-----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, RXOVzgPInzrOL7qBgnAtsYfevbpTdYGkVgX8KdHzaLZz+kv79U7xHku8krD9o/va +XXI4hm/sr90/pSlCoVH6A== 0000927016-01-000094.txt : 20010123 0000927016-01-000094.hdr.sgml : 20010123 ACCESSION NUMBER: 0000927016-01-000094 CONFORMED SUBMISSION TYPE: S-4 PUBLIC DOCUMENT COUNT: 27 FILED AS OF DATE: 20010109 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LEARNINGSTAR INC CENTRAL INDEX KEY: 0001130950 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 770559897 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-4 SEC ACT: SEC FILE NUMBER: 333-53454 FILM NUMBER: 1504990 BUSINESS ADDRESS: STREET 1: 15 CRAWFORD STREET CITY: NEEDHAM STATE: MA ZIP: 02494 BUSINESS PHONE: 7814497567 MAIL ADDRESS: STREET 1: 15 CRAWFORD STREET CITY: NEEDHAM STATE: MA ZIP: 02494 S-4 1 0001.txt FORM S-4 As filed with the Securities and Exchange Commission on January 9, 2001 Registration No. 333- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 -------------- FORM S-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 -------------- LEARNINGSTAR CORP. (Exact name of registrant as specified in its charter) -------------- Delaware 5961 77-0559897 (State or other (Primary Standard (I.R.S. Employer jurisdiction of Industrial Identification Number) incorporation or Classification Code organization) Number) -------------- 15 Crawford Street Needham, Massachusetts 02494 (781) 449-7567 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) -------------- Robert Cahill Chief Financial Officer LearningStar Corp. 15 Crawford Street Needham, Massachusetts 02494 (781) 449-7567 (Name, address including zip code, and telephone number, including area code, of agent for service) -------------- Copies to: Gordon H. Hayes, Esq. Jeffrey L. Kateman, Esq. Testa, Hurwitz & Thibeault, LLP Latham &Watkins 125 High Street 633 West Fifth Street, Suite 4000 Boston, Massachusetts 02110 Los Angeles, California 90071 Tel: (617) 248-7000 Tel: (213) 485-1234 Fax: (617) 248-7100 Fax: (213) 891-8763 Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective and all other conditions to the proposed combination have been satisfied or waived. If the securities being registered on this Form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. [_] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] -------------- CALCULATION OF REGISTRATION FEE - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
Proposed Proposed Maximum Title of Each Class of Maximum Aggregate Amount of Securities to be Amount to be Offering Price Offering Registration Registered Registered(1) Per Share Price(2) Fee(3) - ---------------------------------------------------------------------------------- Common Stock, $.01 par value per share....... 65,510,776 shares Not Applicable $33,245,326 $8,500.00 - ---------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------
(1) Based upon the maximum number of shares of common stock, par value $.01 per share, expected to be issued in connection with the transactions described herein. (2) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(f). The registration fee was calculated as follows: (a) in accordance with Rule 457(f)(1) based on the average of the high and low sale price for shares of common stock of SmarterKids.com, Inc. on January 3, 2001: 20,668,849 shares (the total number of outstanding shares of SmarterKids.com common stock) multiplied by the average price of $0.53125; and (b) in accordance with Rule 457(f)(2) based on the book value of membership interests in Earlychildhood LLC on September 30, 2000: 10,000 membership interests (100% of the outstanding membership interests), multiplied by the book value of $2,226.50 per membership interest. (3) The registration fee for the securities registered hereby has been calculated pursuant to section 6(b) of the Securities Act of 1933, as amended (the "Securities Act"). A fee of $2,197.00 was paid on January 5, 2001 pursuant to Rules 14a-6 and 0-11 promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), in respect of the combination of SmarterKids.com and Earlychildhood and upon the filing by SmarterKids.com of a preliminary proxy statement relating thereto. Pursuant to Rule 457(b) promulgated under the Securities Act and Section 14(g)(2) of the Exchange Act and Rule 0-11 promulgated thereunder, the amount of such previously paid fee has been credited against the registration fee payable in connection with this filing. -------------- The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- [LOGO OF SMARTERKIDS.COM] [LOGO OF EARLYCHILDHOOD] To the stockholders of SmarterKids.com, Inc. A COMBINATION PROPOSAL--YOUR VOTE IS VERY IMPORTANT SmarterKids.com and Earlychildhood have agreed to combine. We are proposing the combination and soliciting your proxy to approve it because we believe the combined strengths of SmarterKids.com and Earlychildhood will enable us to build a stronger provider of children's educational products, information and services to both the school and consumer markets and through a variety of distribution channels. The new combined company will be named LearningStar Corp. and will be managed by executive officers from both SmarterKids.com and Earlychildhood. If the combination is completed, stockholders of SmarterKids.com and members of Earlychildhood will each receive shares of LearningStar common stock in exchange for their existing common stock or membership interests, as the case may be. Each issued and outstanding share of SmarterKids.com common stock will be converted into the right to receive one newly-issued share of LearningStar common stock. All of the issued and outstanding membership interests in Earlychildhood and options therefor will be exchanged for the right to receive an aggregate of 46,388,575 newly-issued shares of LearningStar common stock. Following the combination, SmarterKids.com stockholders will own approximately one-third of the LearningStar capital stock and Earlychildhood members will own approximately two-thirds of the LearningStar capital stock. It is anticipated that LearningStar will apply for approval for quotation of its common stock on the Nasdaq National Market. A new market for trading in the LearningStar common stock will commence immediately following the effectiveness of the combination, which we expect to occur in the spring of 2001. No cash is included as consideration in the combination, except for cash received in lieu of fractional shares of LearningStar common stock. The SmarterKids.com board of directors has unanimously determined that the combination of SmarterKids.com and Earlychildhood is advisable and in the best interests of its stockholders. The SmarterKids.com board of directors has unanimously approved the combination agreement and the combination and unanimously recommends that you vote FOR approval and adoption of the combination agreement and the transactions contemplated thereby. The management committee of Earlychildhood and the holders of all outstanding membership interests in Earlychildhood approved the combination immediately prior to the signing of the combination agreement. No further action is required by Earlychildhood's management committee or members to effect the combination. Information about the combination is contained in this proxy statement- prospectus. We urge you to read this document carefully, including the section describing risk factors that begins on page 18. The special meeting of SmarterKids.com stockholders will be held at the offices of Testa, Hurwitz & Thibeault, LLP, 125 High Street, High Street Tower, 22nd Floor, Boston, Massachusetts on , 2001 at 10:00 a.m. Your vote is very important, regardless of the number of shares you own. Whether or not you plan to attend the special meeting, please vote as soon as possible to make sure that your shares are represented at the special meeting. David Blohm President and Chief Executive Officer SmarterKids.com, Inc. This proxy statement-prospectus is dated , 2001, and is first being mailed to SmarterKids.com stockholders on or about , 2001. As of , 2001, there were approximately holders of SmarterKids.com common stock. