Group Trust, Navy Exchange Service Command Retirement Trust, Western Union Pension Trust and Saturn Fund Ltd. 10.7 -- Security Agreement, dated as of May 23, 1997, between Decorative Home Accents, Inc. and General Motors Domestic Group Pension Trust, Hughes Master Retirement Trust, Department of Pensions - City of Los Angeles, Magten Offshore Fund Ltd., Magten Partners, L.P., Magten Group Trust, Navy Exchange Service Command Retirement Trust, Western Union Pension Trust and Saturn Fund Ltd. 10.8 -- License Agreement, dated as of April 27, 1997, between DHA Home Inc. and Calvin Klein, Inc. 12 -- Computation of Ratio of Earnings to Fixed Charges for Decorative Home Accents, Inc. and Predecessor Companies 18 -- Letter regarding change in accounting principle 21 -- List of Subsidiaries 38 39 INDEPENDENT AUDITORS' REPORT To the Stockholders of Decorative Home Accents, Inc.: We have audited the accompanying consolidated balance sheets of Decorative Home Accents, Inc. and subsidiaries (collectively, the "Company" or "Successor") as of December 31, 1996 and 1995, and the related statements of operations, shareholders' equity (deficiency), and cash flows for the years then ended and the eight months ended December 31, 1994. We have also audited the accompanying combined statements of operations, stockholders' equity and cash flows of International Textile Fabrics, Inc. and Affiliates (the "Predecessor") for the four months ended April 30, 1994. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated/combined financial statements present fairly, in all material respects, the financial position of the Successor as of December 31, 1996 and 1995, and the results of the Successor and Predecessor operations and their cash flows for the years then ended, the eight months ended December 31, 1994 and the four months ended April 30, 1994 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated/combined financial statements taken as a whole, present fairly in all material respects the information set forth therein. As discussed in Note 3 to the consolidated financial statements, in the fourth quarter of 1996 the Company changed its method of accounting for evaluating the recoverability of goodwill. The accompanying consolidated financial statements for the year ended December 31, 1996 have been prepared assuming that the Company will continue as a going concern. As discussed in Note 13 to the financial statements, the Company's recurring net losses, net shareholders' deficiency, and limited liquidity raise substantial doubt about its ability to continue as a going concern. Management's plans concerning these matters are also described in Note 13. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. June 20, 1997 (July 9, 1997 as to Note 14) Greenville, South Carolina F-1 40 DECORATIVE HOME ACCENTS, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
December 31, December 31, 1996 1995 ------------ ------------ ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,980 $ 169 Investment securities - 1,000 Accounts receivable - net of allowance for doubtful accounts of $7,014 and $2,506 at December 31, 1996 and 1995, respectively (Note 7) 25,800 28,982 Inventories (Notes 4 and 7) 32,565 43,713 Income taxes receivable 498 2,714 Deferred income taxes (Note 8) - 4,282 Other current assets 1,212 598 --------- --------- Total current assets 62,055 81,458 PROPERTY, PLANT AND EQUIPMENT, NET (Note 4) 32,262 30,667 INTANGIBLE ASSETS, NET (Note 3) 13,783 94,938 OTHER ASSETS (Note 4) 7,946 8,790 --------- --------- TOTAL ASSETS $ 116,046 $ 215,853 --------- --------- LIABILITIES AND STOCKHOLDERS' (DEFICIENCY) EQUITY CURRENT LIABILITIES: Current portion of long-term debt (Note 7) $ 124,830 $ - Accounts payable 17,231 14,452 Accrued liabilities 6,176 9,775 Accrued interest - 7,583 --------- --------- Total current liabilities 148,237 31,810 --------- --------- LONG-TERM DEBT (Notes 7 and 10) 34,100 131,452 --------- --------- DEFERRED INCOME TAXES (Note 8) - 3,348 REDEEMABLE PREFERRED STOCK (Note 6) 49,351 41,059 --------- --------- REDEEMABLE COMMON STOCK (Note 6) 2,476 1,639 --------- --------- COMMITMENTS AND CONTINGENCIES (Notes 9, 10, 11, 12, 13 and 14) STOCKHOLDERS` (DEFICIENCY) EQUITY (Notes 5, 6 and 7): Common stocks 9 9 Additional paid-in capital 6,685 16,107 Reduction of certain equity interests to predecessor basis (6,209) (6,209) Accumulated deficit (118,603) (3,362) --------- --------- Total stockholders` (deficiency) equity (118,118) 6,545 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS` (DEFICIENCY) EQUITY $ 116,046 $ 215,853 ========= =========
See notes to consolidated/combined financial statements F-2 41 DECORATIVE HOME ACCENTS, INC. CONSOLIDATED/COMBINED STATEMENTS OF OPERATIONS (IN THOUSANDS)
Successor Years Successor Ended Eight Months Predecessor December 31, Ended Four Months ------------------------- December 31, Ended April 30, 1996 1995 1994 1994 --------- --------- ------------- --------------- SALES $ 176,733 $ 128,031 $ 50,102 $ 14,609 COST OF GOODS SOLD 138,633 88,262 23,003 7,498 --------- --------- --------- --------- GROSS PROFIT 38,100 39,769 27,099 7,111 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 52,076 29,501 14,647 4,380 CHARGE FOR GOODWILL IMPAIRMENT 79,717 - - - --------- --------- --------- --------- INCOME (LOSS) FROM OPERATIONS (93,693) 10,268 12,452 2,731 --------- --------- --------- --------- INTEREST INCOME (EXPENSE): Interest expense (19,985) (12,603) (4,765) (151) Interest income 69 322 118 167 --------- --------- --------- --------- Interest income (expense), net (19,916) (12,281) (4,647) 16 --------- --------- --------- --------- INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES AND EXTRAORDINARY LOSS (113,609) (2,013) 7,805 2,747 PROVISION (BENEFIT) FOR INCOME TAXES 1,632 (177) 2,964 56 --------- --------- --------- --------- INCOME (LOSS) BEFORE EXTRAORDINARY LOSS (115,241) (1,836) 4,841 2,691 EXTRAORDINARY LOSS FROM EARLY EXTINGUISHMENT OF DEBT, NET OF TAX BENEFIT OF $936 - (1,526) - - --------- --------- --------- --------- NET INCOME (LOSS) (115,241) (3,362) 4,841 2,691 LESS DIVIDENDS PAID TO PREFERRED STOCKHOLDERS 7,792 3,247 - - --------- --------- --------- --------- NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS ($123,033) ($ 6,609) $ 4,841 $ 2,691 ========= ========= ========= ========= PROFORMA PROVISION FOR INCOME TAXES AND NET INCOME ASSUMING ALL PREDECESSOR INCOME WAS TAXABLE: Income before provision for income taxes (historical) $ 2,747 Proforma provision for income taxes 1,043 --------- PROFORMA NET INCOME $ 1,704 =========
See notes to consolidated/combined financial statements. F-3 42 DECORATIVE HOME ACCENTS, INC. CONSOLIDATED/COMBINED STATEMENTS OF STOCKHOLDERS' (DEFICIENCY) EQUITY (IN THOUSANDS)
Additional Common Class A Paid-in Stocks Warrants Capital ------ -------- --------- Balances at December 31, 1993 $150 $- $20 ------ -------- ------- Stockholders' distributions Net income for the four months ended April 30, 1994 Balances at April 30, 1994 150 - 20 Effect of May 1, 1994 purchase acquisition: Reversal of April 30, 1994 equity accounts (150) (20) Establish new equity accounts at May 1, 1994 1,237 6,763 Accretion of redeemable common stock for the eight months ended December 31, 1994 Net income for the eight months ended December 31, 1994 ------ -------- ------- Balances at December 31, 1994 - 1,237 6,763 Exercise of Class A warrants (1,237) 2,737 Issuance of Class F common stock in connection with sale of 13% Senior Notes due 2002, net of issue costs 1 902 Issuance of Class D common stock in connection with sale of $50 million redeemable preferred stock, net of issue costs 8 5,747 Accretion of redeemable common stock for the year ended December 31, 1995 Accretion of redeemable preferred stock for the six months ended December 31, 1995 Preferred stock dividends paid or accrued for the six months ended December 31, 1995 (390) Accrued compensation on stock options 348 Net loss for the year ended December 31, 1995 ------ -------- -------
Reduction of Certain Equity Retained Total Interests to Earnings Stockholders' Predecessor (Accumulated (Deficiency) Basis Deficit) Equity -------------- ------------ -------------- Balances at December 31, 1993 $- $16,080 $16,250 -------- --------- -------- Stockholders' distributions (3,925) (3,925) Net income for the four months ended April 30, 1994 2,691 2,691 Balances at April 30, 1994 - 14,846 15,016 Effect of May 1, 1994 purchase acquisition: Reversal of April 30, 1994 equity accounts (14,846) (15,016) Establish new equity accounts at May 1, 1994 (6,209) 1,791 Accretion of redeemable common stock for the eight months ended December 31, 1994 (762) (762) Net income for the eight months ended December 31, 1994 4,841 4,841 -------- --------- -------- Balances at December 31, 1994 (6,209) 4,079 5,870 Exercise of Class A warrants 1,500 Issuance of Class F common stock in connection with sale of 13% Senior Notes due 2002, net of issue costs 903 Issuance of Class D common stock in connection with sale of $50 million redeemable preferred stock, net of issue costs 5,755 Accretion of redeemable common stock for the year ended December 31, 1995 (877) (877) Accretion of redeemable preferred stock for the six months ended December 31, 1995 (345) (345) Preferred stock dividends paid or accrued for the six months ended December 31, 1995 (2,857) (3,247) Accrued compensation on stock options 348 Net loss for the year ended December 31, 1995 (3,362) (3,362) -------- --------- --------
F-4 43 DECORATIVE HOME ACCENTS, INC. CONSOLIDATED/COMBINED STATEMENTS OF STOCKHOLDERS' (DEFICIENCY) EQUITY (IN THOUSANDS)
Additional Common Class A Paid-in Stocks Warrants Capital ------ -------- --------- Balances at December 31, 1995 9 - 16,107 Accretion of redeemable common stock for the year ended December 31, 1996 (837) Accretion of redeemable preferred stock for the year ended December 31, 1996 (793) Preferred stock dividends paid for the year ended December 31, 1996 (292) Preferred stock dividends paid-in-kind for the year ended December 31,996 (7,500) Net loss for the year ended December 31, 1996 - - - ---- ---- ------ Balances at December 31, 1996 $9 $- $6,685 ==== ==== ======
Reduction of Certain Equity Retained Total Interests to Earnings Stockholders' Predecessor (Accumulated (Deficiency) Basis Deficit) Equity -------------- ------------ -------------- Balances at December 31, 1995 (6,209) (3,362) 6,545 Accretion of redeemable common stock for the year ended December 31, 1996 (837) Accretion of redeemable preferred stock for the year ended December 31, 1996 (793) Preferred stock dividends paid-in-kind for the year ended December 31, 1996 (7,500) Accrued compensation on stock options Net loss for the year ended December 31, 1996 - (115,241) (115,241) Balances at December 31, 1996 ($6,209) ($118,603) ($118,118)
See notes to consolidated/combined financial statements. F-5 44 DECORATIVE HOME ACCENTS, INC. CONSOLIDATED/COMBINED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
Successor Years Successor Predecessor Ended Eight Months Four Months December 31, Ended Ended ------------------------- December 31, April 30, 1996 1995 1994 1994 --------- ------- ------ ------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $(115,241) $(3,362) $4,841 $2,691 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 10,051 6,552 2,404 465 Write-off of goodwill 79,717 Provision for doubtful accounts 4,507 1,278 225 100 Deferred income tax provision 934 337 355 7 Loss on early extinguishment of debt, net of tax 1,526 Stock compensation expense 348 Changes in operating assets and liabilities, net of HII business acquisition: Accounts receivable (1,326) (9,256) (2,595) 2,018 Income taxes receivable 1,961 (1,007) Inventories 11,148 319 (262) (345) Other current assets (424) 1,105 532 390 Accounts payable 2,603 (5,021) (1,764) 1,780 Accrued liabilities (4,929) (5,903) 2,208 (796) Accrued interest (7,583) 6,979 Income taxes payable (567) --------- ------- ------ ------ Net cash provided by (used in) operating act (18,582) (6,672) 5,944 6,310 --------- ------- ------ ------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of HII: Current assets (55,063) Property, plant and equipment, net (14,291) Other assets (1,270) Intangible assets, net (57,716) Current liabilities 28,779 Deferred income taxes 2,179 Long-term debt 2,296 --------- ------- ------ ------ Net cash used to acquire HII (95,086) Purchases of property and equipment (4,019) (4,106) (3,665) (3,575) Disposal of property and equipment 114 104 Other long term assets 130 (1,180) Sale (purchase) of investment securities 1,000 (1,000) 4,317 --------- ------- ------ ------ Net cash provided by (used in) investing act (2,775) (100,268) (4,665) 742 --------- ------- ------ ------ CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of 13% Senior Notes due 2002 and Class F common stock 125,000 Issuance of $50 million redeemable preferred stock and Class D common stock 50,000 Repayment of indebtedness (68,132) Debt issuance and other financing costs (701) (11,398) Net borrowings under revolving line of credit 25,868 4,972 Distributions to stockholders (3,925) Proceeds from notes payable 182 101 Payments on notes payable (156) Principal payments under capital lease obligations (431) Redeemable preferred stock dividends paid (1,750) (1,789) --------- ------- ------ ------ Net cash provided by (used in) financing act 23,168 98,754 (4,081) --------- ------- ------ ------
F-6 45 DECORATIVE HOME ACCENTS, INC. CONSOLIDATED/COMBINED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (CONTINUED)
Successor Year Successor Predecessor Ended Eight Months Four Months December 31, Ended Ended ----------------------- December 31, April 30, 1996 1995 1994 1994 -------- -------- -------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ 1,811 $( 8,186) $ 1,279 $ 2,971 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 169 8,355 7,076 2,211 -------- -------- -------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,980 $ 169 $ 8,355 $ 5,182 -------- -------- -------- -------- SUPPLEMENTAL CASH FLOW INFORMATION: Interest paid $ 27,568 $ 4,582 $ 4,161 $ 154 -------- -------- -------- -------- Income taxes paid (refunded) ($ 2,559) $ 901 $ 1,882 $ -- -------- -------- -------- -------- SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Accrued redeemable preferred stock dividends $ -- $ 1,458 $ -- $ -- -------- -------- -------- -------- Accrued compensation under stock options $ -- $ 348 $ -- $ -- -------- -------- -------- -------- Accretion of redeemable preferred stock $ 793 $ 345 $ -- $ -- -------- -------- -------- -------- Accretion of redeemable common stock $ 837 $ 875 $ 762 $ -- -------- -------- -------- -------- Exercise of common stock warrants $ -- $ 1,500 $ -- $ -- -------- -------- -------- -------- Preferred stock dividends paid in kind $ 7,500 $ -- $ -- $ -- -------- -------- -------- -------- Capital lease obligations incurred $ 1,716 $ -- $ -- $ -- -------- -------- -------- --------
See notes to consolidated financial statements F-7 46 DECORATIVE HOME ACCENTS, INC. NOTES TO CONSOLIDATED/COMBINED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 1. ORGANIZATION, OPERATIONS AND PURCHASE ACQUISITIONS ORGANIZATION - The accompanying consolidated financial statements (successor) for the years ended December 31, 1996 and 1995, and the eight months ended December 31, 1994, include the consolidated accounts of Decorative Home Accents, Inc. ("DHA" or the "Company") and its wholly-owned subsidiaries, The Rug Barn, Inc. and Home Innovations, Inc. In June 1995, the Company changed its name from CHS Industries, Inc. to Decorative Home Accents, Inc. Also in 1995, the Company's wholly-owned subsidiary, International Textiles, Inc. ("INTEX"), was merged into its wholly-owned subsidiary, The Rug Barn, Inc. The accompanying combined financial statements (predecessor) for the four months ended April 30, 1994 include the combined accounts of the following: International Textile Fabrics, Inc. S Corporation The Rug Barn, Inc. C Corporation QTI Sports, Inc. C Corporation The Rug Barn Accessories, Inc. S Corporation Action International, Inc. C Corporation
OPERATIONS - The Company designs, manufactures and markets an extensive line of decorative home furnishings and accessories. Through its wholly-owned subsidiary, The Rug Barn, Inc. ("The Rug Barn"), the Company produces woven throws, pillows, placemats, rugs and other woven products. Through its wholly-owned subsidiary, Home Innovations, Inc. ("Home Innovations" or "HII"), the Company manufactures niche-oriented home accessories with four major product areas: Bath furnishings, window treatments, bedding products and the Calvin Klein Home Collection ("Calvin Klein"). The Company principally sells to retail companies throughout the United States. PURCHASE OF HOME INNOVATIONS, INC. - Concurrent with the proceeds from the separate debt and equity offerings on July 13, 1995 (see Note 5), the Company purchased all of the outstanding stock of HII, and thus HII became a wholly-owned subsidiary of the Company. The cash purchase price of HII was approximately $95.1 million (after purchase price adjustments described below), including acquisition related costs of approximately $2.0 million plus the assumption of approximately $35.0 million in liabilities consisting principally of trade payables and accruals and $2.3 million of junior subordinated debt. The acquisition was accounted for using the purchase method of accounting. Accordingly, the Company allocated the purchase price to the assets acquired and liabilities assumed based upon their respective fair values. The purchase price for HII was subject to adjustments based on the level of net assets acquired as of the closing date and certain indemnifications from the sellers. The Company finalized negotiations on the purchase price adjustment in November 1995 which resulted in a $6.7 million reduction in the originally agreed-upon $100.0 million purchase price. The final determination of the purchase price allocation resulted in $16.0 million assigned to certain identifiable intangible assets and goodwill of approximately $45.9 million. 1994 ACQUISITION OF THE RUG BARN, INC. - DHA was formed as a holding Company for The Rug Barn, Inc. DHA has no operating activities. Through its subsidiary, The Rug Barn, Inc., DHA purchased certain assets and assumed certain liabilities from a group of commonly controlled companies known as International Textile Fabrics, Inc. ("ITF") and acquired certain other assets from the principal shareholders of ITF effective May 1, 1994. The acquisition was financed, in part, with 11% Senior Notes issued by INTEX. The acquisition was accounted for using the purchase method of accounting. Accordingly, the Company allocated the purchase price (approximately $81 million) to the assets acquired and liabilities assumed, based upon their respective F-8 47 fair values, adjusted for the continuing residual interest in the Company by the principal shareholders of the entities from whom the net assets were acquired. The following summarizes the net effect of this purchase acquisition as of May 1, 1994 (in thousands):
ASSETS LIABILITIES AND EQUITY - ------ ---------------------- Cash and cash equivalents $ 7,076 Current liabilities $ 5,642 Accounts receivable, net 6,034 Long-term debt 68,400 Inventory 3,440 Capital stock and additional paid-in Other current assets 874 capital 6,763 Property, plant and equipment 12,084 Class A warrants outstanding 1,237 Deferred income taxes 3,805 Reduction of certain equity interests Goodwill 42,520 to predecessor basis (6,209) ------- ------- Total $75,833 Total $75,833 ======= =======
Since the stockholders of the entities from which the net assets were acquired retained a minority residual interest in the Company, the Company recorded a reduction in its stockholders' equity to reflect the excess of the purchase price over these stockholders' basis in those net assets acquired, net of the related tax benefit to be realized. The unaudited consolidated results of operations on a pro forma basis as though HII and The Rug Barn, Inc. had been acquired as of January 1, 1994 are as follows (in thousands):
YEAR YEAR ENDED ENDED DECEMBER 31, DECEMBER 31, 1995 1994 ------------ ------------ Sales $206,679 $223,641 Income (loss) before extraordinary items $ (6,515) 2,572 Net income (loss) $ (8,041) 1,045
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION - The consolidated financial statements (successor) for periods subsequent to April 30, 1994 include the accounts of the Company and its wholly-owned subsidiaries, The Rug Barn, Inc. and Home Innovations, Inc. (purchased on July 13, 1995). All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements. PRINCIPLES OF COMBINATION - The combined financial statements (predecessor) for periods prior to May 1, 1994 include the combined accounts of International Textile Fabrics, Inc., The Rug Barn, Inc., QTI Sports, Inc., The Rug Barn Accessories, Inc. and Action International, Inc. All significant intercompany accounts and transactions have been eliminated in the combined financial statements. CASH AND CASH EQUIVALENTS - Cash and cash equivalents include cash in banks and highly-liquid investments with a maturity of one year or less. Substantially all cash receipts are applied to the outstanding balance of the revolving line of credit on a daily basis. INVESTMENT SECURITIES - The Company's investment in municipal bonds (sold in 1996) were classified as securities available-for-sale in 1995 and were carried at fair market value which approximated cost. F-9 48 USE OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of 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. The Company's most significant financial statement estimates include the estimate of the allowance for doubtful accounts and adjustments to reduce inventory to lower of cost or market. Management determines adjustments to reduce inventory to lower of cost or market based on a number of factors, including historical experience, aging of the accounts and the current credit worthiness of its customers. Management determines its estimate of the inventory valuation reserves considering a number of factors, including historical experience, aging and condition of the goods on hand, degree of obsolescence and quantities on hand which might exceed current requirements. Management believes that its estimates provided in the financial statements, including for these valuation reserves and inventory adjustments, are reasonable and adequate. However, actual results could differ from those estimates. CREDIT RISKS AND SIGNIFICANT CUSTOMER - Trade receivables are the principal financial instrument which subject the Company to concentration of credit risks. The Company's principal customers are U.S. retailers of decorative home accessories and the Company operates in a single industry segment. Sales to one of the Company's customers accounted for approximately $27.2 million, $19.0 million and $7.1 million in 1996, 1995 and 1994, respectively. This represented 15.4%, 14.8% and 11.0% of total net sales in the respective years. No sales to a single customer exceeded 10% of sales in any predecessor period. No other customer represented more than 10% of total net sales. Although the Company's exposure to credit risk associated with nonpayment by this customer is affected by conditions or occurrences within the retail industry, trade receivables from this customer (approximately 13.6% of total trade receivables at December 31, 1996) were substantially current as of December 31, 1996 and those which were past due at December 31, 1996 have been subsequently collected. The Company performs ongoing credit evaluations of its customers' financial condition but does not require collateral to support customer receivables. The Company maintains an allowance for doubtful accounts sufficient to provide for estimated credit losses. The allowance is determined based on a variety of factors including management's estimates of collectibility of past due accounts and prior experience. The resulting provisions for losses are charged to income. INVENTORIES - Inventories are stated at the lower of cost or market. Cost, which includes labor, material and factory overhead, is determined on the first-in, first-out basis. ADVERTISING AND CATALOG COSTS - The Company produces annual, periodic and seasonal catalogs and accordingly, costs relating to the production of the catalogs are deferred and amortized using the straight-line method, over the expected period of future benefit of one year or less. No amounts were deferred at December 31, 1996, and approximately $168,000 of deferred catalog costs were included in other assets in the consolidated balance sheet at December 31, 1995. Total advertising and promotional expenses were approximately $2.1 million in 1996, $1.3 million in 1995, $674,000 for the eight months ended December 31, 1994, and $323,000 for the four months ended April 30, 1994. PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment are stated at cost and are depreciated over the estimated useful lives of the assets using the straight-line method. The estimated useful lives used in computing depreciation are as follows: Machinery and equipment 5 to 8 years Furniture and fixtures 5 to 7 years Buildings 30 years
INCOME TAXES - The Company provides deferred income taxes for temporary differences between the tax basis and financial reporting basis of assets and liabilities assuming that they will be realized and settled at the amount reported in the Company's financial statements. F-10 49 Income taxes on earnings of the S Corporations in the predecessor period were payable by the stockholders individually and, accordingly, are not reflected in the financial statements. In addition to the historical income tax provision on the C Corporation income in the predecessor period, the combined statements of operations include disclosure of net income assuming a pro forma income tax provision at 38% as if the Company's entire combined income, rather than a portion of it, was taxed at C Corporation rates. INTANGIBLE ASSETS, NET - Certain identifiable intangible assets purchased in the acquisition of HII, principally the Calvin Klein contract and customer lists, were determined by independent appraisal to have an aggregate value of approximately $16.0 million at the date of acquisition. These identifiable intangible assets are amortized over an average life of approximately 11 years on the straight-line method and are reported net of accumulated amortization of approximately $2,223,000 and $712,000 at December 31, 1996 and 1995, respectively. The excess of cost over the fair value of the net assets (goodwill) of the acquired businesses of approximately $88.5 million was being amortized over 20 years on the straight-line method. As described in Note 3, at December 31, 1996 the Company changed its method of evaluating the realizability of its intangible assets to a fair value approach determined using an estimate of discounted cash flows. Using the fair value approach, the Company wrote off the unamortized value of its goodwill, $79.7 million, in the accompanying 1996 consolidated statement of operations. Prior to the change in method of accounting, the Company evaluated the realizability of its intangible assets based upon expectations of undiscounted cash flows and comparing such future cash flows to the carrying amount of the related assets. DEFERRED FINANCING COSTS - Costs associated with the placement of debt have been deferred and are included in other assets in the consolidated balance sheet and are amortized over the term of the related debt using the effective interest method. Costs associated with the revolving credit facility have been deferred and are amortized over the term of the agreement using the straight-line method. REDEEMABLE STOCK - The carrying amounts of redeemable preferred and common stock are recorded at fair value and are accreted over their terms using the effective interest method. The periodic accretion is charged against retained earnings, or in the absence of retained earnings, by charges against additional paid-in capital. REVENUE RECOGNITION POLICY - The Company recognizes revenue from product sales when it has shipped the goods. The Company's customers have the right to return certain merchandise for replacement with another product. No restocking fee is charged if the customer obtains a return authorization and places a replacement order prior to returning merchandise. The Company provides an accrual for the effect of estimated future returns relating to reported sales. IMPAIRMENT OF LONG-LIVED ASSETS - Effective January 1, 1996, the Company adopted the provisions of Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement requires long-lived and identifiable intangible assets to be reviewed for impairment when circumstances indicate that the carrying amount of the asset may not be recoverable. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, the entity recognizes an impairment loss which is to be measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. No impairment losses were recognized by the Company upon the adoption of SFAS 121. The Company considered the change in executive management combined with revised operating expectations and the Company's liquidity crisis, which occurred in the fourth quarter, to be impairment indicators under SFAS 121. Accordingly, the Company performed an impairment analysis using projected future cash flows (undiscounted and without interest charges) which indicated that the carrying amount of the Company's assets was not impaired. STOCK COMPENSATION - During 1996, the Company adopted Statement of Financial Accounting Standards 123 ("SFAS 123"), "Accounting for Stock-Based Compensation." SFAS 123 recommends that companies account F-11 50 for stock compensation on a fair-value-based method which requires that the fair value of stock options be measured at the grant date based on the value of the award and be recognized over the vesting period. Companies may, however, continue to measure compensation cost using the method prescribed by Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees." Under APB 25, compensation cost is measured based on the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Companies that continue to apply APB 25 must include in the financial statements certain disclosures which reflect pro forma amounts as if the fair value method had been used. The Company has elected to continue to account for such plans under APB 25. See Note 6. RECLASSIFICATIONS - Certain 1995 and 1994 amounts have been reclassified to conform to the 1996 presentation. 3. GOODWILL IMPAIRMENT Prior to the fourth quarter of 1996, the Company evaluated the recoverability of goodwill by determining whether the amortization of the goodwill balance over its remaining amortization period could be recovered through undiscounted future operating cash flows of the acquired operations. In the fourth quarter of 1996, the Company changed its method for evaluating the recoverabilty of goodwill to a method whereby the carrying amount is compared to its estimated fair value, and any excess carrying amount is determined to be impaired. The fair value of goodwill is estimated by subtracting the estimated fair value of the Company's identifiable net assets from the fair value of the Company in its entirety, which is estimated using a discounted cash flow approach. The Company believes fair value is a preferable method to assess goodwill for recoverability as it believes that the value at which the Company could be bought and sold in an arms length transaction between a willing buyer and seller is the most objective evidence and, therefore, the most relevant measure of its value. Based on an evaluation of the recoverability of goodwill at December 31, 1996, the Company concluded that its unamortized balance of goodwill, $79.7 million, was impaired and has recorded a pre-tax charge for such amount in the accompanying 1996 consolidated statement of operations. 4. BALANCE SHEET COMPONENTS Inventories are summarized as follows (in thousands):
DECEMBER 31, ------------------------ 1996 1995 ------- ------- Raw materials and supplies $13,964 $24,464 Work-in-process 2,654 973 Finished goods 15,947 18,276 ------- ------- Total $32,565 $43,713 ======= =======
Property, plant and equipment is summarized as follows (in thousands):
DECEMBER 31, --------------------------- 1996 1995 -------- -------- Land $ 862 $ 863 Buildings and improvements 16,782 15,384 Furniture and fixtures 5,296 3,184 Machinery and equipment 15,536 14,101 -------- -------- 38,476 33,532 Accumulated depreciation (7,594) (3,375) -------- -------- 30,882 30,157 Construction in progress 1,380 510 -------- -------- Property, plant and equipment, net $ 32,262 $ 30,667 ======== ========
F-12 51 Other assets are summarized as follows (in thousands):
DECEMBER 31, ---------------------- 1996 1995 ------ ------ Deferred financing costs, net $7,007 $7,417 Other 939 1,373 ------ ------ Total $7,946 $8,790 ====== ======
5. DEBT AND EQUITY OFFERINGS On July 13, 1995, the Company sold for gross proceeds of $125 million, 125,000 Units, each such Unit consisting of $1,000 principal amount of Series A 13% Senior Notes due June 30, 2002 and one share of the Company's Class F Common Stock, par value $0.01 per share. In connection with the sale of the Units, certain of the Company's stockholders purchased $6.9 million of the Units and received $6.9 million of the Series A 13% Senior Notes and 6,900 shares of the Class F Common Stock. In addition, other stockholders of the Company tendered $23.039 million principal amount of 11% Senior Notes of INTEX in exchange for 23,039 of the Units (see Note 6). On December 26, 1995, the Company completed an exchange of its Series A 13% Senior Notes due 2002 for Series B 13% Senior Notes due 2002 ("13% Senior Notes"). The terms of the Senior Notes are substantially the same except the Series B 13% Senior Notes can be publicly traded (registered with the Securities and Exchange Commission on November 9, 1995). Concurrent with the sale of the Units, the Company sold for gross proceeds of $50 million, 50,000 shares of Redeemable Preferred Stock, 803,333 shares of Class D Common Stock and Class D Warrants (collectively, the "Equity Offering") which are exercisable, under certain conditions, for additional shares of Class D Common Stock. Dividends on the Redeemable Preferred Stock are payable quarterly at an annual rate of 14%. Under certain terms governing the 13% Senior Notes and the amended and restated Revolving Credit Facility, dividends on the Redeemable Preferred Stock must be paid, at a 15% annual rate, by the issuance of additional Redeemable Preferred Stock in lieu of cash dividends. The Redeemable Preferred Stock is redeemable at any time prior to mandatory redemption on July 1, 2003, without penalty, at the Company's option. The Company is required to redeem the Redeemable Preferred Stock upon the occurrence of certain events, including the violation of certain restrictive covenants. Also, upon a change of control of the Company, the preferred stockholders have the option to require the Company to repurchase their shares. The agreements relating to the Redeemable Preferred Stock prohibit the payment of cash dividends on the Company's Common Stock. The Redeemable Preferred Stock is contractually subordinated to the full payment in cash of the Senior Notes. Upon the occurrence of certain events such as the Company's failing to meet certain ratios, the Class D directors will have 50% of the total votes of the Board of Directors of the Company. Such event occurred in April 1996, and accordingly, the Class D directors have 50% of the total votes of the Board of Directors. The holders of the Class D Warrants are entitled to acquire shares of Class D Common Stock representing up to approximately 10% of the Company's Common Stock if the Company does not achieve certain performance criteria, cumulative for fiscal 1996 and 1997, and certain leverage ratios. Also, the holders of the Class D Warrants are entitled to acquire shares of Class D Common Stock representing up to approximately 5% of the Company's Common Stock if the Redeemable Preferred Stock remains outstanding after January 13, 1999 (2.5% of Common Stock) or July 13, 1999 (an additional 2.5% of Common Stock). The net proceeds from the sale of the Units and the Equity Offering, along with approximately $4.2 million of the Company's cash, were used to finance the acquisition on July 13, 1995 of Home Innovations, Inc. ("HII") and to repay certain indebtedness of approximately $46.3 million due to related parties, including approximately $1.2 million in accrued interest and a $1.2 million prepayment penalty on the INTEX 11% F-13 52 Senior Notes. The prepayment penalty, net of taxes, was recognized as an extraordinary loss in the accompanying 1995 consolidated statement of operations. Subsequent to December 31, 1996, the Company reached an agreement in principle to restructure the Units and Redeemable Preferred Stock. See Note 14. F-14 53 6. REDEEMABLE STOCK AND SHAREHOLDERS' EQUITY AMENDED AND RESTATED STOCKHOLDERS' AGREEMENT - On July 13, 1995, the Company amended and restated its Stockholders' Agreement ("Amended and Restated Stockholders' Agreement"). Shares issued and outstanding and shares authorized at December 31, 1996 and 1995, are as follows:
SHARES ISSUED SHARES DESCRIPTION AND OUTSTANDING AUTHORIZED --------------- ---------- Redeemable preferred stock 50,000 200,000 Redeemable common stock: Class A (voting) 109,737 109,737 Class B (non-voting) 1,756,126 1,800,000 Common stock (voting): Class A 965,101 2,790,263 Class C 386,040 400,000 Class D 808,333 2,400,000 Class E -- 2,100,000 Class F 125,000 400,000
REDEEMABLE PREFERRED STOCK - The Redeemable Preferred Stock was recorded at its fair value at its July 13, 1995 issuance. The carrying amount of the Redeemable Preferred Stock is being accreted, using the interest method, to its redemption value of $50 million over its term until mandatory redemption on July 1, 2003. The periodic accretion is charged against retained earnings, or in the absence of retained earnings, by charges against additional paid-in capital. Such accretion totaled $793,000 and $345,000 for the year ended December 31, 1996 and 1995, respectively. Total dividends on the Redeemable Preferred Stock in 1996 were $7.8 million, of which, $7.5 million were paid-in-kind. Total dividends on the Redeemable Preferred Stock in 1995 were $3,247,000, including $1,458,000 paid in 1996 and $1,789,000 paid in 1995. REDEEMABLE COMMON STOCK - Certain holders of the Class A voting common stock (par value $.01 per share, 109,737 shares issued and outstanding) and all holders of the Class B non-voting common stock (par value $.01 per share, 1,756,126 shares issued and outstanding) can, at their option on the later of May 4, 2001 or ninety-one days after the redemption of the Redeemable Preferred Stock (mandatory redemption on July 1, 2003), require the Company to repurchase their shares of common stock ("Redeemable Common Stock") at the then fair market value of each share. The Company has the option, after May 4, 2002, to purchase the Redeemable Common Stock for cash at the then fair market value of each share. The carrying amount of the Redeemable Common Stock is determined by estimating the fair market value of the common stock at the holders' optional redemption date and accreting, using the interest method, to such estimated redemption amount. The periodic accretion is being charged against retained earnings, or in the absence of retained earnings, by charges against additional paid-in capital. F-15 54 The following summarizes accretion in the Redeemable Common Stock account from May 1, 1994 to December 31, 1996 (in thousands):
Accretion for the eight months ended December 31, 1994 and balance at December 31, 1994 $ 762 Accretion for the year ended December 31, 1995 877 ------ Balance at December 31, 1995 1,639 Accretion for the year ended December 31, 1996 837 ------ Balance at December 31, 1996 $2,476 ======
STOCK OPTIONS - During the years ended December 31, 1996 and 1995, the Company granted stock options to certain key employees. As discussed in Note 2, the Company will continue to apply the principles of APB 25 to account for these options. Compensation expense of $348,000 was recognized in 1995 for time-vested options which were granted at less than fair market value. The pro forma effects of applying the fair value measurement principles of SFAS 123 on net income are not materially different from that reported for both 1996 and 1995. Since the Company's equity securities are not publicly held, earnings per share data is not presented. In 1996 and 1995, the Company granted options for 317,000 and 214,908 shares of common stock, respectively, at a weighted-average exercise price of $7.68 and $1.62. The foregoing and following table excludes "super performance" options for 185,185 shares of common stock granted in 1995 with an exercise price of $76.80. Management believes inclusion of such options would reduce the relevance of such disclosures. No options were exercised or canceled in 1996 or 1995. The following summarizes certain information about options outstanding at December 31, 1996:
WEIGHTED AVERAGE REMAINING CONTRACTUAL EXERCISE PRICE SHARES LIFE (YEARS) - ------------------------------------------------------------------------------ $ 0.01 169,908 3.50 $ 7.68 362,000 4.66 ------- 531,908 =======
As of December 31, 1996, there were vested options to purchase 71,636 shares at a weighted-average exercise price of $1.62. Of the options granted during 1996 and 1995, 317,000 and 45,000 shares vest at a rate of 33% per year over a 3 year period in annual increments on each of the first, second and third anniversaries of the date of grant. The remaining options granted during 1995, 84,954 shares vest based on performance and 84,954 shares are time-vested. The performance options are based on the achievement of certain Company performance criteria, cumulative for 1996 and 1997. During 1996, the performance criteria were not met. For the 84,954 time-vested options, vesting occurs with an initial 33% at the date of grant and 33% on each of the first and second anniversaries of the date of grant. F-16 55 EXERCISE OF COMMON STOCK WARRANTS - In June 1995, certain of the Company's stockholders exercised warrants for the purchase of 1,232 shares of the Company's Class A Common Stock for $1.5 million. The exercise price was paid by the reduction of certain indebtedness owed by a subsidiary of the Company to the stockholders. 7. LONG-TERM DEBT Long-term debt consists of the following at December 31, 1996 and 1995 (in thousands):
DECEMBER 31, ----------------------------- 1996 1995 --------- --------- 13% Senior Notes due June 30, 2002 $ 125,000 $ 125,000 Less - discount (821) (917) --------- --------- 124,179 124,083 Borrowings under revolving credit facility 30,841 4,972 Other long-term debt 3,910 2,397 --------- --------- Total 158,930 131,452 Current portion 124,830 -- --------- --------- Long-term portion $ 34,100 $ 131,452 ========= =========
SENIOR NOTES - As described in Note 5, the Company sold $125 million principal amount of 13% Senior Notes due June 30, 2002. Interest is paid semiannually on June 30 and December 31. The Senior Notes were issued at a discount of approximately $958,000. The Senior Notes are being accreted, using the interest method, to their $125 million principal amount. The periodic accretion is charged to interest expense. The Senior Notes are unconditionally, jointly and severally guaranteed by each of the Rug Barn and HII and each of the direct and indirect subsidiaries of HII. Under the indenture agreement of the 13% Senior Notes, the Company is not permitted to declare or pay dividends on capital stock other than the Redeemable Preferred Stock prior to June 30, 1997, except for dividends payable in capital stock. The 13% Senior Notes also contain various covenants, restrictions and redemption features. The payment of cash dividends on the Redeemable Preferred Stock is allowed provided that certain financial covenants of the Company are met. Subsequent to June 30, 1997, cash payment of dividends is allowed on other classes of the Company's capital stock, provided that certain financial covenants of the Company are met. Further, there are limitations on the ability of the Rug Barn and Home Innovations to incur additional indebtedness and pay dividends. As discussed in Note 14, the 13% Senior Notes have been classified as current in the accompanying consolidated balance sheet. The Company has reached an agreement in principal with certain of the Company's bond holders and equity holders to convert the Senior Notes to equity. F-17 56 REVOLVING CREDIT FACILITY - On November 12, 1996, the Company and certain subsidiaries entered into a Loan and Security Agreement (the "Agreement") with a revolving credit facility to provide for revolving loans ("Loans") and letters of credit ("Letters of Credit") in an aggregate principal amount of up to $50 million, subject to borrowing limitations, for a three year period. The Agreement may be renewed from year to year thereafter at the mutual agreement of the parties. The initial borrowing of $35.4 million on November 12, 1996 was utilized to repay amounts owed the prior lender under the Company's former Revolving Credit Facility. Borrowings under the $50 million Revolving Credit Facility bear interest, at the Company's discretion, at a rate of 5/8% percent per annum in excess of the Prime Rate or 3-1/4% percent per annum in excess of the Eurodollar Rate. The borrowings are secured by a first priority lien on the accounts receivable and inventories of the Company's subsidiaries. The Company is required to maintain a minimum adjusted tangible net worth, as defined, and the payment of cash dividends on the Company's common stock is prohibited in accordance with the Agreement. Further, there are limitations on the ability of the Company to incur additional indebtedness and make loans, advances and investments. Under the Company's borrowing formula, which is based on underlying collateral as described above, approximately $3.8 million (net of $30.8 million of outstanding Loans and approximately $418,000 in outstanding Letters of Credit) was available for borrowing by the Company under the Revolving Credit Facility at December 31, 1996. On March 1, 1997, the Agreement was amended to provide for a line of credit ("Supplemental Facility") pursuant to which the lender made supplemental loans ("Supplemental Loans") of $5 million. The Supplemental Loans under the Supplemental Facility were repaid on May 27, 1997. See Note 14. On May 23, 1997, the Agreement was amended for, among other things, changes in certain covenants including the tangible net worth calculation. There were no Events of Default (as defined) under the Agreement, as amended, at December 31, 1996. See Note 13. OTHER LONG-TERM DEBT - Other long-term debt at December 31, 1996 consists principally of $2,579,000 of subordinated notes bearing interest at 7.5% and obligations under capital leases. The debt matures in May 1999. FAIR VALUE OF LONG-TERM DEBT - The fair value of the 13% Senior Notes, based on estimated quoted prices, was $62.5 million at December 31, 1996. The fair value of the amounts outstanding under the revolving credit facility and the other long-term debt approximates their carrying value. 8. INCOME TAXES The provision (benefit) for income taxes of successor consists of the following (in thousands):
YEAR ENDED EIGHT MONTHS DECEMBER 31, ENDED ------------------------- DECEMBER 31, 1996 1995 1994 ------- ------- ------------ Current: Federal $ 849 $ (551) $ 2,244 State (149) 37 365 Deferred: Federal 174 273 305 State 758 64 50 ------- ------- ------- Total provision (benefit) $ 1,632 $ (177) $ 2,964 ======= ======= =======
F-18 57 Presented below are the sources of deferred income tax assets and liabilities (in thousands):
DECEMBER 31, --------------------------- 1996 1995 -------- -------- Gross deferred income tax assets: Allowance for doubtful accounts $ 1,187 $ 935 Inventory valuation reserves 1,385 1,369 Deductible goodwill 13,669 2,807 Reserves for plant relocations 142 1,682 Net operating loss carryforwards 19,369 4,861 Tax credit carryforwards 1,778 703 Other 475 360 Valuation allowance (30,838) (5,106) -------- -------- Total 7,167 7,611 -------- -------- Gross deferred income tax liabilities: Depreciation (1,792) (911) Prepaid advertising -- (63) Identifiable intangible assets (5,375) (5,703) -------- -------- Total (7,167) (6,677) -------- -------- Net deferred income tax asset $ -- $ 934 ======== ========
The net deferred income tax asset at December 31, 1995 was recognized in the accompanying consolidated balance sheet as follows (in thousands):
DECEMBER 31, 1995 ------- Current deferred income tax asset $ 4,282 Noncurrent deferred income tax liability (3,348) ------- Net deferred income tax asset $ 934 =======
Management cannot be assured that the net deferred income tax asset of $30.8 million will be realized. Accordingly, in 1996 the valuation allowance was increased to 100% of the total net deferred income tax asset. In 1995, a valuation allowance was established at $5.1 million or 100% of the deferred tax asset arising from net operating loss carryforwards and state tax credits earned during 1995 as management could not be assured that the deferred asset would be realized. F-19 58 A reconciliation of the statutory income tax rate to the annual effective income tax rate of successor follows:
YEAR ENDED EIGHT MONTHS DECEMBER 31, ENDED --------------------- DECEMBER 31, 1996 1995 1994 ------ ------ ------------ Federal income tax at statutory rate (34)% (34)% 34% State income tax, net of federal tax benefit -- (3) 4 Intangible asset amortization not deductible 16 16 -- Valuation allowance for deferred tax assets 19 10 -- Other -- 2 -- ------ ------ ---- Total 1 % (9)% 38% ====== ====== ====
At December 31, 1996, the Company has available for Federal income tax purposes net operating loss carryforwards of approximately $48.0 million which begin to expire in 2007, Federal general business and alternative minimum tax credits which begin to expire in 2009, state net operating losses totaling $60.9 million which begin to expire in 1997 and state tax credits which begin to expire in 2002. The provision for income taxes for the predecessor companies for the four months ended April 30, 1994 consist of the following (in thousands):
FOUR MONTHS ENDED APRIL 30, 1994 ----------- Current: Federal $ 42 State 7 ----- 49 ----- Deferred: Federal 6 State 1 ----- 7 ----- Total $56 =====
The deferred taxes for the four months ended April 30, 1994, result primarily from reserves for doubtful accounts and inventories, sales adjustments, depreciation and amortization, certain accrued liabilities not currently deductible for income tax purposes and capitalized catalog costs which are currently deductible for income tax purposes. F-20 59 The combined net income of the S Corporations was approximately $2.6 million for the four months ended April 30, 1994. A reconciliation of the statutory income tax rate to the annual effective income tax rate on the C Corporation pretax income is as follows: FOUR MONTHS ENDED APRIL 30, 1994 Federal income tax at statutory rate 34% State income tax, net of federal tax benefit 4 --- Total 38% ===
9. 401(K) CONTRIBUTION PLAN On February 1, 1996, the Company adopted a discretionary contribution plan (the "New Plan") available to employees meeting the New Plan's eligibility requirements. A determination letter has been filed with the Internal Revenue Service. The New Plan is expected to be qualified under Section 401(k) of the Internal Revenue Code. Currently, the Company matches $0.25 per $1.00 of employee contributions, up to a maximum of 6% of each employees' compensation. The Company's contribution is determined by the Board of Directors. The Company's contributions to the New Plan during 1996 were approximately $148,000. Prior to the adoption of the New Plan, the Company's wholly-owned subsidiary, Home Innovations, had a defined contribution plan (the "Old Plan") available to Home Innovations' employees meeting eligibility requirements. The assets of the Old Plan were transferred to the New Plan during 1996. The Old Plan was a tax qualified plan under Section 401(k) of the Internal Revenue Code. The Company made a matching contribution of 25% of each participant's base compensation. The Company's contributions to the Old Plan were approximately $101,000 for the year ended December 31, 1995 (subsequent to the acquisition of Home Innovations in July 1995). 10. LEASES The Company leases office, warehouse and manufacturing facilities, and computer equipment under operating and capital leases expiring through 2003. Rental expense under operating leases totaled approximately $901,000 in 1996, $778,000 in 1995, $42,000 for the eight months ended December 31, 1994, and $198,000 for the four months ended April 30, 1994. Future minimum rental payments under the capital and operating leases are as follows:
CAPITAL OPERATING LEASES LEASES TOTAL ------- --------- ------- 1997 $ 738 $ 1,861 $ 2,599 1998 531 1,308 1,839 1999 194 275 469 2000 45 143 188 2001 -- 138 138 Thereafter -- 279 279 ------- ------- ------- Total minimum lease payments 1,508 $ 4,004 $ 5,512 ======= ======= Less interest (178) ------- Present value of minimum lease payments $ 1,330 =======