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of the securities to be issued in connection with the combination or determined if this proxy statement- prospectus is accurate or complete. Any representation to the contrary is a criminal offense. ADDITIONAL INFORMATION REGARDING SMARTERKIDS.COM This proxy statement-prospectus incorporates important business and financial information about SmarterKids.com and the proposed combination. Other documents that include important business and financial information about SmarterKids.com and the proposed combination are available to you without charge upon your written or oral request. You can obtain the documents incorporated by reference in this proxy statement-prospectus by requesting them in writing or by telephone or via e-mail from SmarterKids.com at the following address: SmarterKids.com, Inc. Investor Relations 15 Crawford Street Needham, Massachusetts 02494 (781) 449-7567 ir@smarterkids.com If you would like to request any documents, please do so by , 2001 (five business days prior to the special meeting) in order to receive them before the special meeting. Also see the section entitled "Where You Can Find More Information" that begins on page of this proxy statement-prospectus. TRADEMARKS SmarterKids.com(R), SmarterKids(R), Smart Kids'(R) and Virtual Knowledge(R) are registered trademarks of SmarterKids.com. Earlychildhood NEWS(R), Flexitemp(R), Little Bit O' Paint(R), Basic Brights(R), First Art(R), The Imagination Playground(R), BioColor(R), Rainbow(R), Dandi-Li-On(R), Squeezables(R) and LifeLong Learning Starts Here(R) are registered trademarks of Earlychildhood. Earlychildhood(TM), Earlychildhood.com(TM) and SchoolWrapPacks(TM) are trademarks of Earlychildhood. This proxy statement- prospectus also contains trademarks or tradenames of companies other than SmarterKids.com and Earlychildhood. All other trademarks and tradenames referred to in this proxy statement-prospectus are the property of their respective owners. [LOGO OF SMARTERKIDS.COM, INC.] SMARTERKIDS.COM, INC. 15 Crawford Street Needham, Massachusetts 02494 Notice of Special Meeting of SmarterKids.com Stockholders , 2001 at 10:00 a.m. To the stockholders of SmarterKids.com, Inc.: Notice is hereby given that a special meeting of stockholders of SmarterKids.com, Inc. will be held on , 2001 at 10:00 a.m., local time, at the offices of Testa, Hurwitz & Thibeault, LLP, 125 High Street, High Street Tower, 22nd Floor, Boston, Massachusetts for the following purposes: 1. To consider and vote upon a proposal to approve and adopt the Contribution Agreement and Plan of Reorganization and Merger by and among Earlychildhood, SmarterKids.com, LearningStar and S-E Educational Merger Corp. pursuant to which, among other things, the combination of SmarterKids.com and Earlychildhood will be effected by: . the contribution to LearningStar by the holders of all of Earlychildhood's outstanding membership interests of their entire ownership interest in Earlychildhood such that Earlychildhood will become a wholly-owned subsidiary of LearningStar, and the holders of Earlychildhood membership interests and options therefor will be entitled to receive an aggregate of 46,388,575 shares of LearningStar common stock; and . the merger of S-E Educational Merger Corp. with and into SmarterKids.com such that SmarterKids.com will become a wholly-owned subsidiary of LearningStar and each issued and outstanding share of SmarterKids.com common stock will be converted into the right to receive one share of LearningStar common stock. 2. To transact any other business as may properly come before the special meeting or any adjournment or postponement of the special meeting. The SmarterKids.com board of directors has unanimously determined that the combination of SmarterKids.com and Earlychildhood is advisable and in the best interests of its stockholders. The SmarterKids.com board of directors has unanimously approved the combination agreement and the combination and unanimously recommends that you vote FOR approval and adoption of the combination agreement and the transactions contemplated thereby. We have described the proposed combination in more detail in the attached proxy statement-prospectus, which you should read in its entirety before voting. A copy of the combination agreement is attached as Annex A to the proxy statement-prospectus. Only holders of record of SmarterKids.com common stock at the close of business on , 2001, the record date for the special meeting, are entitled to notice of, and to vote at, the special meeting and any adjournments or postponements of the special meeting. On the record date there were outstanding shares of SmarterKids.com common stock. SmarterKids.com is a Delaware corporation. Under Delaware law, the affirmative vote of a majority of the shares of SmarterKids.com common stock outstanding on the record date is required to approve and adopt the combination agreement and the transactions contemplated thereby. Your vote is very important, regardless of the number of shares you own. Please vote as soon as possible to make sure that your shares are represented at the special meeting. To vote your shares, you may complete and return the enclosed proxy card. If you are a holder of record, you may also cast your vote in person at the special meeting. If you do not vote, it will have the effect of a vote against approval and adoption of the combination agreement and the transactions contemplated thereby. If your shares are held in an account at a brokerage firm or bank, you must instruct it how to vote your shares. If you do not instruct your broker or bank on how to vote, it will have the same effect as voting against approval and adoption of the combination agreement and the transactions contemplated thereby. By order of the Board of Directors of SmarterKids.com, Inc. David Blohm Corporate Secretary Needham, Massachusetts , 2001 TABLE OF CONTENTS
Page ---- QUESTIONS AND ANSWERS ABOUT THE COMBINATION............................... 1 SUMMARY................................................................... 4 RISK FACTORS.............................................................. 18 Risks Related to the Combination........................................ 18 Risks Relating to the Combined Company.................................. 20 CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS................ 28 THE SMARTERKIDS.COM SPECIAL MEETING....................................... 30 THE COMBINATION........................................................... 33 General................................................................. 33 Background of the Combination........................................... 34 Joint Reasons for the Combination....................................... 36 SmarterKids.com's Reasons for the Combination........................... 38 Earlychildhood's Reasons for the Combination............................ 38 Opinion of J.P. Morgan H&Q, Financial Advisor to SmarterKids.com........ 39 Recommendation of the SmarterKids.com Board Of Directors................ 43 Interests of Certain Persons in the Combination......................... 46 Securities and Exchange Commission Position on Indemnification for Securities Act Liabilities............................................. 49 Material United States Federal Income Tax Consequences of the Combination............................................................ 49 Accounting Treatment of the Combination................................. 53 Dissenters' Rights of Appraisal......................................... 53 Regulatory Matters...................................................... 53 Restrictions on Sales of Shares by Affiliates of SmarterKids.com and Earlychildhood......................................................... 53 Nasdaq National Market Listing of LearningStar Common Stock to be Issued in the Combination..................................................... 54 Delisting and Deregistration of SmarterKids.com Common Stock after the Combination............................................................ 54
Page ---- TERMS OF THE COMBINATION AGREEMENT........................................ 55 Structure of the Combination, Conversion of SmarterKids.com Common Stock and Exchange of Earlychildhood Membership Interests.................... 55 Exchange of SmarterKids.com Stock Certificates for LearningStar Stock Certificates........................................................... 55 Treatment of Options to Purchase SmarterKids.com Common Stock and Earlychildhood Membership Interests, SmarterKids.com Warrants and the SmarterKids.com Employee Stock Purchase Agreement...................... 56 Conditions to the Combination........................................... 57 No Other Transactions Involving SmarterKids.com or Earlychildhood....... 58 Termination............................................................. 60 Termination Fees........................................................ 62 Expenses................................................................ 62 Agreement to Cooperate to Complete the Combination...................... 62 Amendment, Extension and Waiver......................................... 63 Representations and Warranties.......................................... 63 LearningStar Charter and Bylaws......................................... 64 Stockholder Support Agreement........................................... 64 Other Agreements........................................................ 65 Completion and Effectiveness of the Combination......................... 65 No Provision for Unaffiliated Stockholder Access to SmarterKids.com Corporate Files........................................................ 66 Accountants............................................................. 66 MARKET PRICE INFORMATION.................................................. 67 MARKET DATA............................................................... 67 UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION.............. 68 Notes To The Unaudited Pro Forma Condensed Combined Balance Sheet................................................. 72 Notes To The Unaudited Pro Forma Condensed Combined Statements of Operations.......................................................... 73