F-21 60 11. COMMITMENTS AND CONTINGENCIES The Company has a license agreement with Calvin Klein, Inc., expiring April 30, 1998. In connection with the restructuring plan discussed in Note 14, Calvin Klein, Inc. has committed to enter into a new multi-year agreement extending through 2004. The agreement requires that the Company pay various fees and royalties, generally based on net sales, over the term of the agreement. Future commitments for purchases of raw materials are approximately $4.6 million. Certain of these contracts can be canceled without penalty to the Company. The Company is involved in various legal actions, environmental matters and other proceedings that are incidental to the conduct of its business. The Company believes, after reviewing such matters and consulting with counsel, that any liability which may ultimately be incurred with respect to these matters is not expected to have a material effect on either the Company's consolidated financial position or results of operations. 12. RELATED PARTIES MANAGEMENT FEES - In May 1994, the Company entered into a management fee agreement with a stockholder of the Company which required payments of $400,000 each year, payable in equal monthly installments, in consideration of general supervisory and business planning services provided by the stockholder, plus an additional fee based on achieving certain financial thresholds. In addition, this stockholder received reimbursements for expenses incurred in the performance of these services. In July 1995, the Company amended its management fee agreement with the stockholder to require payments of $750,000 each year, payable in equal monthly installments, plus reimbursements to the stockholder for out-of-pocket expenses. Effective January 1, 1996, the stockholder voluntarily reduced his annual fees to $375,000, payable in equal monthly installments, plus reimbursements to the stockholder for out-of-pocket expenses. Payments to the stockholder were approximately $398,000, $603,000 and $451,000 in 1996, 1995 and for the eight months ended December 31, 1994, respectively. OTHER - Under an agreement with a former stockholder of the Company, the Company paid the former stockholder approximately $99,000 in 1996, $266,000 in 1995 and $78,000 for the eight months ended December 31, 1994 for the use of an airplane. The Company also paid approximately $987,000 in 1996, $244,000 in 1995 and $85,000 for the eight months ended December 31, 1994 for printing services to a company wholly owned by certain former stockholders of the Company. 13. GOING CONCERN The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern which contemplates the realization of the assets and the settlement of liabilities and commitments in the normal course of business. The Company has incurred net losses in 1996 and 1995 and has a net shareholders' deficiency of approximately $118.1 million at December 31, 1996. At December 31, 1996 and through the date of this report, the Company's liquidity is limited and it does not have the ability to pay all of its current obligations. Further, the Company maximized its borrowings under its senior revolving credit facility. As described in Notes 7 and 14, the Company has received temporary financing from its bank and certain of its bondholders. In addition to the above-described inability to pay all of its current obligations, the Company also does not foresee the ability to meet its obligations under its Senior Notes (including the interest obligation due on June 30, 1997) or Redeemable Preferred Stock. Accordingly, on February 6, 1997, the Company engaged Houlihan, Lokey, Howard and Zukin, Inc. as financial advisors for a potential financial restructuring of the Company's obligations. As described in Note 14, on May 23, 1997 the Company reached an agreement in principle with F-22 61 certain of the Company's bondholders and equity holders which would convert the Senior Notes into common equity and provide up to $20 million of financing for working capital purposes. Management believes that the restructuring plan, if it is accomplished, will be adequate to finance anticipated operational needs, planned capital expenditures and to meet other debt service obligations during 1997. Consummation of the proposed restructuring is subject to various conditions described in Note 14. There is no assurance that the proposed restructuring will be accomplished. Currently, management of the Company expects that a pre-negotiated filing under the provisions of Chapter 11 of the United States Bankruptcy Code will be necessary to effect the restructuring. The Company intends to present its plan of reorganization substantially simultaneously with its bankruptcy filing and seek confirmation thereof at the earliest possible opportunity. Management of the Company and its legal counsel intend to file a motion with the bankruptcy court to obtain an order to allow full payment during the Chapter 11 case of the pre-petition trade debt of those suppliers that provide customary trade credit terms to the Company during the pendency of its Chapter 11 case. In addition, it is expected that the pre-negotiated plan of reorganization that the Company intends to file will provide for the payment of all unpaid pre-petition trade debt upon the consummation thereof. If the pre-negotiated restructuring plan is not approved by the Court the Company will attempt to negotiate another restructuring plan with its creditors. In the event that a restructuring is not consummated, management of the Company believe that the Company's inability to pay all of the current obligations and service its debt as required raises substantial doubt about the Company's ability to continue as a going concern. 14. SUBSEQUENT EVENTS As described in Note 7, on March 1, 1997, the Company's senior revolving credit facility was amended to provide an additional $5 million unsecured loan which was repaid on May 27, 1997. Also, on May 23, 1997, the Company's senior revolving credit facility was amended for certain matters including revised loan covenants. During 1996, at the request of the Board of Directors, two of the Company's officers and members of the Board of Directors resigned. Subsequent to their resignation, certain allegations concerning wrongful acts were made by the Company and certain stockholders. On March 11, 1997, in consideration of the release and discharge from all claims, damages, and all causes of action, the two former officers and members of the Board of Directors returned to the Company 965,101 shares of the Company's Class A Common Stock, 6,900 shares of the Company's Class F Common Stock, $6.9 million of the Company's Senior Notes and $448,000 in cash. On May 15, 1997, the Company reached an agreement in principle with certain of the Company's bond holders and equity holders providing for a comprehensive capital restructuring plan. The restructuring agreement was entered into by the Company's preferred stockholder, TCW Special Credits Fund V - The Principal Fund ("Fund V") and the beneficial owners of approximately 76% of the principal amount of the Senior Notes, Magten Asset Management Corp., solely as agent for various of its investment advisor clients in their respective accounts at Magten ("Magten"), and CIGNA. The restructuring plan will, among other things, (i) convert the $118.1 million principal amount still outstanding on the 13% Senior Notes plus all accrued and unpaid interest on the Senior Notes into 92.5% of the Company's common equity, (ii) exchange all the Company's 14% redeemable preferred stock into 7.5% of the common equity along with a 5 year warrant to purchase up to 7.5% of the fully diluted common equity and, (iii) exchange all of the classes of common stock into a 5 year warrant to purchase up to 2.5% of the fully diluted equity. In connection with the Company's capital restructuring plan, the Company did not pay interest on the Senior Notes due on June 30, 1997. Pursuant to the restructuring, Magten provided the Company with a secured term loan facility of up to $20 million (the "Secured Term Loan Facility") ($15 million was advanced to the Company on May 23, 1997 and an additional $5 million was advanced to the Company on July 9, 1997). Magten also earned a $5 million closing fee which will be waived under certain conditions set forth in the credit agreement with respect to the Secured Term Loan Facility. Additionally, the indenture that governs the Senior Notes was modified to permit the Company to incur the Secured Term Loan Facility. It is contemplated that the Secured Term Loan Facility F-23 62 will be repaid with the proceeds of a rights offering to purchase additional shares of the Company's common stock upon a consummation of the restructuring. The proposed restructuring plan also provides that Magten and Fund V will each agree to exercise all rights and/or oversubscription options issued to them in the rights offering so that the Company will receive sufficient proceeds from the rights offering to pay in full in cash all of the indebtedness under the Secured Term Loan Facility. A portion of the proceeds from the Secured Term Loan Facility was used to retire the Supplemental Facility described in Note 7. In connection with the Secured Term Loan Facility provided by Magten, the Company's existing working capital lender and Magten entered into an inter-creditor agreement. Management believes that the transactions contemplated by the above described restructuring will generate additional proceeds that will be adequate to finance anticipated operational needs, planned capital expenditures and meet any debt service obligations for the remainder of 1997. The proposed restructuring plan and Magten's related commitments are subject to various conditions, including due diligence by Magten. As described in Note 13, management of the Company expects that a pre-negotiated filing under the provisions of Chapter 11 of the United States Bankruptcy Code will be necessary to effect the restructuring. In connection with the restructuring, the Company entered into employment retention agreements with certain key management personnel. The agreements provide for, among other things, a guaranteed bonus payment in March 1998 if the individual is employed by the Company on that date. The maximum obligation to the Company for payments under these agreements is $1.1 million. The Company also entered into amended and restated employment and non-competition agreements with certain officers. If either of these officers' employment is terminated within 90 days following a change of control of the Company, by (i) the Company without good cause, (ii) a successor to the Company without good cause or (iii) the officers themselves, then the Company shall pay the officers an amount aggregating approximately $2.5 million. On April 27, 1997, Calvin Klein, Inc. terminated its license agreement with Calvin Klein Home, Inc. and entered into a new interim agreement, with similar terms and conditions, that expires on April 30, 1998, or upon the completion of the restructuring plan. If the restructuring plan is consummated, Calvin Klein, Inc. has committed to enter into a new multi-year agreement that would extend through the year 2004. At December 31, 1996, the carrying amount of the Calvin Klein license agreement is $8,365,000, which is calculated based on the original contract period ending in 2004. If the above-described restructuring is not completed, Calvin Klein, Inc. may not renew its license agreement with the Company. Failure to renew the license agreement on a long-term basis would result in a charge to earnings for the unamortized balance of the license agreement and may otherwise have a material adverse effect on the Company's future results of operations. ******** F-24 63 DECORATIVE HOME ACCENTS, INC. SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, DECEMBER 31, 1996 1995 ------------ ------------ CURRENT ASSETS-- INCOME TAXES RECEIVABLE $ -- $ 1,909 DUE FROM SUBSIDIARIES 88,933 63,000 INVESTMENT IN (DUE TO) SUBSIDIARIES (37,547) 118,106 DEFERRED INCOME TAXES -- 132 OTHER ASSETS 6,502 7,324 --------- --------- TOTAL ASSETS $ 57,888 $ 190,471 ========= ========= CURRENT LIABILITIES: Current portion of long-term debt (Notes A and C) $ 124,179 $ -- Accrued liabilities -- 2,288 Accrued interest -- 7,583 Due to subsidiaries -- 7,274 --------- --------- TOTAL CURRENT LIABILITIES 124,179 17,145 --------- --------- LONG-TERM DEBT (NOTES A AND C) -- 124,083 REDEEMABLE PREFERRED STOCK (NOTES A AND B) 49,351 41,059 REDEEMABLE COMMON STOCK (NOTE B) 2,476 1,639 STOCKHOLDERS' (DEFICIENCY) EQUITY (NOTE B): Common stocks 9 9 Additional paid-in capital 476 9,898 Accumulated deficit (118,603) (3,362) --------- --------- Total stockholders' (deficiency) equity (118,118) 6,545 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' (DEFICIENCY) EQUITY $ 57,888 $ 190,471 ========= =========
See Notes to Condensed Financial Information. 64 DECORATIVE HOME ACCENTS, INC. SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF OPERATIONS (IN THOUSANDS)
YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, 1996 1995 ------------ ------------ Equity in income (losses) of consolidated subsidiaries $ (97,075) $ 2,241 --------- --------- Expenses: Selling, general and administrative expenses 504 812 Interest expense 17,253 7,988 --------- --------- Total expenses 17,757 8,800 --------- --------- Loss before income taxes (114,832) (6,599) Income tax provision (benefit) 409 (3,197) --------- --------- Net loss $(115,241) $ (3,362) ========= =========
See Notes to Condensed Financial Information. 65 DECORATIVE HOME ACCENTS, INC. SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENT OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
RETAINED TOTAL ADDITIONAL EARNINGS STOCKHOLDERS' COMMON CLASS A PAID-IN (ACCUMULATED EQUITY STOCK WARRANTS CAPITAL DEFICIT) (DEFICIENCY) ------------- ------------ --------------- ------------------ ------------------ Balances at December 31, 1994 $ -- $ 1,237 $ 554 $ 4,079 $ 5,870 Exercise of Class A warrants (1,237) 2,737 1,500 Issuance of Class F common stock in connection with the sale of the 13% Senior Notes due 2002, net of Notes due 2002, net of issue costs 1 902 903 Issuance of Class D common stock in connection with sale of $50 million redeemable preferred stock, net of issue costs 8 5,747 5,755 Accretion of redeemable common stock for the year ended December 31, 1995 (877) (877) Accretion of redeemable preferred stock for the six months ended December 31, 1995 (345) (345) Preferred stock dividends paid or accrued for the six months ended December 31, 1995 (390) (2,857) (3,247) Accrued compensation on stock options 348 348 Net (loss) for the year ended December 31, 1995 (3,362) (3,362) ------------ ----------- -------------- ----------------- ----------------- Balance at December 31, 1995 9 -- 9,898 (3,362) 6,545 Accretion of redeemable common stock for the year ended December 31, 1996 (837) (837) Accretion of redeemable preferred stock for the year ended (793) (793) December 31, 1996 Preferred stock dividends paid the year ended December 31, 1996 (292) (292) Preferred stock dividends paid-in- kind for the year ended December 31, 1996 (7,500) (7,500) Net (loss) for the year ended December 31, 1996 (115,241) (115,241) ------------ ----------- -------------- ----------------- ----------------- Balance at December 31, 1996 $ 9 $ -- $ 476 $ (118,603) $ (118,118) ============ =========== ============== ================= =================
See Notes to Condensed Financial Information. 66 DECORATIVE HOME ACCENTS, INC. SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED YEAR ENDED DECEMBER 31, 1996 DECEMBER 31, 1995 ----------------- ----------------- CASH FLOWS FROM OPERATING ACTIVITIES: Adjustments to reconcile net loss to net $(115,241) $ (3,362) cash provided by (used in) operating activities: (Equity) losses in income of consolidated subsidiaries 97,074 (2,241) Stock compensation expense -- 348 Deferred income tax provision (benefit) 132 (132) Amortization -- 405 Changes in operating assets and liabilities: Income tax receivable 1,908 (1,908) Accrued liabilities (2,190) 829 Accrued interest (7,584) 7,584 --------- --------- Net cash provided by (used in) operating activities (25,901) 1,523 --------- --------- CASH FLOWS USED IN INVESTING ACTIVITIES -- Purchase of HII -- (93,209) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of 13% Senior Notes due 2002 and Class F common stock -- 125,000 Issuance of $50 million redeemable preferred stock and Class D common stock -- 50,000 Deferred debt issuance and other financing costs (108) (11,275) Other long-term assets 930 Redeemable preferred stock dividends paid (293) (1,789) Net intercompany activity 25,372 (70,250) --------- --------- Net cash provided by financing activities 25,901 91,686 --------- --------- INCREASE IN CASH AND CASH EQUIVALENTS -- -- CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD -- -- --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ -- $ -- ========= ========= SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING ACTIVITIES: Accrued redeemable preferred stock dividends $ -- $ 1,458 ========= ========= Accrued compensation under stock options $ -- $ 348 ========= ========= Accretion of redeemable preferred stock $ 792 $ 345 ========= ========= Accretion of redeemable common stock $ 837 $ 877 ========= ========= Exercise of common stock warrants $ -- $ 1,500 ========= ========= Preferred stock dividends paid-in-kind $ 7,500 $ -- ========= =========
See Notes to Condensed Financial Information. 67 DECORATIVE HOME ACCENTS, INC. SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO CONDENSED FINANCIAL INFORMATION Note A - Debt and Equity Offerings See Note 5 of the Notes to the Consolidated/Combined Financial Statements. Note B - Redeemable Stock and Shareholders' Equity See Note 6 of the Notes to Consolidated/Combined Financial Statements. Note C - Long-Term Debt See Note 7 of the Notes to Consolidated/Combined Financial Statements. Note D - Related Parties See Note 12 of the Notes to Consolidated/Combined Financial Statements. Note E - Going Concern See Note 13 of the Notes to Consolidated/Combined Financial Statements. Note F - Subsequent Events See Note 14 of the Notes to Consolidated/Combined Financial Statements. 68 DECORATIVE HOME ACCENTS, INC. SCHEDULE II ("SUCCESSOR") AND PREDECESSOR COMPANIES Valuation and Qualifying Accounts and Reserves (In Thousands)
Additions ------------------------------ Balance at Charged to Balance Beginning Other Costs and at End Descripton of Period Accounts Expenses Deductions of Period - ---------- ---------- -------- ---------- ---------- --------- Predecessor: Four Months Ended April 30, 1994 Allowance for doubtful accounts $ 1,034 $ -- $ 100 $ 322 (1) $ 812 Inventory reserve 150 -- -- 150 ---------- -------- ---------- ---------- --------- $ 1,184 $ -- $ 100 $ 322 $ 962 ========== ======== ========== ========== ========= Successor Periods: Eight Months Ended December 31, 1994 Allowance for doubtful accounts $ 812 $ -- $ 355 $ 443 (1) $ 724 Inventory reserve 150 -- -- 100 (2) 50 ---------- -------- ---------- ---------- --------- $ 962 $ -- $ 355 $ 543 $ 774 ========== ======== ========== ========== ========= Year Ended December 31, 1995 Allowance for doubtful accounts $ 724 $ 2,189 (3) $ 2,482 $ 2,889 (1) $ 2,506 Inventory reserve 50 2,069 (3) 1,891 400 (1) 3,610 ---------- -------- ---------- ---------- --------- $ 774 $ 4,258 $ 4,373 $ 3,289 $ 6,116 ========== ======== ========== ========== ========= Year Ended December 31, 1996 Allowance for doubtful accounts $ 2,506 $ -- $ 7,437 $ 2,929 $ 7,014 Inventory reserve 3,610 -- 2,998 2,659 3,949 ---------- -------- ---------- ---------- --------- $ 6,116 $ -- $10,435 $ 5,588 $10,963 ========== ======== ========== ========== =========
(1) Deductions represent accounts receivable write-offs. (2) Deduction represents inventory written off. (3) Other additions represent beginning balances for Home Innovations, Inc. at the July 13, 1995 acquisition date. Other activity related to Home Innovations, Inc. for the year is included in the appropriate columns. EX-10.1 2 MUTUAL RELEASE AND SETTLEMENT AGREEMENT 1 EXHIBIT 10.1 MUTUAL RELEASE AND SETTLEMENT AGREEMENT This Mutual Release and Settlement Agreement ("Agreement") is made and entered into this 11th day of March, 1997 by and among Henry E. Scharling, II ("Henry Scharling"), Barbara T. Scharling ("Barbara Scharling"), Decorative Home Accents, Inc. ("DHA"), the Rug Barn, Inc. ("Rug Barn"), Home Innovations, Inc. ("HII"), Calvin Klein Home, Inc. ("CKH"), Draymore Mfg. Corp. (Draymore"), R. A. Briggs and Company ("Briggs"), Howard Industries, Inc., as a common stockholder of DHA ("Industries"), Peter Howard ("Howard"), Cigna Mezzanine Partners III, L.P., as a common stockholder of DHA ("CMPIII"), Connecticut General Life Insurance Company, as a common stockholder of DHA ("CGLIC"), Connecticut Life Insurance Company, on behalf of one or more separate accounts, as a common stockholder of DHA ("CG"), Life Insurance Company of North America, as a common stockholder of DHA ("LINA") and TCW Special Credits Fund V - The Principal Fund, as a common stockholder of DHA ("TCW") (each individually a "Party" and, collectively, the "Parties"). WHEREAS, Rug Barn, HII, CKH, Draymore and Briggs (collectively, the "Subsidiaries") are wholly-owned direct or indirect Subsidiaries of DHA as a result of the acquisition of HII by DHA and related transactions on July 13, 1995 (the "Acquisition"); WHEREAS, pursuant to that certain Employment and Non-Competition Agreement, dated July 13, 1995, by and between DHA and Henry Scharling (the "Henry Scharling Employment Agreement"), Henry Scharling was employed as the Chief Executive Officer of DHA; WHEREAS, Henry Scharling also served as a director of DHA and certain of the Subsidiaries and as an officer of each of the Subsidiaries; 2 WHEREAS, pursuant to that certain Employment and Non-Competition Agreement, dated July 13, 1995, by and between Barbara Scharling and DHA (the "Barbara Scharling Employment Agreement and, together with the Henry Scharling Employment Agreement, the "Employment Agreements"), Barbara Scharling was employed as the Executive Vice President-Operations of DHA; WHEREAS, Barbara Scharling also served as a director of DHA and as an officer of each of the Subsidiaries; WHEREAS, pursuant to a Notice of Resignation, dated October 21, 1996, Henry Scharling voluntarily resigned as a director and officer of DHA and the Subsidiaries; WHEREAS, pursuant to a Notice of Resignation, dated October 21, 1996, Barbara Scharling voluntarily resigned as a director and officer of DHA and the Subsidiaries; WHEREAS, various parties have made allegations concerning wrongful actions of Henry Scharling and/or Barbara Scharling in connection with the Acquisition and in connection with the management and operation of DHA and its subsidiaries, including, without limitation, allegations of improper self dealing transactions, negligence in managing and overseeing the business and affairs of DHA, and failure to disclose material information regarding the financial condition and business plan of DHA, in violation of their duties as officers, directors, and employees of DHA under Delaware Law and in violation of state and federal securities law; WHEREAS, the Parties agree that it is in their best interests to settle and compromise all matters in controversy with respect to Henry Scharling's and Barbara Scharling's employment with, ownership in and/or association with DHA and/or the Subsidiaries to avoid time consuming and costly litigation; and - 2 - 3 WHEREAS, it is understood and agreed that this Agreement is a compromise of disputed claims and shall not be used or construed as an admission of liability or evidence of liability, and each of the Parties expressly denies any liability. WHEREFORE, in consideration of the above, the Parties agree as follows: 1. The foregoing Recitals are material to this Agreement and are incorporated by reference herein and made a part hereof as though fully set forth. 2. Each Party acknowledges that the Employment Agreements (and any other employment relationships, understandings or arrangements between DHA and/or the Subsidiaries, on the one hand, and either Henry Scharling and/or Barbara Scharling, on the other hand) have been terminated. Each Party further acknowledges that all obligations, duties and rights of DHA and/or the Subsidiaries, on the one hand, and Henry Scharling and/or Barbara Scharling, on the other hand, under any employment arrangements (written or oral) are hereby satisfied, released and discharged, except for those provisions of the Employment Agreements contained in Section 6 of the Employment Agreements which shall remain in full force and effect in accordance with the terms of Section 6 of the Employment Agreements. 3. In consideration of the releases contained herein, Henry Scharling and Barbara Scharling shall cause to be paid to DHA $448,500 by wire transfer of immediately available funds simultaneously with the execution of this Agreement. 4. Each of Henry Scharling and Barbara Scharling hereby represents and warrants that neither of them will, except as required by law, solicit or cooperate with the institution or prosecution of any claims, of any kind or nature, against any of the other Parties or their affiliates. - 3 - 4 5. Except as specifically provided in this Agreement, each of DHA, Rug Barn, HII, CKH, Draymore and Briggs, and each of their respective officers, directors, attorneys, heirs, successors, assigns, and predecessors (collectively, the "DHA Parties") hereby releases and discharges Henry Scharling and Barbara Scharling, and their respective attorneys, heirs, successors and assigns from all claims, contracts, agreements, understandings, rights and duties, obligations, debts, liabilities, damages, injuries, actions, causes of action, of every kind and nature, whether now known or unknown, which any of the DHA Parties has under federal, state, or local laws, including common law and securities law, arising from or in any way related to Henry Scharling's and/or Barbara Scharling's employment with, ownership in and/or association with DHA and/or the Subsidiaries through the date of this Agreement; provided however, that nothing herein shall be construed to release any obligations and undertakings pursuant to this Agreement. 6. Except as specifically provided in this Agreement, each of Industries and Howard, and each of their respective officers, directors, attorneys, heirs, successors, assigns, and predecessors (collectively, the "Howard Parties") hereby releases and discharges Henry Scharling and Barbara Scharling, and their respective attorneys, heirs, successors and assigns from all claims, contracts, agreements, understandings, rights and duties, obligations, debts, liabilities, damages, injuries, actions, causes of action, of every kind and nature, whether now known or unknown, which any of the Howard Parties has under federal, state, or local laws, including common law and securities law, arising from or in any way related to Henry Scharling's and/or Barbara Scharling's employment, ownership in and/or association with DHA - 4 - 5 and/or the Subsidiaries through the date of this Agreement; provided however, that nothing herein shall be construed to release any obligations and undertakings pursuant to this Agreement. 7. Except as specifically provided in this Agreement, each of CMPIII, CGLIC, CG and LINA, and each of their respective officers, directors, attorneys, heirs, successors, assigns, and predecessors (collectively "CIGNA Parties") hereby releases and discharges Henry Scharling and Barbara Scharling, and their respective attorneys, heirs, successors and assigns from all claims, contracts, agreements, understandings, rights and duties, obligations, debts, liabilities, damages, injuries, actions, causes of action, of every kind and nature, whether now known or unknown, which any of the CIGNA Parties has under federal, state, or local laws, including common law and securities law, arising from or in any way related to Henry Scharling's and/or Barbara Scharling's employment with, ownership in and/or association with DHA and/or the Subsidiaries through the date of this Agreement; provided however, that nothing herein shall be construed to release any obligations and undertakings pursuant to this Agreement. 8. Except as specifically provided in this Agreement, TCW and its officers, directors, attorneys, successors, assigns, and predecessors (collectively, the "TCW Parties") hereby releases and discharges Henry Scharling and Barbara Scharling, and their respective attorneys, heirs, successors and assigns from all claims, contracts, agreements, understandings, rights and duties, obligations, debts, liabilities, damages, injuries, actions, causes of action, of every kind and nature, whether now known or unknown, which any of the TCW Parties has under federal, state, or local laws, including common law and securities law, arising from or in any way related to Henry Scharling's and/or Barbara Scharling's employment with, ownership in and/or association with DHA and/or the Subsidiaries through the date of this Agreement; - 5 - 6 provided however, that nothing herein shall be construed to release any obligations and undertakings pursuant to this Agreement. 9. Each of Henry Scharling and Barbara Scharling, and each of their respective attorneys, heirs, successors and assigns (collectively the "Scharling Parties") hereby releases and discharges each of the DHA Parties, the Howard Parties, the Cigna Parties and the TCW Parties, and each of their respective officers, directors, attorneys, successors, assigns and predecessors from all claims, contracts, agreements, understandings, rights and duties, obligations, debts, liabilities, damages, injuries, actions, causes of action, of every kind and nature, whether now known or unknown, which any of the Scharling Parties has under federal, state, or local laws, including common law and securities law, arising from or in any way related to Henry Scharling's and/or Barbara Scharling's employment with, ownership in and/or association with DHA and/or the Subsidiaries, including without limiting the generality of the foregoing, claims, demands or actions under Title VII of the Civil Rights Act of 1964, The Age Discrimination in Employment Act of 1967, the Rehabilitation Act of 1973, the Civil Rights Act of 1866 and any other federal, state, or local statute or regulation regarding employment, discrimination in employment, or the termination of employment, and the common law of any state relating to employment contracts, wrongful discharge, or any other matter; provided, however, that nothing herein shall be construed to release (i) any obligations or undertakings pursuant to this Agreement or (ii) the obligations or undertakings of DHA to indemnify each of the Scharling Parties from liabilities arising from acts taken as an officer or director of DHA as provided in Article IX of DHA's Second Amended and Restated Certificate of Incorporation. - 6 - 7 10. Each of the Howard Parties represents and warrants that (i) the Howard Parties collectively own all right, title and interest in and to all debt and equity securities of DHA which they acquired as a result of the Acquisition, (ii) it has not sold, assigned, conveyed, pledged, hypothecated or otherwise transferred to any person, entity, partnership or association other than a Howard Party any of the right title or interest in any debt or equity security of DHA which it acquired as a result of the Acquisition, and (iii) it will not, except as required by law, solicit or cooperate with the institution or prosecution of any claims, of any kind or nature, against Henry Scharling and/or Barbara Scharling. 11. DHA and its subsidiaries will not, except as required by law, solicit or cooperate with the institution or prosecution of any claims of any kind or nature, against Henry Scharling and/or Barbara Scharling. 12. Each of the CIGNA Parties represents and warrants with respect to itself that (i) such CIGNA Party owns all right, title and interest in and to all debt and equity securities of DHA which it acquired as a result of the Acquisition, (ii) it has not sold, assigned, conveyed, pledged, hypothecated or otherwise transferred to any person, entity, partnership or association other than a CIGNA Party any of the right title or interest in any debt or equity security of DHA which it acquired as a result of the Acquisition, and (iii) it will not, except as required by law, solicit or cooperate with the institution or prosecution of any claims, of any kind or nature, against Henry Scharling and/or Barbara Scharling. 13. Each of the TCW Parties represents and warrants that (i) the TCW Parties collectively own all right, title and interest in and to all debt and equity securities of DHA which they acquired as a result of the Acquisition, (ii) it has not sold, assigned, conveyed, pledged, - 7 - 8 hypothecated or otherwise transferred to any person, entity, partnership or association other than a TCW Party any of the right title or interest in any debt or equity security of DHA which it acquired as a result of the Acquisition, and (iii) it will not, except as required by law, solicit or cooperate with the institution or prosecution of any claims, of any kind or nature, against Henry Scharling and/or Barbara Scharling. 14. DHA represents and warrants that, to the best of its knowledge, no person, entity, partnership or association, other than the Parties and the Internal Revenue Service, has asserted or threatened to assert a claim, directly or indirectly, against either Henry Scharling or Barbara Scharling. 15. Each party represents and warrants that it is a sophisticated investor and that the negotiations related hereto have been conducted by persons or entities of relatively equal bargaining power. Each party further represents that it has investigated or had the opportunity to investigate the actions of Henry Scharling and Barbara Scharling in connection with their employment, ownership in, and/or association with DHA and the allegations related thereto sufficient to make a reasonable business determination as to the benefits and risks related to the entry into this Agreement. Consequently, each Party waives and relinquishes any right or benefit it may have under Delaware state law, federal or state securities law, or otherwise, to the fullest extent such party can lawfully waive such right or benefit, to assert that the releases contained in this Agreement do not extend to claims which the releasing party does not know or suspect to exist at the time of executing this Agreement. 16. The Parties hereby agree that the terms of this Agreement are confidential and will not be disclosed to any non-party, except as set forth below and then only to the minimum - 8 - 9 amount necessary. This is a material part of the settlement. Any violation of this provision will render the offender[s] liable for damages and attorneys fees. If anyone inquires as to the terms of this Settlement, the Party responding may only state that the matter was concluded. Exceptions to this confidentiality provision are limited to the following situations: (a) the Parties may make disclosures which are necessary and appropriate to the other Parties; (b) the Parties may make disclosures which are necessary and appropriate to their attorneys; accountants; insurance carriers; financial institutions; and applicable federal, state or other taxation authorities, as required by law; (c) the Parties may make disclosures when they are bound by a legal duty to disclose, including, but not limited to, disclosures in order to satisfy fiduciary duties or duties of disclosure to governmental regulatory agencies and securities self-regulatory organizations, including, but not limited to disclosures pursuant to the Securities Exchange Act of 1934, as amended; however, these disclosures shall disclose only those facts necessary to comply with the applicable legal or regulatory requirements; and (d) the Parties may make such disclosures as may be compelled pursuant to an order of a court of competent jurisdiction. 17. DHA may seek protection of Bankruptcy Court at some time during the next twelve (12) months. The Parties represent that this Agreement contains a set off of mutual obligations for fair value. In the event DHA does seek such protection, the Parties agree not to seek to have the Agreement set aside. If this Agreement is attacked as a voidable preference or a fraudulent conveyance, and is set aside by the Bankruptcy Court, the Parties which are parties in the bankruptcy action agree to ask the Court to return the assets paid by the Scharling Parties to DHA in cash or in kind as opposed to granting a claim or lien. - 9 - 10 18. The Parties acknowledge and confirm that they have read this Agreement, have had the opportunity to review it with counsel, are familiar with the contents thereof and have executed this document with full knowledge and meaning of its legal effect. 19. EACH OF HENRY SCHARLING AND BARBARA SCHARLING ACKNOWLEDGES THAT DHA ADVISED EACH OF THEM IN WRITING TO CONSULT WITH AN ATTORNEY BEFORE SIGNING THIS AGREEMENT, THAT EACH OF THEM WAS GIVEN A PERIOD OF TWENTY-ONE (21) DAYS WITHIN WHICH TO CONSIDER THIS AGREEMENT, THAT EACH OF THEM HAD AN ADEQUATE OPPORTUNITY TO REVIEW THIS AGREEMENT WITH AN ATTORNEY, THAT EACH OF THEM FULLY UNDERSTANDS ITS TERMS, THAT EACH OF THEM WAS NOT COERCED INTO SIGNING IT, AND THAT EACH OF THEM HAS SIGNED IT KNOWINGLY AND VOLUNTARILY. EACH OF HENRY SCHARLING AND BARBARA SCHARLING UNDERSTANDS THAT BY SIGNING THIS AGREEMENT, EACH OF THEM IS WAIVING EACH AND EVERY CLAIM EACH OF THEM HAS, HAD, OR MAY HAVE REGARDING HIS OR HER EMPLOYMENT BY, OR TERMINATION OF EMPLOYMENT WITH, THE COMPANY. 20. This Agreement will take effect seven days after Henry Scharling and Barbara Scharling sign it. In order to revoke this Agreement, Henry Scharling or Barbara Scharling must sign and send a written notice of his or her decision to revoke the Agreement addressed to Peter H. Howard, Chairman, Decorative Home Accents, Inc., 295 Fifth Avenue, New York, New York 10016, and the notice must be received by the Company no later than seven days after Henry Scharling and Barbara Scharling has signed the Agreement. If Henry Scharling or - 10 - 11 Barbara Scharling revokes this Agreement, he or she will not be entitled to any of the benefits or other consideration provided to him or her in this Agreement. 21. Nothing herein shall constitute an admission of any kind of any party hereto, this Agreement being executed solely to settle and compromise all disputed claims. 22. This Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Delaware. 23. If any action is brought to interpret or enforce any provision of this Agreement or the rights or obligations of any Party to the Agreement, the prevailing Party shall be entitled to recover reasonable attorneys' fees and costs from the losing Parties in opposition. 24. All agreements and understandings of the Parties with respect to this Agreement are embodied and expressed in the terms of this Agreement. There are no oral conditions, representations, or warranties with respect to this Agreement. 25. No provisions of this Agreement may be modified, amended or terminated except by a written agreement executed by all of the parties to this Agreement. 26. This Agreement may be executed in counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same document. 27. All of the terms and conditions of this Agreement shall be binding upon and inure to the benefit of the Parties hereto and their respective heirs, successors and assigns. 28. Each person executing this Agreement warrants and represents that he or she is duly authorized to execute the Agreement on behalf of, and to legally bind, the Party for whom he or she is signing. Each Party which is not an individual shall provide to another Party, upon such Party's request, a certified copy of resolutions of the Board of Directors or other governing party authorizing this Agreement. - 11 - 12 IN WITNESS WHEREOF, the Agreement is duly executed as of the date first written above. Decorative Home Accents, Inc. [Signature] By: __________________________________ Chairman Its: __________________________________ The Rug Barn, Inc. [Signature] By: __________________________________ Vice President Its: __________________________________ Home Innovations, Inc. [Signature] By: __________________________________ Vice President Its: __________________________________ Draymore Mfg. Corp [Signature] By: __________________________________ Vice President Its: __________________________________ Calvin Klein Home, Inc. [Signature] By: __________________________________ Vice President Its: __________________________________ R. A. Briggs and Company [Signature] By: __________________________________ Vice President Its: __________________________________ - 12 - 13 Howard Industries, Inc. [Signature] By: ---------------------------------- Vice President Its: ---------------------------------- /s/ Peter Howard - ------------------------------------------- Peter Howard - 13 - 14 CIGNA Mezzanine Partners, L.P. By: CIGNA Investments, Inc., agent By: /s/ Stephen J. Myoh ---------------------------------- Stephen J. Myoh Its: Vice President ---------------------------------- Connecticut General Life Insurance Company By: CIGNA Investments, Inc. By: /s/ James R. Kuzenschak ---------------------------------- James R. Kuzenschak Its: Managing Director ---------------------------------- Connecticut General Life Insurance Company, on behalf of one or more separate accounts By: CIGNA Investments, Inc. By: /s/ James R. Kuzenschak ---------------------------------- James R. Kuzenschak Its: Managing Director ---------------------------------- Life Insurance Company of North America By: CIGNA Investments, Inc. By: /s/ James R. Kuzenschak ---------------------------------- James R. Kuzenschak Its: Managing Director ---------------------------------- - 14 - 15 TCW Special Credits Fund V - The Principal Fund By: TCW Asset Management Company, Its General Partner /s/Stephen Kaplan By: __________________________________ Stephen A. Kaplan Authorized Signatory Its: __________________________________ /s/Richard Goldstein By: __________________________________ Richard J. Goldstein Authorized Signatory Its: __________________________________ - 15 - 16 /s/ Henry E. Scharling II ------------------------------------------- Henry E. Scharling II /s/ Barbara T. Scharling ------------------------------------------- Barbara T. Scharling - 16 - EX-10.2 3 AMENDED EMPLOYMENT AGREEMENT WITH JAY N.B. 1 EXHIBIT 10.2 AMENDED AND RESTATED EMPLOYMENT AND NON-COMPETITION AGREEMENT BY AND BETWEEN DECORATIVE HOME ACCENTS, INC. AND JAY N. BAKER 2 INDEX TO DEFINED TERMS
TERM SECTION REFERENCED ---- ------------------ "Agreement" .................................................... Introduction "Annual Bonus"....................................................Section 2.2 "Base Salary".....................................................Section 2.1 "Budget EBITDA"...................................................Section 2.2 "Board"...........................................................Section 1.2 "Business"...............................................Preliminary Recitals "Company"........................................................Introduction "Confidential Information"..........................................Section 5 "EBITDA"..........................................................Section 2.2 "EBITDA Ratio"....................................................Section 2.2 "Employee".......................................................Introduction "Employment Period"...............................................Section 1.3 "Good Cause"......................................................Section 1.4 "HII"....................................................Preliminary Recitals "Initial Period"..................................................Section 1.3 "Permitted Investments............................................Section 4.2 "Renewal Periods".................................................Section 1.3 "Restricted Period"...............................................Section 4.2 "Restrictive Covenants".............................................Section 8 "Territory".......................................................Section 4.2 "Total Disability"................................................Section 1.4
-i- 3 EMPLOYMENT AND NON-COMPETITION AGREEMENT ---------------------------------------- The EMPLOYMENT AND NON-COMPETITION AGREEMENT (the "Agreement"), by and between DECORATIVE HOME ACCENTS, INC., a Delaware corporation (the "Company"), and JAY BAKER ("Employee") is hereby amended and restated effective as of February 28, 1997. PRELIMINARY RECITALS A. The Company, through its subsidiaries, is engaged in the business of the manufacturing, marketing, distribution and sale of bedding, bath and other home textile products (the "Business"), with principal offices in New York, New York, Abbeville, South Carolina and Mooresville, North Carolina. For purposes of this Agreement, the term "Company" shall include the Company, its subsidiaries, affiliates, and assignees and any successors in interest of the Company and its subsidiaries and/or affiliates. B. The Company has employed Employee, as its Executive Vice President and Chief Financial Officer pursuant to the Agreement. C. The Company desires to continue Employee's employment, and Employee desires to continue his employment with the Company, pursuant to the terms and conditions of this Amended and Restated Agreement. NOW, THEREFORE, in consideration of the premises, the mutual covenants of the parties hereinafter set forth and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. Employment. 1.1 Engagement of Employee. The Company agrees to employ Employee and Employee agrees to accept employment as the Executive Vice President and Chief Financial Officer of the Company, all in accordance with the terms and conditions of this Agreement. 1.2 Duties and Powers. During the Employment Period, Employee will serve as the Executive Vice President and Chief Financial Officer of the Company and will have such responsibilities, duties and authorities, and will render such services of an executive and administrative character or act in such other executive capacity for the Company and its affiliates as the Company's board of directors (the "Board") shall from time to time direct. The Employee shall devote his best efforts, energies and abilities and his full business time, skill and attention (except for permitted vacation periods and reasonable periods of illness or other incapacity) to the business and affairs of the Company. The Employee shall perform the duties and carry out the responsibilities assigned to him, to the best of his ability, in a diligent, trustworthy, businesslike and efficient manner for the purpose of advancing the business of the Company. The Employee acknowledges that his duties and responsibilities will require his full- 4 time business efforts and agrees that during the Employment Period he will not engage in any other business activity or have any business pursuits or interests which interfere or conflict with the performance of Employee's duties hereunder, provided, that nothing in this SECTION 1.2 shall be deemed to prohibit Employee from making Permitted Investments (as defined in SECTION 4.2). Employee further acknowledges that Employee's duties hereunder shall require him to travel between the Company's offices in New York, North Carolina and South Carolina at the direction of the Board. 1.3 Employment Period. Employee's employment under this Agreement shall begin on the date hereof and shall continue through and until February 28, 2000 (the "Initial Period"). This Agreement shall be automatically extended for additional consecutive one-year periods ("Renewal Periods") unless one of the parties hereto provides a written notice at least 90 days prior to the expiration of the Initial Period or any Renewal Period that such party does not desire to extend the Agreement. The Initial Period and the Renewal Periods are hereinafter referred to collectively as the "Employment Period." Notwithstanding anything to the contrary contained herein, the Employment Period is subject to termination pursuant to SECTION 1.4 and SECTION 1.5 below. 1.4 Termination by the Company. The Company has the right to terminate Employee's employment under this Agreement, by notice to Employee in writing (i) for "Good Cause" at any time, (ii) without Good Cause for any or no reason and (iii) due to the death or Total Disability of Employee. Any such termination shall be effective upon the date of service of such notice pursuant to SECTION 16. "Good Cause" as used herein means the occurrence of any of the following events: (a) the failure of Employee to perform his duties or comply with reasonable directions of the Board which continues for fifteen days after the Board has given written notice to Employee specifying in reasonable detail the manner in which Employee has failed to perform such duties or comply with such directions; (b) the determination by the Board in the exercise of its reasonable judgment that Employee has committed an act or acts constituting (i) a felony, (ii) dishonesty or disloyalty with respect to the Company, or (iii) fraud; (c) the determination by the Board in the exercise of its reasonable judgment that Employee has committed an act that (i) materially and negatively affects the Company's business or reputation or (ii) indicates alcohol or drug abuse by Employee that adversely affects his performance hereunder; (d) a material breach by Employee of any of the terms and conditions of this Agreement; provided, however, that if such breach is curable by Employee, such breach -2- 5 shall not constitute Good Cause hereunder until the Company notifies Employee of such breach and Employee does not cure such breach within fifteen days; or (e) Employee's gross negligence or willful misconduct in the performance of his duties hereunder; provided, however, that if such gross negligence or willful misconduct is curable by Employee, such gross negligence or willful misconduct shall not constitute Good Cause hereunder until the Company notifies Employee of such gross negligence or willful misconduct and Employee does not cure such gross negligence or willful misconduct within fifteen days. Employee shall be deemed to have a "Total Disability" for purposes of this Agreement if he is unable to perform, by reason of physical or mental incapacity, his duties or obligations under this Agreement, for a total period of 60 days in any 360-day period. The Board shall determine, according to the facts then available, whether and when the Total Disability of the Employee has occurred. Such determination shall not be arbitrary or unreasonable, and the Board shall take into consideration the opinion of Employee's personal physician, if reasonably available, but such determination by the Board shall be final and binding on the parties hereto. 1.5 Termination by Employee. Employee has the right to terminate his employment under this Agreement for any reason, upon 90 days prior written notice to the Company. 2. Compensation and Benefits. 2.1 Base Compensation. During the Employment Period, the Company will pay Employee a base salary at a rate of $225,000.00 per annum (the "Base Salary"), which Base Salary may be increased but not decreased during the Employment Period at the sole discretion of the Board. The Base Salary shall be payable in accordance with the Company's regular payroll policy for salaried employees. The Board shall also perform an annual review of the Employee's Base Salary based on the Employee's performance of his duties and the Company's other compensation policies. If the Employment Period is terminated pursuant to SECTION 1.4 OR SECTION 1.5 above, then the Base Salary for any partial year will be prorated based on the number of days elapsed in such year during which services were actually performed by Employee. 2.2 Annual Bonus. In addition to his Base Salary, Employee may be paid a bonus for each calendar year in the Employment Period in accordance with the terms of the Decorative Home Accents, Inc. Executive Bonus Plan (the "Executive Bonus Plan") which has been established for senior executives of the Company (the "Annual Bonus"), provided that Employee is employed at the time bonuses are paid under such program, which time shall be the first payroll payment date after the issuance of the Company's audited year-end financial statements. Notwithstanding anything herein to the contrary, Employee shall be entitled to receive a bonus with respect to the final calendar year of the Employment Period and with respect to the bonus payable pursuant to Section 2.2(b) if Employee's employment hereunder is -3- 6 terminated (i) by the expiration of the Employment Period due to the Company's providing Employee notice that it does not desire to extend the Agreement pursuant to SECTION 1.3 or (ii) by the Company without Good Cause after the termination of such final calendar year or after January 1, 1998, as the case may be. For each calendar year in the Employment Period, the Board shall establish bonus levels based on the Company's actual consolidated earnings before interest, taxes, depreciation and amortization ("EBITDA") as compared to a budgeted level of EBITDA ("Budget EBITDA"). With respect to 1997, Employee shall be eligible to receive bonus payments as follows: (a) On March 31, 1998, Employee shall receive a bonus in an amount equal to $112,500, provided that either of the following conditions is satisfied: (i) Employee is employed by the Company on March 31, 1998 and Employee shall not have given notice of his intention to terminate, or notice of termination of his employment or commenced discussions regarding employment with a competitor of the Company; or (ii) Employee's employment was terminated by the Company without Good Cause. (b) In addition to the bonus payable pursuant to SECTION 2.2(A), Employee shall be entitled to a bonus in an amount equal to the amount determined pursuant to the 1997 Executive Bonus Plan, as amended, a copy of which is attached hereto as Exhibit 2.2. 2.3 Compensation After Termination. (a) Except as provided in SECTION 2.3(B), SECTION 2.4, SECTION 2.6 and SECTION 2.9, if Employee's employment hereunder is terminated or expires for any reason, then the Company shall have no further obligations hereunder or otherwise with respect to Employee's employment from and after the termination or expiration date (except payment of Employee's Base Salary accrued through the date of termination or expiration) and the Company shall continue to have all other rights available hereunder (including without limitation, all rights under SECTION 4 at law or in equity). (b) If the Employment Period is terminated by the Company without Good Cause during the Initial Period (other than in connection with a Change of Control which shall be governed by Section 2.9), then the Employee shall be entitled to receive as severance pay his Base Salary hereunder for the remainder of the Initial Period, payable in regular installments in accordance with the Company's general payroll practices for salaried employees. The Company -4- 7 shall have no other obligations hereunder or otherwise with respect to Employee's employment from and after the termination date, and the Company shall continue to have all other rights available hereunder (including, without limitation, all rights under SECTION 4 at law or in equity). Notwithstanding the foregoing, the amount of severance pay due hereunder shall be offset and reduced by any compensation paid to Employee by any new employer of Employee during the period Employee is receiving such severance payments and amounts owed by Employee to the Company, if any. 2.4 Profit Sharing, Pension and Salary Deferral Benefits. It is understood by the parties to this Agreement that, during the Employment Period, Employee shall be entitled to participate in or accrue benefits under any pension, salary deferral or profit sharing plan now existing or hereafter created for employees of the Company upon terms and conditions equivalent to those which the Company may provide for other key management employees. 2.5 Fringe Benefits and Expenses. The Company will provide Employee vacation and other employee fringe benefits substantially comparable to the vacation and benefits which the Company regularly provides for other key management employees, including hospitalization, health and disability insurance, to the extent offered by the Company, and in amounts consistent with Company policy, for key management employees as reasonably determined by the Board. Such vacations and benefits shall be no less than those set forth on Exhibit 2.5, attached hereto. During the Employment Period, the Company will reimburse Employee in accordance with Company policy for his normal and reasonable out-of-pocket expenses incurred in the course of performing his duties hereunder. 2.6 1995 Bonus. In addition to his Base Salary and Annual Bonus, the Company shall pay Employee a bonus in the amount of $100,000 with respect to 1995. Such bonus shall be payable in four equal quarterly installments on March 31, 1997, June 30, 1997, September 30, 1997 and December 31, 1997. 2.7 Disability. At the request of Employee, the Company will reimburse Employee in an amount up to the quotient of (i) $10,000 and (ii) 1 - (the sum of the Employee's marginal federal income tax rate plus the Employee's marginal state income tax rate) for each year in the Employment Period, for premiums paid by Employee on the disability policy currently in force and owned by Employee. Such reimbursement shall be made in accordance with Company policy at the time that Employee pays such premium. If Employee's employment hereunder is terminated prior to a calendar year-end, Employee shall be obligated to repay the Company an amount equal to the product of (1) the reimbursement made by the Company during the calendar year and (2) a fraction, the numerator of which shall be twelve minus the number of complete months which Employee was employed by the Company for such calendar year and the denominator of which shall be 12. 2.8 Taxes, etc. All compensation payable to Employee hereunder is stated in gross amount and shall be subject to all applicable withholding taxes, other normal payroll deductions and any other amounts required by law to be withheld. -5- 8 2.9 Change of Control. If Employee's employment with the Company is terminated within 90 days following a Change of Control of the Company, by (i) the Company without Good Cause, (ii) a successor to the Company without Good Cause or (iii) the Employee, then the Company shall pay Employee an amount equal to $675,000 in a single sum in cash within thirty (30) days after such termination of employment. For purposes of this Agreement, "Change of Control" means any of the following occurring (i) on or prior to the effective date of a restructuring of the Company's $125 million of 13% Senior Notes due 2002 (a "Restructuring") or (ii) in connection with a Restructuring: (a) the consummation of any transaction (other than the transactions contemplated by that certain Mutual Release and Settlement Agreement between the Company, certain of the Company's stockholders and Henry and Barbara Scharling), including, without limitation, any merger or consolidation, the direct result of which is that any Person (other than TCW Special Credits Fund V - the Principal Fund ("Fund V")), owns, directly or indirectly, more than 50% of the voting power of the Board; (b) the sale, lease, transfer, conveyance or other disposition, in one or a series of related transactions, of all or substantially all of the stock or assets of the Company to any Person (other than Fund V); (c) the consummation of any transaction (other than the transactions contemplated by that certain Mutual Release and Settlement Agreement between the Company, certain of the Company's stockholders and Henry and Barbara Scharling), including, without limitation, any merger or consolidation, the direct result of which is that any Person (other than Fund V), controls the issuance of options with respect to the Company's capital stock to members of management; or (d) the adoption and implementation of a plan relating to the liquidation or dissolution of the Company. -6- 9 "Person" means any individual, corporation, partnership, joint venture, association, joint-stock company, trust, unincorporated organization or any other entity. 2.10. Indemnification. The parties acknowledge and agree that Employee shall be fully entitled to indemnification from the Company from liabilities arising from acts taken by the Employee as an officer of the Company as provided in "Article IX - Indemnification" of the Company's Second Amended and Restated Certificate of Incorporation. 3. Equity Incentive. If no Change of Control occurs, the Company shall use its best efforts to grant the Employee stock options, the terms of which shall be negotiated in good faith by and will be mutually acceptable to the Company and the Employee. In determining the amount of stock options to be granted to Employee, consideration shall be given to Employee's past equity ownership. 4. Covenant Not to Compete. 4.1 Employee's Acknowledgment. Employee agrees and acknowledges that in order to assure the Company that it will retain its value and that of the Business as a going concern, it is necessary that Employee undertake not to utilize his special knowledge of the Business and his relationships with customers and suppliers to compete with the Company. Employee further acknowledges that: (a) the Company is and will be engaged in the Business; (b) Employee has occupied and will continue to occupy a position of trust and confidence with the Company during the period of Employee's employment under this Agreement, and Employee has become familiar with the Company's trade secrets and with other proprietary and confidential information concerning the Company and the Business; (c) the agreements and covenants contained in this SECTION 4 are essential to protect the Company and the goodwill of the Business; and (d) Employee's employment with the Company has special, unique and extraordinary value to the Company and the Company would be irreparably damaged if Employee were to provide services to any person or entity in violation of the provisions of this Agreement. 4.2 Non-Compete. Employee hereby agrees that for a period commencing on the date hereof and ending on the later of (1) one year following the termination of his employment with the Company or (2) on such date as the Company shall cease making severance payments to Employee pursuant to SECTION 2.3(B) above (the "Restricted Period"), he will not, directly or indirectly, as employee, agent, consultant, stockholder, director, co-partner or in any other individual or representative capacity, own, operate, manage, control, engage in, invest in or participate in any manner in, act as a consultant or advisor to, render services for (alone or -7- 10 in association with any person, firm, corporation or entity), or otherwise assist any person or entity (other than the Company) that engages in or owns, invests in, operates, manages or controls any venture or enterprise that directly or indirectly engages in the Business anywhere in North America or Western Europe (the "Territory"); provided, however, that nothing contained herein shall be construed to prevent Employee from investing in the stock of any competing corporation listed on a national securities exchange or traded in the over-the-counter market, but only if Employee is not involved in the business of said corporation and if Employee and his associates (as such term is defined in Regulation 14(A) promulgated under the Securities Exchange Act of 1934, as in effect on the date hereof), collectively, do not own more than an aggregate of two percent of the stock of such corporation ("Permitted Investments"). With respect to the Territory, Employee specifically acknowledges that the Company has heretofore conducted the Business throughout those areas comprising the Territory and the Company intends to continue to expand the Business throughout the Territory. 4.3 Non-Solicitation. Without limiting the generality of the provisions of SECTION 4.2 above, Employee hereby agrees that during the Restricted Period he will not (except on behalf of the Company) for the purpose of securing business or contracts related to the Business, directly or indirectly, solicit, or participate as employee, agent, consultant, stockholder, director, partner or in any other individual or representative capacity in any business which solicits business from any person, firm, corporation or other entity which is or was a customer or supplier of the Business during the two-year period preceding the date of this Agreement and/or during the term of this Agreement, or from any successor in interest to any such person, firm, corporation or other entity. 4.4 Blue-Pencil. If any court of competent jurisdiction shall at any time deem the term of this Agreement or any particular Restrictive Covenant (as defined) too lengthy or the Territory too extensive, the other provisions of this SECTION 4 shall nevertheless stand, the Restricted Period shall be deemed to be the longest period permissible by law under the circumstances and the Territory shall be deemed to comprise the largest territory permissible by law under the circumstances. The court in each case shall reduce the Restricted Period and/or Territory to permissible duration or size. 5. Confidential Information. During the term of this Agreement and thereafter, Employee shall keep secret and retain in strictest confidence, and shall not, without the prior written consent of the Board, furnish, make available or disclose to any third party or use for the benefit of himself or any third party, any Confidential Information. As used in this SECTION 5, "Confidential Information" shall mean any information relating to the business or affairs of the Company or the Business, including but not limited to information relating to financial statements, customer identities, potential customers, employees, suppliers, servicing methods, equipment, programs, strategies and information, analyses, profit margins or other proprietary information used by the Company in connection with the Business; provided, however, that Confidential Information shall not include any information which is in the public domain or becomes known through no wrongful act on the part of Employee. Employee acknowledges that the Confidential Information is vital, sensitive, confidential and proprietary to the Company. -8- 11 In the event that Employee reasonably believes after consultation with counsel that he is required by law to disclose any Confidential Information, he may do so provided that he will use his best efforts to (a) provide the Company with proper notice before such disclosure in order that the Company may attempt to obtain a protective order or other assurance that confidential treatment will be accorded such confidential matters and (b) cooperate, at the Company's expense, with the Company in attempting to obtain such order or assurance. 6. Interference with Relationships. During the Restricted Period Employee shall not, directly or indirectly, as employee, agent, consultant, stockholder, director, co-partner or in any other individual or representative capacity: (i) without the prior written consent of the Company, employ or engage, recruit or solicit for employment or engagement, any person who is (or was within six months of the date such employment, engagement or solicitation commences or occurs, as the case may be) employed or engaged by the Company, or otherwise seek to influence or alter any such person's relationship with the Company, or (ii) solicit or encourage any present or future customer or supplier of the Company to terminate or otherwise adversely alter his, her or its relationship with the Company. 7. Effect on Termination. If the Company or the Employee should terminate Employee's employment pursuant to SECTION 1, then, notwithstanding such termination, those provisions contained in SECTIONS 2.3, 2.4, 2.6, 2.9, 2.10, 4, 5, 6, 7, 8, 9, 11, 12, 13, 14, 15, 16, 17, 18 AND 19 hereof shall remain in full force and effect for the duration of the Restricted Period. 8. Remedies. Employee acknowledges and agrees that the covenants set forth in SECTIONS 4, 5 AND 6 of this Agreement (collectively, the "Restrictive Covenants") are reasonable and necessary for the protection of the Company's business interests, that irreparable injury will result to the Company if Employee breaches any of the terms of the Restrictive Covenants, and that in the event of Employee's actual or threatened breach of any such Restrictive Covenants, the Company will have no adequate remedy at law. Employee accordingly agrees that in the event of any actual or threatened breach by him of any of the Restrictive Covenants, the Company shall be entitled to immediate temporary injunctive and other equitable relief, without the necessity of showing actual monetary damages, subject to hearing as soon thereafter as possible. Nothing contained herein shall be construed as prohibiting the Company from pursuing any other remedies available to it for such breach or threatened breach, including the recovery of any damages which it is able to prove. 9. Income Tax Treatment. Employee and the Company acknowledge that it is the intention of the Company to deduct all amounts paid under SECTION 2 hereof as ordinary and necessary business expenses for income tax purposes. Employee agrees and represents that he will treat all amounts paid hereunder as ordinary income for income tax purposes, and should he report such amounts as other than ordinary income for income tax purposes, he will indemnify and hold the Company harmless from and against any and all taxes, penalties, interest, costs and expenses, including reasonable attorneys' and accounting fees and costs, which are incurred by the Company directly or indirectly as a result thereof. -9- 12 10. Key Man Insurance. Employee shall cooperate with the Company if the Company decides to procure "Key Man" insurance covering the life of Employee and Employee shall, at the request of the Company, submit to such medical examinations, supply such information and execute such documents as may be required by the insurance company to which the Company has applied for insurance. Employee shall use his best efforts to qualify for the standard premium category of such insurance company. Employee shall have no interest whatsoever in any "Key Man" insurance policy procured by the Company. 11. Prior Agreement. Employee represents that he is not a party to any agreement, oral or written, which would preclude Employee's acceptance of employment under this Agreement. 12. Assignment. No party hereto may assign or delegate any of its rights or obligations hereunder without the prior written consent of the other party hereto, provided, however, that, whether or not Employee consents, the Company shall have the right to assign all or any part of its rights and obligations under this Agreement to (i) any affiliate of the Company to which the Business is assigned at any time or (ii) the purchaser of substantially all or all of the assets of the Company. Except as otherwise expressly provided herein, all covenants and agreements contained in this Agreement by or on behalf of any of the parties hereto shall bind and inure to the benefit of the respective successors and assigns of the parties hereto whether so expressed or not. 13. Severability. Whenever possible, each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement is held to be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of this Agreement. 14. Counterparts. This Agreement may be executed in multiple counterparts, each of which shall be deemed an original, but all of which taken together shall constitute one and the same Agreement. 15. Descriptive Headings; Interpretation. The descriptive headings in this Agreement are inserted for convenience of reference only and are not intended to be part of or to affect the meaning or interpretation of this Agreement. The use of the word "including" in this Agreement shall be by way of example rather than by limitation. 16. Notices. All notices, demands or other communications to be given or delivered under or by reason of the provisions of this Agreement shall be in writing and shall be deemed to have been duly given if (i) delivered personally to the recipient, (ii) sent to the recipient by reputable express courier service (charges prepaid) or mailed to the recipient by certified or registered mail, return receipt requested and postage prepaid, or (iii) transmitted by telecopy to the recipient with a confirmation copy to follow the next day to be delivered by overnight -10- 13 carrier. Such notices, demands and other communications shall be sent to the addresses indicated below: (a) If to Employee: Jay N. Baker 107 Stratton Lane Anderson, South Carolina 29621 Facsimile: (864) 261-8155 (b) If to the Company: Decorative Home Accents, Inc. 295 Fifth Avenue Suite 1414 New York, New York 10016 Facsimile: (212) 779-0149 Attention: Board of Directors with copies to: Howard Industries, Inc. 136 Main Street Westport, Connecticut 06880 Facsimile: (203) 227-3314 Attention: Peter H. Howard -11- 14 and: Katten Muchin & Zavis 525 West Monroe Street Chicago, Illinois 60661 Facsimile: (312) 902-1061 Attention: David R. Shevitz, Esq. James D. Harrington, Esq. and: Oaktree Capital Management, LLC 550 South Hope Street 22nd Floor Los Angeles, California 90071 Facsimile: (213) 694-1593 Attention: Richard J. Goldstein or to such other address or to the attention of such other Person as the recipient party has specified by prior written notice to the sending party. Date of service of such notice shall be (w) the date such notice is personally delivered, (x) three days after the date of mailing if sent by certified or registered mail, (y) one business day after the date of delivery to the overnight courier if sent by overnight courier or (z) the next business day after the date of transmittal by telecopy. 17. Preamble; Preliminary Recitals. The Preliminary Recitals set forth in the Preamble hereto are hereby incorporated and made part of this Agreement. 18. Entire Agreement. Except as otherwise expressly set forth herein, this Agreement sets forth the entire understanding of the parties, and supersedes and preempts all prior oral or written understandings and agreements, with respect to the subject matter hereof. 19. Governing Law. This Agreement shall be construed and enforced in accordance with, and all questions concerning the construction, validity, interpretation and performance of this Agreement shall be governed by, the laws of the State of South Carolina, without giving effect to provisions thereof regarding conflict of laws. -12- 15 IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. COMPANY: DECORATIVE HOME ACCENTS, INC. By: /s/ Peter H. Howard ------------------------------- Peter H. Howard, Chairman EMPLOYEE: /s/ Jay N. Baker ------------------------------- Jay N. Baker -13- 16 EXHIBIT 2.5 FRINGE BENEFITS AND EXPENSES - Four (4) weeks vacation annually -14- EX-10.3 4 AMENDED EMPLOYMENT AGREE. WITH MURPHY L. FONTENOT 1 Exhibit 10.3 AMENDED AND RESTATED EMPLOYMENT AND NON-COMPETITION AGREEMENT BY AND BETWEEN DECORATIVE HOME ACCENTS, INC. AND MURPHY L. FONTENOT 2 INDEX TO DEFINED TERMS TERM SECTION REFERENCED ---- ------------------ "Agreement".......................................................Introduction "Annual Bonus".....................................................Section 2.2 "Base Salary"......................................................Section 2.1 "Budget EBITDA"....................................................Section 2.2 "Board"............................................................Section 1.2 "Business"................................................Preliminary Recitals "Company".........................................................Introduction "Confidential Information"...........................................Section 5 "EBITDA"...........................................................Section 2.2 "EBITDA Ratio".....................................................Section 2.2 "Employee"........................................................Introduction "Employment Period"................................................Section 1.3 "Good Cause".......................................................Section 1.4 "HII".....................................................Preliminary Recitals "Initial Period"...................................................Section 1.3 "Permitted Investments"........................................... Section 4.2 "Renewal Periods"..................................................Section 1.3 "Restricted Period"................................................Section 4.2 "Restrictive Covenants"..............................................Section 8 "Territory"........................................................Section 4.2 "Total Disability".................................................Section 1.4 -1- 3 EMPLOYMENT AND NON-COMPETITION AGREEMENT The EMPLOYMENT AND NON-COMPETITION AGREEMENT (the "Agreement"), by and between DECORATIVE HOME ACCENTS, INC., a Delaware corporation (the "Company"), and MURPHY L. FONTENOT ("Employee") is hereby amended and restated effective as of February 28, 1997. PRELIMINARY RECITALS A. The Company, through its subsidiaries, is engaged in the business of the manufacturing, marketing, distribution and sale of bedding, bath and other home textile and gift products (the "Business"), with principal offices in New York, New York, Abbeville, South Carolina and Mooresville, North Carolina. For purposes of this Agreement, the term "Company" shall include the Company, its subsidiaries, affiliates, and assignees and any successors in interest of the Company and its subsidiaries and/or affiliates. B. The Company has employed Employee, as its Chief Executive Officer pursuant to the Agreement. C. The Company desires to continue Employee's employment, and Employee desires to continue his employment with the Company, pursuant to the terms and conditions of this Amended and Restated Agreement. NOW, THEREFORE, in consideration of the premises, the mutual covenants of the parties hereinafter set forth and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. Employment. 1.1 Engagement of Employee. The Company agrees to employ Employee and Employee agrees to accept employment as the President and Chief Executive Officer of the Company, all in accordance with the terms and conditions of this Agreement. 1.2 Duties and Powers. During the Employment Period, Employee will serve as the President and Chief Executive Officer of the Company and will have such responsibilities, duties and authorities, and will render such services of an executive and administrative character or act in such other executive capacity for the Company and its affiliates as the Company's board of directors (the "Board") shall from time to time direct. The Employee shall devote his best efforts, energies and abilities and his full business time, skill and attention (except for permitted vacation periods and reasonable periods of illness or other incapacity) to the business and affairs of the Company. The Employee shall perform the duties and carry out the responsibilities assigned to him, to the best of his ability, in a diligent, trustworthy, businesslike and efficient manner for the purpose of advancing the business of the Company. The Employee acknowledges that his duties and responsibilities will require his full-time business efforts and agrees that during the Employment Period he will not engage in any other business activity or have any business pursuits or interests which interfere or conflict with the performance of Employee's duties hereunder, provided, that nothing in this SECTION 1.2 shall be deemed to prohibit Employee from making Permitted Investments (as defined in SECTION 4.2). Employee further acknowledges that Employee's duties hereunder shall require him to travel between the Company's offices in New York, North Carolina and South Carolina at the direction of the Board. Employee shall have use of 4 a Company leased apartment while he is in New York and will be reimbursed for his out of pocket business expenses while in New York in accordance with Section 2.5. 1.3 Employment Period. Employee's employment under this Agreement shall begin on the date hereof and shall continue through and until February 28, 2000 (the "Initial Period"). This Agreement shall be automatically extended for additional consecutive one-year periods ("Renewal Periods") unless one of the parties hereto provides a written notice at least 90 days prior to the expiration of the Initial Period or any Renewal Period that such party does not desire to extend the Agreement. The Initial Period and the Renewal Periods are hereinafter referred to collectively as the "Employment Period." Notwithstanding anything to the contrary contained herein, the Employment Period is subject to termination pursuant to SECTION 1.4 and SECTION 1.5 below. 1.4 Termination by the Company. The Company has the right to terminate Employee's employment under this Agreement, by notice to Employee in writing (i) for "Good Cause" at any time, (ii) without Good Cause for any or no reason and (iii) due to the death or Total Disability of Employee. Any such termination shall be effective upon the date of service of such notice pursuant to SECTION 16. "Good Cause" as used herein means the occurrence of any of the following events: (a) the failure of Employee to perform his duties or comply with reasonable directions of the Board which continues for fifteen days after the Board has given written notice to Employee specifying in reasonable detail the manner in which Employee has failed to perform such duties or comply with such directions; (b) the determination by the Board in the exercise of its reasonable judgment that Employee has committed an act or acts constituting (i) a felony, (ii) dishonesty or disloyalty with respect to the Company, or (iii) fraud; (c) the determination by the Board in the exercise of its reasonable judgment that Employee has committed an act that (i) materially and negatively affects the Company's business or reputation or (ii) indicates alcohol or drug abuse by Employee that adversely affects his performance hereunder; (d) a material breach by Employee of any of the terms and conditions of this Agreement; provided, however, that if such breach is curable by Employee, such breach shall not constitute Good Cause hereunder until the Company notifies Employee of such breach and Employee does not cure such breach within fifteen days; (e) Employee's gross negligence or willful misconduct in the performance of his duties hereunder; provided, however, that if such gross negligence or willful misconduct is curable by Employee, such gross negligence or willful misconduct shall not constitute Good Cause hereunder until the Company notifies Employee of such gross negligence or willful misconduct and Employee does not cure such gross negligence or willful misconduct within fifteen days. Employee shall be deemed to have a "Total Disability" for purposes of this Agreement if he -2- 5 is unable to perform, by reason of physical or mental incapacity, his duties or obligations under this Agreement, for a total period of 60 days in any 360-day period. The Board shall determine, according to the facts then available, whether and when the Total Disability of the Employee has occurred. Such determination shall not be arbitrary or unreasonable, and the Board shall take into consideration the opinion of Employee's personal physician, if reasonably available, but such determination by the Board shall be final and binding on the parties hereto. 1.5 Termination by Employee. Employee has the right to terminate his employment under this Agreement for any reason, upon 90 days prior written notice to the Company. 1.6 Board of Directors and Resignation. For so long as Employee remains an executive officer of the Company, the Company agrees to use its best efforts to cause Employee to be elected to the Board. Upon the termination of Employee's employment with the Company for any reason, Employee shall be deemed to have automatically resigned from any position he may then hold on the Board. Such resignation shall be deemed effective immediately without the requirement that a written resignation be delivered. 2. Compensation and Benefits. 2.1 Base Compensation. During the Employment Period, the Company will pay Employee a base salary at a rate of $300,000.00 per annum (the "Base Salary"), which Base Salary may be increased but not decreased during the Employment Period at the sole discretion of the Board. The Base Salary shall be payable in accordance with the Company's regular payroll policy for salaried employees. The Board shall also perform an annual review of the Employee's Base Salary based on the Employee's performance of his duties and the Company's other compensation policies. If the Employment Period is terminated pursuant to SECTION 1.4 OR SECTION 1.5 above, then the Base Salary for any partial year will be prorated based on the number of days elapsed in such year during which services were actually performed by Employee. 2.2 Annual Bonus. In addition to his Base Salary, Employee may be paid a bonus for each calendar year in the Employment Period in accordance with the terms of the Decorative Home Accents, Inc. Executive Bonus Plan (the "Executive Bonus Plan") which has been established for senior executives of the Company (the "Annual Bonus"), provided that Employee is employed at the time bonuses are paid under such program, which time shall be the first payroll payment date after the issuance of the Company's audited year-end financial statements. Notwithstanding anything herein to the contrary, Employee shall be entitled to receive a bonus with respect to the final calendar year of the Employment Period if Employee's employment hereunder is terminated (i) by the expiration of the Employment Period due to the Company's providing Employee notice that it does not desire to extend the Agreement pursuant to SECTION 1.3 or (ii) by the Company without Good Cause after the termination of such final calendar year or after January 1, 1998, as the case may be.. For each calendar year in the Employment Period, the Board shall establish bonus levels based on the Company's actual consolidated earnings before interest, taxes, depreciation and amortization ("EBITDA") as compared to a budgeted level of EBITDA ("Budget EBITDA"). (a) With respect to 1997, Employee shall be eligible to receive a bonus payment in the amount of $150,000, provided that either of the following conditions -3- 6 is satisfied: (i) Employee is employed by the Company on March 31, 1998 and Employee shall not have given notice of his intention to terminate, or notice of termination of his employment or commenced discussions regarding employment with a competitor of the Company; or (ii) Employee's employment was terminated on or after January 1, 1998 by the Company without Good Cause. (b) In addition to the bonus payable pursuant to SECTION 2.2(a), Employee shall be entitled to a bonus in an amount equal to the amount determined pursuant to the 1997 Executive Bonus Plan, as amended, a copy of which is attached hereto as Exhibit 2.2. 2.3 Compensation After Termination. (a) Except as provided in SECTION 2.3(b), SECTION 2.4 and SECTION 2.9, if Employee's employment hereunder is terminated or expires for any reason, then the Company shall have no further obligations hereunder or otherwise with respect to Employee's employment from and after the termination or expiration date (except payment of Employee's Base Salary accrued through the date of termination or expiration) and the Company shall continue to have all other rights available hereunder (including without limitation, all rights under SECTION 4 at law or in equity). (b) If the Employment Period is terminated by the Company without Good Cause during the Initial Period (other than in connection with a Change of Control which shall be governed by Section 2.9), then the Employee shall be entitled to receive as severance pay his Base Salary hereunder for the remainder of the Initial Period, payable in regular installments in accordance with the Company's general payroll practices for salaried employees. The Company shall have no other obligations hereunder or otherwise with respect to Employee's employment from and after the termination date, and the Company shall continue to have all other rights available hereunder (including, without limitation, all rights under SECTION 4 at law or in equity). Notwithstanding the foregoing, the amount of severance pay due hereunder shall be offset and reduced by any compensation paid to Employee by any new employer of Employee during the period Employee is receiving such severance payments and amounts owed by Employee to the Company, if any. 2.4 Profit Sharing, Pension and Salary Deferral Benefits. It is understood by the parties to this Agreement that, during the Employment Period, Employee shall be entitled to participate in or accrue benefits under any pension, salary deferral or profit sharing plan now existing or hereafter created for employees of the Company upon terms and conditions equivalent to those which the Company may provide for other key management employees. Without limiting the generality of the foregoing, Employee shall be entitled to participate in the HII Retirement Savings Plan and to receive a matching contribution thereunder, consistent with Company policy and the terms of the HII Retirement Savings Plan. -4- 7 2.5 Fringe Benefits and Expenses. The Company will provide Employee vacation and other employee fringe benefits substantially comparable to the vacation and benefits which the Company regularly provides for other key management employees, including hospitalization, health and disability insurance, to the extent offered by the Company, and in amounts consistent with Company policy, for key management employees as reasonably determined by the Board. Such vacations and benefits shall be no less than those set forth on Exhibit 2.5, attached hereto. During the Employment Period, the Company will reimburse Employee in accordance with Company policy for his normal and reasonable out-of-pocket expenses incurred in the course of performing his duties hereunder. 2.6 Life Insurance. At the request of Employee, the Company will reimburse Employee in an amount up to the quotient of (i) $70,000.00 and (ii) 1 - - (the sum of the Employee's marginal federal income tax rate plus the Employee's marginal state income tax rate) for each year in the Employment Period, for premiums paid by Employee on the life insurance policy currently in force and owned by Employee on Employee's life. Such reimbursement shall be made in accordance with Company policy at the time that Employee pays such premium. If Employee's employment hereunder is terminated prior to a calendar year-end, Employee shall be obligated to repay the Company an amount equal to the product of (1) the reimbursement made by the Company during the calendar year and (2) a fraction, the numerator of which shall be twelve minus the number of complete months which Employee was employed by the Company for such calendar year and the denominator of which shall be 12. 2.7 Disability. At the request of Employee, the Company will reimburse Employee in an amount up to the quotient of (i) $10,000 and (ii) 1 - (the sum of the Employee's marginal federal income tax rate plus the Employee's marginal state income tax rate) for each year in the Employment Period, for premiums paid by Employee on the disability policy currently in force and owned by Employee. Such reimbursement shall be made in accordance with Company policy at the time that Employee pays such premium. If Employee's employment hereunder is terminated prior to a calendar year-end, Employee shall be obligated to repay the Company an amount equal to the product of (1) the reimbursement made by the Company during the calendar year and (2) a fraction, the numerator of which shall be twelve minus the number of complete months which Employee was employed by the Company for such calendar year and the denominator of which shall be 12. 2.8 Taxes, etc. All compensation payable to Employee hereunder is stated in gross amount and shall be subject to all applicable withholding taxes, other normal payroll deductions and any other amounts required by law to be withheld. 2.9 Change of Control. If Employee's employment with the Company is terminated within 90 days following a Change of Control of the Company, by (i) the Company without Good Cause, (ii) a successor to the Company without Good Cause or (iii) the Employee, then the Company shall pay Employee an amount equal to $1,800,000 in a single sum in cash within thirty (30) days after such termination of employment. -5- 8 For purposes of this Agreement, "Change of Control" means any of the following occurring on or prior to the effective date of a restructuring of the Company's $125 million of 13% Senior Notes due 2002 (a "Restructuring") or (ii) in connection with a Restructuring: (a) the consummation of any transaction (other than the transactions contemplated by that certain Mutual Release and Settlement Agreement between the Company, certain of the Company's stockholders and Henry and Barbara Scharling), including, without limitation, any merger or consolidation, the direct result of which is that any Person (other than TCW Special Credits Fund V - the Principal Fund ("Fund V")), owns, directly or indirectly, more than 50% of the voting power of the Company's Board; (b) the sale, lease, transfer, conveyance or other disposition, in one or a series of related transactions, of all or substantially all of the stock or assets of the Company to any Person (other than Fund V); (c) the consummation of any transaction (other than the transactions contemplated by that certain Mutual Release and Settlement Agreement between the Company, certain of the Company's stockholders and Henry and Barbara Scharling), including, without limitation, any merger or consolidation, the direct result of which is that any Person (other than Fund V), controls the issuance of options with respect to the Company's capital stock to members of management; or (d) the adoption and implementation of a plan relating to the liquidation or dissolution of the Company. "Person" means any individual, corporation, partnership, joint venture, association, joint-stock company, trust, unincorporated organization or any other entity. 2.10 Indemnification. The parties acknowledge and agree that Employee shall be fully entitled to indemnification from the Company from liabilities arising from acts taken by the Employee as an officer or director of the Company as provided in "Article IX - Indemnification" of the Company's Second Amended and Restated Certificate of Incorporation. 3. Equity Incentive. If no Change of Control occurs, the Company shall use its best efforts to grant the Employee stock options, the terms of which shall be negotiated in good faith by and will be mutually acceptable to the Company and the Employee. In determining the amount of stock options to be granted to Employee, consideration shall be given to Employee's past equity ownership. -6- 9 4. Covenant Not to Compete. 4.1 Employee's Acknowledgment. Employee agrees and acknowledges that in order to assure the Company that it will retain its value and that of the Business as a going concern, it is necessary that Employee undertake not to utilize his special knowledge of the Business and his relationships with customers and suppliers to compete with the Company. Employee further acknowledges that: (a) the Company is and will be engaged in the Business; (b) Employee has occupied and will continue to occupy a position of trust and confidence with the Company during the period of Employee's employment under this Agreement, and Employee has become familiar with the Company's trade secrets and with other proprietary and confidential information concerning the Company and the Business; (c) the agreements and covenants contained in this SECTION 4 are essential to protect the Company and the goodwill of the Business; and (d) Employee's employment with the Company has special, unique and extraordinary value to the Company and the Company would be irreparably damaged if Employee were to provide services to any person or entity in violation of the provisions of this Agreement. 4.2 Non-Compete. Employee hereby agrees that for a period commencing on the date hereof and ending on the later of (1) one year following the termination of his employment with the Company or (2) on such date as the Company shall cease making severance payments to Employee pursuant to SECTION 2.3(b) above (the "Restricted Period"), he will not, directly or indirectly, as employee, agent, consultant, stockholder, director, co-partner or in any other individual or representative capacity, own, operate, manage, control, engage in, invest in or participate in any manner in, act as a consultant or advisor to, render services for (alone or in association with any person, firm, corporation or entity), or otherwise assist any person or entity (other than the Company) that engages in or owns, invests in, operates, manages or controls any venture or enterprise that directly or indirectly engages in the Business anywhere in North America or Western Europe (the "Territory"); provided, however, that nothing contained herein shall be construed to prevent Employee from investing in the stock of any competing corporation listed on a national securities exchange or traded in the over-the-counter market, but only if Employee is not involved in the business of said corporation and if Employee and his associates (as such term is defined in Regulation 14(A) promulgated under the Securities Exchange Act of 1934, as in effect on the date hereof), collectively, do not own more than an aggregate of two percent of the stock of such corporation ("Permitted Investments"). With respect to the Territory, Employee specifically acknowledges that the Company has heretofore conducted the Business throughout those areas comprising the Territory and the Company intends to continue to expand the Business throughout the Territory. 4.3 Non-Solicitation. Without limiting the generality of the provisions of SECTION 4.2 above, Employee hereby agrees that during the Restricted Period he will not (except on behalf of the Company) for the purpose of securing business or contracts related to the Business, directly or indirectly, solicit, or participate as employee, agent, consultant, stockholder, director, partner or in any other individual or representative capacity in any business which solicits business -7- 10 from any person, firm, corporation or other entity which is or was a customer or supplier of the Business during the two-year period preceding the date of this Agreement and/or during the term of this Agreement, or from any successor in interest to any such person, firm, corporation or other entity. 4.4 Blue-Pencil. If any court of competent jurisdiction shall at any time deem the term of this Agreement or any particular Restrictive Covenant (as defined) too lengthy or the Territory too extensive, the other provisions of this SECTION 4 shall nevertheless stand, the Restricted Period shall be deemed to be the longest period permissible by law under the circumstances and the Territory shall be deemed to comprise the largest territory permissible by law under the circumstances. The court in each case shall reduce the Restricted Period and/or Territory to permissible duration or size. 5. Confidential Information. During the term of this Agreement and thereafter, Employee shall keep secret and retain in strictest confidence, and shall not, without the prior written consent of the Board of Directors, furnish, make available or disclose to any third party or use for the benefit of himself or any third party, any Confidential Information. As used in this SECTION 5, "Confidential Information" shall mean any information relating to the business or affairs of the Company or the Business, including but not limited to information relating to financial statements, customer identities, potential customers, employees, suppliers, servicing methods, equipment, programs, strategies and information, analyses, profit margins or other proprietary information used by the Company in connection with the Business; provided, however, that Confidential Information shall not include any information which is in the public domain or becomes known through no wrongful act on the part of Employee. Employee acknowledges that the Confidential Information is vital, sensitive, confidential and proprietary to the Company. In the event that Employee reasonably believes after consultation with counsel that he is required by law to disclose any Confidential Information, he may do so provided that he will use his best efforts to (a) provide the Company with proper notice before such disclosure in order that the Company may attempt to obtain a protective order or other assurance that confidential treatment will be accorded such confidential matters and (b) cooperate, at the Company's expense, with the Company in attempting to obtain such order or assurance. 6. Interference with Relationships. During the Restricted Period Employee shall not, directly or indirectly, as employee, agent, consultant, stockholder, director, co-partner or in any other individual or representative capacity: (i) without the prior written consent of the Company, employ or engage, recruit or solicit for employment or engagement, any person who is (or was within six months of the date such employment, engagement or solicitation commences or occurs, as the case may be) employed or engaged by the Company, or otherwise seek to influence or alter any such person's relationship with the Company, or (ii) solicit or encourage any present or future customer or supplier of the Company to terminate or otherwise adversely alter his, her or its relationship with the Company. 7. Effect on Termination. If the Company or the Employee should terminate Employee's employment pursuant to SECTION 1, then, notwithstanding such termination, those provisions contained in SECTIONS 2.3, 2.4, 2.7, 2.9, 2.10, 4, 5, 6, 7, 8, 9, 11, 12, 13, 14, 15, 16, 17, 18 AND 19 hereof shall remain in full force and effect for the duration of the Restricted Period. 8. Remedies. Employee acknowledges and agrees that the covenants set forth in -8- 11 SECTIONS 4, 5 AND 6 of this Agreement (collectively, the "Restrictive Covenants") are reasonable and necessary for the protection of the Company's business interests, that irreparable injury will result to the Company if Employee breaches any of the terms of the Restrictive Covenants, and that in the event of Employee's actual or threatened breach of any such Restrictive Covenants, the Company will have no adequate remedy at law. Employee accordingly agrees that in the event of any actual or threatened breach by him of any of the Restrictive Covenants, the Company shall be entitled to immediate temporary injunctive and other equitable relief, without the necessity of showing actual monetary damages, subject to hearing as soon thereafter as possible. Nothing contained herein shall be construed as prohibiting the Company from pursuing any other remedies available to it for such breach or threatened breach, including the recovery of any damages which it is able to prove. 9. Income Tax Treatment. Employee and the Company acknowledge that it is the intention of the Company to deduct all amounts paid under SECTION 2 hereof as ordinary and necessary business expenses for income tax purposes. Employee agrees and represents that he will treat all amounts paid hereunder as ordinary income for income tax purposes, and should he report such amounts as other than ordinary income for income tax purposes, he will indemnify and hold the Company harmless from and against any and all taxes, penalties, interest, costs and expenses, including reasonable attorneys' and accounting fees and costs, which are incurred by Company directly or indirectly as a result thereof. 10. Key Man Insurance. Employee shall cooperate with the Company if the Company decides to procure "Key Man" insurance covering the life of Employee and Employee shall, at the request of the Company, submit to such medical examinations, supply such information and execute such documents as may be required by the insurance company to which the Company has applied for insurance. Employee shall use his best efforts to qualify for the standard premium category of such insurance company. Employee shall have no interest whatsoever in any "Key Man" insurance policy procured by the Company. 11. Prior Agreement. Employee represents that he is not a party to any agreement, oral or written, which would preclude Employee's acceptance of employment under this Agreement. 12. Assignment. No party hereto may assign or delegate any of its rights or obligations hereunder without the prior written consent of the other party hereto, provided, however, that, whether or not Employee consents, the Company shall have the right to assign all or any part of its rights and obligations under this Agreement to (i) any affiliate of the Company to which the Business is assigned at any time or (ii) the purchaser of substantially all or all of the assets of the Company. Except as otherwise expressly provided herein, all covenants and agreements contained in this Agreement by or on behalf of any of the parties hereto shall bind and inure to the benefit of the respective successors and assigns of the parties hereto whether so expressed or not. 13. Severability. Whenever possible, each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement is held to be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of this Agreement. 14. Counterparts. This Agreement may be executed in multiple counterparts, each of -9- 12 which shall be deemed an original, but all of which taken together shall constitute one and the same Agreement. 15. Descriptive Headings; Interpretation. The descriptive headings in this Agreement are inserted for convenience of reference only and are not intended to be part of or to affect the meaning or interpretation of this Agreement. The use of the word "including" in this Agreement shall be by way of example rather than by limitation. 16. Notices. All notices, demands or other communications to be given or delivered under or by reason of the provisions of this Agreement shall be in writing and shall be deemed to have been duly given if (i) delivered personally to the recipient, (ii) sent to the recipient by reputable express courier service (charges prepaid) or mailed to the recipient by certified or registered mail, return receipt requested and postage prepaid, or (iii) transmitted by telecopy to the recipient with a confirmation copy to follow the next day to be delivered by overnight carrier. Such notices, demands and other communications shall be sent to the addresses indicated below: (a) If to Employee: Murphy L. Fontenot 4516 Piper Glen Drive Charlotte, North Carolina 28277 Facsimile: (704) 846-7380 with a copy to: Moore & Van Allen 100 North Tryon Street 47th Floor Charlotte, North Carolina 28202-4003 Attention: Stephen D. Hope, Esq. Facsimile: (704) 331-1159 (b) If to the Company: Decorative Home Accents, Inc. 295 Fifth Avenue Suite 1414 New York, New York 10016 Facsimile: (212) 779-0149 Attention: Board of Directors with copies to: Howard Industries, Inc. 136 Main Street Westport, Connecticut 06880 Facsimile: (203) 227-3314 Attention: Peter H. Howard -10- 13 and: Katten Muchin & Zavis 525 West Monroe Street Chicago, Illinois 60661 Facsimile: (312) 902-1061 Attention: David R. Shevitz, Esq. James D. Harrington, Esq. and: Oaktree Capital Management, LLC 550 South Hope Street 22nd Floor Los Angeles, California 90071 Facsimile: (213) 694-1593 Attention: Richard J. Goldstein or to such other address or to the attention of such other Person as the recipient party has specified by prior written notice to the sending party. Date of service of such notice shall be (w) the date such notice is personally delivered, (x) three days after the date of mailing if sent by certified or registered mail, (y) one business day after the date of delivery to the overnight courier if sent by overnight courier or (z) the next business day after the date of transmittal by telecopy. 17. Preamble; Preliminary Recitals. The Preliminary Recitals set forth in the Preamble hereto are hereby incorporated and made part of this Agreement. 18. Entire Agreement. Except as otherwise expressly set forth herein, this Agreement sets forth the entire understanding of the parties, and supersedes and preempts all prior oral or written understandings and agreements, with respect to the subject matter hereof. 19. Governing Law. This Agreement shall be construed and enforced in accordance with, and all questions concerning the construction, validity, interpretation and performance of this Agreement shall be governed by, the laws of the State of North Carolina, without giving effect to provisions thereof regarding conflict of laws. -11- 14 IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. COMPANY: DECORATIVE HOME ACCENTS, INC. By: ______________________________ Peter H. Howard, Chairman EMPLOYEE: ____________________________________ Murphy L. Fontenot -12- EX-10.4 5 AMENDMENT TO FINANCING AGREEMENTS 1 EXHIBIT 10.4 As of February 28, 1997 CONGRESS FINANCIAL CORPORATION 1133 Avenue of the Americas New York, New York 10036 Re: Amendment to Financing Agreements Gentlemen: Reference is made to the financing arrangements between CONGRESS FINANCIAL CORPORATION ("LENDER") and THE RUG BARN, INC., HOME INNOVATIONS, INC., a Delaware corporation, CALVIN KLEIN HOME, INC. and R.A. BRIGGS AND COMPANY (individually and collectively, the "BORROWERS"), pursuant to which Lender may extend loans, advances and other financial accommodations to Borrowers pursuant to the terms and provisions of the Loan and Security Agreement dated November 12, 1996 among Borrowers, Decorative Home Accents, Inc., Draymore Mfg. Corp., Home Innovations, Inc., a New York corporation, and Lender (the "LOAN AGREEMENT"). All capitalized terms used herein and not otherwise defined herein shall have their respective meanings as defined in the Loan Agreement. Borrowers have requested that the Lender make additional loans, advances and other financial accommodations to Borrowers under the Loan Agreement, which Lender is willing to make, on and subject to the terms and conditions of the Loan Agreement and the terms and conditions set forth in this Letter Re: Amendment to Financing Agreements (the "AMENDMENT"). In consideration of the foregoing, the parties hereto hereby agree as follows: 1. (a) In addition to the loans and advances as set forth in the Loan Agreement, Lender agrees, as a one-time financial accommodation to Borrowers, to provide Borrowers with a line of credit (the "SUPPLEMENTAL FACILITY") pursuant to which Lender agrees to make loans to Borrowers (each such loan a "SUPPLEMENTAL LOAN", and all such loans, collectively, the "SUPPLEMENTAL LOANS") up to an aggregate principal amount of $5,000,000 outstanding at any given time. Each Supplemental Loan shall be a Revolving Loan under the Loan Agreement and all references in the Loan Agreement to "Revolving Loans" are hereby amended to include, within the definition thereof, the Supplemental Loans. With respect to the payment of interest, each Supplemental Loan shall be a Prime Rate Loan and shall accrue interest at the applicable Interest Rate set forth in the Loan Agreement for Prime Rate Loans with such interest being payable in accordance with the terms of the Loan Agreement. Each Borrower's right to request a Supplemental Loan under the Supplemental Facility shall terminate on June 20, 1997, 2 or earlier as hereinafter provided in paragraph 1(e) below (the "SUPPLEMENTAL FACILITY TERMINATION DATE") and all Supplemental Loans shall be repaid in full on the Supplemental Facility Termination Date. The outstanding amount of the Supplemental Loans shall not be included in the calculation, from time to time, of Borrowers' availability (as determined by Lender) under the lending formulas in effect as of the date hereof under the Loan Agreement ("AVAILABILITY"). In addition, the outstanding principal amount of the Supplemental Loans plus the aggregate amount of the Loans (excluding the Supplemental Loans) and the Letter of Credit Accommodations outstanding at any time shall not exceed the Aggregate Maximum Credit. (b) Borrowers acknowledge, confirm and agree that each request for a Supplemental Loan shall be made by Borrowers' Representative in accordance with Section 2.4 of the Loan Agreement, except that, so long as there is Availability, Borrowers and Borrowers' Representative shall not make any requests for a Supplemental Loan under the Supplemental Facility. (c) Each Supplemental Loan may be prepaid in whole or in part without penalty or premium, and Borrowers agree that at any time Borrowers have Availability, Borrowers shall make a prepayment of the Supplemental Loans then outstanding in the amount of such Availability. In addition to, and not in limitation of, anything to the contrary contained in the Loan Agreement, prior to the occurrence of an Event of Default after Lender applies all proceeds of Accounts and other Collateral in respect of the Revolving Loans and the other Obligations then outstanding, Borrowers authorize and direct Lender to, and Lender shall, apply any excess proceeds against the then outstanding Supplemental Loans and the other Obligations payable under the Supplemental Facility. (d) At Lender's option, all payments required hereunder, together with interest thereon, may be charged to any loan account of Borrowers maintained by Lender. (e) Immediately (i) upon the occurrence of an Event of Default, or (ii) upon the receipt by Lender of a joint written request delivered by Borrowers and TCW Special Credits Fund V-The Principal Fund to Lender (which written request shall be confirmed by each of Borrowers' Representative and TCW as being received by Lender) requesting that the Supplemental Facility be terminated, the Borrowers' right to request a Supplemental Loan under the Supplemental Facility shall terminate and all Supplemental Loans then outstanding shall be immediately due and payable. (f) Lender agrees that Lender will not make any Supplemental Loans to Borrowers from and after the date that the Supplemental Facility is terminated. Any loans made under the Loan Agreement in excess of the lending formulas as set forth in the Loan Agreement from and after the date that the Supplemental Facility is terminated shall not be deemed to be Supplemental Loans as provide for in this paragraph 1. -2- 3 (g) In the event that the Supplemental Loans are not repaid on the Supplemental Facility Termination Date, or as otherwise provided for herein, the same shall constitute an Event of Default under the Loan Agreement. 2. In consideration of Lender's willingness to establish the Supplemental Facility and to make additional loans to Borrowers as set forth herein, in addition to all other fees due and payable by Borrowers under the Loan Agreement, Borrowers, jointly and severally, agree to pay to Lender a fee in the amount of $75,000. Such fee shall be fully earned as of the date hereof and shall be payable as follows: $25,000 payable contemporaneously with the execution hereof; $25,000 on April 21, 1997 and $25,000 on May 21, 1997. Such fee may be charged by Lender to any loan account(s) of Borrowers maintained by Lender. 3. This Amendment shall not constitute a waiver or amendment of any provision of the Loan Agreement or any of the other Financing Agreements not expressly referred to herein. Except as expressly set forth herein, no other changes or modifications to the Loan Agreement are intended or implied and the Loan Agreement shall remain in full force and effect in accordance with its terms. 4. This Amendment may be executed in counterparts, each of which, when executed, shall be deemed to constitute one and the same Amendment. The terms and provisions of paragraph 1 and this paragraph 4 of this Amendment shall not be amended or modified except in a writing signed by each of the signatories hereto. 5. This Amendment shall be governed by, and construed and interpreted in accordance with, the laws of the State of New York. Very truly yours, THE RUG BARN, INC. HOME INNOVATIONS, INC., (A DELAWARE CORPORATION) CALVIN KLEIN HOME, INC. R.A. BRIGGS AND COMPANY By: __________________________________ Title: Executive Vice President of Each [SIGNATURES CONTINUED ON NEXT PAGE] -3- 4 [SIGNATURES CONTINUED FROM PREVIOUS PAGE] ACCEPTED AND AGREED TO: CONGRESS FINANCIAL CORPORATION By: ----------------------- Title: ----------------------- ACKNOWLEDGED AND AGREED TO: DECORATIVE HOME ACCENTS, INC. DRAYMORE MFG. CORP. By: ----------------------- Title: Executive Vice President of Each -------------------------------- HOME INNOVATIONS, INC., a New York corporation By: ----------------------- Title: Chief Financial Officer ----------------------- TCW SPECIAL CREDITS FUND V- THE PRINCIPAL FUND By: TCW ASSET MANAGEMENT COMPANY Its: General Partner By: /s/ Stephen A. Kaplan ------------------------ STEPHEN A. KAPLAN Its: Authorized Signatory By: /s/ Richard J. Goldstein ------------------------ RICHARD J. GOLDSTEIN Its: Authorized Signatory -4- EX-10.5 6 AMENDMENT AND CONSENT 1 EXHIBIT 10.5 AMENDMENT AND CONSENT AMENDMENT AND CONSENT dated May 23, 1997 by and among CONGRESS FINANCIAL CORPORATION, a California corporation ("Lender"), THE RUG BARN, INC., a South Carolina corporation, HOME INNOVATIONS, INC., a Delaware corporation, DHA HOME, INC., formerly known as CALVIN KLEIN HOME, INC., a Delaware corporation, and R.A. BRIGGS AND COMPANY, an Illinois corporation (each, individually, a "Borrower", and, collectively, the "Borrowers"), DECORATIVE HOME ACCENTS, INC., a Delaware corporation, and DRAYMORE MFG. CORP., a North Carolina corporation (each, individually, a "Guarantor", and collectively, the "Guarantors"), and HOME INNOVATIONS, INC. ("HI New York"), a New York corporation. W I T N E S S E T H: WHEREAS, Lender, Borrowers, Guarantors and HI New York entered into a Loan and Security Agreement dated November 13, 1996 which has been amended pursuant to a letter agreement dated March 1, 1997 (as so amended, the "Loan Agreement"), pursuant to which Lender has made and may continue to make loans, and has provided and may continue to provide other financial accommodations, to Borrowers; and WHEREAS, Borrowers desire to obtain additional working capital financing pending a proposed restructuring of the liabilities and capital stock of Decorative Home Accents, Inc. and Borrowers and Draymore Mfg. Corp. ("Draymore"); and WHEREAS, various investment advisory clients (the "Term Lenders") of Magten Asset Management Corp., a Delaware corporation ("Magten"), Borrowers, Guarantors, and HI New York are entering into the Term Loan Documents (as defined herein) pursuant to which the Term Lenders will make secured loans to Borrowers up to an aggregate principal amount of $20,000,000 (together with the related $5,000,000 closing fee referred to in the Term Loan Documents, collectively, the "Bridge Loan") to provide such additional working capital, which Bridge Loan will be guaranteed on a secured basis by Guarantors and HI New York; and WHEREAS, Borrowers have requested Lender's consent under the Loan Agreement to their execution and delivery of the Term Loan Documents, the incurrence of the indebtedness arising from the Bridge Loan, and the granting of liens and security interests contemplated by the Term Loan Documents; and WHEREAS, certain Events of Default (as defined in the Loan Agreement) have occurred, and Borrowers have requested waivers thereof from Lender; and -1- 2 WHEREAS, Lender is willing to grant such consent and waivers, but only on the terms and conditions of this Amendment and Consent. NOW THEREFORE, in consideration of the mutual conditions and agreements set forth herein, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: 1. Incorporation of Definitions. Capitalized terms used but not defined in this Amendment and Consent shall have the meanings given to such terms in the Loan Agreement. 