i TABLE OF CONTENTS
Page ---- SMARTERKIDS.COM........................................................... 74 Business................................................................ 74 SmarterKids.com Management's Discussion And Analysis Of Financial Condition And Results Of Operations.................................... 83 SmarterKids.com Quantitative And Qualitative Disclosure About Market Risk................................................................... 91 Security Ownership of Certain Beneficial Owners and Management of SmarterKids.com........................................................ 92 EARLYCHILDHOOD............................................................ 94 Business................................................................ 94 Earlychildhood Management's Discussion And Analysis Of Financial Condition And Results Of Operations.................................... 104 Earlychildhood Quantitative and Qualitative Disclosure About Market Risk................................................................... 109 Earlychildhood Certain Relationships and Transactions................... 109 Security Ownership of Certain Beneficial Owners and Management of Earlychildhood......................................................... 110 LEARNINGSTAR.............................................................. 112 The Board of Directors of LearningStar Following the Combination........ 112 Committees of the LearningStar Board of Directors....................... 113 Compensation of the Directors of LearningStar........................... 113 Executive Officers of LearningStar Following the Combination............ 113 Compensation of Executive Officers of LearningStar...................... 114 Option Grants in Last Fiscal Year....................................... 115 Option Exercises and Fiscal Year-End Values............................. 116 Ten Year Option Repricing............................................... 117 Compensation Committee Report on Option Repricing....................... 118 Employment and Change of Control Agreements............................. 118
Page ---- Pro Forma Security Ownership of Certain Beneficial Owners and Management of LearningStar........................................................ 119 DESCRIPTION OF CAPITAL STOCK OF LEARNINGSTAR.............................. 120 Common Stock............................................................ 120 Preferred Stock......................................................... 120 Warrants................................................................ 121 Registration Rights..................................................... 121 Anti-Takeover Effects of Certain Provisions of LearningStar's Charter and Bylaws and Delaware Law............................................ 121 Transfer Agent and Registrar............................................ 122 COMPARISON OF RIGHTS OF HOLDERS OF LEARNINGSTAR COMMON STOCK, SMARTERKIDS.COM COMMON STOCK AND EARLYCHILDHOOD MEMBERSHIP INTERESTS...... 123 LEGAL MATTERS............................................................. 132 EXPERTS................................................................... 132 OTHER MATTERS............................................................. 132 STOCKHOLDER PROPOSALS..................................................... 133 WHERE YOU CAN FIND MORE INFORMATION....................................... 134 INDEX TO FINANCIAL STATEMENTS............................................. F-1
ANNEX A--Contribution Agreement and Plan of Reorganization and Merger ANNEX B--Stockholder Support Agreement ANNEX C--Opinion of J.P. Morgan H&Q ANNEX D--Form of Restated Certificate of Incorporation of LearningStar ANNEX E--Form of Amended and Restated Bylaws of LearningStar ii QUESTIONS AND ANSWERS ABOUT THE COMBINATION Q: Why are SmarterKids.com and Earlychildhood proposing to combine? A: We are proposing the combination because we believe that the combined strengths of SmarterKids.com and Earlychildhood will enable us to build a stronger provider of children's educational products to both parents and educators. The combination will bring together SmarterKids.com's consumer- focused e-commerce capabilities with Earlychildhood's school-focused catalog operation, direct sales force, product assortment and fund-raising programs. We believe that because of the complimentery nature of SmarterKids.com's and Earlychildhood's businesses, LearningStar has the potential to achieve stronger operating and financial results than either company could achieve on its own. Q: What will I receive as a result of the combination? A: If we complete the combination, you will receive one share of LearningStar common stock for each share of SmarterKids.com common stock that you own on the effective date of the combination. After the combination, SmarterKids.com stockholders will own, in the aggregate, approximately one- third of the combined company. We will not issue fractional shares in the combination. Instead of fractional shares, you will receive cash based on the market price of LearningStar common stock on the first day it is traded. Q: Why did the SmarterKids.com board of directors agree to Earlychildhood members receiving approximately two-thirds of the LearningStar capital stock with SmarterKids.com stockholders receiving approximately one-third of the LearningStar capital stock? A: We engaged in extensive negotiations with Earlychildhood regarding the post-combination ownership of the shares of LearningStar common stock to be issued to SmarterKids.com stockholders and Earlychildhood members in the combination. After completion of due diligence and based in part upon the relative size of revenues, operating income and growth prospects of the two companies and the opinion of SmarterKids.com's financial advisor, J.P. Morgan H&Q, we agreed that a post-combination ownership of LearningStar of approximately two-thirds by Earlychildhood members and one- third by SmarterKids.com stockholders was a fair and equitable division of the ownership of LearningStar. Q: What will happen to SmarterKids.com and Earlychildhood after the combination? A: Upon completion of the combination, each of SmarterKids.com and Earlychildhood will be a wholly-owned subsidiary of LearningStar. Q: What approvals are needed to complete the transaction? A: The affirmative vote of a majority of the shares of SmarterKids.com common stock outstanding on the record date is required to approve and adopt the combination agreement and the transactions contemplated thereby. Each holder of SmarterKids.com common stock is entitled to one vote per share. As of the record date, SmarterKids.com directors, executive officers and their affiliates owned approximately % of the SmarterKids.com common stock entitled to vote at the special meeting. Each SmarterKids.com director and executive officer and certain significant stockholders of SmarterKids.com have entered into a stockholder support agreement with Earlychildhood. Pursuant to the stockholder support agreement, each of these directors, executive officers and stockholders have agreed to vote all of their shares of SmarterKids.com common stock in favor of the approval and adoption of the combination agreement and the transactions contemplated thereby at the special meeting. As of the record date, these directors, 1 executive officers and stockholders owned, in the aggregate, approximately % of the voting power of SmarterKids.com common stock entitled to vote at the special meeting. The holders of Earlychildhood's outstanding membership interests approved the combination agreement prior to its signing. No other approvals from the Earlychildhood members are required to complete the combination. Q: Will I recognize a taxable gain or loss for U.S. federal income tax purposes in the combination? A: We have attempted to structure the combination so that generally you will not recognize gain or loss for U.S. federal income tax purposes in connection with the combination, except with respect to any cash received in lieu of fractional shares. We strongly urge you to consult your own tax advisor to determine your particular tax consequences. For more information please see the section entitled "The Combination--Material United States Federal Income Tax Consequences of the Combination" which begins on page of this proxy statement-prospectus. Q: What should I do if my broker holds my shares in "street name"? A: Please contact your broker to obtain instructions on how to vote your shares. Q: Can my broker vote my shares that are held in "street name"? A: Your broker will vote your shares only if you provide your broker instructions on how to vote your shares held in "street name" in accordance with the procedures provided to you by your broker. If you do not instruct your broker to vote your shares they will become "broker non-votes." Broker non-votes will be counted in determining whether a quorum is present at the special meeting, but will not be counted in the number of votes cast. Because the combination proposal requires the affirmative vote of the holders of a majority of outstanding shares of SmarterKids.com common stock eligible to vote at the special meeting, a broker non-vote will have the same effect as a vote against approval and adoption of the combination agreement and the transactions contemplated thereby. You should therefore be sure to provide your broker with instructions on how to vote your shares if you would like them represented at the special meeting. Q: What if I do not vote? A: .If you fail to return your proxy card or attend the special meeting, it will have the same effect as a vote against the approval and adoption of the combination agreement and the transactions contemplated thereby. . If you return your proxy card and do not indicate how you want to vote, your proxy will be counted as a vote FOR the approval and adoption of the combination and the transactions contemplated thereby. .If you return your proxy card and abstain from voting, it will have the same effect as a vote against the approval and adoption of the combination agreement and the transactions contemplated thereby. Q: Can I change my vote after I have delivered my proxy? A: Yes. You can change your vote at any time before your proxy is voted at the special meeting. You can do this in one of three ways. First, you can revoke your proxy. Second, you can submit a new proxy. If you choose either of these two methods, you must submit your notice of revocation or your new proxy to the Secretary of SmarterKids.com before the special meeting. If your shares are held in an account at a brokerage firm or bank, you should contact your brokerage firm or bank to change your vote. Third, if you are a holder of record, you can attend the special meeting and vote in person. 2 Q: Should I send in my stock certificates now? A: No. After the combination is completed, SmarterKids.com's exchange agent will send you written instructions on how to exchange your SmarterKids.com stock certificates for certificates representing shares of LearningStar common stock. Please do not send in your stock certificates with your proxy. Q: Where will my shares of LearningStar common stock be listed? A: We intend to apply to list the LearningStar common stock on the Nasdaq National Market under the symbol "LRNS." Q: Will I receive dividends on my LearningStar shares? A: LearningStar does not currently intend to pay dividends on its common stock. Q: When do you expect to complete the transaction? A: We are working to complete the transaction as quickly as possible. We expect to complete the transaction during the spring of 2001. Q: Who can help answer my questions? A: If you have any questions about the combination or how to submit your proxy, or if you need additional copies of this proxy statement-prospectus or the enclosed proxy card, you should contact: SmarterKids.com, Inc. Investor Relations 15 Crawford Street Needham, Massachusetts 02494 (781) 449-7567 ir@smarterkids.com 3 SUMMARY This summary highlights selected information in the proxy statement- prospectus and may not contain all of the information that is important to you. You should carefully read this entire proxy statement-prospectus and the other documents we refer to for a more complete understanding of the combination. In particular, you should read the documents attached to this proxy statement- prospectus, including the combination agreement and the stockholder support agreement, which are attached as Annexes A and B. The information contained in this proxy statement-prospectus about the businesses of each of SmarterKids.com and Earlychildhood is historical and the information about LearningStar assumes completion of the combination. The information contained on the websites of SmarterKids.com, Earlychildhood and LearningStar are not incorporated by reference into this proxy statement-prospectus and should not be considered a part of this proxy statement-prospectus. The Companies (see pages through ) SmarterKids.com, Inc. 15 Crawford Street Needham, Massachusetts 02494 (781) 449-7567 www.smarterkids.com SmarterKids.com, Inc., or SmarterKids.com, is a leading online educational store dedicated to helping parents help their children learn, develop and grow. The SmarterKids.com website offers one of the Internet's most personalized shopping experiences, linking teacher-reviewed toys, games, books, software and hands-on activities through SmarterKids.com's evaluation and recommendation process. SmarterKids.com serves as a resource for parents, offering specialty centers, the Grade Expectations! guide to education standards and thousands of educational products, including well-known brands and hard-to-find quality offerings for children from ages infant through 15. SmarterKids.com integrates carefully selected products, helpful content and interactive tools with an intuitive and easy-to-use website to create a compelling and unique online shopping experience. SmarterKids.com only sells products that its full-time staff of certified educators believe have educational, developmental or learning value. Its collection of products includes over 4,500 books, toys, games and software titles from over 300 suppliers. Because SmarterKids.com is focused on education, many of its products, particularly toys and games, are often not found on many of the other websites that offer children's products. The personalization area on the SmarterKids.com website allows parents to build a confidential educational profile of their child that can include information about the child's age and grade, learning styles, learning goals and performance on standardized tests. The SmarterKids.com SmartPicks technology then uses this profile to make product recommendations from SmarterKids.com's distinctive assortment of products tailored to a child's individual developmental profile and goals. Earlychildhood LLC 2 Lower Ragsdale Drive, Suite 200 Monterey, California 93940 (831) 333-2000 www.earlychildhood.com Earlychildhood LLC, or Earlychildhood, is a fully integrated, multi-channel supplier of educational products, services and information to schools, educational professionals and parents serving the early childhood and elementary school communities. Through a predecessor entity, Earlychildhood began operations in 1985. 