2. Consent to Term Loan Documents and Related Transactions. To the extent that Lender's consent is required under the Loan Agreement, effective upon the satisfaction of the conditions set forth in Section 6 of this Amendment and Consent, Lender hereby consents to Borrowers', Guarantors', and HI New York's execution and delivery of the Term Loan Documents and their consummation of the transactions contemplated thereby, on the terms contained in the definitive Term Loan Documents delivered to and found satisfactory by Lender and its counsel in accordance with Section 6 of this Amendment and Consent, including, without limitation, (a) the granting by Borrowers, Guarantors, and HI New York to the Term Lenders of (i) a first priority lien on and security interest in all of their existing and other acquired equipment, fixtures (excluding fixtures bearing or identified by the Calvin Klein Intellectual Property (as defined in the Loan Agreement)) and interests in real property and the proceeds thereof, in accordance with the terms of the Intercreditor Agreement (the "Intercreditor Agreement"), dated May 23, 1997, between Lender and the Term Lenders, and (ii) a lien and security interest, subordinate to those of Lender, on and in their existing and future accounts, inventory, general intangibles, documents, instruments, chattel paper, and all other assets and the proceeds thereof (excluding the Calvin Klein License), and (b) the granting by Holdings and HI Delaware to the Term Lenders of a first priority pledge of and security interest in the capital stock of Holdings' and HI Delaware's subsidiaries, and the proceeds thereof, in order to secure their respective obligations under the Bridge Loan. Lender's consent above is limited to the terms and conditions contained in the definitive Term Loan Documents delivered to and found satisfactory by Lender and its counsel in accordance with Section 6 hereof, and Borrowers, Guarantors, and HI New York shall be required to obtain Lender's further consent to any modification, supplement, amendment, extension, renewal, restatement, or replacement of the Term Loan Documents or any transaction not contemplated by such definitive Term Loan Documents. 3. Waiver of Defaults. Effective upon the satisfaction of the conditions set forth in Section 6 of this Amendment and Consent, Lender waives any Event of Default: (a) based on Borrowers' failure to comply with Section 9.13 of the Loan Agreement on or prior to the date hereof; (b) based on Borrowers' and Guarantors' failure to comply with the covenants set forth in Section 9.6 of the Loan Agreement with respect to the delivery, on or prior to the dates required under Section 9.6(a) of the Loan Agreement, of audited financial statements for the -2- 3 fiscal year ended December 31, 1996 or unaudited financial statements for the months of March 1997 and April 1997, (c) based on Borrowers' and Guarantors' failure at any time to comply with the covenant set forth in Section 9.9(b) of the Loan Agreement insofar as they have any trade obligations unpaid for more than 50 days; (d) based on Borrower's and Guarantors' failure to comply with the covenant set forth in Section 9.16(a) of the Loan Agreement insofar as the Calvin Klein License has been terminated without Lender's consent; and (e) based on HI New York's failure to effectively merge into HI Delaware under the applicable laws of the State of New York (the "Merger") on or prior to the date hereof. In order to induce Lender to grant the foregoing waivers, (x) Borrowers and Guarantors agree to deliver audited financial statements meeting the requirements of Section 9.6(a) of the Loan Agreement for the fiscal year ended December 31, 1996 no later than May 30, 1997, unaudited financial statements meeting such requirements for the month of March 1997 no later than May 23, 1997, and unaudited financial statements meeting such requirements for the month of April 1997 no later than June 6, 1997, and (y) Holdings, HI Delaware and HI New York covenant and agree to take all necessary action to effect the Merger, and to deliver evidence of such effectiveness to Lender, not later than June 30, 1997. Any failure to comply with any agreement in the immediately preceding sentence shall be an Event of Default. 4. Amendments to Loan Agreement. Effective upon the satisfaction of the conditions set forth in Section 6 of this Amendment and Consent: (a) Section 1 of the Loan Agreement is amended by amending the following definition in its entirety to read as follows: "Adjusted Tangible Net Worth" shall mean as to any Person, at any time, in accordance with GAAP (except as otherwise specifically set forth below), on a consolidated basis for such Person and its subsidiaries (if any), the amount, calculated in the same manner as set forth on Schedule 1.3, equal to: (a) the difference between: (i) the aggregate net book value of all assets of such Person and its subsidiaries, calculating the book value of inventory for this purpose on a first-in-first-out basis, after deducting from such book values all appropriate reserves in accordance with GAAP (including all reserves for doubtful receivables, obsolescence, depreciation and amortization) and (ii) the aggregate amount of the indebtedness and other liabilities of such Person and its subsidiaries (including tax and other proper accruals); minus (b) the net book value of (i) deferred assets, other than prepaid insurance, prepaid taxes, deferred income taxes, prepaid advertising, deposits, and other prepaid costs, (ii) patents, copyrights, trademarks, trade names, licenses, customer lists, franchises, goodwill, and other similar intangibles, (iii) amounts due from affiliates and stockholders, and (iv) unamortized debt discount and expense; provided, however, that the foregoing calculation shall exclude and not otherwise give effect to any cancellation, forgiveness, exchange, or restructuring of the indebtedness or capital stock of such Person or any of its subsidiaries -3- 4 accruing on or after the date of the Term Loan Documents. (b) Section 1 of the Loan Agreement is amended by adding the following definitions thereto in the proper numerical order: 1.8A "Calvin Klein License" shall mean (i) the License Agreement, dated as of May 26, 1994, between Calvin Klein, Inc. and Calvin Klein Home, Inc., (ii) the License Agreement, dated as of April 27, 1997, between Calvin Klein, Inc. and DHA Home, Inc., and (iii) any other license agreements entered into in replacement of the foregoing license agreements regarding Borrowers' right to manufacture and distribute Inventory bearing Calvin Klein trademarks. 1.45A "Real Property" shall mean all now owned and hereafter acquired real property of each Borrower, including leasehold interests, together with all buildings, structures, and other improvements located thereon and all licenses, easements and appurtenances relating thereto, wherever located, including the real property and related assets more particularly described on Schedule 1.45A hereto (but specifically excluding fixtures bearing or identified by the Calvin Klein Intellectual Property). 1.49A "Term Loan Documents" shall mean the Credit Agreement dated as of May 23, 1997 among Borrowers, Guarantors, HI New York, and General Motors Employees Domestic Group Pension Trust, Hughes Master Retirement Trust, Department of Pensions-City of Los Angeles, Magten Offshore Fund Ltd., Magten Partners, L.P., Magten Group Trust, Navy Exchange Service Command Retirement Trust, Western Union Pension Trust, and Saturn Fund Ltd., and each and every note, guarantee, security agreement, pledge agreement, mortgage or deed of trust, or other agreement, instrument, or document establishing terms of or evidencing, guaranteeing, or securing obligations arising in connection with such Credit Agreement. (c) Section 4.1(i) of the Loan Agreement is hereby amended in its entirety to read as follows: (i) Lender shall have received a written agreement from Calvin Klein, Inc., in form and substance satisfactory to Lender, containing certain agreements facilitating Lender's enforcement of its security interest in Inventory bearing trademarks licensed under the License Agreement dated as of May 26, 1994 (the "Original Calvin Klein License") between Calvin Klein, Inc. and Calvin Klein Home, Inc.; and. (d) Section 5 of the Loan Agreement is hereby amended in its entirety -4- 5 to read as follows: To secure payment and performance of all Obligations, each Borrower and HI New York hereby grants to Lender a continuing security interest in, a lien upon, and a right of set off against, and hereby assigns to Lender as security, the following property and interests in property, whether now owned or hereafter acquired or existing, and wherever located (collectively, the "Collateral"): 5.1 Accounts; 5.2 all present and future contract rights (specifically excluding the Calvin Klein License), general intangibles (including, but not limited to, tax and duty refunds, registered and unregistered patents, trademarks, service marks, copyrights, trade names, applications for the foregoing, trade secrets, goodwill, processes, drawings, blueprints, customer lists, all licenses (other than the Calvin Klein License and any sublicenses thereunder), whether as licensor or licensee, choses in action and other claims), chattel paper, documents, instruments, letters of credit, bankers' acceptances and guaranties provided, however, that this excludes any and all interests and/or rights to use the trademark "Calvin Klein" (or "CK/Calvin Klein" or other derivative thereof) deriving from the Calvin Klein License or otherwise including any and all copyrights, copyrightable material or other intellectual property or proprietary data or information which may exist or arise in connection with or relating to the Calvin Klein License (collectively, the "Calvin Klein Intellectual Property"), except as otherwise agreed in writing by Calvin Klein, Inc.; 5.3 all present and future monies, securities, credit balances, deposits, deposit accounts and other property of such Borrower or HI New York now or hereafter held or received by or in transit to Lender or its affiliates or at any other depository or other institution from or for the account of such Borrower or HI New York, whether for safekeeping, pledge, custody, transmission, collection or otherwise, and all present and future liens, security interests, rights, remedies, title and interest in, to and in respect of Accounts and other Collateral, including, without limitation, (a) rights and remedies under or relating to guaranties, contracts of suretyship, letters of credit and credit and other insurance related to the Collateral, (b) rights of stoppage in transit, replevin, repossession, reclamation and other rights and remedies of an unpaid vendor, lienor or secured party, (c) goods described in invoices, documents, contracts or instruments with respect to, or otherwise representing or evidencing, Accounts or other Collateral, including, without limitation, returned, repossessed and reclaimed goods, and (d) deposits by and property of account debtors or other persons -5- 6 securing the obligations of account debtors; 5.4 Inventory; 5.5 Records; 5.6 Equipment; 5.7 Real Property; and 5.8 all products and proceeds of the foregoing, in any form, including, without limitation, insurance proceeds and all claims against third parties for loss or damage to or destruction of any or all of the foregoing. Each Borrower hereby confirms that the property constituting Collateral is, and is intended to be, the same as the property of Borrowers and HI New York in which security interests and liens have been or will be granted pursuant to the Term Loan Documents, notwithstanding any differences in the language used to describe such property in the Term Loan Documents. (d) The first sentence of Section 9.13 of the Loan Agreement is hereby amended in its entirety to read as follows: Borrowers shall maintain an aggregate Adjusted Tangible Net Worth of not less than ($110,000,000) at all times. 5. Amendment to General Security Agreement. Effective upon the satisfaction of the conditions set forth in Section 6 of this Amendment and Consent: (a) Section 1 of the General Security Agreement dated November 12, 1996 between Draymore and Lender (the "General Security Agreement") is amended by adding the following definition in the proper numerical order: 1.12A "Real Property" shall mean all now owned and hereafter acquired real property of Guarantor, including leasehold interests, together with all buildings, structures, and other improvements located thereon and all licenses, easements and appurtenances relating thereto, wherever located, including the real property and related assets more particularly described on Schedule 1.12A hereto. (b) Section 2 of the General Security Agreement is hereby amended in its entirety to read as follows: To secure payment and performance of all Obligations, Guarantor -6- 7 hereby grants to Lender a continuing security interest in, a lien upon, and a right of set off against, and hereby assigns to Lender as security, the following property and interests in property, whether now owned or hereafter acquired or existing, and wherever located (collectively, the "Collateral"): 2.1 Accounts; 2.2 all present and future contract rights, general intangibles (including, but not limited to, tax and duty refunds, registered and unregistered patents, trademarks, service marks, copyrights, trade names, applications for the foregoing, trade secrets, goodwill, processes, drawings, blueprints, customer lists, all licenses, whether as licensor or licensee, choses in action and other claims), chattel paper, documents, instruments, letters of credit, bankers' acceptances and guaranties; 2.3 all present and future monies, securities, credit balances, deposits, deposit accounts and other property of Guarantor now or hereafter held or received by or in transit to Lender or its affiliates or at any other depository or other institution from or for the account of Guarantor, whether for safekeeping, pledge, custody, transmission, collection or otherwise, and all present and future liens, security interests, rights, remedies, title and interest in, to and in respect of Accounts and other Collateral, including, without limitation, (a) rights and remedies under or relating to guaranties, contracts of suretyship, letters of credit and credit and other insurance related to the Collateral, (b) rights of stoppage in transit, replevin, repossession, reclamation and other rights and remedies of an unpaid vendor, lienor or secured party, (c) goods described in invoices, documents, contracts or instruments with respect to, or otherwise representing or evidencing, Accounts or other Collateral, including, without limitation, returned, repossessed and reclaimed goods, and (d) deposits by and property of account debtors or other persons securing the obligations of account debtors; 2.4 Inventory; 2.5 Records; 2.6 Equipment; 2.7 Real Property; and 2.8 all products and proceeds of the foregoing, in any form, including, without limitation, insurance proceeds and all claims against third parties -7- 8 for loss or damage to or destruction of any or all of the foregoing. Guarantor hereby confirms that the property constituting Collateral is, and is intended to be, the same as the property of Guarantor in which security interests and liens have been or will be granted pursuant to the Term Loan Documents (as defined in the Loan Agreement), notwithstanding any differences in the language used to describe such property in the Term Loan Documents. 6. Conditions Precedent. The consent set forth in Section 2 hereof, the waivers set forth in Section 3 hereof, and the amendments to the Loan Agreement and General Security Agreement set forth in Section 4 and Section 5 hereof shall not be effective unless and until each of the following conditions precedent is satisfied as determined by Lender: (a) each of Borrowers, Guarantors and HI New York shall have executed and delivered to Lender this Amendment and Consent; (b) Lender and its counsel shall have received, reviewed and found satisfactory, in form and substance, each of the documents listed on Exhibit A hereto, and all other agreements, instruments, and documents entered into or delivered pursuant thereto or in connection therewith to establish terms or conditions of or evidence, secure, or guarantee the Bridge Loan (collectively, the "Term Loan Documents"); (c) the Term Lenders shall have executed and delivered to Lender the Intercreditor Agreement, in form and substance satisfactory to Lender, together with the acknowledgement of Borrowers, Guarantors and HI New York, in form and substance satisfactory to Lender, indicating their agreement and acknowledgement of the terms thereof; (d) Lender and its counsel shall have received, reviewed and found satisfactory, in form and substance, the Supplemental Indenture to the Indenture, containing the waiver of any breach of the Indenture arising from the Term Loan Documents and this Amendment and Consent; (e) Lenders and its counsel shall have received, reviewed, and found satisfactory, in form and substance, (i) the License Agreement dated April 27, 1997 between Calvin Klein, Inc. and DHA Home, Inc. (the "New CK License") and (ii) Letter Agreements from Calvin Klein Inc., substantially identical to those letter agreements dated November 8, 1996, between Calvin Klein, Inc. and Lender relating to the New CK License; (f) DHA Home, Inc. shall have executed and delivered to Lender such UCC-1 Financing Statements and other instruments and documents, and taken such other action, as Lender shall have requested to continue the -8- 9 perfection of Lender's security interest after giving effect to the change of name of Calvin Klein Home, Inc. to DHA Home, Inc.; (g) Borrowers, HI New York, and Guarantors shall have executed and delivered to Lender such UCC-3 Amendments and other instruments and documents, and taken such other action, as Lender shall have requested to perfect or continue the perfection of Lender's security interests in and liens on the Collateral, after giving effect to the amendments in Section 4 and 5 hereof; and (h) at the time the conditions in sections (a) through (g) above have been satisfied, no Event of Default or default under the Indenture shall have occurred and be continuing. 7. Fees and Expenses. In consideration of Lender's agreements contained herein and in order to induce Lender to enter into this Amendment and Consent, Borrowers, Guarantors and HI New York shall herewith pay Lender a non-refundable fee of $25,000, due as of the date hereof, which each of Borrowers, Guarantors and HI New York acknowledge and agree has been fully earned by Lender and is payable on such date and which Lender is authorized to charge to Borrowers' loan account with Lender. Each of Borrowers, Guarantors, and HI New York confirms that, under the Loan Agreement, it shall pay Lender's attorneys' fees and expenses incurred in connection with this Amendment and Consent and the transactions contemplated hereby. 8. Ratification. (a) Except as expressly set forth herein, the Loan Agreement and the other Financing Agreements are not modified hereby and each shall remain in full force and effect in accordance with the respective provisions thereof on the date hereof, and the Loan Agreement and the other Financing Agreements are each in all respects ratified and affirmed. The consent and waivers given herein are limited to the specific instances in which given and shall not be deemed to be a consent to or waiver of any other or further divergence from full compliance with the terms of the Financing Agreements, or, except as expressly set forth herein, to be an amendment or modification of any of the terms of the Financing Agreements, or to require Lender to give a consent or waiver in any other or subsequent situation, regardless of the similarity of circumstances. Lender's agreements herein shall not be construed to require Lender to extend any additional credit not expressly contemplated by the Loan Agreement, or make any amendment to the Loan Agreement or any other Financing Agreements, on any other occasion, regardless of the similarity of circumstances. (b) Each Borrower and Guarantor and HI New York hereby (i) acknowledges notice of the terms and conditions of this Amendment and Consent, (ii) confirms and agrees that the Guaranteed Obligations under and as defined in such Borrower's or Guarantor's or in HI New York's guarantee set forth on Exhibit B hereto (collectively, the "Guarantees") include all Borrowers' Obligations for or in respect of the principal of, accrued interest in, and other charges now or hereafter payable in connection with the Loans and Letter of -9- 10 Credit Accommodations including, without limitation, those arising after giving effect to this Amendment and Consent, and (iii) confirms that, after giving effect to this Amendment and Consent and to the making of the amendments to the Loan Agreement contemplated hereby, its Guarantee is its valid and binding obligation, enforceable against it in accordance with their terms, without defenses, offsets, or counterclaims, and continues in full force and effect. 9. Representations and Warranties. Without limiting any other provision of this Amendment and Consent, and as an inducement to Lender to enter into this Amendment and Consent, each of Borrowers, Guarantors and HI New York hereby: (a) represents, warrants and agrees that the Loan Agreement and the other Financing Agreements are its valid and binding obligations enforceable against it in accordance with their terms, without defenses, offsets or counterclaims; and (b) represents and warrants that: (i) each of the representations and warranties of each of Borrowers, Guarantors and HI New York set forth in the Loan Agreement and the other Financing Agreements is true and correct in all material respects, as of the date hereof, except as set forth in Exhibit C hereto (it being understood that Lender's receipt of the disclosure of the exceptions set forth on Exhibit C should not be construed as Lender's acceptance of or waiver of any of its rights or remedies with respect to the facts and circumstances so disclosed); and (ii) no Event of Default, or event which with notice or the passage of time would become an Event of Default, has occurred and is continuing with respect to each of the Financing Agreements and the Indenture. 10. Governing Law. The validity, interpretation and enforcement of this Amendment and Consent and any dispute arising out of the relationship between the parties hereto, whether in contract, tort, equity or otherwise, shall be governed by the internal laws of the State of New York (without giving effect to principles of conflicts of law). 11. Amendments and Waivers. Neither this Amendment and Consent nor any provision hereof shall be amended, modified, waived or discharged orally or by course of conduct, but only by a written agreement signed by an authorized officer of Lender. Lender shall not, by any act, delay, omission or otherwise be deemed to have expressly or impliedly waived any of its rights, powers and/or remedies unless such waiver shall be in writing and signed by an authorized officer of Lender. Any such waiver shall be enforceable only to the extent specifically set forth therein. A waiver by Lender of any right, power and/or remedy on any one occasion shall not be construed as a bar to or waiver of any such right, power and/or remedy which Lender would otherwise have on any future occasion, whether similar in kind or otherwise. 12. Counterparts. This Amendment may be executed in one or more counterparts, and by Lender and each other party hereto in separate counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. -10- 11 IN WITNESS WHEREOF, Lender, Borrowers, Guarantors and HI New York have caused these presents to be duly executed as of the day and year first above written. LENDER BORROWERS - ------ --------- CONGRESS FINANCIAL CORPORATION THE RUG BARN, INC. By:_____________________________ By:_____________________________ Title:__________________________ Title:__________________________ Address: Chief Executive Office: - -------- ----------------------- 1133 Avenue of the Americas Highway 28 Bypass, Industrial Park Road New York, NY 10036 Abbeville, South Carolina 29620 HOME INNOVATIONS, INC., a Delaware corporation By:_____________________________ Title:__________________________ Chief Executive Office: ----------------------- 346 East Plaza Drive Mooresville, North Carolina 28115 DHA HOME, INC., formerly known as CALVIN KLEIN HOME, INC. By:_____________________________ Title:__________________________ 12 Chief Executive Office: ----------------------- 346 East Plaza Drive Mooresville, North Carolina 28115 R.A. BRIGGS & COMPANY By:_____________________________ Title:__________________________ Chief Executive Office: ----------------------- 143 Main Street Lake Zurich, Illinois 60047 GUARANTORS ---------- DECORATIVE HOME ACCENTS, INC. By:_____________________________ Title:___________________________ Chief Executive Office: ----------------------- Highway 28 Bypass, Industrial Park Road Abbeville, South Carolina 29620 DRAYMORE MFG. CORP. By:_____________________________ Title:___________________________ Chief Executive Office: ----------------------- 346 East Plaza Drive Mooresville, North Carolina 28115 HOME INNOVATIONS, INC., a New York corporation 13 By:_____________________________ Title:___________________________ Chief Executive Office: ----------------------- 346 East Plaza Drive Mooresville, North Carolina 28115 -13- 14 SCHEDULE 1.45A to Loan and Security Agreement --------------------------------------------- Real Property Highway 52 Morven, North Carolina 28119 Highway 28 Bypass Industrial Park Road Abbeville, South Carolina 29620 346 East Plaza Drive Mooresville, North Carolina 28115 15 EXHIBIT A --------- Term Loan Documents 1. Credit Agreement, dated as of May 23, 1997, among The Rug Barn, Inc., Home Innovations, Inc., DHA Home, Inc. and R.A. Briggs and Company, as Borrowers, Decorative Home Accents, Inc., Draymore Mfg. Corp., and Home Innovations, Inc., as Guarantors and the Lenders Listed on the Signatures Pages, as Lenders. 2. Security Agreement, dated as of May 23, 1997 from The Rug Barn, Inc., Home Innovations, Inc., a Delaware corporation, DHA Home, Inc., R.A. Briggs and Company, Decorative Home Accents, Inc., Draymore Mfg. Corp., and Home Innovations, Inc., a New York corporation as Grantors to the Lenders Party to the Credit Agreement Referred to Herein. 3. Pledge Agreement, dated as of May 23, 1997, made by Decorative Home Accents, Inc. in favor of the Lenders Party to the Credit Agreement. 4. Pledge Agreement, dated as of May 23, 1997, made by Home Innovations, Inc., a Delaware corporation, in favor of the Lenders Party to the Credit Agreement. 5. Term Notes 6. [Safekeeping Agreement] 7. Collateral Assignment of Trademarks and Trademark Licenses (Security Agreement), dated as of May 23, 1997, between Home Innovations, Inc., a Delaware corporation, and the Assignees. 8. Collateral Assignment of Trademarks and Trademark Licenses (Security Agreement), dated as of May 23, 1997, between The Rug Barn, Inc. and the Assignees. 9. Collateral Assignment of Trademarks and Trademark Licenses (Security Agreement), dated as of May 23, 1997, between R.A. Briggs and Company and the Assignees. 10. Copyright Mortgage and Security Agreement, dated May 23, 1997, between The Rug Barn, Inc. and the Secured Parties. 11. Copyright Mortgage and Security Agreement, dated May 23, 1997, between Home Innovations, Inc., a Delaware corporation and the Secured Parties. 12. Instructions for Disbursing Loan Proceeds 13. UCC-1s and UCC-3s 14. Stock Powers (in blank) 16 15. Landlord Waivers 16. Letter from Accountants 17. Letter from Calvin Klein, Inc. dated as of May 23, 1997 addressed to the Lenders Listed on the Signature Pages thereto regarding Approved Distribution Channels. 18. Letter from Calvin Klein, Inc. dated as of May 23, 1997 addressed to the Lenders Listed on the Signature Pages thereto regarding Acknowledgement of Lenders' Rights with License Agreement and Licensed Articles. -16- 17 EXHIBIT B --------- Guarantees 1. Guarantee, dated as of November 12, 1996, of The Rug Barn, Inc. 2. Guarantee, dated as of November 12, 1996, of Home Innovations, Inc., a Delaware corporation. 3. Guarantee, dated as of November 12, 1996, of R.A. Briggs and Company. 4. Guarantee, dated as of November 12, 1996, of Calvin Klein Home, Inc. 18 EXHIBIT C --------- EX-10.6 7 CREDIT AGREEMENT 1 EXHIBIT 10.6 CREDIT AGREEMENT THIS CREDIT AGREEMENT, dated as of May 23, 1997, among THE RUG BARN, INC., a South Carolina corporation, HOME INNOVATIONS, INC., a Delaware corporation, DHA HOME, INC., a Delaware corporation, and R.A. BRIGGS AND COMPANY, an Illinois corporation (each a "Borrower" and collectively, the "Borrowers"), DECORATIVE HOME ACCENTS, INC., a Delaware Corporation, DRAYMORE MFG. CORP., a North Carolina corporation, and HOME INNOVATIONS, INC., a New York corporation (each a "Guarantor" and collectively, the "Guarantors") and the lenders listed on the signature pages hereto (each a "Lender" and collectively, the "Lenders"). BACKGROUND The Borrowers have requested the Lenders to provide the Borrowers with term loans having an aggregate principal amount equal to $20 million and, subject to the terms and conditions set forth herein, the Lenders have agreed to provide such loans. In consideration of the mutual covenants herein contained and of other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, and intending to be legally bound hereby, the parties hereto agree as follows: ARTICLE I DEFINITIONS; CONSTRUCTION 1.01. Certain Definitions. In addition to other words and terms defined elsewhere in this Agreement, as used herein the following words and terms shall have the following meanings, respectively, unless the context hereof otherwise clearly requires: "Accelerated Maturity Date" shall mean the date on which the Obligations (including, without limitation, the entire unpaid principal balance of the Loans and accrued but unpaid interest thereon) shall become due and payable pursuant to the terms of any of the Loan Documents, including, without limitation, by reason of the occurrence of an Event of Default. "Affiliate" of a Person shall mean any other Person (other than a Subsidiary) which, directly or indirectly, is in control of, is controlled by, or is under common control with, such Person. For purposes of this definition, "control" of a Person means the power, directly or indirectly, either to (a) vote 10% or more of the securities having ordinary voting power for the election of directors of such Person or (b) direct or 2 cause the direction of the management and policies of such Person, whether by contract or otherwise. "Agreement" shall mean this Credit Agreement as amended, modified, supplemented or restated from time to time in accordance with the terms hereof. "Bankruptcy Code" shall mean Title 11, United States Code, 11 U.S.C. Sections 101 et seq., or any similar United States federal or state law for the relief of debtors, as amended from time to time. "Borrower" and "Borrowers" shall have the meanings given such terms in the introductory paragraph to this Agreement. "Business Day" shall mean any day other than a Saturday, Sunday or other day on which banking institutions are authorized or obligated to close in New York, New York. "Calvin Klein License" shall mean that certain License Agreement dated as of April 27, 1997, by and between Calvin Klein, Inc. and DHA Home, Inc., as the same may be amended or modified from time to time and any auxiliary agreement entered into in connection therewith. "Capitalized Lease" shall mean any lease which is required under GAAP to be capitalized on the balance sheet of the lessee. "Capitalized Lease Obligations" shall mean the aggregate amount which is required under GAAP to be reported as a liability on the balance sheet of a Person as lessee under a Capitalized Lease. "Closing Date" shall mean the date on which the conditions set forth in Section 3.01 hereof shall be satisfied, which date shall be no later than May 23, 1997. "Closing Fee" shall have the meaning given such term in Section 2.07 hereof. "Code" shall mean the Internal Revenue Code of 1986, as amended, and any successor statute of similar import, and regulations thereunder, in each case as in effect from time to time. References to sections of the Code shall be construed also to refer to any successor sections. "Collateral" shall have the meaning given such term in Section 5.01 hereof. "Congress" shall mean Congress Financial Corporation, a California corporation. -2- 3 "Congress Debt Documents" shall mean the Congress Loan Agreement and all other instruments and documents that are in effect as of the date hereof and are executed in connection with or otherwise relating to any Congress Debt Document. "Congress Liens" shall mean the Liens granted to Congress pursuant to the Congress Loan Agreement. "Congress Loan Agreement" shall mean that certain Loan and Security Agreement, dated November 12, 1996, as amended as of the date hereof, by and between Congress, the Borrowers and the Guarantors. "Congress Supplemental Line" shall mean the $5,000,000 supplemental credit line provided to the Borrowers by Congress under the Congress Loan Agreement in accordance with that certain letter agreement, dated March 1, 1997, by and among Congress, the Borrowers, the Guarantors and TCW Special Credits Fund V - The Principal Fund. "Decorative Home" shall mean Decorative Home Accents, Inc., a Delaware corporation. "Designated Borrowing Officer" shall mean Murphy L. Fontenot or Jay N. Baker, or such other officer as shall be designated from time to time in writing by the Borrowers to Lenders. "Designated Financial Officer" of a Person shall mean the individual designated from time to time by the Board of Directors or governing body performing like functions of such Person to be the chief financial officer or treasurer of such Person (and individuals designated from time to time by the Board of Directors or governing body performing like functions of such Person to act in lieu of the chief financial officer or the treasurer). "Dollar," "Dollars" and the symbol "$" shall mean lawful money of the United States of America. "Effective Date" shall mean the date on which the Restructuring is consummated pursuant to either a plan of reorganization under chapter 11 of the Bankruptcy Code or an out-of-court restructuring. "Environmental Law" shall mean all federal, state and local laws, statutes, ordinances and regulations, now or hereafter in effect relating to the regulation and protection of human health, safety, the environment and natural resources. Environmental Laws include but are not limited to the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (42 U.S.C. Section 9601 et seq.) ("CERCLA"); the Hazardous Material Transportation Act, as amended (49 U.S.C. Section -3- 4 180 et seq.); the Resource Conservation and Recovery Act, as amended (42 U.S.C. Section 6901 et seq.) ("RCRA"); the Toxic Substance Control Act, as amended (15 U.S.C. Section 2601 et seq.); the Clean Air Act, as amended (42 U.S.C. Section 7401 et seq.); the Federal Water Pollution Control Act, as amended (33 U.S.C. Section 1251 et seq.); and their state and local counterparts or equivalents. "Environmental Liabilities and Costs" shall mean all liabilities, monetary obligations, Remedial Actions, losses, damages, punitive damages, consequential damages, treble damages, costs and expenses (including all reasonable fees, disbursements and expenses of counsel, expert and consulting and costs of investigation and feasibility studies), fines, penalties, sanctions and interest incurred as a result of any claim or demand by any Governmental Authority or any third party, and which relate to any environmental condition or a Release of Hazardous Materials from or onto (i) any property presently or formerly owned by any of the Borrowers or any of the Guarantors or (ii) any facility which received Hazardous Materials generated by any of the Borrowers or any of the Guarantors. "Environmental Lien" shall mean any Lien in favor of any Governmental Authority or any other Person for Environmental Liabilities and Costs. "Equipment" shall have the meaning given such term in Section 5.01(a) hereof. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended, and any successor statute of similar import, and regulations thereunder, in each case as in effect from time to time. References to sections of ERISA shall be construed also to refer to any successor sections. "ERISA Affiliate" shall mean any (i) corporation which is a member of the same controlled group of corporations (within the meaning of Section 414(b) of the Code) as any Borrower, (ii) partnership or other trade or business (whether or not incorporated) under common control (within the meaning of Section 414(c) of the Code) with any Borrower, or (iii) member of the same affiliated service group (within the meaning of Section 414(m) of the Code) as any Borrower, any corporation described in clause (i) above or any partnership or trade or business described in clause (ii) above. "Event of Default" shall mean any of the Events of Default described in Section 7.01 hereof. "First Supplemental Indenture" shall mean the First Supplemental Indenture, substantially in the form of Exhibit C hereto, by and among the Indenture Trustee, the Borrowers, and the Guarantors, as amended, modified and supplemented from time to time. -4- 5 "Fund V Guarantee" shall mean the guarantee of the obligations under the Congress Supplemental Line made by TCW Special Credits Fund V - The Principal Fund, pursuant to that certain letter agreement dated March 1, 1997, in favor of Congress. "GAAP" shall mean generally accepted accounting principles as such principles shall be in effect in the United States at the relevant date. "Governmental Authority" shall mean any nation or government, any federal, state, city, town, municipality, county, local or other political subdivision thereof or thereto and any department, commission, board, bureau, instrumentality, agency or other entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government. "Guarantee" shall mean the guarantees granted by the Guarantors to Lenders pursuant to Article VIII hereof. "guarantee" of or by any Person shall mean any obligation of such Person guaranteeing any Indebtedness of any other Person (the "primary obligor"), directly or indirectly, through an agreement (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Indebtedness or to purchase (or to advance or supply funds for the purchase of) any security for the payment of such Indebtedness, (ii) to purchase property, securities or services for the purpose of assuring the owner of such Indebtedness against loss, or (iii) to maintain working capital, equity capital or other financial statement condition or liquidity of the primary obligor so as to enable the primary obligor to pay such Indebtedness; provided, however, that the term guarantee shall not include endorsements for collection or deposit, in either case in the ordinary course of business. "Guarantor" and "Guarantors" shall have the meanings given to such terms in the introductory paragraph to this Agreement. "Hazardous Materials" shall mean (i) any element, compound or chemical that is defined, listed or otherwise classified as a solid waste contaminant, pollutant, toxic pollutant, hazardous substance, extremely hazardous substance, toxic substance, hazardous waste, or special waste under any Environmental Law; (ii) petroleum and its refined fractions, (iii) any dielectric fluids containing more than 50 parts per polychlorinated biphenyls, (iv) any flammable, explosive or radioactive materials; and (v) any other materials used or stored by any Borrower, building, components (including but not limited to asbestos containing materials) and manufactured products containing Hazardous Materials. "Indebtedness" shall mean as to any Person (i) indebtedness for borrowed money; (ii) indebtedness for the deferred purchase price of property or services (other than current trade payables incurred in the ordinary course of business and payable in accordance with customary practices); (iii) indebtedness evidenced by bonds, debentures, -5- 6 notes or other similar instruments (other than performance, surety and appeal or other similar bonds arising in the ordinary course of business); (iv) obligations and liabilities secured by a Lien upon property owned by such Person, whether or not owing by such Person and even though such Person has not assumed or become liable for the payment thereof; (v) any guarantee, direct or indirect, by such Person of any obligations and liabilities; (vi) obligations or liabilities created or arising under any conditional sales contract or other title retention agreement with respect to property used and/or acquired by such Person, even though the rights and remedies of the lessor, seller and/or lender thereunder are limited to repossession of such property; (vii) Capitalized Lease Obligations; (viii) all liabilities in respect of letters of credit, acceptances and similar obligations created for the account of such Person; and (ix) net liabilities of such Person under interest rate cap agreements, interest rate swap agreements, foreign currency exchange agreements and other hedging agreements or arrangements calculated on a basis satisfactory to the Lenders and in accordance with accepted practice. "Indemnified Parties" shall have the meaning given such term in Section 9.05 hereof. "Indenture Trustee" shall mean American Bank National Association, as Trustee, under the Indenture. "Initial Term Loan" shall have the meaning given such term in Section 2.01 hereof. "Initial Term Notes" shall have the meaning given such term in Section 2.02 hereof. "Intercreditor Agreement" shall mean the Intercreditor Agreement, substantially in the form of Exhibit D hereto, by and among the Lenders and Congress and acknowledged by the Borrowers and the Guarantors, dated the Closing Date hereof, as amended, modified and supplemented and in effect from time to time, regarding the relative priority of the Liens granted to the Lenders under this Agreement and the Security Documents and the Congress Liens. "Interest Rate" shall have the meaning given such term in Section 2.08 hereof. "Inventory" shall mean all goods and merchandise of the Borrowers and the Guarantors including, but not limited to, all raw materials, work in process, finished goods, materials and supplies of every nature used or usable in connection with the shipping, storing, advertising or sale of such goods and merchandise, whether now owned or hereafter acquired and all such property, the sale or disposition of which would give rise to accounts receivable or cash. -6- 7 "Indenture" shall mean that certain Indenture, dated July 13, 1995, pursuant to which Decorative Home issued the Senior Notes. "Lender" and "Lenders" shall have the meanings given such terms in the introductory paragraph to this Agreement. "Letter Agreement" shall mean the letter agreement, dated as of May 15, 1997, among Decorative Home, TCW Special Credits Fund V - The Principal Fund, the entities listed on Schedule I thereto, and Magten, as agent on behalf of certain of its accounts, a copy of which Letter Agreement is attached hereto as Exhibit E. "Lien" shall mean any mortgage, deed of trust, pledge, lien, claim, security interest, charge or other encumbrance or security arrangement of any nature whatsoever, including but not limited to any conditional sale or title retention arrangement, and any assignment, deposit arrangement or lease intended as, or having the effect of, security. "Loan" or "Loans" shall mean any and all loans made by the Lenders to the Borrowers under this Agreement. "Loan Documents" shall mean this Agreement, the Term Notes, the Security Documents, the Intercreditor Agreement and all other instruments, agreements and documents from time to time delivered in connection herewith or therewith. "Magten" shall mean Magten Asset Management Corp., as agent on behalf of certain of its accounts. "Material Adverse Effect" shall mean a material adverse effect upon (i) any Borrower's or Guarantor's assets, property, prospects, or condition, financial or otherwise, (ii) the Collateral or Lenders' security interest therein, (iii) any Borrower's or Guarantor's ability to pay or perform the Obligations, or (iv) any of the Lenders' rights and remedies under any Loan Document or applicable law or the Lenders' ability to enforce any such rights and remedies. "Maturity Date" shall mean the earlier to occur of (a) the Accelerated Maturity Date and (b) the Stated Maturity Date. "Mortgages" shall mean one or more mortgages or deeds of trust executed by one or more of the Borrowers and Guarantors, the form and substance of which shall be reasonably satisfactory to Lenders, that encumber the Real Property Collateral and the related improvements thereto. "Note Register" shall have the meaning given such term in Section 4.17 hereof. -7- 8 "Note Registrar" shall have the meaning given such term in Section 4.17 hereof. "Notice of Borrowing" shall have the meaning given such term in Section 2.04 hereof. "Obligations" shall mean any and all Loans and all other indebtedness, obligations, indemnities and liabilities of every kind, nature and description owing by any one or more Borrowers to Lenders and/or their respective Affiliates including, without limitation, the Closing Fee and all principal, interest, charges, fees, costs and expenses, however evidenced, whether as principal, surety, endorser or otherwise, whether arising under this Agreement or otherwise, whether now existing or hereafter arising, whether arising before, during or after the initial or any renewal term of this Agreement or after the commencement of any case with respect to a Borrower under the Bankruptcy Code or any similar statute (including, without limitation, the payment of interest and other amounts which would accrue and become due but for the commencement of such case), whether direct or indirect, absolute or contingent, joint or several, due or not due, primary or secondary, liquidated or unliquidated, secured or unsecured, and however acquired by Lenders. "Other Taxes" shall have the meaning given to such term in Section 2.12(a) hereof. "Percentage Interest" shall mean, with respect to each Lender, the percentage interest of each Term Loan made by such Lender as set forth next to such Lender's name on the signature pages hereto. "Permitted Liens" shall mean, collectively, the (i) Congress Liens, (ii) Liens granted pursuant to the Loan Documents and (iii) Liens permitted under the Congress Loan Agreement but only to the extent such Liens exist as of the date hereof. "Person" shall mean an individual, corporation, partnership, limited liability company, limited liability partnership, trust, unincorporated association, joint venture, joint-stock company, government (including political subdivisions), Governmental Authority or agency, or any other entity. "Pledge Agreements" shall mean collectively the Pledge Agreement made by Decorative Home in favor of the Lenders, dated as of the date hereof, and the Pledge Agreement made by Home Innovations, Inc., a Delaware corporation, in favor of the Lenders, dated as of the date hereof, substantially in the forms annexed collectively hereto as Exhibit F, as amended, modified, supplemented or restated from time to time. -8- 9 "Potential Default" shall mean any event or condition which, with notice or passage of time, or any combination of the foregoing, would constitute an Event of Default. "Real Property Collateral" shall mean the parcels of real property and the related improvements thereto identified on Schedule I hereto. "Receivables" shall have the meaning given such term in Section 5.01(c) hereof. "Related Contracts" shall have the meaning given such term in Section 5.01(c) hereof. "Release" shall mean any release, spill, emission, leaking, pumping, injection, deposit, disposal, discharge, dispersal, leaching or migration of a Hazardous Material into the indoor or outdoor environment or onto or from any property presently or formerly owned or operated by any of the Borrowers or any of the Guarantors, or at any disposed facility that received Hazardous Materials generated by any of the Borrowers or any of the Guarantors including the movement of Hazardous Materials through or in the air, soil, surface water, groundwater or property. "Remedial Action" shall mean all actions necessary to monitor, assess, evaluate, investigate, clean up, remove or treat any Release or threatened Release of Hazardous Materials or to prevent, mitigate or minimize any Release or threatened Release so that the Release or threatened Release does not migrate or endanger or threaten to endanger public health or welfare or the environment. "Restructuring" shall have the meaning given such term in the Letter Agreement. "Secured Obligations" has the meaning given to such term in Section 5.02 hereof. "Security Agreement" shall mean the Security Agreement, substantially in the form of Exhibit G hereto, made by the Borrowers and the Guarantors in favor of the Lenders, as amended, modified, supplemented or restated from time to time. "Security Documents" shall mean, collectively, the Pledge Agreements, the Mortgages, the Security Agreement, each executed and delivered by the Borrowers and the Guarantors, and each Collateral Assignment of Trademarks and Trademark Licenses (Security Agreement) and each Copyright Mortgage and Security Agreement, substantially in the forms of Exhibits H and I hereto, executed and delivered by the applicable Borrower or Guarantor, and all Uniform Commercial Code financing statements required by this Agreement and the Security Agreement to be filed with -9- 10 respect to the security interests in personal property and fixtures created pursuant to such agreements, and all other documents and agreements executed and delivered by the Borrowers and the Guarantors in connection with any of the foregoing documents. "Senior Notes" shall mean the 13% Senior Notes due 2002 issued pursuant to the Indenture. "Stated Maturity Date" shall mean September 20, 1997. "Subsequent Borrowing Date" shall have the meaning given such term in Section 2.04 hereof. "Subsequent Term Loan" shall have the meaning given such term in Section 2.01 hereof. "Subsequent Term Notes" shall have the meaning given such term in Section 2.03 hereof. "Subsidiary" shall mean, with respect to any Person, any corporation, limited or general partnership, limited liability company, limited liability partnership, trust, association or other business entity of which an aggregate of 30% or more of the outstanding stock or other interests entitled to vote in the election of the board of directors of such corporation (irrespective of whether, at the time, stock of any other class or classes of such corporation shall have or might have voting power by reason of the happening of any contingency), managers, trustees or other controlling persons, or an equivalent controlling interest therein, of such Person is, at the time, directly or indirectly, owned or controlled by such Person and/or one or more Subsidiaries of such Person. "Taxes" shall have the meaning given such term in Section 2.12(a) hereof. "Term Loans" shall mean the Initial Term Loan and the Subsequent Term Loan. "Term Notes" shall mean the Initial Term Notes and the Subsequent Term Notes. "Trademarks" shall have the meaning given such term in Section 5.01(d) hereof. "Trademark Licenses" shall have the meaning given such term in Section 5.01(d) hereof. 1.02. Construction. Unless the context of this Agreement otherwise clearly requires, references to the plural include the singular, the singular the plural and the part the whole and "or" has the inclusive meaning represented by the phrase "and/or." -10- 11 References in this Agreement to "determination" by the Lenders include good faith estimates by the Lenders (in the case of quantitative determinations) and good faith beliefs by the Lenders (in the case of qualitative determinations). The words "hereof," "herein," "hereunder" and similar terms in this Agreement refer to this Agreement as a whole and not to any particular provision of this Agreement. The section and other headings contained in this Agreement and the Table of Contents preceding this Agreement are for reference purposes only and shall not control or affect the construction of this Agreement or the interpretation thereof in any respect. Section, subsection and exhibit references are to this Agreement unless otherwise specified. 1.03. Accounting Principles. Except as otherwise provided in this Agreement, all computations and determinations as to accounting or financial matters and all financial statements to be delivered pursuant to this Agreement shall be made and prepared in accordance with GAAP (including principles of consolidation where appropriate), and all accounting or financial terms shall have the meanings ascribed to such terms by GAAP. Notwithstanding the definition of GAAP contained in this Agreement, no change in GAAP that would affect the method or calculation of any of the financial covenants, restrictions or standards or definitions of terms used herein shall be given effect in such calculations until such financial covenants, restrictions or standards or definitions are amended in a manner satisfactory to the Borrowers and the Lenders so as to reflect such change in GAAP. ARTICLE II THE TERM LOANS 2.01. Term Loans. Subject to the terms and conditions hereof, Lenders agree to make Loans to Borrowers not exceeding Twenty Million Dollars ($20,000,000) in the original aggregate amount as follows: (i) term loans on the Closing Date in the aggregate principal amount of $15,000,000 (the "Initial Term Loan") and (ii) term loans in the aggregate principal amount of $5,000,000 (the "Subsequent Term Loan") at the request of Borrowers at any time from and after the Closing Date and through, but not including, the Maturity Date in accordance with Section 2.04 hereof. 2.02. Initial Term Notes. The Borrowers agree that in order to evidence the Initial Term Loan, the Borrowers will execute and deliver to each Lender on the Closing Date a promissory note, dated the Closing Date, substantially in the form of Exhibit A (collectively, the "Initial Term Notes"), payable to the order of such Lender in the principal amount of its respective Percentage Interest in the Initial Term Loan. 2.03. Subsequent Term Notes. The Borrowers agree that in order to evidence the Subsequent Term Loan, the Borrowers will execute and deliver to each -11- 12 Lender on the Subsequent Borrowing Date a promissory Note, dated the Subsequent Borrowing Date, substantially in the form of Exhibit B (collectively, the "Subsequent Term Notes"), payable to the order of such Lender in the principal amount of its respective Percentage Interest in the Subsequent Term Loan. 2.04. Request for Subsequent Term Loan. Whenever, at any time from and after the Closing Date and through, but not including, the Maturity Date, the Borrowers desire that Lenders make the Subsequent Term Loan, the Borrowers shall provide notice to the Lenders of such proposed borrowing (a "Notice of Borrowing"), such notice to be given not later than 12:00 noon (New York City time) on the date which is ten (10) Business Days prior to the date of such proposed borrowing setting forth: (a) the date, which shall be a Business Day, on which such borrowing is to occur (the "Subsequent Borrowing Date"), and (b) the account information where the proceeds of the Subsequent Term Loan are to be received. Such Notice of Borrowing shall be given to the Lenders in writing by a Designated Borrowing Officer. Subject to the terms and conditions of this Agreement (including, without limitation, Sections 2.03 and 3.02 hereof), Lenders shall make the Subsequent Term Loan on the Subsequent Borrowing Date. 2.05. Maturity Date. On the Maturity Date, all Obligations (including, without limitation all outstanding amounts under the Term Notes and the Closing Fee and all accrued and unpaid interest on the Obligations) shall become immediately due and payable without notice or demand. 