4 Earlychildhood manufactures, imports and sells company-developed products as part of its diverse mix of school supplies and educational toys, while also distributing and selling a carefully selected range of third-party brands such as Crayola(R), Lego(R) and Elmer's(R). Earlychildhood utilizes multiple sales, marketing and distribution channels, including: . catalogs issued under its tradename Discount School Supply, or DSS; . sales programs conducted through its wholly-owned subsidiary, Educational Products, Inc., or EPI; . the Earlychildhood.com website; and . Earlychildhood NEWS, a professional content resource published in print and online. All of the foregoing are supported by a national sales force which, as of December 31, 2000, numbered 93 people. LearningStar Corp. 2 Lower Ragsdale Drive, Suite 200 Monterey, California 93940 (831) 333-2000 www.learningstarcorp.com LearningStar Corp., formerly S-E Educational Holdings Corp., is a newly- formed corporation that has not, to date, conducted any activities other than those incident to its formation, the matters contemplated by the combination agreement and the preparation of this proxy statement-prospectus. Upon completion of the combination, SmarterKids.com and Earlychildhood will each become a wholly-owned subsidiary of LearningStar. The business of LearningStar will be the combined businesses currently conducted by SmarterKids.com and Earlychildhood. The SmarterKids.com Special Meeting Record Date for the Special Meeting; Quorum (see page ) SmarterKids.com's board of directors has fixed the close of business on , 2001 as the record date for determination of the SmarterKids.com stockholders entitled to notice of, and to vote at, the special meeting. A majority of the shares of the SmarterKids.com common stock outstanding as of the record date must be represented either in person or by proxy to constitute a quorum at the special meeting. Vote Required for Approval and Adoption of the Combination Agreement (see page ) The affirmative vote of a majority of the shares of SmarterKids.com common stock outstanding as of the record date is required to approve and adopt the combination agreement and the transactions contemplated thereby. Each share of SmarterKids.com common stock is entitled to one vote on all matters properly submitted to the SmarterKids.com stockholders. Recommendation of SmarterKids.com's Board of Directors (see page ) SmarterKids.com's board of directors has unanimously determined that the combination of SmarterKids.com and Earlychildhood is advisable and in the best interests of its stockholders. The SmarterKids.com board of directors has unanimously approved the combination agreement and the combination and unanimously recommends that you vote FOR approval and adoption of the combination agreement and the transactions contemplated thereby. 5 The Combination The Structure of the Combination (see page ) To accomplish the combination of their businesses, SmarterKids.com and Earlychildhood jointly formed a new company, LearningStar Corp. LearningStar has one subsidiary, S-E Educational Merger Corp. The combination will be effected by: . the contribution of all of the outstanding membership interests in Earlychildhood to LearningStar by the holders of those membership interests; and . the merger of S-E Educational Merger Corp. into SmarterKids.com, with SmarterKids.com being the surviving corporation. As a result of the contribution and the merger, Earlychildhood and SmarterKids.com will each become a wholly-owned subsidiary of LearningStar. Approval of the Combination by Earlychildhood (see pages through ) The Earlychildhood management committee and holders of all outstanding membership interests in Earlychildhood approved the combination agreement prior to its signing. No other approvals from the Earlychildhood members are required to complete the combination. Consideration in the Combination (see page ) SmarterKids.com common stockholders will be entitled to receive one share of LearningStar common stock for each share of SmarterKids.com common stock held on the closing date of the combination. The holders of outstanding membership interests in Earlychildhood will be entitled to receive an aggregate of 46,388,575 shares of LearningStar common stock, which will be allocated among the holders of those membership interests based on an exchange ratio set forth in the combination agreement more fully described in the section entitled "Terms of the Combination Agreement--Structure of the Combination, Conversion of SmarterKids.com Common Stock and Exchange of Earlychildhood Membership Interests" which begins on page of this proxy statement-prospectus. As a result of the combination, former holders of SmarterKids.com common stock will own approximately one-third, and former holders of Earlychildhood membership interests will own approximately two-thirds of the capital stock of LearningStar. Reasons for the Combination (see pages through ) The SmarterKids.com board of directors and the Earlychildhood management committee believe that the following mutual benefits will be achieved by combining the two companies: . broaden the market of the combined company; . diversified sales and distribution channels; . expanded technology capabilities; . enhanced marketing efforts; . increased product development capabilities; . combined management expertise; . reduced operating costs; and . enhanced capability to raise funds in the public market. The SmarterKids.com board of directors had the following additional reasons for approving the combination agreement and submitting the combination agreement for approval and adoption by its stockholders: . the ability to leverage Earlychildhood's operational infrastructure; 6 . the ability to access Earlychildhood's unique mix of company-developed and internationally-sourced products; . the ability to capitalize on Earlychildhood's geographically distributed warehouse and fulfillment operations; and . the creation of a greater analyst following for the stock of the combined company. Earlychildhood's management committee had the following additional reasons for approving the combination agreement and submitting the combination agreement for approval and adoption by the holders of Earlychildhood membership interests: . the ability to leverage SmarterKids.com's Internet infrastructure; . broadened exposure to the consumer market; and . improved capital availablity of access to the public markets for Earlychildhood members. Opinion of SmarterKids.com's Financial Advisor (see pages through ) In deciding to approve the combination, the SmarterKids.com board of directors considered the opinion of its financial advisor, J.P. Morgan H&Q, a division of Chase Securities Inc., that, as of the date of its opinion, and subject to, and based on the considerations referred to in its opinion, the consideration given to SmarterKids.com stockholders in the transaction is fair, from a financial point of view, to those stockholders. The full text of the J.P. Morgan H&Q opinion is attached as Annex C to this proxy statement- prospectus. We urge you to read the opinion of J.P. Morgan H&Q in its entirety prior to voting. Interests of Certain Persons in the Combination (see page ) In considering the recommendation of the SmarterKids.com board of directors, you should be aware that some of the directors and executive officers of SmarterKids.com have interests in the combination that are different from, or are in addition to, your interests as a SmarterKids.com stockholder generally. These interests include the potential for positions as directors or executive officers of LearningStar, the acceleration of the vesting of options, consulting agreements with LearningStar or severance arrangements under existing agreements with SmarterKids.com or LearningStar and the right to continued indemnification and insurance coverage by LearningStar for acts or omissions occurring prior to the combination. You should also be aware that certain members of the Earlychildhood management committee and executive officers of Earlychildhood have certain interests in the combination, including the potential for positions as directors or executive officers of LearningStar, severance arrangements under existing agreements with Earlychildhood and the right to continued indemnification and insurance coverage by LearningStar for acts or omissions occurring prior to the combination. Treatment of Outstanding Stock Options and Warrants (see page ) When the combination is completed, each outstanding option to purchase SmarterKids.com common stock or membership interests in Earlychildhood, as the case may be, whether vested or unvested, will be converted into an option to purchase shares of LearningStar common stock. As of December 31, 2000, there were outstanding options to purchase 5,097,855 shares of SmarterKids.com common stock and outstanding options to purchase up to 3.33% of total membership interests in Earlychildhood giving effect to the exchange ratios set forth in the combination agreement. For more information on the exchange ratios applicable to the Earlychildhood membership interests, see the section entitled "Terms of the Combination--Structure of the Combination, Conversion of SmarterKids.com Common Stock and Earlychildhood Membership Interests." If the combination is completed and, within a certain period of time thereafter, certain executive officers of SmarterKids.com are terminated, the vesting of certain options to purchase shares of SmarterKids.com common 7 stock owned by those persons may be accelerated in accordance with the terms of the applicable stock option agreements or change of control agreements between SmarterKids.com and those executive officers. See the section entitled "The Combination--Interests of Certain Persons in the Combination" which begins on page of this proxy statement-prospectus. Upon completion of the combination, each outstanding warrant to purchase shares of SmarterKids.com common stock will be converted into the right to purchase shares of LearningStar common stock on substantially the same terms and conditions as were applicable to those warrants prior to the combination. As of December 31, 2000, there were outstanding warrants to purchase an aggregate of 217,292 shares of SmarterKids.com common stock. Material United States Federal Income Tax Consequences (see pages through ) The combination is generally intended to be tax-free to SmarterKids.com's stockholders for U.S. federal income tax purposes, except with respect to any cash received in lieu of fractional shares of LearningStar common stock. The combination is conditioned upon: . Earlychildhood receiving an opinion from its tax counsel that the contribution of all of the outstanding membership interests in Earlychildhood to LearningStar will be treated as a transfer of property under Section 351 of the Internal Revenue Code; and . SmarterKids.com receiving an opinion from its tax counsel that the merger of S-E Educational Merger Corp. into SmarterKids.com will be treated as a "reorganization" within the meaning of Section 368(a) of the Internal Revenue Code or, taken together with the contribution of all of the membership interests in Earlychildhood to LearningStar, as a transfer of property under Section 351 of the Internal Revenue Code. For a more complete description of the intended U.S. federal income tax consequences of the combination and some of the related risks, see the section entitled "The Combination--Material United States Federal Income Tax Consequences of the Combination" which begins on page of this proxy statement-prospectus. Tax matters can be very complicated and the tax consequences to SmarterKids.com's stockholders will depend on the facts and circumstances of each stockholder's situation. Accordingly, SmarterKids.com stockholders should consult their tax advisors to determine their particular tax consequences. Accounting Treatment (see page ) We intend to account for the combination of SmarterKids.com with Earlychildhood under the purchase method of accounting for business combinations as if Earlychildhood were acquiring SmarterKids.com. Dissenters' Rights of Appraisal (see page ) Under Delaware law, SmarterKids.com stockholder are entitled to appraisal of the value of their shares of SmarterKids.com common stock in connection with the combination. Overview of the Combination Agreement (see page ) Conditions to the Completion of the Combination. The completion of the combination depends upon the satisfaction or waiver of a number of specified conditions, including those listed below: . the combination agreement must be adopted by the SmarterKids.com stockholders; . no law, injunction or order prohibiting the completion of the combination may be in effect; . SmarterKids.com and Earlychildhood must obtain regulatory approvals from governmental entities, such as the Securities and Exchange Commission and other self-regulatory bodies such as the Nasdaq National Market; 8 . the shares of LearningStar common stock to be issued in the combination must have been approved for listing on the Nasdaq National Market; . both SmarterKids.com and Earlychildhood must have complied with their respective obligations in the combination agreement; . the representations and warranties of each of SmarterKids.com and Earlychildhood in the combination agreement must be true and correct; . Earlychildhood must receive an opinion from its tax counsel to the effect that the contribution of all outstanding Earlychildhood membership interests to LearningStar will be treated for U.S. federal income tax purposes as a transfer of property qualifying under Section 351 of the Internal Revenue Code; . SmarterKids.com must receive an opinion from its tax counsel to the effect that the merger of S-E Educational Merger Corp. into SmarterKids.com will be treated for U.S. federal income tax purposes as a "reorganization" within the meaning of Section 368(a) of the Internal Revenue Code or, taken together with the contribution of all of the membership interests in Earlychildhood to LearningStar, as a transfer of property qualifying under Section 351 of the Internal Revenue Code; and . SmarterKids.com must have Cash on Hand (as defined by U.S. generally accepted accounting principles) of not less than $18,000,000 after deducting certain fees and expenses of both SmarterKids.com and Earlychildhood incurred in connection with the combination, including costs and expenses resulting from the integration of the two companies and their technologies. Termination of the Combination Agreement. SmarterKids.com and Earlychildhood can jointly agree in writing to terminate the combination agreement at any time. Either company may also terminate the combination agreement if, among other things: . the combination is not completed on or before April 30, 2001, provided, however, that if the combination is not completed by April 30, 2001 due to a failure to receive all governmental approvals, the date will be extended to July 31, 2001; . if a court of competent jurisdiction or other governmental entity has issued a non-appealable final order, decree or ruling or taken any other non-appealable final action having the effect of permanently restraining, enjoining or otherwise prohibiting the combination; or . the other party breaches its representations, warranties or covenants in the combination agreement in a material way, which breach is not cured within 30 business days following receipt of notice of breach. The combination agreement may be terminated by SmarterKids.com prior to the date of the special meeting if the SmarterKids.com board of directors reasonably determines in good faith and in accordance with the applicable provisions of the combination agreement: . after consultation with a financial advisor of nationally recognized reputation, that an unsolicited bona fide "Acquisition Proposal," is more favorable or is reasonably likely to lead to an Acquisition Proposal that is more favorable to the SmarterKids.com stockholders from a financial point of view than the transactions proposed by the combination agreement and is made by a third party reasonably believed by the SmarterKids.com board of directors to be financially capable of completing the Acquisition Proposal; and . after consultation with outside counsel, that failure to take action with respect to an Acquisition Proposal would cause the members of the SmarterKids.com board of directors to breach their fiduciary duties to the SmarterKids.com stockholders under applicable law. 9 An Acquisition Proposal is: . any transaction pursuant to which a third party, other than Earlychildhood or its affiliates, acquires more than 20% of the outstanding shares of SmarterKids.com common stock pursuant to a tender offer or exchange offer or otherwise; . a merger or other business combination, recapitalization, restructuring or similar transaction involving SmarterKids.com; . any other transaction pursuant to which any third party acquires control of assets of SmarterKids.com with a fair market value of 20% of the fair market value of all SmarterKids.com assets immediately prior to the transaction; or . any public announcement of a proposal, plan or intention to do any of the foregoing. The combination agreement may be terminated by Earlychildhood if any of the following occurs: . the requisite vote of the SmarterKids.com stockholders to approve and adopt the combination agreement is not obtained at a duly held meeting of the SmarterKids.com stockholders; . the SmarterKids.com board of directors has withdrawn or modified in any manner its recommendation that its stockholders vote in favor of the combination agreement; . SmarterKids.com fails to include in this proxy statement-prospectus the recommendation of its board of directors in favor of the approval and adoption of the combination agreement; . after the receipt by SmarterKids.com of an Acquisition Proposal, Earlychildhood requests in writing that the SmarterKids.com board of directors reconfirm its recommendation of the combination agreement to the SmarterKids.com stockholders and the SmarterKids.com board of directors fails to do so within ten business days after receipt of Earlychildhood's request; . the SmarterKids.com board of directors or any committee thereof approves or recommends to the stockholders of SmarterKids.com an Acquisition Proposal other than the combination; . a third party, other than Earlychildhood or its