2.06. Joint and Several Liability. (a) Each of the Borrowers shall be jointly and severally liable with the other Borrowers for the Obligations, and each of the Obligations shall be secured by all of the Collateral. Each of the Borrowers acknowledges that it is a co-borrower hereunder and is jointly and severally liable under this Agreement and the other Loan Documents. All financial accommodations extended to any of the Borrowers or requested by any of the Borrowers shall be deemed to be financial accommodations extended for each of the Borrowers, and each of the Borrowers hereby authorizes each other of the Borrowers to effectuate borrowings on its behalf. Notwithstanding anything to the contrary contained in this Agreement or any of the other Loan Documents, the Lenders shall be entitled to rely upon any request, notice or other communication received by them from any of the Borrowers on behalf of all Borrowers, and shall be entitled to treat their giving of any notice hereunder to any of the Borrowers as notice to each and all Borrowers. (b) Each of the Borrowers agrees that the joint and several liability of the Borrowers provided for in this Section 2.06 shall not be impaired or affected by any modification, supplement, extension or amendment or any contract or agreement to which the other Borrowers may hereafter agree (other than an agreement signed by the Lenders specifically releasing such liability), nor by any delay, extension of time, renewal, -12- 13 compromise or other indulgence granted by any Lender with respect to any of the Obligations, nor by any other agreements or arrangements whatsoever with the other Borrowers or with any other person, each of the Borrowers hereby waiving all notice of such delay, extension, release, substitution, renewal, compromise or other indulgence, and hereby consenting to be bound thereby as fully and effectually as if it had expressly agreed thereto in advance. The liability of each of the Borrowers is direct and unconditional as to all of the Obligations, and may be enforced without requiring any Lender first to resort to any other right, remedy or security. Each of the Borrowers hereby expressly waives promptness, diligence, notice of acceptance and any other notice with respect to any of the Obligations, the Term Notes, the Closing Fee, this Agreement or any other Loan Document and any requirement that the Lenders protect, secure, perfect or insure any Lien or any property subject thereto or exhaust any right or take any action against any of the Borrowers or any other person or any Collateral. (c) Each of the Borrowers hereby irrevocably waives and releases each other of the Borrowers from all "claims" (as defined in Section 101(5) of the Bankruptcy Code) to which such Borrowers are or would be entitled by virtue of the provisions of the subsection 2.06(b) hereof or the performance of such Borrower's obligations thereunder including, without limitation, any right of subrogation (whether contractual, under Section 509 of the Bankruptcy Code or otherwise), reimbursement, contribution, exoneration or similar right, or indemnity, or any right of recourse to security for any of the Obligations. 2.07. Closing Fee. On the Closing Date, a closing fee of $5,000,000 (the "Closing Fee") shall be for all purposes fully earned and non-refundable by Lenders (it being agreed that, as of the Closing Date, the Closing Fee shall be deemed to be a portion of the Obligations by the Borrowers to Lenders hereunder); provided, however, that (a) Lenders shall be deemed to have waived Borrowers' obligation to pay the Closing Fee if either (i) the Restructuring is not consummated consistent with the terms and conditions described in the Letter Agreement solely by reason of Magten's breach of its commitments described in the Letter Agreement or (ii) the Restructuring is consummated and on the Effective Date all outstanding Obligations are repaid in full in cash, and (b) if Magten terminates the Letter Agreement during the 45 day due diligence period referred to in paragraph 3(b) thereof and prior to the later of (i) the end of such 45 day period and (ii) 5 days following Magten's notice of such termination to Borrowers, the sum of (A) $750,000 and (B) all outstanding Obligations shall have been paid in full in cash to the Lenders, then Borrowers' obligation in respect of the Closing Fee shall be deemed to have been satisfied in full. 2.08. Interest Rate. The Obligations shall bear interest at a rate (the "Interest Rate") per annum equal to the greater of (i) the highest per annum interest rate for "Loans" (as such term is used in the Congress Loan Agreement) in effect from time to time under the Congress Loan Agreement plus 3% and (ii) 12%. -13- 14 2.09. Interest Payment Dates. The Borrowers shall pay interest on the unpaid principal amount of each Loan and the Closing Fee from the date of such Loan or, in the case of the Closing Fee, from the Closing Date, until such principal amount shall be paid in full, which interest shall be payable monthly in arrears on the first Business Day of each month, commencing June 1, 1997. 2.10. Payments. (a) Time, Place and Manner. All payments to be made in respect of the Obligations or other amounts due hereunder, under the Term Notes or any other Loan Document shall be payable at or before 12:00 Noon, New York City time, on the day when due without presentment, demand, protest or notice of any kind, all of which are hereby expressly waived. Such payments shall be made in Dollars by wire transfer in funds immediately available to each Lender in its Percentage Interest of such payments according to the wire instructions set forth on Schedule II hereto (or at any other address at which such Lender shall notify the Borrowers in writing), without setoff, counterclaim or other deduction or defense of any nature or kind whatsoever. Interest on all Obligations and all fees that accrue on a per annum basis shall be computed on the basis of the actual number of days elapsed in the period during which interest or such fee accrues and a year of 360 days. In computing interest on any Loan, the date of the making of such Loan shall be included and the date of payment shall be excluded. (b) Interest Upon Events of Default. To the extent permitted by law, after there shall have occurred and so long as there is continuing an Event of Default pursuant to Section 7.01, all principal, interest, fees, indemnities or any other Obligations of the Borrowers hereunder, or under any Term Note or any other Loan Document (and including, without limitation, interest accrued under this subsection 2.10(b)) shall compound on a daily basis as provided in this subsection 2.10(b) and shall bear interest for each day until paid (before and after judgment), payable on demand, at a rate per annum of 2% above the Interest Rate for such day. 2.11. Use of Proceeds. The Borrowers hereby covenant, represent and warrant that the proceeds of the Term Loans made to them will be used first to retire the $5,000,000 Congress Supplemental Line (and any and all accrued interest, fees and expenses due to Congress in connection therewith), and thereafter to fund working capital in the ordinary course of the business of the Borrowers and the Guarantors through the Effective Date. 2.12. Taxes. (a) All payments made by any Borrower or Guarantor hereunder, under the Term Notes or under any other Loan Document will be made without setoff, counterclaim or other deduction or defense of any nature or kind whatsoever. All such payments shall be made free and clear of, and without deduction for, any present or future income, franchise, sales, use, excise, stamp or other taxes, levies, imposts, deductions, charges, fees, withholdings, restrictions or conditions of any nature now or hereafter imposed, levied, collected, withheld or assessed by any -14- 15 jurisdiction (whether pursuant to United States Federal, state, local or foreign law) or by any political subdivision or taxing authority thereof or therein, and all interest, penalties or similar liabilities, excluding taxes on the overall net income of any Lender (such nonexcluded taxes are hereinafter collectively referred to as the "Taxes"). If any Borrower or Guarantor shall be required by law to deduct or to withhold any Taxes from or in respect of any amount payable hereunder, (i) the amount so payable shall be increased to the extent necessary so that after making all required deductions and withholdings (including Taxes on amounts payable to the Lenders pursuant to this sentence) the Lenders receive an amount equal to the sum they would have received had no such deductions or withholdings been made, (ii) such Borrower or Guarantor shall make such deductions or withholdings, and (iii) such Borrower or Guarantor shall pay the full amount deducted or withheld to the relevant taxation authority in accordance with applicable law. Whenever any Taxes are payable by any Borrower, as promptly as possible thereafter, such Borrower or Guarantor shall send the Lenders an official receipt showing payment. In addition, the Borrowers and Guarantors agree to pay any present or future taxes, charges or similar levies which arise from any payment made hereunder or from the execution, delivery, performance, recordation or filing of, or otherwise with respect to, this Agreement, the Term Notes or any other Loan Document (hereinafter referred to as "Other Taxes"). (b) The Borrowers will indemnify each Lender for the amount of Taxes or Other Taxes (including, without limitation, any Taxes or Other Taxes imposed by any jurisdiction on amounts payable under this Section 2.11) paid by such Lender and any liability (including penalties, interest and expenses for nonpayment, late payment or otherwise) arising therefrom or with respect thereto, whether or not such Taxes or Other Taxes were correctly or legally asserted. This indemnification shall be paid immediately following the date on which such Lender makes written demand. (c) If any Borrower or Guarantor fails to perform its obligations under this Section 2.12, the Borrowers shall indemnify the Lenders for any incremental taxes, interest or penalties that may become payable as a result of any such failure. ARTICLE III CONDITIONS PRECEDENT TO LOANS 3.01. Conditions Precedent to Initial Term Loan. This Agreement shall become effective as of the Business Day when each of the following conditions precedent shall have been satisfied and the obligation of Lenders to make the Initial Term Loan hereunder shall be subject to the satisfaction of the following conditions precedent: -15- 16 (a) Payment of Expenses, Etc. The Borrowers shall have paid all amounts then owing to the Lenders by the Borrowers or Guarantors hereunder, or under any other Loan Document or the Letter Agreement, including, without limitation, those amounts due and payable on the Closing Date pursuant to Section 9.05 hereof. The Borrowers shall have paid to counsel to the Lenders all fees and other client charges due to such counsel on the Closing Date. (b) Representations and Warranties; No Event of Default. The representations and warranties contained in Article IV of this Agreement and in each other Loan Document and certificate or other writing delivered to the Lenders pursuant hereto or thereto or prior to the Closing Date shall be correct on and as of the Closing Date as though made on and as of such date; and no Potential Default or Event of Default shall have occurred and be continuing on the Closing Date or would result from (i) this Agreement becoming effective in accordance with its terms or (ii) the Loans being made on the Closing Date. (c) Legality. The making of the Loans shall not contravene any law, rule or regulation applicable to the Lenders. (d) Delivery of Documents. Lenders shall have received on or before the Closing Date the following, each in form and substance satisfactory to the Lenders and their counsel and, unless indicated otherwise, dated the Closing Date: (i) Each Lender shall have received its respective Initial Term Note payable to the order of such Lender and duly executed by each Borrower; (ii) the Security Agreement, duly executed by each Borrower and Guarantor, together with the Collateral Assignments of Trademarks and Trademark Licenses (Security Agreements) and Copyright Mortgages and Security Agreements duly executed by the applicable Borrower or Guarantor; (iii) the Pledge Agreements duly executed by each Borrower and Guarantor; (iv) the Intercreditor Agreement duly executed by Congress and duly acknowledged by the Borrowers and the Guarantors; (v) acknowledgment copies of appropriate financing statements on Form UCC-1, duly executed by the Borrowers and the Guarantors and duly filed in such office or offices as may be necessary or, in the opinion of the Lenders, desirable to perfect the security interests purported to be created by the Security Documents and evidence that all necessary filing fees and taxes or other expenses related to such filings have been paid in full; -16- 17 (vi) a copy of the resolutions adopted by the Board of Directors of each of the Borrowers and the Guarantors, certified as of the Closing Date by authorized officers thereof, authorizing (A) in the case of the Borrowers, the borrowings hereunder and the transactions contemplated by the Loan Documents to which each Borrower is or will be a party, and (B) the execution, delivery and performance by such Person of each Loan Document and the execution and delivery of the other documents to be delivered by such Person in connection therewith; (vii) a certificate of an authorized officer of each Borrower and the Guarantors, certifying the names and true signatures of the officers of such Person authorized to sign each Loan Document to which such Person is or will be a party and the other documents to be executed and delivered by such Person in connection therewith, together with evidence of the incumbency of such authorized officers; (viii) a certificate, dated as of a date not more than five Business Days prior to the Closing Date, of the appropriate official(s) of the states of incorporation and each state of foreign qualification of the Borrowers and the Guarantors, certifying as to the subsistence in good standing of, and the payment of taxes by, such Person in such states and listing all charter documents of such Person on file with such official(s), together with confirmation by telephone or telegram (where available) on the Closing Date from such official(s) as to such matters; (ix) a copy of the charter of the Borrowers and the Guarantors certified as of a date not more than three days prior to the Closing Date by the appropriate official(s) of the state of incorporation of each such Person and as of the Closing Date by an authorized officer of each such Person; (x) a copy of the by-laws of the Borrowers and the Guarantors, certified as of the Closing Date by an authorized officer of each such Person; (xi) an opinion of Katten, Muchin & Zavis, counsel to the Borrowers and the Guarantors, in form and substance satisfactory to the Lenders; (xii) a certificate of the Designated Financial Officer of each of the Borrowers, certifying as to the matters set forth in Section 3.01(b); (xiii) a certificate of insurance evidencing insurance on the property of the Borrowers and the Guarantors as is required by Article VI of this Agreement, naming the Lenders as additional insureds and loss payees, using a long form loss payee endorsement, for all insurance maintained by the Borrowers and the Guarantors on the Inventory; -17- 18 (xiv) a certificate of an authorized officer of the Borrowers certifying the names and true signatures of those officers of the Borrowers that are authorized to provide all notices under this Agreement and the Loan Documents; (xv) true and complete certified copies of the Congress Debt Documents as in effect on the Closing Date; (xvi) evidence satisfactory to Lenders in their sole discretion that all obligations under the Congress Supplemental Line (including all interest accrued and unpaid with respect thereto) have been paid in full and fully satisfied and that the Fund V Guarantee has been extinguished; (xvii) the First Supplemental Indenture duly executed by the Indenture Trustee, the Borrowers and the Guarantors; (xviii) certified copies of requests for copies of information on Form UCC-11 or reports from a reporting company satisfactory to the Lenders, listing all effective UCC financing statements, tax liens and judgment liens which name as debtor any Borrower or Gurantor and which are filed in the appropriate offices in the states in which are located the chief executive office and other operating offices of such Person, together with copies of such financing statements; (xix) the written consent of Congress in accordance with the Congress Loan Documents permitting the transactions contemplated under this Agreement and the other Loan Documents to occur in accordance herewith and therewith, duly executed by Congress, Borrowers and Guarantors as of the Closing Date; (xx) evidence satisfactory to Lenders in their sole discretion that any and all agreements by and among any Borrower and/or Guarantor and Congress Talcott Corporation, and any related security interests in any of the Borrowers' or Guarantors' properties or assets, have been terminated, including, without limitation, evidence that appropriate UCC-3 termination statements have been filed in the applicable jurisdictions; and (xxi) such other agreements, instruments, approvals, opinions and other documents as the Lenders may reasonably request. (e) Lien Priority. The Liens in favor of the Lenders pursuant to the Loan Documents shall be valid and perfected, first priority Liens on the Collateral, subject only to the Permitted Liens. -18- 19 (f) Legal Restraints/Litigation. There shall be no (1) litigation, investigation or proceeding (judicial or administrative) pending or threatened against the Borrowers or the Guarantors or their respective assets or properties, by any Person relating in any way to the transactions contemplated by this Agreement and the other Loan Documents or the consummation of the Restructuring, (2) injunction, writ or restraining order restraining or prohibiting the transactions contemplated by this Agreement and the other Loan Documents or the consummation of the Restructuring, or (3) suit, action, investigation or proceeding (judicial or administrative) pending or threatened against the Borrowers or the Guarantors, or their assets, which, in the opinion of the Lenders, if adversely determined could have a Material Adverse Effect. (g) Indebtedness. The Borrowers and the Guarantors shall have no Indebtedness or other liabilities other than (1) Indebtedness to Congress under the Congress Loan Agreement, (2) Indebtedness permitted under the Congress Loan Agreement but only to the extent such Indebtedness exists as of the date hereof, and (3) Indebtedness permitted under the Loan Documents. (h) Congress Obligations. The outstanding Indebtedness under the Congress Debt Documents shall not exceed $40,000,000, after giving effect to the satisfaction in full of all obligations under the Congress Supplemental Line (including all interest accrued and unpaid with respect thereto). (i) Material Adverse Effect. Since April 25, 1997, no situation, event or circumstance shall have occurred which could have a Material Adverse Effect which has not been fully and accurately disclosed to Lenders in writing. 3.02. Conditions Precedent to Subsequent Term Loan. In addition to the requirements of Section 3.01, the obligation of the Lenders to make the Subsequent Term Loan is subject to the fulfillment, in a manner satisfactory to the Lenders, of each of the following conditions precedent: (a) Payment of Expenses, Etc. The Borrowers shall have paid all expenses and taxes then payable by the Borrowers pursuant to Section 9.05 hereof; (b) Representations and Warranties; No Event of Default. The following statements shall be true, and the submission by the Borrowers to the Lenders of the Notice of Borrowing with respect to the Subsequent Term Loan and the Borrowers' acceptance of the proceeds of such Loan shall be deemed to be a representation and warranty by the Borrowers on the date of such Loan that, (i) the representations and warranties contained in Article IV of this Agreement and in each other Loan Document and certificate or other writing delivered to the Lenders pursuant hereto on or prior to the Subsequent Borrowing Date are correct on and as of such date as though made on and as of such date (except for representations and warranties which relate to a specific date); -19- 20 and (ii) no Potential Default or Event of Default has occurred and is continuing or would result from the making of the Loan to be made on such date. (c) Legality. The making of the Subsequent Term Loan shall not contravene any law, rule or regulation applicable to the Lenders. (d) Borrowing Notice. Each Lender shall have received the Notice of Borrowing pursuant to Section 2.04 hereof no later than 12:00 noon (New York City time) on the date which is ten (10) Business Days prior to the date of such proposed borrowing. (e) Delivery of Documents. Each Lender shall have received its respective Subsequent Term Note payable to the order of such Lender and duly executed by the Borrowers and such other agreements, instruments, approvals and other documents, each in form and substance satisfactory to the Lenders, as the Lenders may reasonably request. (f) Lien Searches. Certified copies of requests for copies of information on Form UCC-11 or reports from a reporting company satisfactory to the Lenders, listing all effective UCC financing statements, tax liens and judgment liens which name as debtor any Borrower or Gurantor and which are filed in the appropriate offices in the states in which any of the Borrowers or Guarantors own or have an interest in real property or the Real Property Collateral is located, together with copies of such financing statements. (g) Real Property Documents. The Lenders shall have received the Mortgages duly executed by the Borrowers and Guarantors, as applicable, and title policies and opinions of counsel in respect of the Real Property Collateral, in each case in form and substance satisfactory to the Lenders. (h) Material Adverse Effect. Since the Closing Date, no situation, event or circumstance shall have occurred which could have a Material Adverse Effect. The Notice of Borrowing shall constitute a representation and warranty by the Borrowers that the conditions set forth in this Section 3.02 have been satisfied as of the date of such request. Failure of the Lenders to receive notice from the Borrowers to the contrary before the Subsequent Borrowing Date shall constitute a further representation and warranty by the Borrowers that the conditions set forth in this Section 3.02 have been satisfied as of the Subsequent Borrowing Date. -20- 21 ARTICLE IV REPRESENTATIONS AND WARRANTIES Each Borrower and Guarantor hereby represents and warrants to Lenders the following (which shall survive the execution and delivery of this Agreement): 4.01. Corporate Existence, Power and Authority; Subsidiaries. Each Borrower and Guarantor is a corporation duly organized and in good standing under the laws of its state of incorporation and is duly qualified as a foreign corporation and in good standing in all states or other jurisdictions where the nature and extent of the business transacted by it or the ownership of assets makes such qualification necessary, except for those jurisdictions in which the failure to so qualify has not had and could not reasonably be expected to have a Material Adverse Effect. The execution, delivery and performance of this Agreement, the other Loan Documents and the transactions contemplated hereunder and thereunder are all within each Borrower's and Guarantor's corporate powers, have been duly authorized and are not in contravention of law or the terms of such Borrower's or Guarantor's certificate of incorporation, by-laws, or other organizational documentation, or any indenture, agreement or undertaking to which such Borrower or Guarantor is a party or by which such Borrower or Guarantor or its property are bound. This Agreement and the other Loan Documents constitute legal, valid and binding obligations of each Borrower and Guarantor enforceable in accordance with their respective terms. No Borrower or Guarantor has any Subsidiaries except as set forth on Schedule III hereto. 4.02. Financial Statements; No Material Adverse Change. All financial statements relating to the Borrowers and Guarantors which have been delivered by any Borrower or Guarantor to Lenders on or prior to any date that this representation and warranty is made or deemed to be made have been prepared in accordance with GAAP and fairly present the financial condition and the results of operation of such of the Borrowers and Guarantors as are included therein as at the dates and for the periods set forth therein. Since April 25, 1997, no situation, event or circumstance shall have occurred which could have a Material Adverse Effect which has not been fully and accurately disclosed to Lenders in writing. 4.03. Chief Executive Office; Collateral Locations. The chief executive office of each Borrower and Guarantor and each Borrower's and Guarantor's records concerning Receivables are located only at the address set forth on the signature pages to this Agreement and its only other places of business and the only other locations of Collateral, if any, are the addresses set forth in Schedule IV hereto, subject to the right of a Borrower or Guarantor to establish new locations in accordance with Section 6.01 below. Schedule IV correctly identifies any of such locations which are not owned by a Borrower or Guarantor and sets forth the owners and/or operators thereof and to the best -21- 22 of the applicable Borrower's and Guarantor's knowledge, the holders of any mortgages on such locations. 4.04. Priority of Liens; Title to Properties. The security interests and liens granted to Lenders under this Agreement and the other Loan Documents constitute valid and perfected first priority liens and security interests in and upon the Collateral, subject only to the Permitted Liens. Each Borrower and Guarantor has good and marketable title to all of its properties and assets subject to no liens, mortgages, pledges, security interests, encumbrances or charges of any kind, except those granted to Lenders and the Permitted Liens. 4.05. Maintenance of Equipment. The Equipment is, and will be kept by the Borrowers and Guarantors, in good operating condition and repair (ordinary wear and tear excepted). 4.06. Tax Returns. Each Borrower and Guarantor has filed, or caused to be filed, in a timely manner all tax returns, reports and declarations which are required to be filed by it (without requests for extension except as previously disclosed in writing to Lenders). All information in such tax returns, reports and declarations is complete and accurate in all material respects. Each Borrower and Guarantor has paid or caused to be paid all taxes due and payable or claimed due and payable in any assessment received by it, except taxes the validity of which are being contested in good faith by appropriate proceedings diligently pursued and available to such Borrower or Guarantor and with respect to which adequate reserves have been set aside on its books. Adequate provision has been made for the payment of all accrued and unpaid Federal, State, county, local, foreign and other taxes whether or not yet due and payable and whether or not disputed. 4.07. Litigation. Except as disclosed on Schedule V hereto, there is no present investigation by any governmental agency pending, or to the best of any Borrower's and Guarantor's knowledge threatened, against or affecting any Borrower or Guarantor, its assets or business and there is no action, suit, proceeding or claim by any Person pending, or to the best of any Borrower's or Guarantor's knowledge threatened, against any Borrower or Guarantor or its assets or goodwill, or against or affecting any transactions contemplated by this Agreement or the other Loan Documents, which has resulted, or if adversely determined against a Borrower or Guarantor could reasonably be expected to result, in any Material Adverse Effect. 4.08. Compliance with Other Agreements and Applicable Laws. Except as disclosed on Schedule VI hereto, no Borrower or Guarantor is in default under, or in violation of any of the terms of, any agreement, contract, instrument, lease or other commitment to which it is a party or by which it or any of its assets are bound and each Borrower and Guarantor is in compliance with all applicable provisions of laws, rules, regulations, licenses, permits, approvals and orders of any foreign, Federal, State or local -22- 23 governmental authority. No "Event of Default" (as defined in the Congress Loan Agreement) has occurred under the Congress Loan Agreement which has not been either waived by Congress prior to the Closing Date or cured prior to the Closing Date. 4.09. Employee Benefits. (a) No Borrower or Guarantor or any of their ERISA Affiliates maintains or is required to contribute to, and no Borrower or Guarantor or any of their ERISA Affiliates previously maintained or was previously required to contribute to, any employee pension benefit plan subject to Title IV of ERISA. (b) No Borrower or Guarantor or any of their ERISA Affiliates has engaged in any transaction in connection with which a Borrower or Guarantor or any of their ERISA Affiliates could be subject to either a civil penalty assessed pursuant to Section 502(i) of ERISA or a tax imposed by Section 4975 of the Code in an aggregate amount in excess of $500,000. (c) Full payment has been made of all amounts which any Borrower or Guarantor or any of their ERISA Affiliates is required to have contributed under the terms of each employee pension benefit plan as contributions to such plan as of the last day of the most recent fiscal year of such plan ended prior to the date hereof and where nonpayment could result in a liability to any Borrower or Guarantor or any of their ERISA Affiliates in an aggregate amount in excess of $500,000, and no accumulated funding deficiency (as defined in Section 302 of ERISA and Section 412 of the Code), whether or not waived, exists with respect to any employee pension benefit plan that is subject to Title IV of ERISA. (d) None of the Borrowers or Guarantors or their ERISA Affiliates is or has ever been obligated to contribute to any "multiemployer plan" (as such term is defined in Section 4001(a)(3) of ERISA) that is subject to Title IV of ERISA. 4.10. Environmental Compliance. (a) Except as disclosed on Schedule VII hereto, no Borrower or Guarantor has generated, used, stored, treated, transported, manufactured, handled, produced or disposed of any Hazardous Materials, on or off its premises (whether or not owned by it) in any manner which at any time violates any applicable Environmental Law or any license, permit, certificate, approval or similar authorization thereunder, where such violation has had or could reasonably be expected to have a Material Adverse Effect. The operations of each Borrower and Guarantor comply in all material respects with all Environmental Laws and all licenses, permits, certificates, approvals and similar authorizations thereunder. (b) Except as disclosed on Schedule VII hereto, there has been no investigation, proceeding, complaint, order, directive, claim, citation or notice by any Governmental Authority or any other person nor is any pending or to the best of any Borrower's or Guarantor's knowledge threatened, with respect to any non-compliance -23- 24 with or violation of the requirements of any Environmental Law by any Borrower or Guarantor or the release, spill or discharge, threatened or actual, of any Hazardous Material or the generation, use, storage, treatment, transportation, manufacture, handling, production or disposal of any Hazardous Materials or any other environmental, health or safety matter, which affects any Borrower or Guarantor or its business, operations or assets or any properties at which any Borrower or Guarantor has transported, stored or disposed of any Hazardous Materials. (c) Except as disclosed on Schedule VII hereto, no Borrower or Guarantor has any material liability (contingent or otherwise) in connection with a release, spill or discharge, threatened or actual, of any Hazardous Materials or the generation, use, storage, treatment, transportation, manufacture, handling, production or disposal of any Hazardous Materials. (d) Each Borrower and Guarantor has all licenses, permits, certificates, approvals or similar authorizations required to be obtained or filed in connection with the operations of such Borrower or Guarantor under any Environmental Law and all of such licenses, permits, certificates, approvals or similar authorizations are valid and in full force and effect. 4.11. Accuracy and Completeness of Information. All information furnished by or on behalf of any Borrower or Guarantor in writing to Lenders in connection with this Agreement or any of the other Loan Documents or any transaction contemplated hereby or thereby, including, without limitation, all information on the Schedules attached hereto, is true and correct in all material respects on the date as of which such information is dated or certified and does not omit any material fact necessary in order to make such information not misleading. No event or circumstance has occurred which has had or could reasonably be expected to have a Material Adverse Effect, which has not been fully and accurately disclosed to Lenders in writing. 4.12. Survival of Warranties; Cumulative. All representations and warranties contained in this Agreement or any of the other Loan Documents shall survive the execution and delivery of this Agreement and shall be deemed to have been made again to Lenders on the date of each additional borrowing or other credit accommodation hereunder and shall be conclusively presumed to have been relied on by Lenders regardless of any investigation made or information possessed by Lenders. The representations and warranties set forth herein shall be cumulative and in addition to any other representations or warranties which any Borrower or Guarantor shall now or hereafter give, or cause to be given, to Lenders. 4.13. Enforceability of Loan Documents. This Agreement is, and each other Loan Document to which each Borrower and each Guarantor is or will be a party, when delivered hereunder, will be, a legal, valid and binding obligation of the Borrowers -24- 25 and the Guarantors, enforceable against the Borrowers and the Guarantors in accordance with its terms. 4.14. Nature of Business. The Borrowers and the Guarantors are primarily engaged in the business of designing, manufacturing and marketing an extensive line of decorative home accessories. 4.15. Use of Proceeds. The proceeds of the Term Loans shall be used first to retire the $5,000,000 Congress Supplemental Line (and any and all accrued and unpaid interest, fees and expenses with respect thereto) under the Congress Loan Agreement, and thereafter for general working capital through the Effective Date in the ordinary course of business of the Borrowers and the Guarantors. 4.16. Congress Debt Documents. The copies of the Congress Debt Documents delivered to the Lenders pursuant to Section 3.01(d) hereof are true, correct and complete copies of the Congress Debt Documents. 4.17. Registration and Transfer of Term Notes. (a) The Borrowers shall cause to be kept at the principal executive office of The Rug Barn, Inc. a register (the register maintained in such office being herein referred to as the "Note Register") in which the Borrowers shall provide for the registration of the Term Notes and of transfers of Term Notes. The name and address of each registered holder of a Term Note, each transfer thereof made pursuant to paragraph (b) of this Section 4.17, and the name and address of each transferee of the Term Notes shall be registered in the Note Register. The Note Register shall be in written form or any other form capable of being converted into written form within a reasonable time. The Borrowers hereby appoint The Rug Barn, Inc. as security registrar (the "Note Registrar") for the purpose of registering Term Notes and transfers of Term Notes as herein provided. (b) Upon surrender for registration of transfer of any Term Note at the principal executive office of The Rug Barn, Inc., the Borrowers and the Guarantors shall execute and deliver, in the name of the designated transferee or transferees, one or more new Term Notes of denominations of a like aggregate principal amount. All Term Notes issued upon any registration of transfer of Term Notes shall be the valid obligations of the Borrowers and the Guarantors, evidencing the same debt (including, without limitation, the Guarantee), and entitled to the same benefits under this Agreement and the other Loan Documents, as the Term Notes surrendered upon such registration of transfer. Every Term Note presented or surrendered for registration of transfer shall (if so required by the Borrowers) be duly endorsed, or be accompanied by a written instrument of transfer, in form reasonably satisfactory to the Borrowers duly executed by the registered holder thereof or his attorney duly authorized in writing. No service charge shall be made for any registration of transfer of Term Notes. -25- 26 ARTICLE V COLLATERAL 5.01. Grant of Security Interest. As collateral security for all of the Secured Obligations, each Borrower and each Guarantor hereby pledges and assigns to the Lenders, their successors and assigns, and hereby grants to the Lenders an undivided continuing senior, first priority security interest in and to all of such Borrower's or Guarantor's right, title and interest in and to the following (the "Collateral"): (a) all equipment of any kind and in all of its forms, wherever located and whether now or hereafter existing and whether now owned or hereafter acquired (including, but not limited to, all machinery, apparatus, furniture, fixtures, excluding fixtures bearing or identified by the Calvin Klein Intellectual Property (unless removed or as approved by Calvin Klein, Inc.), conveyors, tools, attachments, materials, storage and handling equipment, motor vehicles, boats, trucks, trailers, vessels, aircraft and rolling stock and all parts thereof), together with all substitutes, replacements, accessions and additions thereto, and all tools, parts, accessories and attachments used in connection therewith (hereinafter collectively referred to as the "Equipment"); (b) all Inventory of any kind and in all of its forms, wherever located and whether now or hereafter existing and whether now owned or hereafter acquired; (c) (i) all accounts, contract rights, chattel paper, instruments, deposit accounts, general intangibles and other obligations of any kind (including, but not limited to, any obligations of a Borrower or Guarantor to another Borrower or Guarantor) whether now or hereafter existing, whether now owned or hereafter acquired, and whether or not arising out of or in connection with the sale or lease of goods or the rendering of services, and (ii) all rights now or hereafter existing in and to all credit insurance, guaranties, letters of credit, security agreements, leases and other contracts now or hereafter existing and securing or otherwise relating to any such accounts, contract rights, chattel paper, instruments, deposit accounts, general intangibles or obligations (any and all such accounts, contract rights, chattel paper, instruments, deposit accounts, general intangibles and obligations being hereinafter referred to collectively as the "Receivables", and any and all such credit insurance, guaranties, letters of credit, leases, security agreements and other contracts, specifically excluding the Calvin Klein License, being hereinafter referred to collectively as the "Related Contracts"); (d) (i) all trademarks, service marks, trade names, business names, trade styles, designs, logos, other source or business identifiers, copyrights and all general intangibles of like nature, now or hereafter owned, adopted, acquired or used by any Borrower or Guarantor, all applications, registrations and recordings thereof (including, without limitation, applications, registrations and recordings in the United States Patent -26- 27 and Trademark Office or in any similar office or agency of the United States, any state thereof or any other country or any political subdivision thereof), and all reissues, extensions or renewals thereof, together with all goodwill of the business symbolized by such marks and all customer lists, formulae and other records of any Borrower or Guarantor relating to the distribution of products and services in connection with which any of such marks are used, and all income, royalties, damages and payments now or hereafter due and/or payable under and with respect thereto, including, without limitation, payments under all licenses entered into in connection therewith and damages and payments for past and future infringements or dilutions thereof and the right to sue for past, present and future infringements and dilutions thereof (hereinafter referred to collectively as the "Trademarks"); provided, however, that Trademarks excludes any and all interests and/or rights to use the trademark "Calvin Klein" (or "CK/Calvin Klein" or other derivative thereof) deriving from the Calvin Klein License or otherwise including any and all copyrights, copyrightable material or other intellectual property or proprietorial data or information which may exist or arise in connection therewith or relating thereto (collectively, the "Calvin Klein Intellectual Property"), and (ii) all licenses (other than the Calvin Klein License and any sublicenses thereunder), contracts or other agreements, whether written or oral, naming any Borrower or Guarantor as licensor or licensee and providing for the grant of any right to use any Trademark, together with any goodwill connected with and symbolized by any such trademark licenses or agreements and the right to prepare for sale and sell any and all Inventory now or hereafter owned by any Borrower or Guarantor and now or hereafter covered by such licenses (hereinafter referred to collectively as the "Trademark Licenses"); (e) (i) all moneys, securities and other property, and the proceeds thereof, now or hereafter held or received by, or in transit to, the Lenders from or for any Borrower or Guarantor, whether for safekeeping, pledge, custody, transmission, collection or otherwise, and all of the Borrowers' and Guarantors' claims against any Lender at any time existing; (ii) all rights relating to the sale or other transfer of property to, or the construction, renovation or other improvement of property by or for, any Borrower or Guarantor; (iii) all rights, interests, choses in action, causes of actions, claims and all other intangible property of every kind and nature, in each instance whether now owned or hereafter acquired by any Borrower or Guarantor, including, without limitation, all corporate and other business records, all loans, royalties, and all other forms of obligations receivable whatsoever (other than Receivables); (iv) all customer and supplier contracts, sale orders, rights under license and franchise agreements, and other contracts and contract rights (other than the Calvin Klein License); (v) all interests (including, without limitation, profit participations) in partnerships, joint ventures, corporations, limited liability companies or other Persons, and all other equity or debt securities issued by any Persons, including all moneys due from time to time in respect thereof; (vi) all federal, state and local tax refunds and federal, state and local tax refund claims; (vii) all right, title and interest under leases, subleases, licenses and concessions -27- 28 and other agreements relating to personal property, including all moneys due from time to time in respect thereof; (viii) all payments due or made to any Borrower or Guarantor in connection with any requisition, confiscation, condemnation, seizure or forfeiture of any property by any Person, Governmental Authority or regulatory body; (ix) all deposit accounts (general or special) with any bank or other financial institution and all funds on deposit therein, and all certificates and instruments, if any, from time to time representing or evidencing any of such accounts; (x) all credits with and other claims against third parties (including carriers and shippers) (other than Receivables); (xi) all rights to indemnification; (xii) all reversionary interests in pension and profit sharing plans and reversionary, beneficial and residual interests in trusts; (xiii) all letters of credit, guaranties, liens, security interests and other security held by or granted to any Borrower or Guarantor; (xiv) all instruments, files, records, ledger sheets and documents covering or relating to any of the Collateral; (xv) all other intangible property, whether or not similar to the foregoing, in each instance, however and wherever arising (other than the Calvin Klein Intellectual Property); (xvi) all notes, certificates of deposit, deposit accounts, checks and other instruments from time to time hereafter delivered to or otherwise possessed by any Lender for or on behalf of any Borrower or Guarantor, in substitution for or in addition to any or all of the foregoing; and (xvii) all interest, dividends, cash, instruments and other property and assets from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of the foregoing; (f) the books and records of the Borrowers and the Guarantors relating to any of the Collateral, including, without limitation, all customer contracts, sale orders, minute books, ledgers, records, computer programs, software, printouts and other computer materials, customer lists, credit files, correspondence and advertising materials, in each case indicating, summarizing or evidencing any of the Collateral; (g) all of the shares of capital stock of each of the Borrowers and each of the Guarantors (other than Decorative Homes); (h) the Real Property Collateral and any estates or interests in real property now owned and hereafter acquired by any Borrower or Guarantor (including, without limitation, leasehold estates or interests); (i) any such other property not included under paragraphs (a) through (h) above that would otherwise be deemed to constitute "Collateral" as defined in the Congress Loan Agreement, as such agreement may be amended, modified or replaced from time to time, or in any other Congress Debt Document; (j) any and all other assets or property of any kind and in all of its forms, wherever located and whether now or hereafter existing and whether now owned or hereafter acquired, not included under paragraphs (a) through (i) above; and -28- 29 (k) all proceeds (in whatever form, whether cash, securities or any other type of property) of any and all of the foregoing Collateral (including, without limitation, (A) damages and payments for past or future infringements of the Trademarks and (B) the right to sue for past, present and future infringements of the Trademarks) and, to the extent not otherwise included, all payments under insurance (whether or not the Lenders are the loss payees thereof), any indemnity, warranty or guaranty payable by reason of loss or damage to or otherwise with respect to any of the foregoing Collateral; in each case howsoever any Borrower's or any Guarantor's interest therein may arise or appear (whether by ownership, security interest, claim or otherwise). Notwithstanding the foregoing, the senior, first priority security interest granted to the Lenders in the Collateral shall be subject to Permitted Liens. 5.02. Security for Secured Obligations. The security interest created hereby and by the Security Documents in the Collateral constitutes continuing collateral security for the payment of all of the Obligations and all obligations of each Borrower and Guarantor now or hereafter arising under or with respect to this Agreement, the Guarantee, the Term Notes or any other Loan Document, whether for principal, premium, interest, fees, expenses or otherwise, including, without limitation, the obligations to pay the Term Loans and the Closing Fee and to perform each and every obligation set forth in this Agreement (including, without limitation, the Guarantee), the Term Notes and the other Loan Documents (all such obligations being hereinafter collectively referred to as the "Secured Obligations"). 5.03. Proceeds of Collateral. The proceeds of any sale or other disposition of Collateral by any Lender permitted under this Agreement or any other Loan Document shall be distributed by such Lender to each Lender based upon each Lender's Percentage Interest. ARTICLE VI AFFIRMATIVE AND NEGATIVE COVENANTS 6.01. Covenants Under Congress Loan Agreement. Section 9 of the Congress Loan Agreement and any definitions of any capitalized terms set forth in such section which are set forth in the Congress Loan Agreement (as in effect on the date of this Agreement) shall be incorporated by reference in this Agreement (without regard to any amendment, supplement, modification or waiver relating thereto or the termination or expiration thereof) to the same extent as if set forth at length herein, except that all references to the term "Lender" shall mean the Lenders, and the Borrowers and Guarantors jointly and severally agree to cause the Borrowers and Guarantors to perform and observe their covenants, agreements and obligations under said Section 9, so long as -29- 30 the Obligations (whether or not due) remain unpaid in full in cash, including without limitation all principal of and accrued and unpaid interest on the Loans. 6.02. Liens. No Borrower or Guarantor shall create, incur, assume or suffer to exist any Lien on any of its assets or properties including, without limitation, the Collateral, except the Permitted Liens. 6.03. Indebtedness. No Borrower or Guarantor shall incur, create, assume, become or be liable in any manner with respect to, or permit to exist, any obligation or Indebtedness, except (a) Indebtedness to Congress under the Congress Loan Agreement, (b) Indebtedness permitted under the Congress Loan Agreement but only to the extent such Indebtedness exists as of the date hereof, and (c) Indebtedness permitted under the Loan Documents. 6.04. Post-Closing Date Covenants. Within 30 days following the Closing Date, the Borrowers shall cause (i) each of the parties to whom the letter agreements annexed hereto as Exhibit J are addressed to execute and deliver to the Lenders letter agreements substantially in the form of the agreements annexed as Exhibit J hereto in favor of the Lenders, with all references to "Congress" being replaced with "the Lenders", (ii) UCC-3 termination statements, satisfactory to Lenders in all respects, with respect to any and all Liens filed against the property or assets of any Borrower or Guarantor by LaSalle National Bank or The CIT Group, including without limitation all such statements described on Schedule VIII hereto, to be executed by the appropriate Borrower or Guarantor and filed in the appropriate jurisdictions and (iii) file any and all documentation, satisfactory to Lenders in all respects, with the appropriate Governmental Authority or other Person in order to establish The Rug Barn, Inc. as the owner of the trademarks and copyrights listed on Schedule IX hereto. 6.05. Overadvances. No Borrower or Guarantor shall incur, create, assume, become or be liable in any manner with respect to, or permit to exist any Indebtedness under the credit facility provided by Congress pursuant to the Congress Loan Agreement which constitutes an overadvance under such facility. ARTICLE VII DEFAULTS 7.01. Events of Default. An Event of Default shall mean the occurrence or existence of one or more of the following events or conditions (whatever the reason for such Event of Default and whether voluntary, involuntary or effected by operation of law): -30- 31 (a) The Borrowers shall fail to pay when due any of the Obligations; or (b) Any representation or warranty made by the Borrowers or Guarantors under this Agreement or any other Loan Document or any statement made by the Borrowers or Guarantors in any financial statement, certificate, report or document furnished to any Lender pursuant to or in connection with this Agreement or any other Loan Document, shall prove to have been false or misleading in any material respect as of the time when made (including by omission of material information necessary to make such representation, warranty or statement, in light of the circumstances under which it was made, not misleading), or any of the Borrowers or Guarantors shall fail to observe or perform any of the covenants or provisions contained in this Agreement or any of the other Loan Documents; or (c) Any "Event of Default" shall have occurred under the Congress Loan Agreement; or (d) Any Congress Debt Document shall be amended, modified or supplemented subsequent to the date hereof without the prior written consent of the Lenders; or (e) The Calvin Klein License shall cease to be in effect or shall be terminated; or (f) Any Borrower or any Guarantor (i) shall institute any proceeding or voluntary case seeking to adjudicate it a bankrupt or insolvent, or seeking dissolution, liquidation, winding up, reorganization, arrangement, adjustment, protection, relief or composition of it or its debts under any law relating to bankruptcy, insolvency, reorganization or relief of debtors, or seeking the entry of an order for relief or the appointment of a receiver, trustee, custodian or other similar official for any Borrower or any Guarantor or for any substantial part of its property, (ii) shall be generally not paying its debts as such debts become due, or shall admit in writing its inability to pay its debts generally, (iii) shall make a general assignment for the benefit of creditors, or (iv) shall take any action to authorize or effect any of the actions set forth above in this subsection (f); or (g) Any proceeding shall be instituted against any Borrower or any Guarantor seeking to adjudicate it a bankrupt or insolvent, or seeking dissolution, liquidation, winding up, reorganization, arrangement, adjustment, protection, relief of debtors, or seeking the entry of an order for relief or the appointment of a receiver, trustee, custodian or other similar official for any -31- 32 Borrower or any Guarantor or for any substantial part of its property, and either such proceeding shall remain undismissed or unstayed for a period of 45 days or any of the actions sought in such proceeding (including, without limitation, the entry of an order for relief against it or the appointment of a receiver, trustee, custodian or other similar official for it or for any substantial part of its property) shall occur; or (h) Any provision of any Loan Document shall at any time for any reason be declared to be null and void, or the validity or enforceability thereof shall be contested by any Borrower or any Guarantor, or a proceeding shall be commenced by any of the Borrowers, or by any Governmental Authority or other regulatory body having jurisdiction over any Borrower or any Guarantor, seeking to establish the invalidity or unenforceability thereof, or any Borrower or any Guarantor shall deny in writing that such Borrower or any Guarantor has any liability or obligation purported to be created under any Loan Document; or (i) The security interests purported to be created by the Security Documents shall cease to be, or shall be asserted by any Borrower or any of the Guarantors not to be, a valid, perfected, first priority security interest in the Collateral covered thereby, subordinate to no other Lien except for Permitted Liens; or (j) The Guarantee shall cease to be, or shall be asserted by any Borrower or any Guarantor not to be, in full force and effect and enforceable in accordance with its terms, or any of the Borrowers or the Guarantors shall contest or deny in writing the validity or enforceability of any of the Obligations; or (k) Any Borrower shall request or permit an overadvance under the credit facility provided by Congress pursuant to the Congress Loan Agreement, without the prior written consent of the Lenders. 7.02. Consequences of an Event of Default. If an Event of Default shall occur and be continuing or shall exist, the Lenders may by notice to the Borrowers, (a) declare all Obligations, including, without limitation the Loans, all interest thereon and all other amounts, to be immediately due and payable without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by the Borrowers, and an action therefor shall immediately accrue; or (b) give notice to the Borrowers of the occurrence and continuance of an Event of Default; -32- 33 provided, however, that upon the occurrence of any Event of Default described in subsections (f) or (g) of Section 7.01, all Obligations, including, without limitation, the Loans, all interest thereon and all other amounts, shall immediately become and be forthwith due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by the Borrowers. 7.03. Certain Remedies. If an Event of Default occurs, the Lenders may exercise all rights and remedies which they may have hereunder or under any other Loan Document or at law or in equity or otherwise. All such remedies shall be cumulative and not exclusive. 7.04. Certain Events of Default. The Lenders hereby agree that any "Event of Default" under the Congress Loan Agreement that is waived by Congress pursuant to Section 3 of that certain Amendment and Consent, dated May 23, 1997, by and among, the Borrowers and the Guarantors, shall not constitute or be deemed to constitute to an Event of Default under this Agreement. ARTICLE VIII GUARANTEE 8.01. Guarantee. Each of the Guarantors, for consideration received, jointly and severally unconditionally and irrevocably guarantees to the Lenders the due and punctual payment of the Obligations, whether or not arising after the commencement of a proceeding under any Bankruptcy Law (including post-petition interest) and whether or not allowed or allowable as a claim in any such proceeding, and whether or not recovery of any such obligation or liability may be barred by a statute of limitations or such obligation or liability may otherwise be unenforceable. All Obligations shall be conclusively presumed to have been created in reliance on the Guarantee. The Guarantee is a continuing guaranty of the Obligations and may not be revoked and shall not otherwise terminate unless and until any and all Obligations have been indefeasibly paid and performed in full, in cash. 8.02. Nature of Guarantee. The liability of each Guarantor under the Guarantee is independent of and not in consideration of or contingent upon the liability of the Borrowers or any other Guarantor and a separate action or actions may be brought and prosecuted against any Guarantor, whether or not any action is brought or prosecuted against the Borrowers or any other Guarantor or whether any Borrower or any other Guarantor is joined in any such action or actions. The Guarantee given by each Guarantor shall be construed as a continuing, absolute and unconditional guaranty of payment (and not merely of collection) without regard to: -33- 34 (a) the legality, validity or enforceability of the Term Notes, this Agreement or any other Loan Document, any of the Obligations, any Lien on Collateral, the security interest granted under this Agreement or any Security Document or the Guarantee given by any other Guarantor; (b) any defense (other than payment), set-off or counterclaim that may at any time be available to the Borrowers or any other Guarantor against, and any right of setoff at any time held by, the Lenders; or (c) any other circumstance whatsoever (with or without notice to or knowledge of any Guarantor or any Borrower), whether or not similar to any of the foregoing, that constitutes, or might be construed to constitute, an equitable or legal discharge of the Borrowers or any other Guarantor, in bankruptcy or in any other instance. Any payment by any Borrower or any Guarantor or other circumstance that operates to toll any statute of limitations applicable to such Persons shall also operate to toll the statute of limitations applicable to each Guarantor. 8.03. Authorization. Each Guarantor authorizes the Lenders, without notice to or further assent by such Guarantor, and without affecting any Guarantor's liability hereunder (regardless of whether any subrogation or similar right that such Guarantor may have or any other right or remedy of such Guarantor is extinguished or impaired), from time to time to do any or all of the following: (a) permit the Borrowers to increase or create Obligations, or terminate, release, compromise, subordinate, extend, accelerate or otherwise change the amount or time, manner or place of payment of, or rescind any demand for payment or acceleration of, the Obligations or any part thereof, consent or enter into supplemental loan agreements or otherwise amend the terms and conditions of the Loan Documents or any provision thereof; (b) take and hold Collateral from the Borrowers or any other Person, perfect or refrain from perfecting a Lien on such Collateral, and exchange, enforce, subordinate, release (whether intentionally or unintentionally), or take or fail to take any other action in respect of, any such Collateral or Lien or any part thereof; (c) exercise in such manner and order as they elect in their sole discretion, fail to exercise, waive, suspend, terminate or suffer expiration of, any of the remedies or rights of the Lenders against the Borrowers or any Guarantor in respect of any Obligation or any Collateral; (d) release, add or settle with any Guarantor or any Borrower in respect of the Guarantee or the Obligations; -34- 35 (e) accept partial payments on the Obligations and apply any and all payments or recoveries from any Guarantor or any Borrower or Collateral to such of the Obligations as Lenders may elect in their sole discretion, whether or not such Obligations are secured or guaranteed; (f) refund at any time, at Lenders' sole discretion, any payments or recoveries received by Lenders in respect of any Obligations or Collateral; and (g) otherwise deal with any Borrower, any Guarantor and any Collateral as Lenders may elect in their sole discretion. 8.04. Right to Demand Full Performance. In the event of any demand for payment or performance by Lenders from any Guarantor hereunder, Lenders shall have the right to demand their full claims and to receive all dividends or other payments in respect thereof until the Obligations have been paid in full, and the Guarantors shall continue to be jointly and severally liable hereunder for any balance which may be owing to Lenders by the Borrowers under this Agreement, the Term Notes or any other Loan Document. The retention by the Lenders of any security, prior to the realization by the Lenders of their rights to such security upon foreclosure thereon, shall not, as between the Lenders and any Guarantor, be considered as a purchase of such security, or as payment, satisfaction or reduction of the Obligations due to the Lenders by the Borrowers or any part thereof. Without limiting Section 9.05 or any other provision of this Agreement, each Guarantor, promptly after demand, will reimburse the Lenders for all costs and expenses of collecting such amount under, or enforcing this Guarantee, including, without limitation, the reasonable fees and expenses of counsel. 8.05. Certain Waivers. Each Guarantor waives: (a) the right to require the Lenders to proceed against the Borrowers or any other Guarantor, to proceed against or exhaust any Collateral or to pursue any other remedy in Lenders' power whatsoever and the right to have the property of any Borrower or any other Guarantor first applied to the discharge of the Obligations; (b) all rights and benefits under applicable law purporting to reduce a guarantor's obligations in proportion to the obligation of the principal or providing that the obligation of a surety or guarantor must neither be larger nor in other respects more burdensome than that of the principal; (c) the benefit of any statute of limitations affecting the Obligations or any Guarantor's liability hereunder; (d) any requirement of marshaling or any other principle of election of remedies; -35- 36 (e) any right to assert against the Lenders any defense (legal or equitable), set-off, counterclaim and other right that any Guarantor may now or any time hereafter have against any Borrower or any other Guarantor; (f) presentment, demand for payment or performance (including diligence in making demands hereunder), notice of dishonor or nonperformance, protest, acceptance and notice of acceptance of this Guarantee, and, except to the extent expressly required by the Loan Documents, all other notices of any kind, including (i) notice of any action taken or omitted by the Lenders in reliance hereon, (ii) notice of any default by the Borrowers or any other Guarantor, (iii) notice that any portion of the Obligations is due, (iv) notice of any action against the Borrowers or any other Guarantor, or any enforcement of other action with respect to any Collateral, or the assertion of any right of the Lenders hereunder; and (g) all defenses that at any time may be available to any Guarantor by virtue of any valuation, stay, moratorium or other law now or hereafter in effect. 8.06. The Guarantors Remain Obligated in Event the Borrowers Are No Longer Obligated to Discharge Obligations. It is the express intention of the Lenders and the Guarantors that if for any reason any Borrower has no legal existence, is or becomes under no legal obligation to discharge the Obligations owing to the Lenders by the Borrowers or if any of the Obligations owing by the Borrowers to the Lenders becomes irrecoverable from any Borrower by operation of law or for any reason whatsoever, this Guarantee and the covenants, agreements and obligations of the Guarantors contained in this Article VIII shall nevertheless be binding upon the Guarantors, as principal debtor, until such time as all such Obligations have been paid in full in cash to the Lenders and all Obligations owing to the Lenders by the Borrowers have been discharged, and the Guarantors shall be responsible for the payment thereof to the Lenders upon demand. 8.07. Severability of Void Obligations under Guarantee. The obligations of any Guarantor hereunder shall be limited to the maximum amount that would not render its obligations hereunder subject to avoidance under Section 548 of the Bankruptcy Code or any applicable provisions of comparable state law. 8.08. Guarantee Is in Addition to Other Security. This Guarantee shall be in addition to and not in substitution for any other guarantees or other security which the Lenders may now or hereafter hold in respect of the Obligations owing to the Lenders by the Borrowers and (except as may be required by law) the Lenders shall be under no obligation to marshal in favor of each of the Guarantors any other guarantees or other security or any moneys or other assets which the Lenders may be entitled to receive or upon which any Lender may have a claim. -36- 37 8.09. Release of Security Interest. Without limiting the generality of the foregoing, each Guarantor hereby consents and agrees, to the fullest extent permitted by applicable law, that the rights of the Lenders hereunder, and the liability of the Guarantors hereunder, shall not be affected by any and all releases for any purpose of any Collateral from the security interest created by any Security Document and that this Guarantee shall continue to be effective or be reinstated, as the case may be, if at any time any payment of any of the Obligations is rescinded or must otherwise be returned by any Lender upon the insolvency, bankruptcy or reorganization of any Borrower or otherwise, all as though such payment had not been made. 8.10. No Bar to Further Actions. Except as provided by law, no action or proceeding brought or instituted under this Article VIII and the Guarantee and no recovery or judgment in pursuance thereof shall be a bar or defense to any further action or proceeding which may be brought under this Article VIII and the Guarantee by reason of any further default or defaults under this Article VIII and the Guarantee or in the payment of any of the Obligations owing by the Borrowers. 8.11. Failure to Exercise Rights Shall Not Operate as a Waiver; No Suspension of Remedies. (a) No failure to exercise and no delay in exercising, on the part of the Lenders, any right, power, privilege or remedy under this Article VIII and the Guarantee shall operate as a waiver thereof, nor shall any single or partial exercise of any rights, power, privilege or remedy preclude any other or further exercise thereof, or the exercise of any other rights, powers, privileges or remedies. The rights and remedies herein provided for are cumulative and not exclusive of any rights or remedies provided in law or equity. (b) Nothing contained in this Article VIII shall limit the right of the Lenders to take any action to accelerate the maturity of the Obligations pursuant to Article VII and as set forth in this Agreement or the other Loan Documents or to pursue any rights or remedies hereunder or thereunder or under applicable law. 8.12. Lenders' Duties; Notice to Lenders. (a) Any provision in this Article VIII or elsewhere in this Agreement or any other Loan Document allowing the Lenders to request any information or to take any action authorized by, or on behalf of any Guarantor, shall be permissive and shall not be obligatory on the Lenders. (b) The Lenders shall not be required to inquire into the existence, powers or capacities of any Borrower, any Guarantor or the officers, directors or agents acting or purporting to act on their respective behalf. -37- 38 8.13. Successors and Assigns. All terms, agreements and conditions of this Article VIII shall extend to and be binding upon each Guarantor and its successors and permitted assigns and shall inure to the benefit of and may be enforced by the Lenders and their respective successors and assigns. 8.14. Release of Guarantee. Concurrently with the payment in full in cash of all of the Obligations, the Guarantors shall be released from and relieved of their obligations under this Article VIII. If any of the Obligations are revived and reinstated after the termination of this Guarantee, then all of the obligations of the Guarantors under this Guarantee shall be revived and reinstated as if this Guarantee had not been terminated until such time as the Obligations are paid in full, in cash, and each Guarantor shall enter into an amendment to this Guarantee, reasonably satisfactory to the Lenders, evidencing such revival and reinstatement. 8.15. Execution of Guarantee. To evidence the Guarantee, each Guarantor hereby agrees to execute a notation relating to the Guarantee to be endorsed on each Term Note. Each Guarantor agrees that this Agreement shall be executed on behalf of each Guarantor by its Chairman of the Board, its President, its Chief Executive Officer, Chief Operating Officer or one of its Vice Presidents, under its corporate seal reproduced thereon attested by its Secretary or one of its Assistant Secretaries. 8.16. No Subrogation; Certain Agreements. (a) EACH GUARANTOR WAIVES ANY AND ALL RIGHTS OF SUBROGATION, INDEMNITY OR REIMBURSEMENT, AND ANY AND ALL BENEFITS OF AND RIGHTS TO ENFORCE ANY POWER, RIGHT OR REMEDY THAT THE LENDERS MAY NOW OR HEREAFTER HAVE IN RESPECT OF THE OBLIGATIONS AGAINST THE BORROWERS OR ANY OTHER GUARANTOR, ANY AND ALL BENEFITS OF AND RIGHTS TO PARTICIPATE IN ANY COLLATERAL, WHETHER REAL OR PERSONAL PROPERTY, NOW OR HEREAFTER HELD BY THE LENDERS, AND ANY AND ALL OTHER RIGHTS AND CLAIMS (AS DEFINED IN THE BANKRUPTCY CODE) ANY GUARANTOR MAY HAVE AGAINST ANY BORROWER OR ANY OTHER GUARANTOR, UNDER APPLICABLE LAW OR OTHERWISE, AT LAW OR IN EQUITY, BY REASON OF ANY PAYMENT UNDER THE GUARANTEE, UNLESS AND UNTIL THE OBLIGATIONS SHALL HAVE BEEN PAID IN FULL IN CASH. (b) Each Guarantor assumes the responsibility for being and keeping itself informed of the financial condition of each other Guarantor and of all other circumstances bearing upon the risk of nonpayment of the Obligations or the Guarantee of any other Guarantor that diligent inquiry would reveal, and agrees that the Lenders shall have no duty to advise any Guarantor of information regarding such condition or any such circumstances. -38- 39 8.17. Bankruptcy; No Discharge. (a) Without limiting Section 8.02 or any other provision of this Article VIII, the Guarantee shall not be discharged or otherwise affected by any bankruptcy, reorganization or similar proceeding commenced by or against any Borrower or any other Guarantor, including (i) any discharge of, or bar or stay against collecting, all or any part of the Obligations in or as a result of any such proceeding, whether or not assented to by the Lenders, (ii) any disallowance of all or any portion of any claim for repayment of the Obligations, (iii) any use of cash or other collateral in any such proceeding, (iv) any agreement or stipulation as to adequate protection in any such proceeding, (v) any failure by any Lender to file or enforce a claim against any Borrower or any other Guarantor or its estate in any bankruptcy or reorganization case, (vi) any amendment, modification, stay or cure of any Lender's rights that may occur in any such proceeding, (vii) any election by any Lender under Section 1112(b)(2) of the Bankruptcy Code, or (viii) any borrowing or grant of a Lien under Section 364 of the Bankruptcy Code. Each Guarantor understands and acknowledges that by virtue of this Guarantee, it has specifically assumed any and all risks of any such proceeding with respect to the Borrowers and each other Guarantor. (b) Notwithstanding anything in this Article VIII to the contrary, any Event of Default under Section 7.01(f) or (g) of this Agreement shall render all Obligations automatically due and payable for purposes of the Guarantee, without demand on the part of the Lenders. (c) Notwithstanding anything to the contrary herein contained, the Guarantee (and any Lien on the Collateral securing the Guarantee or the Obligations) shall continue to be effective or be reinstated, as the case may be, if at any time any payment, or any part thereof, of any or all of the Obligations is rescinded, invalidated, declared to be fraudulent or preferential or otherwise required to be restored or returned by any Lender in connection with any bankruptcy, reorganization or similar proceeding involving any Borrower, any other Guarantor or otherwise, if the proceeds of any Collateral are required to be returned by any Lender under any such circumstances, or if any Lender elects to return any such payment or proceeds or any part thereof in its sole discretion, all as though such payment had not been made or such proceeds not been received. ARTICLE IX MISCELLANEOUS 9.01. Holidays. Except as otherwise provided herein, whenever any payment or action to be made or taken hereunder or under the Notes, or the other Loan Documents shall be stated to be due on a day which is not a Business Day, such payment or action shall be made or taken on the next following Business Day and such extension -39- 40 of time shall be included in computing interest or fees, if any, in connection with such payment or action. 9.02. Amendments and Waivers. No amendment or modification of any provision of this Agreement or of any of the Notes or of any other Loan Document shall be effective without the prior written agreement of the Lenders and the Borrowers and Guarantors and no termination or waiver of any provision of this Agreement (including, without limitation, Section 2.07 hereof) or of any of the Term Notes or consent to any departure by the Borrowers and Guarantors therefrom, shall in any event be effective without the written concurrence of the Lenders, which the Lenders shall have the right to grant or withhold at their sole discretion. Any waiver or consent shall be effective only in the specific instance and for the specific purpose for which it was given. No notice to or demand on the Borrowers or the Guarantors in any case shall entitle the Borrowers or Guarantors to any other or further notice or demand in similar or other circumstances. 9.03. No Implied Waiver; Cumulative Remedies. No course of dealing and no delay or failure of the Lenders in exercising any right, power or privilege under this Agreement, the Notes or any other Loan Document shall affect any other or future exercise thereof or exercise of any other right, power or privilege; nor shall any single or partial exercise of any such right, power or privilege or any abandonment or discontinuance of steps to enforce such a right, power or privilege preclude any further exercise thereof or of any other right, power or privilege. The rights and remedies of the Lenders under this Agreement, the Term Notes and the other Loan Documents are cumulative and not exclusive of any rights or remedies which the Lenders have hereunder or thereunder or at law or in equity or otherwise. The Lenders may exercise their rights and remedies against the Borrowers, the Guarantors and the Collateral as the Lenders may elect, and regardless of the existence or adequacy of any other right or remedy. 9.04. Notices. (a) Unless otherwise provided herein, all notices, requests, demands, directions and other communications (collectively "notices") under the provisions of this Agreement, the Term Notes or any other Loan Document shall be in writing and shall be mailed (by certified mail, postage prepaid and return receipt requested), telecopied, or delivered and shall be effective (i) if mailed, three days after being deposited in the mails, (ii) if telecopied, when sent, confirmation received and (iii) if delivered, upon delivery. All notices shall be sent to the applicable party at the address stated on the signature page hereof or in accordance with the last unrevoked written direction from such party to the other parties hereto. (b) Without limiting Section 9.06 or any other provision of this Agreement, the Lenders may rely, and shall be fully protected in relying, on any notice purportedly made by or on behalf of the Borrowers or the Guarantors and the Lenders -40- 41 shall have no duty to verify the identity or authority of any Person giving such notice. The preceding sentence shall apply to all notices whether or not made in a manner authorized or required by this Agreement or any other Loan Document. 9.05. Expenses; Taxes; Attorneys' Fees; Indemnification. The Borrowers agree to pay or cause to be paid, on demand, and to save the Lenders harmless against liability for the payment of, all reasonable out-of-pocket expenses, regardless of whether the transactions contemplated hereby are consummated, including but not limited to reasonable fees and expenses of counsel for the Lenders, accounting, due diligence, periodic field audits, investigation, monitoring of assets, miscellaneous disbursements, examination, travel, lodging and meals, incurred by the Lenders from time to time arising from or relating to: (a) the negotiation, preparation, execution, delivery, performance and administration of this Agreement and the other Loan Documents, (b) any requested amendments, waivers or consents to this Agreement or the other Loan Documents whether or not such documents become effective or are given, (c) the preservation and protection of any of the Lenders' rights under this Agreement or the other Loan Documents, (d) the defense of any claim or action asserted or brought against any Lender by any Person that arises from or relates to this Agreement, any other Loan Document, such Lender's claims against the Borrowers or the Guarantors, or any and all matters in connection therewith, (e) the commencement or defense of, or intervention in, any court proceeding arising from or related to this Agreement or any other Loan Document, (f) the filing of any petition, complaint, answer, motion or other pleading by any Lender, or the taking of any action in respect of the Collateral or other security, in connection with this Agreement or any other Loan Document, (g) the protection, collection, lease, sale, taking possession of or liquidation of, any Collateral or other security in connection with this Agreement or any other Loan Document, (h) any attempt to enforce any lien or security interest in any Collateral or other security in connection with this Agreement or any other Loan Document, (i) any attempt to collect from the Borrowers or the Guarantors, (j) the receipt of any advice with respect to any of the foregoing, (k) all Environmental Liabilities and Costs arising from or in connection with the past, present or future operations of any of the Borrowers or any of the Guarantors involving any damage to real or personal property or natural resources or harm or injury alleged to have resulted from any Release of Hazardous Materials on, upon or into such property, (l) any costs or liabilities incurred in connection with the investigation, removal, cleanup and/or remediation of any Hazardous Materials present or arising out of the operations of any facility of the Borrowers, the Guarantors or their respective Subsidiaries, or (m) any costs or liabilities incurred in connection with any Environmental Lien. Without limitation of the foregoing or any other provision of any Loan Document: (x) the Borrowers agree to pay all stamp, document, transfer, recording or filing taxes or fees (including, without limitation, mortgage recording taxes) and similar impositions now or hereafter determined by the Lenders to be payable in connection with this Agreement or any other Loan Document, and the Borrowers agree to indemnify and hold the Lenders harmless from -41- 42 and against any and all present or future claims, liabilities or losses with respect to or resulting from any omission to pay or delay in paying any such taxes, fees or impositions, and (y) if the Borrowers or the Guarantors fail to perform any covenant or agreement contained herein or in any other Loan Document, any Lender may itself perform or cause performance of such covenant or agreement, and the expenses of such Lender incurred in connection therewith shall be reimbursed on demand by the Borrowers. The Borrowers agree to indemnify and defend the Lenders and their directors, officers, employees, affiliates, partners, shareholders, counsel and agents and any affiliate of any of the foregoing (collectively, the "Indemnified Parties") from, and hold each of them harmless against, any and all losses, liabilities, claims, damages, costs or expenses of any nature whatsoever (including, without limitation, fees, expenses and disbursements of counsel and amounts paid in settlement) incurred by, imposed upon or asserted against any of them arising out of or by reason of any investigation, litigation or other proceeding brought or threatened relating to, or otherwise arising out of or relating to, the execution of this Agreement, the Letter Agreement or any other Loan Document, the transactions contemplated hereby or thereby or any Loan or proposed Loan hereunder (including, but without limitation, any use made or proposed to be made by the Borrowers, the Guarantors or any of their Affiliates of the proceeds of any thereof, or the delivery or use or transfer of or the payment or failure to pay under any Loan) but excluding any such losses, liabilities, claims, damages, costs or expenses to the extent finally judicially determined, by a final and non-appealable order of a court of competent jurisdiction, to have directly resulted directly from the gross negligence or willful misconduct of the Indemnified Party. 9.06. Several and Not Joint; Limited Liability. (a) Notwithstanding anything herein or in any other Loan Document to the contrary, or any document or instrument executed and delivered in connection herewith, the parties hereto agree that the obligations, liabilities and indemnities of each Lender hereunder shall be several and not joint, and no Lender shall have any liability hereunder for any breach by any other Lender of any obligation of such Lender set forth herein or in any other Loan Document. (b) The Borrowers and Guarantors hereby acknowledge and agree that neither this Agreement nor any other Loan Document is being executed on behalf of the partners of any Lender that is a limited partnership as individuals and the obligations of this Agreement are not binding upon any of the partners, officers, employees or beneficiaries of such Lender individually but are binding only upon the assets and property of such Lender, and the Borrowers and Guarantors agrees that no beneficiary, partner, employee or officer of such Lender may be held personally liable or responsible for any obligations of such Lender arising out of this Agreement or any other Loan Document. With respect to obligations of each Lender arising out of this Agreement or any other Loan Document, the Borrowers and Guarantors shall look for payment or satisfaction of any claim solely to the assets and property of such Lender. -42- 43 (c) Magten represents and warrants to the Borrowers and Guarantors that it has full power and authority to execute and deliver this Agreement as agent or as general partner, as applicable, for the Lenders on whose behalf Magten is executing this Agreement as set forth on the signature pages hereto. Except for the foregoing representations and warranties, the Borrowers and Guarantors hereby acknowledge and agree that Magten shall not have any personal obligation or liability to the Borrowers and Guarantors under this Agreement or any other Loan Document but that it is acting solely for and on behalf of the aforementioned Lenders, and without limiting the generality of the foregoing, the Borrowers and Guarantors shall have no recourse against Magten for the performance or satisfaction of any obligation under this Agreement or any other Loan Document, but shall look for payment or satisfaction of any claim arising under this Agreement or any other Loan Document solely to the assets and properties of the Lenders. 9.07. Application. Except to the extent, if any, expressly set forth in this Agreement or in the Loan Documents, each Lender shall have the right to apply any payment received or applied by it in connection with the Obligations to such of the Obligations then due and payable as it may elect. 9.08. Severability. The provisions of this Agreement are intended to be severable. If any provision of this Agreement shall be held invalid or unenforceable in whole or in part in any jurisdiction such provision shall, as to such jurisdiction, be ineffective to the extent of such invalidity or unenforceability without in any manner affecting the validity or enforceability thereof in any other jurisdiction or the remaining provisions hereof in any jurisdiction. 9.09. Governing Law. This Agreement and the Term Notes shall be deemed to be contracts under the laws of the State of New York, without regard to choice of law principles, and for all purposes shall be governed by and construed and enforced in accordance with the laws of said State. 9.10. Prior Understandings. This Agreement supersedes all prior understandings and agreements, whether written or oral, among the parties hereto relating to the transactions provided for herein (it being agreed that with respect to the Letter Agreement, this Agreement only supersedes those transactions contemplated by the Senior Bridge Facility (as defined therein) and not any other transactions contemplated thereunder; provided, that any provision obligating the Borrowers or Guarantors to pay for Lenders' fees or expenses in connection with the Senior Bridge Facility shall not be superseded hereby). 9.11. Duration; Survival. All representations and warranties of the Borrowers and Guarantors contained herein or made in connection herewith shall survive the making of the Loans and shall not be waived by the execution and delivery of this -43- 44 Agreement, the Term Notes or any other Loan Document, any investigation by or knowledge of the Lenders, the making of any Loan hereunder, or any other event whatsoever. All covenants and agreements of the Borrowers and the Guarantors contained herein shall continue in full force and effect from and after the date hereof so long as the Borrowers may borrow hereunder and until the Obligations have been paid in full in cash. Without limitation, it is understood that all obligations of the Borrowers and the Guarantors to make payments to or indemnify the Lenders (including, without limitation, obligations arising under Section 9.05 hereof) shall survive the payment in full of the Term Notes and all Obligations and of all other obligations of the Borrowers and the Guarantors thereunder and hereunder, termination of this Agreement and all other events whatsoever and whether or not any Loans are made hereunder. 9.12. Counterparts. This Agreement may be executed in any number of counterparts and by the different parties hereto on separate counterparts each of which, when so executed, shall be deemed an original, but all such counterparts shall constitute but one and the same instrument. 9.13. Successors and Assigns. This Agreement and the other Loan Documents shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns except that the Borrowers and the Guarantors may not assign or transfer any of their rights hereunder or thereunder without the prior written consent of the Lenders. 9.14. Waiver of Jury Trial. BY ITS EXECUTION AND DELIVERY OF THIS AGREEMENT, EACH OF THE BORROWERS AND THE GUARANTORS, AND THE LENDERS HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVES ANY RIGHTS IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, OR ARISING OUT OF, UNDER OR IN CONNECTION WITH, THIS AGREEMENT, THE TERM NOTES OR ANY OTHER LOAN DOCUMENT, ANY OF THE TRANSACTIONS CONTEMPLATED HEREBY OR THEREBY OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER VERBAL OR WRITTEN) OR ACTIONS OF THE LENDERS OR ANY BORROWER OR GUARANTOR IN CONNECTION HEREWITH OR THEREWITH. THIS PROVISION IS A MATERIAL INDUCEMENT FOR EACH PARTY HERETO TO ENTER INTO THIS AGREEMENT. 9.15. Right of Setoff. Upon the occurrence and during the continuance of any Event of Default, each Lender may, and is hereby authorized to, at any time from time to time, without notice to the Borrowers or the Guarantors (any such notice being expressly waived by the Borrowers and the Guarantors) and to the fullest extent permitted by law, set off and apply any and all deposits (general or special, time or demand, provision or final) at any time held and other indebtedness at any time owing by such -44- 45 Lender to or for the credit or the account of the Borrowers and the Guarantors against any and all Obligations of the Borrowers or the Guarantors now or hereafter existing under the Loan Documents, irrespective of whether or not such Lender shall have made any demand hereunder or thereunder and although such Obligations may be contingent or unmatured. Each Lender agrees promptly to notify the Borrowers and the Guarantors after any such setoff and application made by such Lender; provided, however, that the failure to give such notice shall not affect the validity of such setoff and application. The rights of the Lenders under this Section 9.15 are in addition to the other rights and remedies (including, without limitation, other rights of setoff under applicable law or otherwise) which the Lenders may have. 9.16. Headings. Section headings herein are included for convenience of reference only and shall not constitute a part of this Agreement for any other purpose. 9.17. Forum Selection and Consent to Jurisdiction. Any litigation based hereon, or arising out of, under or in connection with, this Agreement or any other Loan Document, or any course of conduct, course of dealing, statement (whether verbal or written) or action of the Lenders or any Borrower or Guarantor may be brought and maintained exclusively in the courts of the State of New York situated in New York County or the United States District Court for the Southern District of New York; provided, however, that any suit seeking enforcement against any Collateral or other property may be brought, at the Lenders' option, in the courts of any jurisdiction where such Collateral or other property may be found. The Borrowers and the Guarantors hereby expressly and irrevocably submit to the jurisdiction of the courts of the State of New York and of the United States District Court for the Southern District of New York for the purpose of any such litigation and irrevocably agree to be bound by any judgment rendered thereby in connection with such litigation. The Borrowers and the Guarantors further irrevocably consent to the service of process (i) by registered or certified mail, postage prepaid, to the Borrowers and the Guarantors at their addresses set forth on the signature pages hereto, such service to become effective two days after such mailing, or (ii) by personal service within or without the State of New York. Nothing herein shall affect the right of the Lenders to service of process in any other manner permitted by law. The Borrowers and the Guarantors hereby expressly and irrevocably waive, to the fullest extent permitted by law, any objection which they may now or hereafter have to the laying of venue of any such litigation brought in any such court referred to above and any claim that any such litigation has been brought in an inconvenient forum. To the extent that the Borrowers and the Guarantors have or hereafter may acquire any immunity from jurisdiction of any court or from any legal process (whether through service or notice, attachment prior to judgment, attachment in aid of execution or otherwise) with respect to themselves or their property, the Borrowers and the Guarantors hereby irrevocably waive such immunity in respect of their obligations under this Agreement and the other Loan Documents. -45- 46 IN WITNESS WHEREOF, the parties hereto, by their officers thereunto duly authorized, have executed and delivered this Agreement as of the date first above written. BORROWERS: THE RUG BARN, INC. By: /s/ Murphy L. Fontenot ---------------------------- Name: Murphy L. Fontenot Title: President Address for Notices: Highway 28 Bypass Industrial Park Road Abbeville, SC 29620 HOME INNOVATIONS, INC. By: /s/ Murphy L. Fontenot ---------------------------- Name: Murphy L. Fontenot Title: President Address for Notices: 346 East Plaza Drive P.O. Box 297 Mooresville, NC 28115 -46- 47 DHA HOME, INC. By: /s/ Murphy L. Fontenot ---------------------------- Name: Murphy L. Fontenot Title: Vice President Address for Notices: 346 East Plaza Drive P.O. Box 297 Mooresville, NC 28115 R.A. BRIGGS AND COMPANY By: /s/ Murphy L. Fontenot ---------------------------- Name: Murphy L. Fontenot Title: President Address for Notices: 143 Main Street Lake Zurich, IL 60047 With a copy to: Katten, Muchin & Zavis 525 West Monroe Street Suite 1600 Chicago, IL 60661 Attention: David R. Shevitz Telephone: (312) 902-5200 Telecopier: (312) 902-1061 -47- 48 LENDERS: GENERAL MOTORS EMPLOYEES Percentage Interest: 37.25% DOMESTIC GROUP PENSION TRUST By: MELLON BANK, N.A., as Trustee By: --------------------------- Name: Title: Address for Notices: c/o Magten Asset Management 35 East 21st Street New York, NY 10010 Attention: Robert Capozzi Telephone: (212) 529-6600 Telecopier: (212) 505-0484 with a copy to: Fried, Frank, Harris, Shriver & Jacobson One New York Plaza New York, NY 10004 Attention: Brad Eric Scheler Lawrence A. First Telephone: (212) 859-8000 Telecopier: (212) 859-4000 -48- 49 HUGHES MASTER RETIREMENT Percentage Interest: 17.00% TRUST By: MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi --------------------------- Name: Robert Capozzi Title: Managing Director Address for Notices: c/o Magten Asset Management Corp. 35 East 21st Street New York, New York 10010 Attention: Robert Capozzi Telephone: (212) 529-6600 Telecopier: (212) 505-0484 with a copy to: Fried, Frank, Harris, Shriver & Jacobson One New York Plaza New York, New York 10004 Attention: Brad Eric Scheler Lawrence A. First Telephone: (212) 859-8000 Telecopier: (212) 859-4000 -49- 50 DEPARTMENT OF PENSIONS - CITY Percentage Interest: 21.40% OF LOS ANGELES By: MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi --------------------------- Name: Robert Capozzi Title: Managing Director Address for Notices: Use same address as for HUGHES MASTER RETIREMENT TRUST. MAGTEN OFFSHORE FUND LTD. Percentage Interest: 3.50% By: MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi --------------------------- Name: Robert Capozzi Title: Managing Director Address for Notices: Use same address as for HUGHES MASTER RETIREMENT TRUST. -50- 51 MAGTEN PARTNERS, L.P. Percentage Interest: 3.67% By: MAGTEN ASSET MANAGEMENT CORP., its General Partner By: /s/ Robert Capozzi --------------------------- Name: Robert Capozzi Title: Managing Director Address for Notices: Use same address as for HUGHES MASTER RETIREMENT TRUST. MAGTEN GROUP TRUST Percentage Interest: 2.37% By: MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi --------------------------- Name: Robert Capozzi Title: Managing Director Approved: CUSTODIAL TRUST COMPANY By: _________________________ Name: Title: Address for Notices: Use same address as for HUGHES MASTER RETIREMENT TRUST. -51- 52 NAVY EXCHANGE SERVICE Percentage Interest: 6.93% COMMAND RETIREMENT TRUST By: MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi --------------------------- Name: Robert Capozzi Title: Managing Director Address for Notices: Use same address as for HUGHES MASTER RETIREMENT TRUST. WESTERN UNION PENSION TRUST Percentage Interest: 5.38% By: MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi --------------------------- Name: Robert Capozzi Title: Managing Director Address for Notices: Use same address as for HUGHES MASTER RETIREMENT TRUST. -52- 53 SATURN FUND LTD. Percentage Interest: 2.50% By: MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi --------------------------- Name: Robert Capozzi Title: Managing Director Address for Notices: Use same address as for HUGHES MASTER RETIREMENT TRUST. -53- 54 GUARANTORS: DECORATIVE HOME ACCENTS, INC. By: /s/ Murphy L. Fontenot --------------------------- Name: Murphy L. Fontenot Title: President Address for Notices: Highway 28 Bypass Industrial Park Road Abbeville, SC 29620 DRAYMORE MFG. CORP. By: /s/ Murphy L. Fontenot --------------------------- Name: Murphy L. Fontenot Title: President Address for Notices: 346 East Plaza Drive Mooresville, NC 28115 HOME INNOVATIONS, INC. By: /s/ Murphy L. Fontenot --------------------------- Name: Murphy L. Fontenot Title: President Address for Notices: 346 East Plaza Drive Mooresville, NC 28115 With a copy to: Katten, Muchin & Zavis 525 West Monroe Street Suite 1600 Chicago, IL 60661 Attention: David R. Shevitz Telephone: (312) 902-5200 Telecopier: (312) 902-1061 -54- 55 ================================================================================ CREDIT AGREEMENT, dated as of May 23, 1997, among THE RUG BARN, INC., HOME INNOVATIONS, INC., DHA HOME, INC. AND R.A. BRIGGS AND COMPANY, AS BORROWERS, ------------ DECORATIVE HOME ACCENTS, INC., DRAYMORE MFG. CORP. AND HOME INNOVATIONS, INC., AS GUARANTORS, ------------- and THE LENDERS LISTED ON THE SIGNATURE PAGES HERETO, AS LENDERS ---------- ================================================================================ 56 Table of Contents ----------------- Page ---- ARTICLE I DEFINITIONS; CONSTRUCTION......................................1 1.01. Certain Definitions...............................................1 1.02. Construction.....................................................10 1.03. Accounting Principles............................................11 ARTICLE II THE TERM LOANS...............................................11 2.01. Term Loans.......................................................11 2.02. Initial Term Notes...............................................12 2.03. Subsequent Term Notes............................................12 2.04. Request for Subsequent Term Loan.................................12 2.05. Maturity Date....................................................12 2.06. Joint and Several Liability......................................13 2.07. Closing Fee......................................................14 2.08. Interest Rate....................................................14 2.09. Interest Payment Dates...........................................14 2.10. Payments ........................................................14 2.11. Use of Proceeds..................................................14 2.12. Taxes............................................................14 ARTICLE III CONDITIONS PRECEDENT TO LOANS...............................15 3.01. Conditions Precedent to Initial Term Loan........................15 3.02. Conditions Precedent to Subsequent Term Loan.....................19 ARTICLE IV REPRESENTATIONS AND WARRANTIES...............................21 4.01. Corporate Existence, Power and Authority; Subsidiaries...........21 4.02. Financial Statements; No Material Adverse Change.................21 4.03. Chief Executive Office; Collateral Locations.....................21 4.04. Priority of Liens; Title to Properties...........................22 4.05. Maintenance of Equipment.........................................22 4.06. Tax Returns......................................................22 4.07. Litigation ......................................................22 4.08. Compliance with Other Agreements and Applicable Law..............22 4.09. Employee Benefits................................................23 4.10. Environmental Compliance.........................................23 4.11. Accuracy and Completeness of Information.........................24 i 57 4.12. Survival of Warranties; Cumulative..............................24 4.13. Enforceability of Loan Documents................................24 4.14. Nature of Business..............................................25 4.15. Use of Proceeds.................................................25 4.16. Congress Debt Documents.........................................25 4.17. Registration and Transfer of Term Notes.........................25 ARTICLE V COLLATERAL...................................................26 5.01. Grant of Security Interest......................................26 5.02. Security for Secured Obligations................................29 5.03. Proceeds of Collateral..........................................29 ARTICLE VI AFFIRMATIVE AND NEGATIVE COVENANTS..........................29 6.01. Covenants Under Congress Loan Agreement.........................29 6.02. Liens...........................................................30 6.03. Indebtedness....................................................30 6.04. Post-Closing Date Covenants.....................................30 6.05. Overadvances....................................................30 ARTICLE VII DEFAULTS...................................................30 7.01. Events of Default...............................................30 7.02. Consequences of an Event of Default.............................32 7.03. Certain Remedies................................................33 7.04. Certain Events of Default.......................................33 ARTICLE VIII GUARANTEE.................................................33 8.01. Guarantee.......................................................33 8.02. Nature of Guarantee.............................................33 8.03. Authorization...................................................34 8.04. Right to Demand Full Performance................................35 8.05. Certain Waivers.................................................35 8.06. The Guarantors Remain Obligated in Event the Borrowers Are No Longer Obligated to Discharge Obligations....................36 8.07. Severability of Void Obligations under Guarantee................36 8.08. Guarantee Is in Addition to Other Security......................36 8.09. Release of Security Interest....................................37 8.10. No Bar to Further Actions.......................................37 8.11. Failure to Exercise Rights Shall Not Operate as a Waiver; No Suspension of Remedies.......................................37 ii 58 8.12. Lenders' Duties; Notice to Lenders.................................37 8.13. Successors and Assigns.............................................38 8.14. Release of Guarantee...............................................38 8.15. Execution of Guarantee.............................................38 8.16. No Subrogation; Certain Agreements.................................38 8.17. Bankruptcy; No Discharge...........................................39 ARTICLE IX MISCELLANEOUS...................................................39 9.01. Holidays...........................................................39 9.02. Amendments and Waivers.............................................40 9.03. No Implied Waiver; Cumulative Remedies.............................40 9.04. Notices............................................................40 9.05. Expenses; Taxes; Attorneys' Fees; Indemnification..................41 9.06. Several and Not Joint; Limited Liability...........................42 9.07. Application........................................................43 9.08. Severability.......................................................43 9.09. Governing Law......................................................43 9.10. Prior Understandings...............................................43 9.11. Duration; Survival.................................................43 9.12. Counterparts.......................................................44 9.13. Successors and Assigns.............................................44 9.14. Waiver of Jury Trial...............................................44 9.15. Right of Setoff....................................................44 9.16. Headings...........................................................45 9.17. Forum Selection and Consent to Jurisdiction........................45 Exhibits - -------- Exhibit A Form of Initial Term Notes Exhibit B Form of Subsequent Term Notes Exhibit C First Supplemental Indenture Exhibit D Intercreditor Agreement Exhibit E Letter Agreement Exhibit F Pledge Agreements Exhibit G Security Agreement Exhibit H Collateral Assignment of Trademarks and Trademark Licenses (Security Agreement) Exhibit I Copyright Mortgage and Security Agreement Exhibit J Landlord Waiver Letter Agreements Exhibit K Calvin Klein Letter Agreements iii 59 Schedules - --------- Schedule I Real Property Collateral Schedule II Wire Transfer Instructions Schedule III Subsidiaries Schedule IV Locations of Collateral Schedule V Litigation Schedule VI Compliance With Applicable Laws Schedule VII Environmental Compliance Schedule VIII UCC-3 Termination Statements Schedule IX Certain Trademarks and Copyrights iv EX-10.7 8 SECURITY AGREEMENT 1 EXHIBIT 10.7 SECURITY AGREEMENT Dated May 23, 1997 From THE RUG BARN, INC., HOME INNOVATIONS, INC., a Delaware corporation, DHA HOME, INC., R.A. BRIGGS AND COMPANY, DECORATIVE HOME ACCENTS, INC., DRAYMORE MFG. CORP., AND HOME INNOVATIONS, INC., a New York corporation, as Grantors, to THE LENDERS PARTY TO THE CREDIT AGREEMENT REFERRED TO HEREIN 2 TABLE OF CONTENTS Page ---- ARTICLE 1 DEFINITIONS AND INCORPORATIONS BY REFERENCE....................1 Section 1.01. Definitions....................................1 Section 1.02. Rules of Construction..........................1 ARTICLE 2 COLLATERAL.....................................................2 Section 2.01. Grant of Security Interest.....................2 Section 2.02. Security for Secured Obligations...............6 ARTICLE 3 COVENANTS, REPRESENTATIONS AND WARRANTIES......................6 Section 3.01. Representations and Warranties.................6 Section 3.02. Certain Covenants..............................9 ARTICLE 4 POSSESSION AND USE OF COLLATERAL..............................13 Section 4.01. Possession of Collateral......................13 Section 4.02. Revocation, Condemnation, Seizure, Alteration, Modification, Amendment or Suspension of Collateral.................13 Section 4.03. Place of Perfection; Records; Provisions Concerning the Receivables..................13 Section 4.04. Transfers and Other Liens.....................15 Section 4.05. Trademarks....................................15 Section 4.06. Reports and Opinions; Inspections.............17 ARTICLE 5 REMEDIES; APPLICATION OF PROCEEDS.............................17 -i- 3 Section 5.01. Lenders' Rights..................................17 Section 5.02. Lenders Appointed Attorneys-In-Fact..............18 Section 5.03. Lenders' Rights Regarding Trademarks.............18 Section 5.04. Lenders May Perform..............................19 Section 5.05. Lenders' Duties..................................19 Section 5.06. Obligations Under Related Contracts and Trademark Licenses.........................19 Section 5.07. Remedies.........................................19 Section 5.08. Discontinuance of Remedies.......................21 Section 5.09. Cumulative Remedies..............................21 Section 5.10. Indemnity and Expenses...........................21 Section 5.11. Security Interest Absolute.......................22 ARTICLE 6 MISCELLANEOUS....................................................23 Section 6.01. Amendments; Waivers; Etc.........................23 Section 6.02. Addresses for Notices............................23 Section 6.03. No Waiver; Remedies..............................24 Section 6.04. Effect of Headings...............................24 Section 6.05. Severability.....................................24 Section 6.06. Waiver of Trial by Jury..........................24 Section 6.07. Continuing Security Interest; Assignment Under the Loan Documents............25 Section 6.08. Release and Termination..........................25 Section 6.09. Deeds of Trust or Mortgage.......................25 Section 6.10. Governing Law; Terms.............................26 -ii- 4 Section 6.11. Execution in Counterparts........................26 Schedules - --------- Schedule I -- List of Trademarks, Tradenames, Applications and Copyrights Schedule II - List of Deposit Accounts Schedule III - List of Subsidiaries Schedule IV - Locations of Collateral Schedule V - Chief Executive Offices Schedule VI - Schedule of UCC Filings Schedule VII - Taxpayer Identification Numbers Schedule VIII - Licensing and Franchising Agreements Exhibits - -------- Exhibit A - Collateral Assignments of Trademarks and Trademark Licenses (Security Agreements) Exhibit B - Copyright Mortgages and Security Agreements -iii- 5 SECURITY AGREEMENT SECURITY AGREEMENT, dated May 23, 1997 made by THE RUG BARN, INC., a South Carolina corporation, HOME INNOVATIONS, INC., a Delaware corporation, DHA HOME, INC., a Delaware corporation, and R.A. BRIGGS AND COMPANY, an Illinois corporation (each a "Borrower" and collectively, the "Borrowers"), and DECORATIVE HOME ACCENTS, INC., a Delaware corporation, DRAYMORE MFG. CORP., a North Carolina corporation, and HOME INNOVATIONS, INC., a New York corporation, (the "Guarantors" and together with the Borrowers, the "Grantors", and each individually a "Grantor") in favor of the Lenders party to the Loan Agreement referred to below. RECITALS: WHEREAS, the Borrowers, the Guarantors and certain lenders party thereto (the "Lenders") are parties to a Credit Agreement, dated as of May 23, 1997 (such Loan Agreement, as amended or otherwise modified from time to time, being hereinafter referred to as the "Loan Agreement"); WHEREAS, pursuant to the Loan Agreement, the Lenders have agreed to make Loans (as defined in the Loan Agreement) to the Borrowers; WHEREAS, pursuant to the Guarantee, the Guarantors have guaranteed the Obligations (as defined in the Loan Agreement); WHEREAS, it is a condition precedent to the Lenders making any Loan pursuant to the Loan Agreement that the Grantors shall have executed and delivered to the Lenders a security agreement providing for the grant to the Lenders of a security interest in all assets and property of the Grantors; NOW, THEREFORE, in consideration of the premises and the agreements herein and in order to induce the Lenders to make and maintain the Loans pursuant to the Loan Agreement, the Grantors hereby agree with the Lenders as follows: ARTICLE 1 DEFINITIONS AND INCORPORATIONS BY REFERENCE Section 1.01. Definitions. Capitalized terms that are not otherwise defined herein shall have the respective meanings ascribed to them in the Loan Agreement. Section 1.02. Rules of Construction. Unless the context otherwise requires: 6 (a) the term has the meaning assigned to it; (b) whenever the context may require, any pronoun shall include the corresponding masculine, feminine and neuter forms; (c) the words "include", "includes" and "including" shall be deemed to be followed by the phrase "without limitation"; (d) references to documents, contracts or agreements, shall include any and all supplements and amendments thereto; (e) references to a specific person shall include the successors and assigns of such person; (f) references to "applicable laws" shall include statutes, ordinances, rules, regulations, court and administrative decisions and conditions, restrictions and limitations in licenses, permits, approvals and authorizations issued or granted by federal, state or local United States or foreign governmental bodies and agencies; (g) unless otherwise specified in the computation of a period of time from a specified date to a later specified date, the word "from" means "from and including", and the words "to" and "until" each mean "to but excluding"; (h) words in the singular include the plural, and words in the plural include the singular; (i) provisions apply to successive events and transactions; and (j) "herein", "hereof" and other words of similar import refer to this Agreement as a whole and not to any particular Article, Section or other subsection. ARTICLE 2 COLLATERAL Section 2.01. Grant of Security Interest. As collateral security for all of the Secured Obligations (as defined in Section 2.02 hereof), each Grantor hereby pledges and assigns to the Lenders, their successors and assigns, and hereby grants to the Lenders an undivided continuing senior, first priority security interest (the "Security Interest") in and to all of such Grantor's right, title and interest in and to the following (the "Collateral"): (a) all equipment of any kind and in all of its forms, wherever located and whether now or hereafter existing and whether now owned or hereafter acquired -2- 7 (including, but not limited to, all machinery, apparatus, furniture, fixtures, but excluding fixtures bearing or identified by the Calvin Klein Intellectual Property (unless removed or as approved by Calvin Klein, Inc.), conveyors, tools, attachments, materials, storage and handling equipment, motor vehicles, boats, trucks, trailers, vessels, aircraft and rolling stock and all parts thereof), together with all substitutes, replacements, accessions and additions thereto, and all tools, parts, accessories and attachments