affiliates, commences a tender offer or exchange offer for 20% or more of the outstanding shares of SmarterKids.com common stock and the SmarterKids.com board of directors does not oppose the tender or exchange offer; . SmarterKids.com enters into any letter of intent or similar document or any agreement, contract or commitment accepting or expressing an intent to accept an Acquisition Proposal; or . SmarterKids.com fails to call and hold the SmarterKids.com special meeting by April 30, 2001. Termination Fees. The combination agreement provides that, under certain circumstances, SmarterKids.com will be required to pay Earlychildhood a termination fee of $1,300,000. The circumstances under which SmarterKids.com will be obligated to pay the termination fee are described on pages through of this proxy statement-prospectus. Expenses. The combination agreement provides that, under certain circumstances, either party may be required to pay the other party's expenses incurred in connection with the proposed combination up to a maximum of $350,000. These circumstances are described on pages through of this proxy statement-prospectus. "No Solicitation" and "No Negotiation" Provisions. The combination agreement contains detailed provisions prohibiting SmarterKids.com and Earlychildhood from seeking an alternative transaction. These "no solicitation" and "no negotiation" provisions prohibit SmarterKids.com and Earlychildhood, as well as their officers, directors, managers, subsidiaries and representatives, from taking any action to solicit an alternative transaction. The combination agreement does not, however, prohibit SmarterKids.com or its board of directors from considering, and potentially recommending an unsolicited bona fide Acquisition Proposal if: 10 . the SmarterKids.com board of directors, after consultation with a financial advisor of nationally recognized reputation, reasonably determines in good faith that the Acquisition Proposal is more favorable or reasonably likely to lead to an Acquisition Proposal more favorable from a financial point of view to the SmarterKids.com stockholders than the transactions contemplated by the combination agreement and is made by a third party reasonably believed by the SmarterKids.com board of directors to be financially capable of completing the Acquisition Proposal; and . the SmarterKids.com board of directors, after consultation with outside counsel, reasonably determines that failure to take action with respect to the Acquisition Proposal would cause the members of the SmarterKids.com board of directors to breach their fiduciary duties to the SmarterKids.com stockholders under applicable law. The no solicitation and no negotiation provisions of the combination agreement are described in more detail in the section entitled "Terms of the Combination Agreement--No Other Transactions Involving SmarterKids.com or Earlychildhood" which begins on page of this proxy statement-prospectus. Stockholder Support Agreement. As required by the combination agreement, Earlychildhood has entered into a stockholder support agreement with each director and executive officer and certain significant stockholders of SmarterKids.com pursuant to which these directors, officers and stockholders have agreed to vote all their shares of SmarterKids.com common stock in favor of the approval and adoption of the combination agreement and the transactions contemplated thereby. As of the record date, these stockholders owned shares of SmarterKids.com common stock representing approximately % of the voting power of SmarterKids.com common stock entitled to vote at the SmarterKids.com special meeting. The terms of the stockholder support agreement are described in more detail in the section entitled "Terms of the Combination--Stockholder Support Agreement" on pages through of this proxy statement-prospectus. Consent and Non-Contravention Agreement. Prior to the combination, all of the holders of membership interests in Earlychildhood executed a consent and non-contravention agreement pursuant to which, among other things, each member agreed to accept the applicable number of shares of LearningStar common stock in exchange for his, her or its membership interests contributed to LearningStar. Affiliate Agreements. In connection with the combination, each of the affiliates of SmarterKids.com (the directors and executive officers of SmarterKids.com and holders of 5% or more of the outstanding common stock of SmarterKids.com) and each of the affiliates of Earlychildhood (the members of the management committee and executive officers of Earlychildhood and holders of 5% or more of the outstanding membership interests in Earlychildhood) was required to execute an affiliate agreement pursuant to which each affiliate agreed to comply with Rule 145 of the Securities Act of 1933 with respect to the sale of LearningStar common stock acquired by each affiliate in the combination. Lock-up Agreements. In connection with the combination, each of the directors and executive officers and certain significant stockholders of SmarterKids.com, as well as the members of the Earlychildhood management committee and the holders of membership interests in Earlychildhood entered into lock-up agreements with LearningStar. These lock-up agreements restrict their sale of LearningStar common stock acquired in the transaction for 180 days after the LearningStar registration statement on Form S-4, of which this proxy statement-prospectus is a part, is declared effective by the Securities and Exchange Commission. Registration Rights Agreement. All of the persons or entities who executed a lock-up agreement in connection with the combination also executed a registration rights agreement with LearningStar with respect to the shares of LearningStar common stock they will receive in the combination. 11 Consulting Agreement. Upon completion of the combination, David Blohm, the current President and Chief Executive Officer of SmarterKids.com, will enter into an 18-month consulting agreement with LearningStar. Upon expiration of the 18 month consulting period, LearningStar will provide Mr. Blohm with severance payments for 24 months. Each of the foregoing agreements are more fully described in the section entitled "Terms of the Combination--Other Agreements" which begins on page of this proxy statement-prospectus. Completion and Effectiveness of the Combination. We will complete the combination when all of the conditions to completion of the combination are satisfied or waived in accordance with the combination agreement. The combination will become effective when: . the contribution of all the outstanding membership interests in Earlychildhood to LearningStar is completed; and . a certificate of merger is filed with the Secretary of State of the State of Delaware with respect to the merger of S-E Educational Merger Corp. with and into SmarterKids.com. We expect to complete the combination during the spring of 2001. Nasdaq National Market Listing of LearningStar Common Stock to be Issued in the Combination (see page ) LearningStar will use its reasonable best efforts to cause the shares of LearningStar common stock to be issued in connection with the combination to be approved for listing on the Nasdaq National Market, subject to official notice of issuance, before the combination is completed. Delisting and Deregistration of SmarterKids.com Common Stock after the Combination (see page ) When the combination is completed, the SmarterKids.com common stock will be delisted from the Nasdaq National Market and will be deregistered under the Securities Exchange Act of 1934, as amended. Restrictions on Resales by Affiliates; Affiliate Agreements (see page through ) Affiliates of both SmarterKids.com and Earlychildhood are subject to Rule 145 of the Securities Act of 1933, as amended, which governs the resale of shares of LearningStar common stock acquired by those affiliates in the combination. Each affiliate of SmarterKids.com and Earlychildhood has entered into an affiliate agreement with LearningStar pursuant to which each affiliate agreed to comply with Rule 145 of the Securities Act of 1933 with respect to the sale of LearningStar common stock acquired by each affiliate in the transaction. The terms of the affiliate agreements are described in the section entitled "Terms of the Combination--Other Agreements," which begins on page of this proxy statement-prospectus. The Board of Directors and Management of LearningStar following the Combination (see page ) SmarterKids.com and Earlychildhood have agreed that, upon completion of the combination, the board of directors of LearningStar will be expanded to nine members, two of whom will be