used in connection therewith (hereinafter collectively referred to as the "Equipment"); (b) all Inventory of any kind and in all of its forms, wherever located and whether now or hereafter existing and whether now owned or hereafter acquired; (c) (i) all accounts, contract rights, chattel paper, instruments, deposit accounts, general intangibles and other obligations of any kind (including, but not limited to, any obligations of a Grantor to another Grantor) whether now or hereafter existing, whether now owned or hereafter acquired, and whether or not arising out of or in connection with the sale or lease of goods or the rendering of services, and (ii) all rights now or hereafter existing in and to all credit insurance, guaranties, letters of credit, security agreements, leases and other contracts now or hereafter existing and securing or otherwise relating to any such accounts, contract rights, chattel paper, instruments, deposit accounts, general intangibles or obligations (any and all such accounts, contract rights, chattel paper, instruments, deposit accounts, general intangibles and obligations being hereinafter referred to collectively as the "Receivables", and any and all such credit insurance, guaranties, letters of credit, leases, security agreements and other contracts (specifically excluding the Calvin Klein License) being hereinafter referred to collectively as the "Related Contracts"); (d) (i) all trademarks, service marks, trade names, business names, trade styles, designs, logos, other source or business identifiers, copyrights and all general intangibles of like nature, now or hereafter owned, adopted, acquired or used by any Grantor (including, without limitation, all trademarks, service marks, trade names, business names, trade styles, designs, logos and other source or business identifiers and copyrights described in Schedule I hereto, all applications, registrations and recordings thereof (including, without limitation, applications, registrations and recordings in the United States Patent and Trademark Office or in any similar office or agency of the United States, any state thereof or any other country or any political subdivision thereof), and all reissues, extensions or renewals thereof, together with all goodwill of the business symbolized by such marks and all customer lists, formulae and other records of any Grantor relating to the distribution of products and services in connection with which any of such marks are used, and all income, royalties, damages and payments now or hereafter due and/or payable under and with respect thereto, including, without limitation, payments under all licenses entered into in connection therewith and damages and payments for past and future infringements or dilutions thereof and the right to sue for -3- 8 past, present and future infringements and dilutions thereof (hereinafter referred to collectively as the "Trademarks"); provided, however, that Trademarks excludes any and all interests and/or rights to use the trademark "Calvin Klein" (or "CK/Calvin Klein" or other derivative thereof) deriving from the Calvin Klein License or otherwise including any and all copyrights, copyrightable material or other intellectual property or proprietorial data or information which may exist or arise in connection therewith or relating thereto (collectively, the "Calvin Klein Intellectual Property"), and (ii) all licenses (other than the Calvin Klein License and any sublicenses thereunder), contracts or other agreements, whether written or oral, naming any Grantor as licensor or licensee and providing for the grant of any right to use any Trademark, together with any goodwill connected with and symbolized by any such trademark licenses or agreements and the right to prepare for sale and sell any and all Inventory now or hereafter owned by any Grantor and now or hereafter covered by such licenses (hereinafter referred to collectively as the "Trademark Licenses"); (e) (i) all moneys, securities and other property, and the proceeds thereof, now or hereafter held or received by, or in transit to, the Lenders from or for any Grantor, whether for safekeeping, pledge, custody, transmission, collection or otherwise, and all of the Grantor's claims against any Lender at any time existing; (ii) all rights relating to the sale or other transfer of property to, or the construction, renovation or other improvement of property by or for, any Grantor; (iii) all rights, interests, choses in action, causes of actions, claims and all other intangible property of every kind and nature, in each instance whether now owned or hereafter acquired by any Grantor, including, without limitation, all corporate and other business records, all loans, royalties, and all other forms of obligations receivable whatsoever (other than Receivables); (iv) all customer and supplier contracts, sale orders, rights under license and franchise agreements, and other contracts and contract rights (other than the Calvin Klein License); (v) all interests (including, without limitation, profit participations) in partnerships, joint ventures, corporations, limited liability companies or other Persons, and all other equity or debt securities issued by any Persons, including all moneys due from time to time in respect thereof; (vi) all federal, state and local tax refunds and federal, state and local tax refund claims; (vii) all right, title and interest under leases, subleases, licenses and concessions and other agreements relating to personal property, including all moneys due from time to time in respect thereof; (viii) all payments due or made to any Grantor in connection with any requisition, confiscation, condemnation, seizure or forfeiture of any property by any Person, Governmental Authority or regulatory body; (ix) all deposit accounts (general or special) with any bank or other financial institution and all funds on deposit therein and the balance from time to time in all accounts described in Schedule II hereto, and all certificates and instruments, if any, from time to time representing or evidencing any of such accounts; (x) all credits with and other claims against third parties (including carriers and shippers) (other than Receivables); (xi) all rights to -4- 9 indemnification; (xii) all reversionary interests in pension and profit sharing plans and reversionary, beneficial and residual interests in trusts; (xiii) all letters of credit, guaranties, liens, security interests and other security held by or granted to any Grantor; (xiv) all instruments, files, records, ledger sheets and documents covering or relating to any of the Collateral; (xv) all other intangible property, whether or not similar to the foregoing, in each instance, however and wherever arising (other than the Calvin Klein Intellectual Property); (xvi) all notes, certificates of deposit, deposit accounts, checks and other instruments from time to time hereafter delivered to or otherwise possessed by any Lender for or on behalf of any Grantor, in substitution for or in addition to any or all of the foregoing; and (xvii) all interest, dividends, cash, instruments and other property and assets from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of the foregoing; (f) the books and records of any Grantor relating to any of the Collateral, including, without limitation, all customer contracts, sale orders, minute books, ledgers, records, computer programs, software, printouts and other computer materials, customer lists, credit files, correspondence and advertising materials, in each case indicating, summarizing or evidencing any of the Collateral; (g) any such other property not included under paragraphs (a) through (f) above that would otherwise be deemed to constitute "Collateral" as defined in the Congress Loan Agreement, as such agreement may be amended, modified or replaced from time to time, or in any other Congress Debt Document; (h) any and all other assets or property of any kind and in all of its forms, wherever located and whether now or hereafter existing and whether now owned or hereafter acquired, not included under paragraphs (a) through (g) above; and (i) all proceeds (in whatever form, whether cash, securities or any other type of property) of any and all of the foregoing Collateral (including, without limitation, (A) damages and payments for past or future infringements of the Trademarks and (B) the right to sue for past, present and future infringements of the Trademarks) and, to the extent not otherwise included, all payments under insurance (whether or not the Lenders are the loss payees thereof), any indemnity, warranty or guaranty payable by reason of loss or damage to or otherwise with respect to any of the foregoing Collateral; in each case howsoever any Grantor's interest therein may arise or appear (whether by ownership, security interest, claim or otherwise). Notwithstanding the foregoing, the senior, first priority security interest granted to the Lenders in the Collateral shall be subject to Permitted Liens. -5- 10 Section 2.02. Security for Secured Obligations. This Agreement secures the payment of the Obligations and all obligations of each Grantor now or hereafter arising under or with respect to the Loan Agreement, the Guarantee, the Term Notes or any other Loan Document, whether for principal, premium, interest, fees, expenses, or otherwise, including, without limitation, the obligations to pay the Term Loans and the Closing Fee and to perform each and every obligation set forth in the Loan Agreement (including, without limitation, the Guarantee), the Term Notes and the other Loan Documents (all such obligations being hereinafter collectively referred to as the "Secured Obligations"). ARTICLE 3 COVENANTS, REPRESENTATIONS AND WARRANTIES Section 3.01. Representations and Warranties. Each Grantor represents and warrants to the Lenders as follows (which shall survive the execution and delivery of this Agreement): (a) Corporate Existence; Power and Authority; Subsidiaries. Each of the Grantors is a corporation duly organized and in good standing under the laws of its state of incorporation and is duly qualified as a foreign corporation and in good standing in all states or other jurisdictions where the nature and extent of the business transacted by it or the ownership of assets makes such qualification necessary, except for those jurisdictions in which the failure to so qualify has not had and could not reasonably be expected to have a Material Adverse Effect. The execution, delivery and performance of this Agreement, the other Loan Documents and the transactions contemplated hereunder and thereunder are all within each Grantor's corporate powers, have been duly authorized and are not in contravention of law or the terms of such Grantor's certificate of incorporation, by-laws, or other organizational documentation, or any indenture, agreement or undertaking to which such Grantor is a party or by which such Grantor or its property are bound. This Agreement and the other Loan Documents constitute legal, valid and binding obligations of each Grantor enforceable in accordance with their respective terms. No Grantor has any Subsidiaries except as set forth on Schedule III hereto. (b) Financial Statements; No Material Adverse Effect. All financial statements relating to the Grantors which have been delivered by any Grantor to Lenders on or prior to any date that this representation and warranty is made or deemed to be made have been prepared in accordance with GAAP and fairly present the financial condition and the results of operation of such of the Grantors as are included therein as at the dates and for the periods set forth therein. Since April 25, 1997, no situation, event or circumstance shall have occurred which could have a Material Adverse Effect which has not been fully and accurately disclosed to Lenders in writing. -6- 11 (c) Equipment; Inventory. All Equipment and Inventory now existing is, and all Equipment and Inventory hereafter existing will be, located at the addresses specified therefor in Schedule IV hereto, subject to the right of a Grantor to establish new locations in accordance with Section 3.02(b) hereof. Each of the Grantors' chief place of business and chief executive office, the place where each of the Grantors keeps its records concerning Receivables, the original copy of each Related Contract and all originals of all chattel paper which constitute or evidence Receivables are located at the addresses specified therefor in Schedule V hereto. None of the Receivables or the Related Contracts is evidenced by a promissory note, chattel paper or other instrument. Set forth in Schedule I hereto is a complete and correct list of each trade name used by each of the Grantors. Set forth in Schedule II hereto is a complete and correct list of each depository account and other bank and securities account of each of the Grantors, together with the account number and the type of account. (d) Related Contracts; Trademark Licenses. Each Related Contract sets forth the entire agreement and understanding of the parties thereto relating to the subject matter thereof, and there are no other agreements, arrangements or understandings, written or oral, relating to the matters covered thereby or the rights of each Grantor or any of its Affiliates in respect thereof. Each Related Contract now existing is, and each other Related Contract and Trademark License will be, the legal, valid and binding obligation of the parties thereto, enforceable against such parties in accordance with its terms. No default thereunder by any such party has occurred, nor does any defense, offset, deduction or counterclaim exist thereunder in favor of any such party. (e) Trademarks. Each of the Grantors owns and controls, or otherwise possesses adequate rights to use, all Trademarks, which are the only trademarks (other than the Calvin Klein Intellectual Property) necessary to conduct its business in substantially the same manner as conducted as of the date hereof. Schedule I hereto sets forth a true and complete list of all Trademarks owned or used by each of the Grantors as of the date hereof. All of such Trademarks are subsisting and in full force and effect, have not been adjudged invalid or unenforceable, are valid and enforceable and have not been abandoned in whole or in part. None of such Trademarks is the subject of any licensing or franchising agreement, other than those agreements described on Schedule VIII hereto. None of the Grantors has any knowledge of any conflict with the rights of others to any Trademark and, to the best knowledge of each of the Grantors, each of the Grantors is not now infringing or in conflict with any such rights of others, and, no other Person is now infringing or in conflict with any such properties, assets and rights owned or used by any of the Grantors. (f) Ownership of the Collateral. Each of the Grantors is and will be at all times the sole, exclusive, legal and beneficial owner of the Collateral in which it is granting a security interest free and clear of any Lien, except for the Security Interest and -7- 12 the Permitted Liens. No effective financing statement or other instrument similar in effect covering all or any part of the Collateral is on file in any recording or filing office except such as may have been filed in favor of the Lenders relating to the Security Interest or in respect of the Permitted Liens. Each Grantor has exclusive possession and control of its Equipment and Inventory. (g) Compliance with other Applicable Laws. The exercise by the Lenders of any of their rights and remedies hereunder will not contravene law or any contractual restriction binding on or otherwise affecting any Grantor or any of their properties and will not result in or require the creation of any Lien upon or with respect to any of its properties. (h) Governmental or Regulatory Authorizations. No authorization or approval or other action by any Governmental Authority or other regulatory body, or any other Person, is required for (i) the grant by any Grantor, or the perfection or maintenance, of the security interest purported to be created hereby in the Collateral or the execution, delivery or performance of this Agreement by any Grantor or (ii) the exercise by the Lenders of any of their rights and remedies hereunder, except with respect to the perfection of the security interest created hereby in Trademarks by the recording of this Agreement in the United States Patent and Trademark Office and the filing under the Uniform Commercial Code as in effect in the applicable jurisdiction of the financing statements described in Schedule VI hereto. (i) Priority of Liens; Title to Property. The security interests and Liens granted to Lenders under this Agreement and the other Loan Documents constitute valid and perfected first priority liens and security interests in and upon the Collateral, subject only to the Permitted Liens. Each Grantor has good and marketable title to all of its properties and assets subject to no liens, mortgages, pledges, security interests, encumbrances or charges of any kind, except the Security Interest and the Permitted Liens. (j) Perfection of Security Interest. This Agreement creates valid security interests in favor of the Lenders in the Collateral, as security for the Secured Obligations. The recording of the Collateral Assignments of Trademarks and Trademark Licenses (Security Agreements), annexed hereto collectively as Exhibit A, in the United States Patent and Trademark Office, the recording of the Copyright Mortgages and Security Agreements, annexed hereto collectively as Exhibit B, in the Library of Congress (United States Copyright Office), the filing of the financing statements described in Schedule VI hereto and, with respect to Trademarks hereafter existing, the recording in the United States Patent and Trademark Office of the appropriate documentation, shall result in the perfection of such security interests. Such security interests are, or in the case of Collateral in which any of the Grantors obtains rights after -8- 13 the date hereof, will be, perfected, senior, first priority Liens, subject only to Permitted Liens. (k) Collateral of Grantor or Grantor's Subsidiary. The Collateral consists of all of the property and assets owned by the Grantors or any of the Grantor's Subsidiaries. The Collateral includes all property and assets necessary to operate the business of the Grantors and the Grantor's Subsidiaries in the same manner as such business is conducted on the date hereof and as such business is intended to be conducted. (l) Tax Identification Number. The number listed opposite each Grantor in Schedule VII hereto is such Grantor's federal tax identification number and such Grantor shall not change such number, except upon at least 30 days, prior written notice to the Lenders and upon the taking or causing to be taken at such Grantor's expense of such actions as may be reasonably requested by the Lenders. (m) Accuracy and Completeness of Information. All information furnished by or on behalf of any Grantor in writing to Lenders in connection with this Agreement or any of the other Loan Documents or any transaction contemplated hereby or thereby, including, without limitation, all information on the Schedules attached hereto or to the Loan Agreement or any of the other Loan Documents, is true and correct in all material respects on the date as of which such information is dated or certified and does not omit any material fact necessary in order to make such information not misleading. No event or circumstance has occurred which has had or could reasonably be expected to have a Material Adverse Effect, which has not been fully and accurately disclosed to Lenders in writing. (n) Survival of Warranties; Cumulative. All representations and warranties contained in this Agreement or any of the other Loan Documents shall survive the execution and delivery of this Agreement and shall be deemed to have been made again to Lenders on the date of each additional borrowing or other credit accommodation under the Loan Agreement and shall be conclusively presumed to have been relied on by Lenders regardless of any investigation made or information possessed by Lenders. The representations and warranties set forth herein shall be cumulative and in addition to any other representations or warranties which any Grantor shall now or hereafter give, or cause to be given, to Lenders. (o) Enforceability of Loan Documents. This Agreement is, and each other Loan Document to which each Grantor is or will be a party, when delivered hereunder, will be, a legal, valid and binding obligation of the Grantors, enforceable against the Grantors in accordance with its terms. Section 3.02. Certain Covenants. So long as any Secured Obligations (whether due or not due) remain unpaid in full in cash, each Grantor will: -9- 14 (a) Compliance with Laws, Etc. Comply, and cause each of its Subsidiaries to comply, in all material respects, with all applicable laws, rules, regulations and orders, such compliance to include, without limitation, compliance with the Employment Retirement Income Security Act of 1974, as amended. (b) Location of Equipment and Inventory. Keep all Equipment and Inventory in which such Grantor is granting a security interest at the places therefor specified in Section 3.01(c) hereof or, upon 30 days' prior written notice to the Lenders, at such other places in a jurisdiction where all action required by Section 3.01(c) hereof shall have been taken with respect to such Equipment and Inventory and the Lenders' rights in such Equipment and Inventory, including, without limitation, the existence, perfection and priority of the Security Interest in such Equipment and Inventory are not adversely affected. (c) Condition of Equipment. Cause the Equipment to be maintained and preserved in the same condition, repair and working order as when acquired and in accordance with any manufacturer's manual, ordinary wear and tear excepted, and will forthwith, or in the case of any loss or damage to any Equipment as quickly as practicable after the occurrence thereof, make or cause to be made all repairs, replacements and other improvements in connection therewith which are necessary or desirable or which the Lenders may request to such end. The Grantors will promptly furnish to the Lenders a statement describing in reasonable detail any loss or damage in excess of $25,000 to any Equipment. (d) Taxes, Etc. Pay promptly when due and discharge, and cause each of its Subsidiaries to pay promptly when due and discharge, before the same shall become delinquent, all property and other taxes, assessments and governmental charges or levies imposed upon it or upon the Collateral, and all lawful claims (including claims for labor, materials and supplies) against, the Collateral that, if unpaid might by law become a Lien upon the Collateral, in accordance with, and to the extent required under, Section 4.06 of the Loan Agreement, except to the extent the validity thereof is being contested in good faith by proper proceedings which stay the imposition of any penalty, fine or Lien resulting from the non-payment thereof and with respect to which adequate reserves in accordance with GAAP have been set aside for the payment thereof. (e) Production of Inventory. To the extent any Grantor or any of its Subsidiaries produces any Inventory in which such Grantor is granting a Security Interest, produce, and cause each of its Subsidiaries to produce, all such Inventory in compliance with all requirements of the Fair Labor Standards Act. (f) Visitation Rights. Permit the Lenders or any agents or representatives thereof from time to time upon prior reasonable notice to examine and -10- 15 make copies of and abstracts from the records and books of account of, and visit the properties of, any Grantor and any of its Subsidiaries, and to discuss the affairs, finances and accounts of any Grantor and any of its Subsidiaries with any of their officers or directors and with their independent public accountants. (g) Limitation on Accounts. Not maintain, or permit any of its Subsidiaries to maintain, any deposit accounts other than the deposit accounts set forth on Schedule II hereto or, upon prior written notice to the Lenders, such other accounts acceptable to Lenders in their reasonable discretion. (h) Further Assurances. From time to time at the sole expense of such Grantor, (i) promptly execute and deliver all further instruments and documents, and take all further action, that may be necessary or reasonably desirable, or that the Lenders may request, in order to perfect and protect any assignment or security interest granted or purported to be granted hereby, to enable the Lenders to exercise and enforce their rights and remedies hereunder with respect to any Collateral or to otherwise effect the purposes of this Agreement, including, without limitation: (A) marking conspicuously each document included in the Inventory, each chattel paper included in the Receivables, each Related Contract, each Trademark License and, at the request of the Lenders, each of its records pertaining to the Collateral with a legend, in form and substance satisfactory to the Lenders, indicating that such document, chattel paper, Related Contract, Trademark License or Collateral is subject to the Security Interest granted or created hereby; (B) if any Collateral shall be evidenced by a promissory note or other instrument or chattel paper, delivering and pledging to the Lenders hereunder such note, instrument or chattel paper duly endorsed and accompanied by duly executed instruments of transfer or assignment, all in form and substance reasonably satisfactory to the Lenders; and (C) executing and filing such financing or continuation statements, or amendments thereto, and such other instruments or notices, as may be necessary or reasonably desirable, or as the Lenders may request, in order to perfect and preserve the assignment and Security Interest granted or purported to be granted or created hereby; and -11- 16 (ii) furnish to the Lenders from time to time statements and schedules further identifying and describing the Collateral and such other reports in connection with the Collateral as the Lenders may reasonably request, all in reasonable detail. Each Grantor hereby authorizes the Lenders to file one or more financing or continuation statements, and amendments thereto, relating to all or any part of the Collateral without the signature of such Grantor where permitted by law. A photocopy or other reproduction of this Agreement or any financing statement covering the Collateral or any part thereof shall be sufficient as a financing statement where permitted by law. (i) Insurance. (i) At its own expense, maintain insurance (including, without limitation, comprehensive general liability and hazard insurance) with such responsible and reputable insurance companies or associations, in such amounts, covering such risks and in such form as shall be satisfactory to the Lenders from time to time. Each policy for liability insurance shall provide for all losses to be paid on behalf of the Lenders and any Grantor as their interests may appear, and each policy for property damage insurance shall provide for all losses (except, and so long as no Event of Default has occurred and is continuing, for losses of less than $100,000 per occurrence) to be adjusted with, and paid directly to, the Lenders. Each such policy shall in addition (i) name such Grantor and the Lenders as insured parties thereunder (without any representation or warranty by or obligation upon the Lenders) as their interests may appear, (ii) contain the agreement by the insurer that any loss thereunder shall be payable to the Lenders on their own account notwithstanding any action, inaction or breach of representation or warranty by such Grantor, (iii) provide that there shall be no recourse against the Lenders for payment of premiums or other amounts with respect thereto and (iv) provide that at least 30 days' prior written notice of cancellation or of lapse shall be given to the Lenders by the insurer. Each Grantor shall, if so requested by the Lenders, deliver to the Lenders original or duplicate policies of such insurance and, as often as the Lenders may reasonably request, a report of a reputable insurance broker with respect to such insurance. Furthermore, such Grantor shall also, at the request of the Lenders, duly execute and deliver instruments of assignment of such insurance policies and cause the insurers to acknowledge notice of such assignment. (ii) Reimbursement under any liability insurance maintained by such Grantor pursuant to the preceding paragraph may be paid directly to -12- 17 the Person who shall have incurred liability covered by such insurance. In case of any loss involving damage to Equipment or Inventory such Grantor shall make or cause to be made the necessary repairs to or replacements of such Equipment or Inventory to the extent required by Section 3.02(c) hereof, and any proceeds of insurance maintained by such Grantor pursuant to the immediately preceding paragraph shall be paid to such Grantor as reimbursement for the costs of such repairs or replacements to the extent of expenditures by the Grantor for such repairs or replacements. ARTICLE 4 POSSESSION AND USE OF COLLATERAL Section 4.01. Possession of Collateral. So long as no Event of Default has occurred and is continuing, each Grantor shall be permitted to remain in full possession, enjoyment and control of the Collateral and to manage, operate and use the same and each part thereof with the rights and franchises appertaining thereto, provided, however, that the possession, enjoyment, control and use thereof shall, at all times, be subject to the observance and performance of the terms of the Loan Agreement and the other Loan Documents. Section 4.02. Revocation, Condemnation, Seizure, Alteration, Modification, Amendment or Suspension of Collateral. Any Grantor, immediately upon obtaining knowledge of the institution of any proceedings for the revocation, condemnation, seizure, termination, alteration, modification, amendment or suspension or other taking of the Collateral or any portion thereof, shall notify the Lenders of the pendency of such proceedings. The Lenders, at the expense of such Grantor, in their capacity as secured party hereunder, may participate in any such proceedings, and such Grantor from time to time will deliver or cause to be delivered to the Lenders all instruments, documents, data and information reasonably requested by them to permit such participation. In the event of such revocation, condemnation, seizure, alteration, modification, amendment or suspension or other taking proceedings, any award or compensation payable to any Grantor shall be paid to the Lenders, and any such award or compensation shall be retained by the Lenders and applied to the repayment of the Loans. Any such award or compensation, if received by a Grantor, shall be held in trust by such Grantor for the benefit of the Lenders until such award or compensation can be paid to the Lenders. The Lenders shall be under no obligation to question the amount of the award or compensation and the Lenders may accept any such award or compensation without further duty with respect thereto. Section 4.03. Place of Perfection; Records; Provisions Concerning the Receivables. -13- 18 (a) Each Grantor shall (i) give the Lenders at least 30 days' prior written notice of any change in such Grantor's name, identity, or organizational structure, (ii) keep its principal place of business and chief executive office and the office where it keeps its records concerning the Collateral, and the original copies of any Related Contracts and all originals of all chattel paper that evidence or constitute Receivables, at the location therefor specified in Section 3.01(c) hereof, or upon 30 days' prior written notice to the Lenders, at such other locations in a jurisdiction where all actions required by Section 3.02(h) hereof shall have been taken with respect to the Collateral and (iii) hold and preserve such accurate records concerning the Receivables, Related Contracts and such chattel paper and permit representatives of the Lenders at any time during normal business hours upon prior reasonable notice to inspect and make abstracts from such records and chattel paper. (b) Except as otherwise provided in this subsection (b), each Grantor shall continue to collect, at its own expense, all amounts due or to become due such Grantor under the Receivables. In connection with such collections, such Grantor may (and, at the Lenders' direction, will) take such action as such Grantor or the Lenders may deem necessary or advisable to enforce collection of the Receivables; provided, however, the Lenders shall have the right at any time, upon the occurrence and during the continuance of an Event of Default and upon written notice to such Grantor of its intention to do so, to notify the account debtors or obligors under any Receivables of the assignment of such Receivables to the Lenders and to direct such account debtors or obligors to make payment of all amounts due or to become due to such Grantor thereunder directly to the Lenders or their designated agent and, upon such notification and at the expense of such Grantor and to the extent permitted by law, to enforce collection of any such Receivables, and to adjust, settle or compromise the amount or payment thereof, in the same manner and to the same extent as such Grantor might have done. After receipt by such Grantor of the notice from the Lenders referred to in the proviso to the immediately preceding sentence, (i) all amounts and proceeds (including instruments) received by such Grantor in respect of the Receivables shall be received in trust for the benefit of the Lenders hereunder, shall be segregated from other property and funds of such Grantor and shall be forthwith paid over to the Lenders in the same form as so received (with any necessary endorsement) and, thereafter, applied in accordance with Section 5.07(b) hereof and (ii) such Grantor shall not adjust, settle or compromise the amount or payment of any Receivable or release, wholly or partly, any account debtor or obligor thereof, or allow any credit or discount thereon. In addition, upon the occurrence and during the continuance of an Event of Default, the Lenders shall have the right to notify the United States Postal Service authorities to change the address for delivery of mail addressed to the Grantors at such address as the Lenders may designate and to do all other acts and things necessary to carry out this Agreement. -14- 19 (c) Upon the occurrence and during the continuance of any breach or default under any Related Contract or Trademark License by any party thereto other than any of the Grantors, (i) each of the Grantors will, promptly after obtaining knowledge thereof, give the Lenders written notice of the nature and duration thereof, specifying what action, if any, it has taken and proposes to take with respect thereto, (ii) each of the Grantors will not, without the prior written consent of the Lenders, declare or waive any such breach or default or affirmatively consent to the cure thereof or exercise any of its remedies in respect thereof, and (iii) each of the Grantors will, upon written instructions from the Lenders and at such Grantor's expense, take such action as the Lenders may deem necessary or advisable in respect thereof. (d) Each of the Grantors will, at its expense, promptly deliver to the Lenders a copy of each notice or other communication received by it by which any other party to any Related Contract or Trademark License purports to exercise any of its rights or affect any of its obligations thereunder, together with a copy of any reply by such Grantor thereto. (e) Each of the Grantors will exercise promptly and diligently each and every right which it may have under each Trademark License (other than any right of termination) and will duly perform and observe in all respects all of its obligations under each Trademark License and will take all actions necessary to maintain the Trademark Licenses in full force and effect. The Grantors will not, without the prior written consent of the Lenders, cancel, terminate, amend or otherwise modify in any respect, or waive any provision of, any Related Contract or Trademark License. Section 4.04. Transfers and Other Liens. Except as otherwise expressly permitted pursuant to the Loan Agreement and the other Loan Documents, no Grantor shall (i) sell, assign (by operation of law or otherwise), lease, exchange or otherwise transfer dispose of, whether in one transaction or in a series of related transactions, or grant any option with respect to, any of the Collateral, or (ii) create or suffer to exist any Lien upon or with respect to any of the Collateral, except for the Security Interest and the Permitted Liens. Section 4.05. Trademarks. (a) Each of the Grantors (either itself or through licensees) will, and will cause each licensee thereof to, take all action necessary to maintain all of the Trademarks in full force and effect, including, without limitation, using the proper statutory notices and markings and using the Trademarks on each applicable trademark class of goods in order to so maintain the Trademarks in full force free from any claim of abandonment for non-use, and each of the Grantors will not (and will not permit any licensee thereof to) do any act or knowingly omit to do any act whereby any Trademark may become invalidated. Each of the Grantors will cause to be taken all necessary steps in any proceeding before the United States Patent and Trademark Office to maintain each registration of the Trademarks, including, without -15- 20 limitation, filing of renewals, affidavits of use, affidavits of incontestability and opposition, interference and cancellation proceedings and payment of taxes. If any Trademark is infringed, misappropriated or diluted by a third party, the Grantors shall (x) upon learning of such infringement, misappropriation or dilution, promptly notify the Lenders and (y) to the extent such Grantor shall deem appropriate under the circumstances, promptly sue for infringement, misappropriation or dilution, seek injunctive relief where appropriate and recover any and all damages for such infringement, misappropriation or dilution, or take such other actions as such Grantor shall deem appropriate under the circumstances to protect such Trademark. Each of the Grantors shall furnish to the Lenders from time to time statements and schedules further identifying and describing the Trademarks and such other reports in connection with the Trademarks as the Lenders may reasonably request, all in reasonable detail and promptly upon request of the Lenders, following receipt by the Lenders of any such statements, schedules or reports, the Grantors shall modify this Agreement by amending Schedule I hereto, as the case may be, to include any Trademark which becomes part of the Collateral under this Agreement or any other Loan Document. Notwithstanding anything herein to the contrary, upon the occurrence of an Event of Default the Grantors may not abandon or otherwise permit a Trademark to become invalid without the prior written consent of the Lenders, and if any Trademark is infringed, misappropriated or diluted in any material respect by a third party, each of the Grantors will take such action as the Lenders shall deem appropriate under the circumstances to protect such Trademark. (b) In no event shall any of the Grantors, either itself or through any agent, employee, licensee or designee, file an application for the registration of any Trademark with the United States Patent and Trademark Office, unless it gives the Lenders prior written notice thereof. Upon request of the Lenders, each of the Grantors shall execute and deliver any and all assignments, agreements, instruments, documents and papers as the Lenders may reasonably request to evidence the Lenders' Security Interest in such Trademark and the general intangibles of such Grantor relating thereto or represented thereby, and each of the Grantors hereby appoints the Lenders as its attorneys-in-fact to execute and file all such writings for the foregoing purposes, all acts of such attorneys being hereby ratified and confirmed, and such power (being coupled with an interest) shall be irrevocable until the Secured Obligations are paid in full in cash. (c) If any of the Grantors shall at any time own, use or possess the right to use any registered copyright, such Grantor shall promptly notify the Lenders thereof and shall execute such documents (including any assignment for security of copyrights to be filed with the United States Copyright Office) and do such acts as shall be necessary or, in the judgment of the Lenders, desirable to subject such copyrights to the Lien of this Agreement. -16- 21 Section 4.06. Reports and Opinions; Inspections. (a) Each Grantor will furnish to the Lenders from time to time statements and schedules further identifying and describing the Collateral and such other reports in connection with the Collateral as the Lenders may reasonably request, all in reasonable detail. (b) On the Closing Date, the Grantors will furnish to the Lenders an opinion of counsel stating that, in the opinion of such counsel, the Uniform Commercial Code financing statements described on Schedule VI hereto are in proper form for filing in either the State of North Carolina, South Carolina, Illinois, Texas or New York, as the case may be, and adequately describe the Collateral in which the Lenders are granted a Security Interest by the Grantors under this Agreement. To the extent that the Security Interests in the Collateral granted by this Agreement are governed by Article 9 of the Uniform Commercial Code as in effect in the States of North Carolina, South Carolina, Illinois, Texas or New York, as to types or items of Collateral in which a security interest may be perfected by filing a financing statement in such states such security interests may be duly perfected by the filing of financial statements executed by each Grantor in the Office of the Secretary of State of either North Carolina, South Carolina, Illinois, Texas or New York, as applicable, in the case of items of Collateral which do not constitute fixtures, and in the real estate records of Iredell and Anson Counties in North Carolina, Abbeville and Chesterfield Counties in South Carolina, New York County in New York, Collin County in Texas, and Lake County in Illinois, as the case may be, in the case of items of Collateral which constitute fixtures. (c) Each of the Grantors shall permit representatives of the Lenders, upon reasonable notice and at any time during normal business hours, to inspect and make abstracts from its books and records pertaining to the Collateral, and permit representatives of the Lenders to be present at each Grantor's place of business to receive copies of all communications and remittances relating to the Collateral, and to forward copies of any notices or communications received or made by each Grantor with respect to the Collateral, all in such manner as the Lenders may require. ARTICLE 5 REMEDIES; APPLICATION OF PROCEEDS Section 5.01. Lenders' Rights. Each Grantor agrees that when any Event of Default has occurred, the Lenders may, without limitation of any other rights and remedies available at law or in equity in such event, exercise any one or more or all, and in any order, of the remedies hereinafter set forth or as set forth in the Loan Agreement or any other Loan Document, it being expressly understood that no remedy herein conferred is intended to be exclusive of any other remedy or remedies; but each and every remedy shall be cumulative and shall be in addition to every other remedy given herein or now or hereafter existing at law, in equity or by statute. Lenders acknowledge that their rights -17- 22 with respect to Inventory bearing any Calvin Klein trademark are governed by those certain letter agreements dated as of the date hereof between Calvin Klein, Inc. and Lenders, substantially in the form of Exhibit K to the Loan Agreement. Section 5.02. Lenders Appointed Attorneys-In-Fact. Each Grantor hereby irrevocably appoints each Lender such Grantor's attorney-in-fact, with full authority in the place and stead of such Grantor and in the name of such Grantor or otherwise, from time to time, to take any action and to execute any instrument which such Lender may deem necessary or advisable to accomplish the purposes of this Agreement, including, without limitation: (a) to obtain and adjust insurance required to be paid to the Lenders pursuant to Section 3.02(i) hereof; (b) to ask for, demand, collect, sue for, recover, compromise, receive and give acquittance and receipts for moneys due and to become due under or in respect of any of the Collateral; (c) to receive, endorse and collect any drafts or other instruments, documents and chattel paper, in connection with clause (a) or (b) above; and (d) to file any claims or take any action or institute any proceedings which the Lenders may deem necessary or desirable for the collection of any of the Collateral or otherwise to enforce compliance with the terms and conditions of any Related Contract or any other agreements that are part of the Collateral, or the rights of the Lenders with respect to any of the Collateral. Section 5.03. Lenders' Rights Regarding Trademarks. For the purpose of enabling the Lenders to exercise rights and remedies hereunder at such time as the Lenders shall be lawfully entitled to exercise such rights and remedies, and for no other purpose, each of the Grantors hereby grants to the Lenders, to the extent assignable, an irrevocable, non-exclusive license (exercisable without payment of royalty or other compensation to the Grantors) to use, assign, license or sublicense any of the Trademarks now owned or hereafter acquired by any Grantor, wherever the same may be located, including in such license reasonable access to all media in which any of the licensed items may be recorded or stored and to all computer programs used for the compilation or printout thereof. Notwithstanding anything contained herein to the contrary, but subject to the provisions of Section 4.05 hereof, so long as no Event of Default shall have occurred and be continuing, the Grantors may exploit, use, enjoy, protect, license, sublicense, assign, sell, dispose of or take other actions with respect to the Trademarks in the ordinary course of the business of the Grantors. Upon the payment in full of all of the Secured Obligations, the Lenders shall transfer to the Grantors all of the Lenders' right, title and interest in and to the Trademarks, and the Trademark Licenses, all without -18- 23 recourse, representation or warranty whatsoever. The exercise of rights and remedies hereunder by the Lenders shall not terminate the rights of the holders of any licenses or sublicenses theretofore granted by the Grantors in accordance with the first sentence of this Section 5.03. Each of the Grantors hereby releases each Lender from any claims, causes of action and demands at any time arising out of or with respect to any actions taken or omitted to be taken by such Lender under the powers of attorney granted herein other than actions taken or omitted to be taken through such Lender's gross negligence or willful misconduct. Section 5.04. Lenders May Perform. If any of the Grantors fails to perform any agreement contained herein, any Lender may itself perform, or cause performance of, such agreement or obligation, in the name of the Grantors or such Lender, and the expenses of such Lender incurred in connection therewith shall be payable by such Grantor pursuant to Section 5.10 hereof. Section 5.05. Lenders' Duties. The powers conferred on the Lenders hereunder are solely to protect their interest in the Collateral and shall not impose any duty upon them to exercise any such powers. Except for the safe custody of any Collateral in their possession and the accounting for moneys actually received by them hereunder, and notwithstanding any other provision herein, the Lenders shall have no duty as to any Collateral or as to the taking of any necessary steps to preserve rights against any parties or any other rights pertaining to any Collateral. Section 5.06. Obligations Under Related Contracts and Trademark Licenses. Anything herein to the contrary notwithstanding, (i) each of the Grantors shall remain liable under the Related Contracts and Trademark Licenses and otherwise with respect to any of the Collateral to the extent set forth therein to perform all of its obligations thereunder to the same extent as if this Agreement had not been executed, (ii) the exercise by the Lenders of any of their rights hereunder shall not release any Grantor from any of its obligations under the Related Contracts and Trademark Licenses or otherwise in respect of the Collateral, and (iii) the Lenders shall not have any obligation or liability by reason of this Agreement under the Related Contracts and Trademark Licenses or with respect to any of the other Collateral, nor shall the Lenders be obligated to perform any of the obligations or duties of any Grantor thereunder or to take any action to collect or enforce any claim for payment assigned hereunder. Section 5.07. Remedies. If any Event of Default under the Loan Agreement shall have occurred and be continuing: (a) the Lenders may exercise in respect of the Collateral, in addition to other rights and remedies provided for herein or otherwise available to them under the Loan Documents, all the rights and remedies of a secured party upon default under the Uniform Commercial Code in effect in any state in which any of the Collateral is located (the "Relevant UCC") and also may (i) require any Grantor to, and each Grantor hereby -19- 24 agrees that it will at its expense and upon request of the Lenders forthwith, assemble all or part of the Collateral as directed by the Lenders and make it available to the Lenders at a place or places to be designated by the Lenders that is reasonably convenient to all parties and (ii) 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 Lender's office or elsewhere, for cash, on credit or for future delivery, and at such price or prices and upon such other terms as the Lenders may deem commercially reasonable. Each of the Grantors agrees that, to the extent notice of sale shall be required by law, at least ten days' notice to such Grantor 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. The Lenders shall not be obligated to make any sale of Collateral regardless of notice of sale having been given. The Lenders 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. The Grantors hereby waive any claims against the Lenders arising by reason of the fact that the price at which the Collateral may have been sold at a private sale was less than the price which might have been obtained at a public sale or was less than the aggregate amount of the Secured Obligations, even if the Lenders accept the first offer received and do not offer the Collateral to more than one offeree, and waive all rights which any Grantor may have to require that all or any part of the Collateral be marshaled upon any sale (public or private) thereof. In addition to the foregoing, (i) upon notice from the Lenders, the Grantors shall cease any use of the Trademarks or any mark similar thereto for any purpose described in such notice; (ii) the Lenders may, at any time and from time to time, upon 10 days' prior notice to the Grantors, license, whether general, special or otherwise, and whether on an exclusive or non-exclusive basis, any of the Trademarks, throughout the world for such term or terms, on such conditions, and in such manner, as the Lenders shall in their sole discretion determine; and (iii) the Lenders may, at any time, pursuant to the authority granted in Section 5.03 hereof, execute and deliver on behalf of any of the Grantors, one or more instruments of assignment of the Trademarks (or any application or registration thereof), in form suitable for filing, recording or registration in any country; (b) any cash held by any Lender as Collateral and all cash proceeds received by any Lender in respect of any sale of, collection from, or other realization upon all or any part of the Collateral may, in the discretion of such Lender, be held by such Lender as collateral for, and/or then or at any time thereafter applied (after payment of any amounts payable to such Lender pursuant to Section 5.10(b) hereof), in whole or in part, by such Lender against, all or any part of the Secured Obligations. Any surplus of such cash or cash proceeds held by any Lender and remaining after payment in full of all the Secured Obligations shall be paid over to such Grantor of such Collateral or to whosoever may be lawfully entitled to receive such surplus; -20- 25 (c) the Lenders may exercise any and all rights and remedies of any Grantor under or in connection with the Related Contracts or Trademark Licenses or otherwise in respect of the Collateral, including, without limitation, any and all rights of such Grantor to demand or otherwise require payment of any amount under, or performance of any provision of, any Related Contract or Trademark License; and (d) all payments received by any Grantor under or in connection with any Related Contract or otherwise in respect of the Collateral shall be received in trust for the benefit of the Lenders, shall be segregated from other property and funds of such Grantor and shall be forthwith paid over to the Lenders in the same form as so received (with any necessary endorsement). Section 5.08. Discontinuance of Remedies. In case the Lenders shall have proceeded to enforce any right under this Agreement by foreclosure, sale, entry or otherwise, and such proceedings shall have been discontinued or abandoned for any reason or shall have been determined adversely, then and in every such case the applicable Grantor and the Lenders shall be restored to their former positions and rights hereunder with respect to the Collateral subject to the Security Interest created under this Agreement. Section 5.09. Cumulative Remedies. No delay or omission of the Lenders to exercise any right or power arising from the occurrence of an Event of Default or otherwise, shall exhaust or impair any such right or power or prevent its exercise during the continuance of such Event of Default. No waiver by the Lenders of any such Event of Default, whether such waiver be full or partial, shall extend to or be taken to affect the occurrence of any subsequent Event of Default, or to impair the rights resulting therefrom except as may be otherwise provided therein. No remedy hereunder is intended to be exclusive of any other remedy but each and every remedy shall be cumulative and in addition to any and every other remedy given hereunder or otherwise existing; nor shall the giving, taking or enforcement of any other or additional security, collateral or guaranty for the performance of the Secured Obligations operate to prejudice, waive or affect the security of this Agreement or any rights, powers or remedies hereunder, nor shall the Lenders be required to first look to, enforce or exhaust such other or additional security, collateral or guaranties. Section 5.10. Indemnity and Expenses. (a) Each Grantor agrees to indemnify and hold harmless each Lender (to the full extent permitted by law) from and against any and all claims, demands, losses, damages, obligations, judgments, liabilities, costs and expenses (including, without limitation, legal fees, costs, expenses and other client charges) of whatever nature arising out of or otherwise resulting from this Agreement (including, without limitation, enforcement of this Agreement). In no event shall any Lender be liable to any of the -21- 26 Grantors for any matter or thing in connection with this Agreement or any other Loan Document other than to account for moneys actually received by it in accordance with the terms hereof, its obligations hereunder, and for its gross negligence or willful misconduct with respect to the Collateral as determined by a final judgment of a court of competent jurisdiction. The indemnification of the Lenders set forth in the immediately preceding paragraph is cumulative and not exclusive of any indemnity of the Lenders set forth in the other Loan Documents. (b) Each Grantor will pay upon demand to any Lender the amount of any and all reasonable costs and expenses, including the reasonable fees, costs, expenses and other client charges of its counsel and of any experts and agents (including, without limitation, any Person which may act as agent for such Lender), that such Lender may incur in connection with (i) the preparation, negotiation, execution, delivery, recordation, administration, amendment, waiver or other modification or termination of this Agreement, (ii) the custody, preservation, use or operation of, or the sale of, collection from or other realization upon, any of the Collateral, (iii) the exercise or enforcement of any of the rights of the Lenders hereunder or (iv) the failure by such Grantor to perform or observe any of the provisions hereof, and all amounts so incurred by any Lender shall be entitled to the benefits of Section 9.05 of the Loan Agreement. (c) All indemnities contained in this Section 5.10 shall survive the termination of this Agreement. Section 5.11. Security Interest Absolute. The obligations of each of the Grantors under this Agreement are independent of the Secured Obligations, and a separate action or actions may be brought and prosecuted against any Grantor to enforce this Agreement, irrespective of whether any action is brought against any other Grantor or whether any such other Grantor is joined in any such action or actions. All rights of the Lenders and the pledge, assignment and security interest granted hereunder, and all obligations of each Grantor hereunder, shall be absolute and unconditional, irrespective of: (a) any lack of validity or enforceability of the Loan Agreement or any other Loan Document or any other agreement or instrument relating thereto; (b) any change in the time, manner or place of payment of, or in any other term of, all or any of the Secured Obligations or any other amendment or waiver of or any consent to any departure from the Loan Agreement or any other Loan Document; -22- 27 (c) any taking, exchange, release or nonperfection of any other collateral, or any taking, release or amendment or waiver of or consent to departure from any guaranty, for all or any of the Secured Obligations; (d) any manner of application of Collateral, or proceeds thereof, to all or any of the Secured Obligations, or any manner of sale or other disposition of any Collateral for all or any of the Secured Obligations or any other assets of the Grantors or any Grantor's Subsidiary; (e) any change, restructuring or termination of the corporate structure or existence of the Grantors or any Grantor's Subsidiary; or (f) any other circumstance that might otherwise constitute a defense available to, or a discharge of, any Grantor or a third party grantor of a Lien. ARTICLE 6 MISCELLANEOUS Section 6.01. Amendments; Waivers; Etc. No amendment or waiver of any provision of this Agreement, and no consent to any departure by any Grantor therefrom, shall in any event be effective unless the same shall be in writing and signed by each Lender, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. No failure on the part of the Lenders to exercise, and no delay in exercising any right hereunder or under the other Loan Documents, shall operate as a waiver thereof or consent thereto, nor shall any single or partial exercise of any such right preclude any other or further exercise thereof or the exercise of any other right. The rights and remedies of the Lenders provided herein and in the other Loan Documents are cumulative and are in addition to, and not exclusive of, any rights or remedies provided by law. The rights of the Lenders under any Loan Document against any party thereto are not conditional or contingent on any attempt by the Lenders to exercise any of their rights under any other Loan Document against such party or against any other Person. Section 6.02. Addresses for Notices. All notices and other communications provided for hereunder shall be in writing and mailed (by certified mail, postage prepaid and return receipt requested), telecopied or delivered to any Grantor or to any Lender, as the case may be, addressed to it at its address as specified below its signature line on the signature pages hereof or, as to any party, at such other address as shall be designated by such party in a written notice to each other party complying as to delivery with the terms of this Section 6.02. All such notices and other communications shall be effective (i) if mailed, three days after being deposited in the mails, (ii) if telecopied, when sent, confirmation received and (iii) if delivered, upon delivery. An -23- 28 affidavit by any person representing or acting on behalf of any Grantor or any Lender as to such mailing, having the registry receipt attached, shall be conclusive evidence of the giving of such demand, notice or communication. Where this Agreement provides for notice in any manner, such notice may be waived in writing by the Person entitled to receive such notice, either before or after the event, and such waiver shall be the equivalent of such notice. Section 6.03. No Waiver; Remedies. (a) No failure on the part of the Lenders to exercise, and no delay in exercising any right hereunder shall operate as a waiver thereof; nor shall any single or partial exercise of any right hereunder preclude any other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative, may be exercised singly or concurrently, and are not exclusive of any remedies provided by law or as set forth in the Loan Documents. (b) Failure by the Lenders at any time or times hereafter to require strict performance by any Grantor or any other Person of any of the provisions, warranties, terms or conditions contained herein or in any of the other Loan Documents now or at any time or times hereafter executed by any Grantor or any such other Person and delivered to the Lenders shall not waive, affect or diminish any right of the Lenders at any time or times hereafter to demand strict performance thereof, and such right shall not be deemed to have been modified or waived by any course of conduct or knowledge of the Lenders or any agent, officer or employee of any Lender. Section 6.04. Effect of Headings. The Article and Section headings and the Table of Contents contained in this Agreement are and shall be without substantive meaning or content of any kind whatsoever and are not a part of this Agreement. Section 6.05. Severability. In case any provision in this Agreement shall be invalid, illegal or unenforceable in any jurisdiction, such provision, as to such jurisdiction, shall be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining portions hereof or thereof or effecting the validity, legality and enforceability of the remaining portions hereof or thereof or affecting the validity or enforceability of such provision in any other jurisdiction. Section 6.06. Waiver of Trial by Jury. BY ITS EXECUTION AND DELIVERY OF THIS AGREEMENT, EACH GRANTOR HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVES ANY RIGHTS IT MAY HAVE TO TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, OR ARISING OUT OF, UNDER, OR IN CONECTION WITH, THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT, ANY OF THE TRANSACTIONS CONTEMPLATED HEREBY OR -24- 29 THEREBY OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER VERBAL OR WRITTEN) OR ACTIONS OF ANY LENDER OR ANY GRANTOR IN CONNECTION THEREWITH. THIS PROVISION IS A MATERIAL INDUCEMENT FOR EACH PARTY HERETO TO ENTER INTO THIS AGREEMENT. Such waiver of right to trial by jury is separately given, knowingly and voluntarily, by each Grantor, and this waiver is intended to encompass individually each instance and each issue as to which the right to a jury trial would otherwise accrue. The Lenders are hereby authorized and requested to submit this Agreement to any court having jurisdiction, so as to serve as conclusive evidence of each Grantor's waiver of the right to trial by jury. Further, each Grantor hereby certifies that no representative or agent of any Lender has represented, expressly or otherwise, to any Grantor that such Lender will not seek to enforce this waiver of right to trial by jury. Section 6.07. Continuing Security Interest; Assignment Under the Loan Documents. This Agreement shall create a continuing security interest in the Collateral and shall (a) remain in full force and effect until the date on which the Secured Obligations shall have been paid in full in cash, (b) be binding upon each Grantor, its successors and assigns and (c) inure, together with the rights and remedies of the Lenders hereunder, to the benefit of the Lenders, their respective successors, transferees and assigns. Except to the extent permitted under any of the Loan Documents, none of the rights or obligations of the Grantors hereunder may be assigned or otherwise transferred, and any such assignment or transfer shall be null and void. Section 6.08. Release and Termination. On the date on which the Secured Obligations shall have been paid in full in cash, the assignment and security interest granted hereby shall terminate and all rights to the Collateral shall revert to the Grantors. Upon any such termination, the Lenders, at the appropriate Grantor's expense, will return to such Grantor such of the Collateral in its possession as shall not have been sold, transferred or otherwise applied pursuant to the terms of this Agreement or any of the other Loan Documents, and will execute and deliver to such Grantor such documents prepared by such Grantor and delivered to the Lenders as such Grantor shall reasonably request to evidence such termination. Section 6.09. Deeds of Trust or Mortgages. In the event that any of the Collateral hereunder is also subject to a security interest under the terms of any mortgage or deed of trust and the terms of such mortgage or deed of trust are inconsistent with the terms of this Agreement, then with respect to such Collateral, the terms of such mortgage or deed of trust shall be controlling in the case of fixtures and leases, lettings and licenses of, and contracts and agreements relating to real property or leases of real property, and the terms of this Agreement shall be controlling in the case of all other Collateral. -25- 30 Section 6.10. Governing Law; Terms. This Agreement shall be governed by, and construed in accordance with, the laws of the State of New York, except to the extent that the validity or perfection of the security interest hereunder, or remedies hereunder, in respect of any particular Collateral are governed by the laws of a jurisdiction other than the State of New York. Unless otherwise defined herein or in any other Loan Document, terms used in Article 9 of the New York Uniform Commercial Code are used herein as therein defined. Any legal action or proceeding with respect to this Agreement or any other Loan Document, may be brought in the courts of the State of New York or in the United States District Court for Southern District of New York and, by execution and delivery of this Agreement, each of the Grantors hereby accepts for itself and in respect of its property, generally and unconditionally, the jurisdiction of the aforesaid courts. Each of the Grantors hereby irrevocably waives any objection, including, without limitation, any objection to the laying of venue or based on the grounds of forum non conveniens, which it may now or hereafter have to the bringing of any such action or proceeding in such respective jurisdictions and consents to the granting of such legal or equitable relief as is deemed appropriate by the court. Each of the Grantors irrevocably consents to the service of process of any of the aforesaid courts in any such action or proceeding by the mailing of copies thereof by registered or certified mail, postage prepaid, to such Grantor at its address provided herein, such service to become effective 30 days after such mailing. Nothing contained herein shall affect the right of any Lender to serve process in any other manner permitted by law or commence legal proceedings or otherwise proceed against each of the Grantors or any of the Grantors' property in any other jurisdiction. Section 6.11. Execution in Counterparts. This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which when so executed shall be deemed to be an original and all of which when taken together shall constitute one and the same agreement. Delivery of an executed counterpart of a signature page of this Agreement by telecopier shall be effective as delivery of a manually executed counterpart of this Agreement. Section 6.12. Conflicts. In the event that there shall be any discrepancy, inconsistency or conflict between any of the terms or provisions of this Agreement and any other Security Document, the terms and provisions of this Agreement shall prevail. -26- 31 IN WITNESS WHEREOF, each Grantor has caused this Agreement to be duly executed and delivered by its officer thereunto duly authorized as of the date first above written. THE RUG BARN, INC. By: /s/ Murphy L. Fontenot --------------------------- Name: Murphy L. Fontenot Title: President Address for Notices: Highway 28 Bypass Industrial Park Road Abbeville, SC 29620 HOME INNOVATIONS, INC., a Delaware corporation By: /s/ Murphy L. Fontenot --------------------------- Name: Murphy L. Fontenot Title: President Address for Notices: 346 East Plaza Drive Mooresville, NC 28115 DHA HOME, INC. By: /s/ Murphy L. Fontenot --------------------------- Name: Murphy L. Fontenot Title: Vice President Address for Notices: 346 East Plaza Drive Mooresville, NC 28115 -27- 32 R.A. BRIGGS AND COMPANY By: /s/ Murphy L. Fontenot --------------------------- Name: Murphy L. Fontenot Title: President Address for Notices: -------------------- 145 Main Street Lake Zurich, IL 60047 DECORATIVE HOME ACCENTS, INC. By: /s/ Murphy L. Fontenot --------------------------- Name: Murphy L. Fontenot Title: President Address for Notices: -------------------- Highway 28 Bypass Industrial Park Road Abbeville, SC 29620 DRAYMORE MFG. CORP., By: /s/ Murphy L. Fontenot --------------------------- Name: Murphy L. Fontenot Title: President Address for Notices: -------------------- 346 East Plaza Drive Mooresville, NC 28115 -28- 33 HOME INNOVATIONS, INC., a New York corporation By: /s/ Murphy L. Fontenot --------------------------- Name: Murphy L. Fontenot Title: President Address for Notices: -------------------- 346 East Plaza Drive Mooresville, NC 28115 with a copy to: Katten, Muchin & Zavis 525 West Monroe Street Suite 1600 Chicago, IL 60661 Attention: David R. Shevitz Telephone: (312) 902-5200 Telecopier: (312) 902-1061 -29- 34 Acknowledged and Agreed to: GENERAL MOTORS EMPLOYEES DOMESTIC GROUP PENSION TRUST By: MELLON BANK, N.A., as Trustee By:_______________________________ Name: Title: Address for Notices: -------------------- c/o Magten Asset Management Corp. 35 East 21st Street New York, New York 10010 Attention: Robert Capozzi Telephone: (212) 529-6600 Telecopier: (212) 505-0484 with a copy to: Fried, Frank, Harris, Shriver & Jacobson One New York Plaza New York, New York 10004 Attention: Brad Eric Scheler Lawrence A. First Telephone: (212) 859-8000 Telecopier: (212) 859-4000 -30- 35 HUGHES MASTER RETIREMENT TRUST By: MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi ----------------------- Name: Robert Capozzi Title: Managing Director Address for Notices: - -------------------- c/o Magten Asset Management Corp. 35 East 21st Street New York, New York 10010 Attention: Robert Capozzi Telephone: (212) 529-6600 Telecopier: (212) 505-0484 with a copy to: Fried, Frank, Harris, Shriver & Jacobson One New York Plaza New York, New York 10004 Attention: Brad Eric Scheler Lawrence A. First Telephone: (212) 859-8000 Telecopier: (212) 859-4000 DEPARTMENT OF PENSIONS - CITY OF LOS ANGELES By MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi ----------------------- Name: Robert Capozzi Title: Managing Director Address for Notices: - -------------------- Use same address as for HUGHES MASTER RETIREMENT TRUST. -31- 36 MAGTEN OFFSHORE FUND LTD. By: MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi ----------------------- Name: Robert Capozzi Title: Managing Director Address for Notices: - -------------------- Use same address as for HUGHES MASTER RETIREMENT TRUST. MAGTEN PARTNERS, L.P. By: MAGTEN ASSET MANAGEMENT CORP., its General Partner By: /s/ Robert Capozzi ----------------------- Name: Capozzi Title: Managing Director Address for Notices: - -------------------- Use same address as for HUGHES MASTER RETIREMENT TRUST. -32- 37 MAGTEN GROUP TRUST By: MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi --------------------------- Name: Robert Capozzi Title: Managing Director Address for Notices: - -------------------- Use same address as for HUGHES MASTER RETIREMENT TRUST. Approved: CUSTODIAL TRUST COMPANY By:___________________________ Name: Title: NAVY EXCHANGE SERVICE COMMAND RETIREMENT TRUST By: MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi --------------------------- Name: Robert Capozzi Title: Managing Director Address for Notices: - -------------------- Use same address as for HUGHES MASTER RETIREMENT TRUST. -33- 38 WESTERN UNION PENSION TRUST By: MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi --------------------------- Name: Robert Capozzi Title: Managing Director SATURN FUND LTD. By: MAGTEN ASSET MANAGEMENT CORP., as its attorney-in-fact By: /s/ Robert Capozzi --------------------------- Name: Robert Capozzi Title: Managing Director Address for Notices: - -------------------- Use same address as for HUGHES MASTER RETIREMENT TRUST. -34- EX-10.8 9 LICENSE AGREEMENT 1 EXHIBIT 10.8 CONFIDENTIALITY REQUEST PENDING LICENSE AGREEMENT AGREEMENT made as of April 27, 1997, by and between CALVIN KLEIN, INC., a New York corporation having its principal business office at 205 West 39th Street, New York, New York 10018 (the "Licensor"), and DHA HOME INC., a Delaware corporation having its principal business office at 295 Fifth Avenue, New York, New York 10016 (the "Licensee"). W I T N E S S E T H : WHEREAS, Licensor is the licensee for the Licensed Mark (as defined in Section 1.1 hereof) for the Licensed Articles (as defined in Section 1.1 hereof) pursuant to an exclusive, perpetual license from the Calvin Klein Trademark Trust (the "Trust"), the owner of such Licensed Mark for Licensed Articles; WHEREAS, Licensor and Licensee had entered into a License Agreement, dated as of May 26, 1994, as amended (the "Terminated License Agreement"), under which Licensee had been granted the right to use the Licensed Mark on the Licensed Articles in the Licensed Territory (as defined in Section 1.3 hereof), which terminated effective April 26, 1997; and WHEREAS, Licensee desires to use the Licensed Mark on the Licensed Articles, and Licensor desires to grant to Licensee a license to use the Licensed Mark on the Licensed Articles on the terms and subject to the conditions set forth herein. NOW, THEREFORE, in consideration of the premises and the mutual covenants hereinafter set forth, Licensor and Licensee do hereby respectively grant, covenant and agree as follows: 2 1. Grant of License. 1.1 Grant. Licensor hereby grants to Licensee an exclusive license (the "License") to use the trademark set forth on Schedule A, attached hereto (hereinafter referred to collectively as the "Licensed Mark") on and in connection with the manufacture, distribution and sale at wholesale throughout the Licensed Territory (as defined in Section 1.3 hereof) of the products set forth on Schedule B, attached hereto which have been approved by Licensor, from time to time for each collection, for sale in accordance with this Agreement (hereinafter referred to collectively as the "Licensed Articles"). The License shall include the right to use the Licensed Mark to advertise, market and promote the Licensed Articles as approved by Licensor in accordance with this Agreement. 1.2 [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 1.3 Licensed Territory. The "Licensed Territory" shall mean (a) the countries specified on Schedule C, attached hereto, as such schedule may be modified from time to time by written amendment to this Agreement signed by both parties hereto and [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 1.4 Limitations. All Licensed Articles shall bear the Licensed Mark except as hereinafter provided, and no Licensed Article shall be sold or otherwise distributed by Licensee under any mark other than the Licensed Mark. Licensor reserves all rights to the Licensed Mark except as specifically granted herein to -2- 3 Licensee and Licensor may exercise any of its rights at any time. Licensee specifically acknowledges that Licensor has retained the right to own, operate and license retail outlets and boutiques bearing the Licensed Mark throughout the world. Licensee acknowledges that, subject to the provisions of Section 1.2 hereof, Licensor has retained all rights in the trademark "CK/Calvin Klein" for use on the Licensed Articles and that the Trust and/or the Licensor, as applicable, has retained such rights to any "CK" derivative trademark for use on the Licensed Articles. 1.5 Best Efforts. Licensee will use its best efforts to exploit the rights herein granted throughout each jurisdiction which constitutes the Licensed Territory and to sell the maximum quantity of each category of Licensed Articles therein consistent with the high standards and prestige represented by the Licensed Mark. 1.6 Other Matters. (a) On or prior to the date hereof Licensee has paid to Licensor all amounts owed by Licensee to Licensor under the Terminated License Agreement as indicated on the statement delivered by Licensor. Licensee shall also reimburse Licensor for all costs and expenses (including the fees and expenses of Paul, Weiss, Rifkind, Wharton & Garrison and other reasonable attorneys' fees and expenses) incurred (whether prior to or after the date hereof) in connection with the preparation, negotiation, execution and enforcement of this Agreement (and matters relating thereto), but not the day-to-day maintenance of this Agreement, and the preparation, negotiation, execution and enforcement of the Letter of Intent date as of -3- 4 the date hereof (the "Letter of Intent") by and among Licensor, Decorative Home Accents, Inc. ("DHA") and Licensee and the transactions contemplated by such agreements and the review and preparation of ancillary materials and agreements. (b) In the event of any dispute between Licensee and any other licensee of Licensor in the Licensed Territory with respect to whether particular merchandise is covered by the License or by such other licensee's license, such dispute shall be submitted to arbitration before the American Arbitration Association in New York, New York. The arbitrator's determination shall be final and binding on Licensee. (c) Licensee shall not export Licensed Articles from the Licensed Territory and shall not sell Licensed Articles to any third party which may export Licensed Articles from the Licensed Territory. Licensor retains the right to use, and to grant third parties the right to use, the Licensed Mark on products which constitute Licensed Articles outside the Licensed Territory. In connection therewith, Licensor may grant third parties the right to manufacture products which constitute Licensed Articles outside the Licensed Territory as long as such Licensed Articles are not distributed or sold within the Licensed Territory by Licensor or by any such third party. Licensee agrees to fully cooperate with such third parties (including, without limitation, by supplying design data, specifications and samples) on a timely basis as requested by Licensor and Licensor shall undertake to use its reasonable best efforts to ensure that such third parties cooperate with Licensee (including, without limitation, by supplying design data, specifications and samples) on a timely basis as requested by -4- 5 Licensor. 2. Term. The term of this Agreement shall commence as of April 27, 1997 and continuing through April 30, 1998 (the "Term") unless sooner terminated in accordance with this Agreement. The term of this Agreement shall constitute and hereinafter shall be referred to as the "Annual Period." 3. The Collection. 3.1 General. Licensor and Licensee will cooperate and will exercise their respective best efforts, in the preparation of collections of Licensed Articles. The complete line of Licensed Articles (the "Collection") shall be manufactured, marketed and sold under the name "Calvin Klein Home." Licensee shall prepare and file a fictitious name certificate (a "doing business as" or "d/b/a" certificate) evidencing such name. Licensee may only use the name "Calvin Klein Home." during the Term as its fictitious name and not its legal or corporate name and shall immediately upon termination of the Term, change such name so that it does not include either of the names "Calvin Klein" or "CK/Calvin Klein" or any variation thereof and file a termination of the fictitious name certificate referred to above. No sublicensee of the Licensee may include in its name either of the names "Calvin Klein" or "CK/Calvin Klein" or any variation thereof. There will be only two seasonal collections of Licensed Articles during the Annual Period, i.e., the Fall/Winter 1997 collection and the Spring/Summer 1998 collection. In no event will any designs, preparations or other matters relating to any collection subsequent to Spring/Summer 1998 be covered under this Agreement and Licensor will have no obligations as to the -5- 6 same. 3.2 Designs. Within a reasonable period of time prior to the commencement of the design of each seasonal collection of Licensed Articles, Licensor will provide Licensee with creative concepts and fashion direction as to each such seasonal collection, including recommendations as to color, material, design and styling of Licensed Articles and such additional design assistance as Licensor and Licensee mutually determine is necessary in order to timely complete the seasonal collection. Specifically, Licensor shall provide Licensee with such information and assistance based upon the schedule set forth on Schedule D, attached hereto, as agreed to by Licensor and Licensee for development of all seasonal collections. Licensor shall designate at least one individual who shall have principal responsibility for the Collection and whose primary responsibilities during normal business hours shall be relating to the Collection. Licensor may, from time to time, submit to Licensee sketches, designs, colors, samples, labels, and packaging and other materials for use by Licensee in connection with its preparation of collections of the Licensed Articles. In order to present a representative seasonal collection for each category of Licensed Articles, Licensee will utilize a sufficient number of designs submitted or approved by Licensor and produce and offer for sale those Licensed Articles which are produced therefrom, unless Licensor otherwise consents. 3.3 Showroom. Licensee will be responsible [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] the design, development, construction and maintenance of a showroom or showrooms in accordance with the -6- 7 provisions of Section 5(b) hereof and in-store shops or stores in which Licensed Articles are sold all of which shall be subject to the on-going approval of Licensor. 3.4 Samples. Licensee shall make available to Licensor, without charge, three samples per SKU of each Licensed Article, or such other reasonable quantities of Licensed Articles as requested by Licensor, for use in advertising and promotion. Licensee shall permit Licensor and its employees and other representatives to purchase, from time to time, reasonable quantities of Licensed Articles for personal use at regular wholesale prices. 3.5 Confidentiality. (a) All information relating to this Agreement and any related agreements entered into by the parties or relating to the Licensor and its Affiliates and/or designees which Licensee learns or has learned since the commencement of negotiation of the Terminated License Agreement, all design concepts which Licensor or its Affiliates or designees provide to Licensee hereunder and all sketches and designs received by Licensee from Licensor or its Affiliates or designees or are approved for use in connection with the Licensed Articles and all Works of Authorship (collectively, "Licensor's Data") are valuable property of Licensor and such Affiliates or designees. Licensee acknowledges the need to preserve the confidentiality and secrecy of Licensor's Data. During and after the Term, Licensee will not use or disclose same (except for use required to fulfill the provisions of this Agreement during the Term and the inventory disposal period referred to in Section 14.1, and will take all necessary steps to ensure that the use of Licensor's Data -7- 8 by Licensee or its Affiliates or designees (which use by the designees will be solely as necessary for the manufacture, distribution, sale, advertising or promotion of Licensed Articles hereunder) will preserve such confidentiality and secrecy in all respects. Notwithstanding the foregoing, Licensee's obligation to keep Licensor's Data confidential will terminate (except for designs and design concepts and materials) at such time and solely to the extent that any such Licensor's Data will become generally known to the public and in the public domain, through no fault of Licensee or any of its Affiliates or designees. (b) All information relating to Licensee and its Affiliates and/or designees which Licensor learns or has learned since the commencement of negotiation of the Terminated License Agreement other than Licensor's Data (collectively "Licensee's Data") is valuable property of Licensee and such Affiliates or designees. Licensor acknowledges the need to preserve the confidentiality and secrecy of Licensee's Data. During and after the Term, Licensor will not use or disclose same (except for use required to fulfill the provisions of this Agreement during the Term and use deemed necessary by Licensor in connection with its business; provided, that such use will not include disclosure of non-public financial information (excluding information such as sales levels, advertising expenditures and other information relating to the operations of this Agreement) unless covered by a confidentiality agreement, and will take all necessary steps to ensure that the use of Licensee's Data by Licensor or its Affiliates or designees (which use by such designees will be solely as necessary for the manufacture, distribution, sale, advertising or promotion of Licensed Articles -8- 9 hereunder) will preserve such confidentiality and secrecy in all respects. Notwithstanding the foregoing, Licensor's obligations to keep Licensee's Data confidential will terminate at such time and solely to the extent that any such Licensee's Data will become generally known to the public and in the public domain, through no fault of Licensor or any of its Affiliates or designees. 4. Quality Control. 4.1 General. The components, workmanship, fit and durability of the Licensed Articles, and of all packaging and ancillary materials related to Licensed Articles, will at all times be of the highest quality and commensurate with the reputation, image and prestige of the Licensed Mark. 4.2 [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 4.3 Approvals. Licensor will have the right to approve the styles, designs, packaging, components, workmanship, quality, display, merchandising, advertising and promotion of all Licensed Articles so as to ensure that the Licensed Articles comply with Section 4.1. All such approvals shall be given in writing and shall be given within ten business days of submission by Licensee and requests for approval of such submissions. In the event that such approval is not given within the specified time period, the submitted Licensed Articles shall be deemed approved. 4.4 Maintenance of Quality. Before selling, distributing or promoting any Licensed Article, Licensee will deliver to Licensor for its approval, free of charge, one prototype sample of each such Licensed Article together with prototype -9- 10 tags, labels and packaging and other ancillary material to be used in connection therewith. In addition, upon Licensor's request, Licensee will deliver to Licensor, free of charge, initial and/or then current production samples of each Licensed Article produced hereunder together with the tags, labels and packaging being used in connection therewith so that Licensor may assure itself of the maintenance of the quality standards set forth herein. Licensor and its duly authorized representatives will have the right, upon reasonable advance notice and during normal business hours, to examine Licensed Articles in the process of being manufactured and to inspect all facilities utilized by Licensee and its contractors in connection therewith. 4.5 [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 4.6 Advertising and Promotional Materials. Before using any proposed advertising or promotional material or publicity material or any other printed matter, Licensee will submit the same to Licensor for Licensor's approval, which shall be given in accordance with the provisions of Section 4.3 hereof. After any sample, copy, art work or other material has been approved, Licensee will not depart therefrom in any material respect, without the prior written approval of Licensor. 4.7 Distribution. In order to maintain the reputation, image and prestige of the Licensed Mark, Licensee's distribution patterns shall consist of those retail outlets whose location, merchandising and overall operations are consistent with the high quality of the Licensed Articles and the reputation, image and prestige of the Licensed Mark and as are approved by Licensor on an ongoing basis. -10- 11 4.8 [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 5. Covenants of Licensee. Licensee, during the term of this Agreement, may not use "Calvin Klein" or "CK" or any variation or derivation thereof as part of its corporate name, but may do business as (d/b/a) or use the name "Calvin Klein Home," and no other name or mark. Licensee shall be exclusively engaged in the business of performing the obligations and responsibilities of Licensee hereunder. Licensor shall furnish Licensee with any corporate consents necessary to allow Licensee to use the name "Calvin Klein Home" during the Term and Licensee shall change such name at the conclusion of the Term to remove the Licensed Mark. The use of the Licensed Mark in connection herewith shall be subject to the provisions of Section 10 below. In connection with the operation of such business, Licensee shall: (a) employ, on an exclusive basis, a "President" of the Company who shall be subject to the ongoing approval of Licensor, both upon and throughout his or her employment with Licensee, and such sales, merchandising, production and public relations personnel as will enable Licensee to exploit the License herein granted and to maintain the quality standards required hereunder; (b) maintain throughout the term of this Agreement, a separate showroom in New York, New York for the sole purpose of displaying, promoting and selling the Licensed Articles, located at 205 West 39th Street, New York, New York and which shall occupy at least 50% of an entire floor at such location -11- 12 (unless otherwise agreed to by Licensor) and the decor of which shall be subject to the ongoing approval of Licensor (which shall include the selection or approval of the architect for such showroom, as well as all plans for such location). [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] (c) [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] (d) furnish Licensor with information regarding the above as Licensor may, from time to time, reasonably request; and (e) deliver: (i) by March 31, 1998, copies of its unaudited statement of operations and balance sheet prepared in accordance with, or supplemental to ensure compliance with, U.S. generally accepted accounting principles, consistently applied ("US GAAP"), together with a certificate executed by Licensee's chief financial officer certifying Licensee's compliance with and setting forth computations necessary to demonstrate Licensee's compliance with the financial covenants referred to in Section 5(c) and DHA's Annual Report on Form 10-K; (ii) within 45 days after the close of each calendar quarter copies of financial reports, which will be prepared on a basis consistent with the annual financial reports together with the chief financial officer's certificate described in Section 5(e)(i) above and DHA's Quarterly Report on Form 10-Q; and (iii) promptly (and in any event within five business days) after -12- 13 discovery thereof, notice of any failure comply with any of the financial covenants contained in Section 5(c). 6. Amounts Expended for Advertising and Promotion. 6.1 [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 6.2 Definition of Consumer Advertising. For purposes hereof, consumer advertising shall be deemed to exclude co-operative and trade advertising and to include print advertisements in prestigious national publications and such other approved forms of advertisements and promotions as Licensor may deem to be consumer advertising. 6.3 [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 6.4 Publicity/Press Releases. Licensee recognizes that its public actions and statements can affect the image of Licensor, the Licensed Mark, the Licensed Articles and Licensor's other trademarks, licensees and licensed products. Accordingly, (a) the use and release of any and all promotional material (printed or otherwise) relating to the Licensed Articles or Licensee's activities pursuant to this Agreement in the nature of press releases, interviews or other public relations events, and (b) any other corporate release, data or information of Licensee or DHA referring to or relating to the Licensed Mark, the Licensed Articles, this Agreement or the operations hereunder which will or is likely to become public or of DHA, which does not refer or relate to any of the foregoing, which will or is likely to become public and, -13- 14 if so, could in DHA's reasonable opinion affect such image, will be prepared or conducted in consultation with, and subject to guidelines prepared by Licensor and the prior approval of, Licensor's Public Relations Department, which shall promptly be addressed by such department. After any such approval, Licensee will not modify the approved material or activity in any material respect unless such modification is specifically approved by Licensor's Public Relations Department. 7. Approvals. Licensee acknowledges that all approvals required pursuant to this Agreement may be based solely on Licensor's subjective aesthetic standards and may be granted or withheld in Licensor's sole and absolute discretion. 8. Royalties. 8.1 [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 8.2 [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 8.3 [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 8.4 Statement and Payments. Within 30 days after the close of each "quarter" (i.e., each three (3) month period during the Annual Period), Licensee shall deliver to Licensor statements (the "Quarterly Statements") signed by an officer of Licensee and certified by him as accurate, indicating, by month, the amount of Net Sales by product categories, showing separately by account units and gross sales of Licensed Articles shipped, the type and amount of discounts and credits deductible from -14- 15 gross sales, the applicable royalty rate, a computation of the amount of the Actual Royalties payable and a computation of the Minimum Advertising Expenditure for such quarter and the amounts and details of all advertising and promotional expenditures (including remittances to Licensor if any). Licensee also shall use its best efforts to break down Net Sales by jurisdiction on such Quarterly Statements. The Actual Royalties for the Licensed Articles for such preceding quarter shall accompany the Quarterly Statements. All payments required of Licensee hereunder shall be made to Licensor in New York, New York in U.S. Dollars. Where sales of Licensed Articles are made in currency other than U.S. Dollars, the royalties shall be computed on the basis of the conversion rate of local currency into U.S. Dollars in effect in New York, New York at Chemical Bank as of the close of business on the last day of each applicable quarter of the Annual Period (with appropriate verification of such conversion rates supplied to Licensor). Notwithstanding any provision of this Agreement or of any other agreement, instrument or undertaking to the contrary, Licensee shall not have the right to set off or otherwise withhold any amount payable to Licensor pursuant to this Agreement against the amount of any claim or other cause of action that Licensee may have against Licensor pursuant to this Agreement or to any other agreement, instrument or undertaking. 8.5 Report of Independent Accountants. Licensee shall furnish to Licensor not later than 90 days following the close of the Annual Period during the Term (or portion thereof), a report certified by the independent certified public accountants of the Licensee covering the Annual Period (or portion thereof) and -15- 16 containing the same information required to be contained in the statements referred to in Section 8.4 above. 8.6 [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 9. Record Keeping. 9.1 Books and Records. Licensee will prepare and maintain, in accordance with generally accepted accounting principles consistently applied, complete and accurate books of account and records covering all transactions relating to this Agreement and Licensee's performance hereunder. Licensor and its duly authorized representatives have the right, during regular business hours and upon reasonable notice, for the duration of this Agreement and for two years thereafter, to examine said books of account and records and all other documents and material in the possession or under the control of Licensee or its affiliates with respect to the subject matter and the terms of this Agreement. In addition, Licensee shall use its reasonable efforts to provide Licensor with access to the workpapers of Licensee's independent accountants as permitted thereby. All such books of account, records and documents will be kept available by Licensee for at least two years after the Annual Period. 9.2 Audit. If, as a result of any examination of Licensee's books and records, it is shown that Licensee owes Actual Royalties to Licensor, Licensee shall promptly make all payments required to be made to eliminate any discrepancy which was revealed by said examination and if such amount is in excess of 5% of the Actual Royalties paid to Licensor, Licensee will also promptly reimburse Licensor for -16- 17 the cost of such examination. 10. The Licensed Mark. 10.1 General. Licensees agrees that (a) no name or names shall be co-joined with the Licensed Mark, and (b) no other name or names shall be used in connection with the Licensed Mark in any advertising, promotion, publicity, labeling, packaging or printed matter of any kind utilized by Licensee in connection with the Licensed Articles, except and only to the extent Licensor consents in writing. 10.2 Ownership of Licensed Mark. Licensee acknowledges that Licensor is the beneficial owner of all rights, title and interest in and to the Licensed Mark in the world in any form or embodiment thereof as such relate to the Licensed Articles and that the Trust is the owner of the Licensed Mark and the goodwill related thereto in the world in any form or embodiment thereof. Licensee will not, at any time, do or suffer to be done any act or thing which may in any way adversely affect any rights of Licensor or the Trust in and to the Licensed Mark or any registrations thereof or any applications for registration thereof or which, directly or indirectly, may reduce the value thereof or detract from their reputation, image or prestige or that of Licensor or Calvin Klein. Licensor, and its officers, directors and shareholders, shall not, at any time, do or suffer to be done any act or thing which, directly or indirectly, may reduce the value of the Licensed Mark or detract from their reputation, image or prestige or that of Licensor or Calvin Klein. [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 10.3 Cooperation. Licensee will, at Licensor's request and -17- 18 expense, execute any and all documents and take any actions required by Licensor to confirm the Trust's ownership of and Licensor's beneficial ownership of all rights in and to the Licensed Mark in the world and the respective rights of the Trust, Licensor and Licensee pursuant to this Agreement. 10.4 No Challenge. Whether during the term of this Agreement or subsequent to its termination, Licensee will never (a) challenge the Trust's ownership or Licensor's beneficial ownership of or the validity of the Licensed Mark or any application for registration thereof, or any trademark registration thereof, or any rights of Licensor therein, nor (b) challenge the fact that Licensee's rights pursuant to this Agreement are solely those of a licensee. 10.5 Copyright. Licensee acknowledges that Licensor owns and will own all rights including copyrights in and to certain works of authorship created by Licensor including fabric designs (hereinafter "Works of Authorship") for use on Licensed Articles and in connection with the Licensed Mark. Licensor grants to Licensee a license to reproduce the Works of Authorship in copies on Licensed Articles bearing the Licensed Mark, and on advertising, promotional and packaging materials for the same, as applicable, and to distribute and sell such copies in accordance with the terms of this Agreement. Upon preparation by Licensee of any works of authorship ("New Works") or contributions to Licensor's Works of Authorship ("Contributions") for use in connection with the Licensed Mark on Licensed Articles, Licensee hereby assigns to Licensor all right, title and interest in and to such New Works and Contributions, and Licensee shall execute and deliver to Licensor such further -18- 19 instruments of ownership and transfer in respect thereto as Licensor may request. If Licensee shall fail to do so, Licensor may execute such instruments on behalf of Licensee and make appropriate disposition thereof. New Works and Contributions may be prepared by Licensee only through Licensee's employees whose contribution is to be considered as a "work made for hire" and by others who have executed a written assignment of their contribution in favor of Licensee. Licensee shall fully cooperate with Licensor to ensure that copyright notice in the name of Licensor appears on the Licensed Articles to the extent they incorporate Works of Authorship. Infringements of Licensor's copyrights in the Works of Authorship shall be governed by the provisions of Section 11. 11. Infringements. In the event that Licensee learns of any infringement or imitation of the Licensed Mark or of any use by any person of a trademark similar to the Licensed Mark or of any acts of unfair competition involving the Licensed Mark, it will promptly notify Licensor thereof. Licensor will take such action as it deems advisable for the protection of Licensor's rights in and to the Licensed Mark, including, without limitation, requesting Licensee to take action in Licensor's name and on Licensor's behalf and Licensee shall cooperate with Licensor in all material and reasonable respects, provided that Licensee need not take action if it reasonably determines not to do so. With respect to any such infringement actions taken by Licensee, Licensee shall bear the expenses thereof. If Licensee determines not to take any action and Licensor then decides it will take action relative thereto, Licensor will bear its expenses in connection therewith. Licensee will cooperate with -19- 20 Licensor with regard to any such action. Licensor will not be required to take any action it deems inadvisable and Licensee will have no right to take any action with respect to the Licensed Mark without Licensor's prior written approval. Licensee will take no action, including, without limitation, settling any action, appealing any adverse decision or discontinuing any action taken by it, except to the extent the same is approved in advance by Licensor. [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 12. Indemnification. 12.1 By Licensee. Licensee does hereby indemnify Licensor, the Trust and Calvin Klein, individually, against, and save and hold each of them harmless of and from, any and all losses, liability, damages and expenses (including reasonable attorneys' fees and expenses) which may arise in connection with Licensee's performance of this Agreement and transactions arising therefrom. The provisions of this section and the obligations of Licensee set forth herein shall survive expiration or other termination of this Agreement. 12.2 [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 12.3 Insurance. Licensee will maintain at all times during which Licensed Articles are being sold a public liability insurance policy, including products liability coverage as well as contractual liability with respect to this Agreement, with a limit of liability of not less than $5,000,000 in the aggregate. Licensee will deliver certificates of such insurance to Licensor promptly upon issuance of said policy and -20- 21 annually thereafter. Insurance will not be deemed to limit the indemnification provisions of Section 12.1 above. 13. [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 14. Expiration or Termination. 14.1 Rights and Obligations Upon Expiration or Termination. On the expiration or earlier termination of this Agreement all the rights of Licensee hereunder shall forthwith terminate and automatically revert to Licensor. However, in the event of expiration or earlier termination of this Agreement other than material breach or bankruptcy of Licensee, Licensee shall be entitled, for six months only, on a non-exclusive basis, to continue to sell its inventory of the Licensed Articles. Such sales shall be made under the Licensed Mark and in accordance with all of the terms and provisions of this Agreement, and the payment of Actual Royalties thereon. 14.2 Discontinue Use of Licensed Mark. Upon termination (except for the inventory disposal right referred to in Section 14.1 above), Licensee shall forthwith discontinue all use of the Licensed Mark or any variation or simulation thereof. Licensee shall deliver to Licensor or to Licensor's designee, free of charge, all materials utilized in connection with the Licensed Articles or with the Licensed Mark thereon. 15. [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 16. Miscellaneous. -21- 22 16.1 Notices. All reports, approvals and notices required or permitted by this Agreement shall be in writing, duly given if mailed (by certified or registered mail, return receipt requested) to the appropriate address set forth above (or subsequently specified). Such notice shall be deemed effective two business days following the date the notice is mailed. Copies of all notices sent to Licensor shall be sent to the attention of Deirdre Miles-Graeter, and to Robert B. DiPaola, Esq., 375 Park Avenue, New York, NY 10022. Copies of all notices sent to Licensee shall be sent to Squadron, Ellenoff, Plesent & Sheinfeld, LLP, 551 Fifth Avenue, New York, New York 10176, Attention: Stephen J. Gulotta, Jr., Esq. 16.2 Assignment, etc. Licensee acknowledges and recognizes that (i) it has been granted the License because of its particular expertise, knowledge, judgement, skill and ability; (ii) it has substantial and direct responsibilities to perform this Agreement in accordance with its terms; (iii) Licensor is relying on Licensee's unique knowledge, experience and capabilities to perform this Agreement in specific manner consistent with the high standards of integrity and quality associated with Licensor and its business; (iv) the granting of the License under this Agreement creates a relationship of confidence and trust between Licensee and Licensor; and (v) this Agreement is one under which applicable law excuses Licensor from accepting performance from, or rendering performance to, a person or entity other than Licensee, within the meaning of Section 365(c) and (e) of the Bankruptcy Code (title 11, U.S. Code). Licensee may not assign, sublicense except as permitted in Section 8.6 or otherwise transfer any of its rights or obligations hereunder, (including any attempt by -22- 23 Licensee to establish a distributorship without the prior consent of Licensor as to such distributor and distributorship agreement). Any such attempted assignment, sublicense or transfer, whether voluntary or by operation of law, directly or indirectly, will be void and of no force or effect. For purposes hereof, any transfer of all or a controlling portion of any equity interest of Licensee entitled to vote in the election of the board of directors of Licensee or any similar governing body in one or more transactions (whether over a period of time or all at once), except to Licensor or a person or entity approved in writing by Licensor, will be deemed an attempted transfer of this Agreement prohibited by this Section 16.2 and will be void pursuant to the preceding sentence. Schedule 16.2 attached hereto sets forth a list of the shareholders of Licensee and their share holdings. Except as otherwise provided herein, this Agreement will inure to the benefit of and will be binding upon the parties and permitted successors and assigns. 16.3 [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 16.4 Entire Agreement. This Agreement together with the Letter of Intent and the Exhibits and Schedules attached hereto, all of which are incorporated herein by reference, contains the final, complete and exclusive understanding and agreement between the parties hereto with respect to the subject matter hereof, supersedes all prior oral and written understandings and may not be modified, nor may any of the provisions hereof be waived, except by a writing executed by the parties. Notwithstanding the foregoing, Licensee remains fully obligated to Licensor under the -23- 24 terms of the Terminated License Agreement, including royalties and other amounts due and indemnities thereunder, and Licensor retains any and all applicable rights thereunder including, without limitation, the right to conduct or arrange for audits and Licensor remains fully obligated to Licensee for any indemnities under the terms of the Terminated License Agreement. 16.5 [INFORMATION SUBJECT TO PENDING CONFIDENTIALITY REQUEST] 16.6 No Joint Venture. Nothing herein shall be construed to constitute the parties hereto as partners or as joint venturers, or either as agent of the other, and Licensee shall have no power to obligate or bind Licensor in any manner whatsoever. 16.7 Waivers. No waiver by either party, whether expressed or implied, of any breach hereof or default hereunder shall constitute a continuing wavier of such provision or of any other provision of this Agreement. Acceptance of payments by Licensor shall be deemed a waiver by Licensor of any violation of or default under any of the provisions of this Agreement by Licensee. 16.8 Unenforceability. If any provision or any portion of any provision of this Agreement shall be held to be void or unenforceable, the remaining provisions of this Agreement and the remaining portion of any provision held void or unenforceable in part shall continue in full force and effect. 16.9 Choice of Law. This Agreement shall be considered as having been entered into in the State of New York and shall be construed and -24- 25 interpreted in accordance with the laws of that state applicable to agreements made and to be performed therein. However, disputes regarding the Licensed Mark shall be resolved in accordance with the Federal trademark laws and related laws, statutes, rules and regulations of the United States unless there are no Federal laws, statutes, rules or regulations dispositive of such a dispute, in which event such dispute shall be resolved in accordance with the laws of the State of New York. IN WITNESS WHEREOF, the parties hereto have executed this Agreement the day and year first above written. CALVIN KLEIN, INC. By: /s/ Richard A. Martin ---------------------------------- DHA HOME, INC. By: /s/ M. L. Fontenot ---------------------------------- -25- EX-12 10 COMPUTATIONS OF EARNINGS TO FIXED CHARGES 1 EXHIBIT 12 DECORATIVE HOME ACCENTS, INC. ("SUCCESSOR") AND PREDECESSOR COMPANIES Computations of Ratio of Earnings to Fixed Charges (In Thousands)
SUCCESSOR SUCCESSOR YEARS EIGHT MONTHS PREDECESSOR ENDED ENDED FOUR MONTHS DECEMBER 31, DECEMBER 31, ENDED APRIL 30, --------------------------- 1996 1995 1994 1994 --------- ------- ------- ------ Earnings (loss) before income taxes $(113,609) $(2,013) $ 7,805 $2,747 Add: Interest expense 19,916 12,281 4,647 (16) --------- ------- ------- ------ Earnings available for fixed charges $ (93,693) $10,268 $12,452 $2,731 ========= ======= ======= ====== Fixed charges: Interest expense 19,916 12,281 4,647 (16) ========= ======= ======= ====== Ratio of earnings to fixed charges -- 0.84 x 2.68 x -- ========= ======= ======= ======
- -- Not meaningful. EX-18 11 LETTER REGARDING CHANGE IN ACCOUNTING PRINCIPLE 1 Exhibit 18 August 1, 1997 To the Board of Directors of Decorative Home Accents, Inc. Dear Directors: We have audited the consolidated financial statements of Decorative Home Accents, Inc. ("the Company") as of December 31, 1996 and 1995, and for each of the three years in the period ended December 31, 1996, included in your Annual Report on Form 10-K to the Securities and Exchange Commission and have issued our report thereon dated June 20, 1997 (July 9, 1997 as to Note 14). Note 3 to such financial statements describes a change in the Company's method of evaluating the recoverability of goodwill from an undiscounted projected cash flow approach to a fair value method using discounted projected cash flows. In our judgment, such change is to an alternative accounting principle that is preferable under the circumstances. Yours truly, Deloitte & Touche LLP Greenville, South Carolina EX-21 12 LIST OF SUBSIDIARIES 1 EXHIBIT 21 SUBSIDIARIES OF DECORATIVE HOME ACCENTS, INC. Name of Subsidiary Jurisdiction of Incorporation ------------------ ----------------------------- Home Innovations, Inc. Delaware The Rug Barn, Inc. South Carolina DHA Home, Inc. Delaware Draymore Mfg. Corp. North Carolina R.A. Briggs & Company Illinois EX-27 13 FDS
5 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1,980 0 32,814 7,014 32,565 62,055 39,856 7,594 116,046 148,237 0 49,351 0 2,485 (118,127) 116,046 176,733 176,733 138,633 138,633 131,793 0 19,916 (113,609) 1,632 (115,241) 0 0 0 (115,241) 0 0
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