designated by SmarterKids.com, and four of whom will be designated by Earlychildhood. The remaining three directors will be independent directors designated jointly by SmarterKids.com and Earlychildhood. Upon completion of the combination, Al Noyes, currently the Chief Operating Officer of SmarterKids.com, and Michael Kolowich, currently a director of SmarterKids.com, will be the two directors of LearningStar designated by SmarterKids.com. Ronald Elliott, the current President and Chief Executive Officer of Earlychildhood, Robert MacDonald, Managing Director and President of the Private Equity Group of William E. Simon & Sons, LLC, 12 Scott Graves, a Principal of the Private Equity Group of William E. Simon & Sons, LLC, and Stephen Kaplan, each a current member of Earlychildhood's management committee, will be the four directors of LearningStar designated by Earlychildhood. Upon completion of the combination, Ronald Elliott will serve as Chairman of the Board of LearningStar and Al Noyes will serve as Chief Executive Officer of LearningStar. Robert Cahill, currently the Vice President of Finance and Chief Financial Officer of SmarterKids.com, will serve as the Chief Financial Officer of LearningStar and Judith McGuinn, currently the Chief Operating Officer of Earlychildhood, will serve as the Chief Operating Officer of LearningStar. Ownership of LearningStar following the Combination (see page ) Upon completion of the combination, approximately 20,668,849 shares of LearningStar common stock will be issued to former holders of SmarterKids.com common stock, and options to purchase SmarterKids.com common stock will be converted into the right to purchase an aggregate of approximately 4,774,950 shares of LearningStar common stock. Upon completion of the combination, warrants to purchase SmarterKids.com common stock will be converted into the right to purchase approximately 217,292 shares of LearningStar common stock. As a result of the combination, we estimate that former holders of SmarterKids.com common stock and options and warrants therefor will own approximately one-third of the capital stock of LearningStar. Approximately 44,841,828 shares of LearningStar common stock will be issued to former holders of Earlychildhood membership interests, and options to purchase an aggregate of 3.33% of the outstanding membership interests in Earlychildhood will be converted into the right to purchase an aggregate of 1,546,747 shares of LearningStar common stock. As a result of the combination, we estimate that the holders of membership interests in Earlychildhood and options therefor will own approximately two-thirds of the capital stock of LearningStar. Immediately prior to the completion of the combination, the directors and executive officers of SmarterKids.com and their affiliates and the members of the management committee and executive officers of Earlychildhood and their affiliates will own, in the aggregate, approximately 9.5% and 62.2%, respectively, of the fully-diluted outstanding capital stock of LearningStar. After the combination is completed, North Bridge Venture Partners III, L.P. and Commonwealth Capital Ventures II, L.P., the two largest stockholders of SmarterKids.com, will own approximately 4.1% and 2.6%, respectively, of the capital stock of LearningStar. Educational Simon, L.L.C. and QTL Corporation, the two largest holders of membership interests in Earlychildhood, will own approximately 32.7% and 26.6%, respectively, of the fully-diluted capital stock of LearningStar after the combination is completed. Comparison of Shareholder Rights (see page ) Upon completion of the combination, stockholders of SmarterKids.com and members of Earlychildhood will become stockholders of LearningStar. The rights of the holders of LearningStar capital stock will be governed by Delaware law, the restated certificate of incorporation and the amended and restated bylaws of LearningStar. See the section entitled "Comparison of Rights of Holders of LearningStar Common Stock, SmarterKids.com Common Stock and Earlychildhood Membership Interests" which begins on page of this proxy statement- prospectus. Regulatory Approvals (see page ) SmarterKids.com and Earlychildhood are not aware of any governmental approvals or actions that are required to complete the combination. Should any approval or action be required, SmarterKids.com and Earlychildhood currently plan to seek the approval or take the necessary action. 13 SUMMARY SELECTED FINANCIAL DATA We are providing the following summary financial information to aid you in your analysis of the financial aspects of the combination. This information should be read in conjunction with the historical financial statements of SmarterKids.com, Earlychildhood and Educational Products, Inc., or EPI, a wholly-owned subsidiary of Earlychildhood, included elsewhere in this proxy statement-prospectus. SMARTERKIDS.COM SUMMARY SELECTED HISTORICAL FINANCIAL DATA (in thousands, except per share data) The following statement of operations data for the years ended December 31, 1997, 1998 and 1999 and the balance sheet data at December 31, 1998 and 1999 are derived from the audited financial statements of SmarterKids.com included elsewhere in this proxy statement-prospectus. The statement of operations data for the years ended December 31, 1995 and 1996 and the balance sheet data at December 31, 1995, 1996 and 1997 are derived from the audited financial statements of SmarterKids.com not included in this proxy statement-prospectus. The statement of operations data for the nine months ended September 30, 1999 and 2000 and the balance sheet data at September 30, 2000 are derived from the unaudited interim financial statements of SmarterKids.com included elsewhere in this proxy statement-prospectus. The unaudited interim financial statements, in the opinion of SmarterKids.com management, include all adjustments necessary for a fair presentation of those financial statements. Historical results are not indicative of the results to be expected in the future.
Nine Months Ended Year Ended December 31, September 30, -------------------------------------------- ---------------------- 1995 1996 1997 1998 1999 1999 2000 ------- ------- ------- ------- -------- ------------- -------- Statement of Operations Data: Revenues........................ $ 401 $ 1,240 $ 1,416 $ 2,300 $ 5,421 $ 1,108 $ 4,504 Income from operations.......... 82 833 925 1,372 1,416 313 1,118 Net loss........................ (1,470) (1,649) (1,014) (3,342) (34,728) (14,142) (23,470) Net loss attributable to common stockholders................... (1,470) (1,649) (1,081) (3,596) (34,917) (14,261) (23,470) Basic and diluted net loss per common share................... $ (0.98) $ (1.10) $ (0.72) $ (2.34) $ (9.20) $ (8.10) $ (1.15) Shares used to compute basic and diluted net loss per common share.......................... 1,500 1,501 1,502 1,534 3,796 1,760 20,476 As of As of December 31, September 30, -------------------------------------------- ------------- 1995 1996 1997 1998 1999 2000 ------- ------- ------- ------- -------- ------------- Balance Sheet Data: Cash and cash equivalents....... $ 2,307 $ 433 $ 293 $4,273 $ 55,621 $17,754 Short-term investments.......... -- -- -- -- 11,735 15,201 Working capital................. 1,959 333 110 3,066 60,126 33,612 Restricted cash................. -- 199 -- -- 500 1,208 Total assets.................... 2,748 1,470 1,145 5,504 82,335 48,484 Long term debt and capital lease obligations, net of current portion........................ -- 104 41 -- 34 806 Redeemable preferred stock...... 3,251 3,251 4,011 10,287 -- -- Stockholders' equity (deficit).. (1,144) (2,791) (3,839) (7,162) 63,634 41,426
14 EARLYCHILDHOOD SUMMARY SELECTED HISTORICAL FINANCIAL DATA (In thousands, except per share data) The following statement of operations data for the year ended March 31, 1998, the nine months ended December 31, 1998 and the year ended December 31, 1999 and the balance sheet data as of December 31, 1998 and 1999 are derived from the audited consolidated financial statements of Earlychildhood appearing elsewhere in this proxy statement-prospectus. The balance sheet data as of March 31, 1998 is derived from the audited consolidated financial statements of Earlychildhood not included in this proxy statement-prospectus. The statement of operations data for the nine months ended September 30, 1999 and 2000 and the balance sheet data as of September 30, 2000 are derived from the unaudited consolidated financial statements of Earlychildhood included in this proxy statement-prospectus. The statement of operations data for the years ended March 31, 1996 and 1997 and the balance sheet data as of March 31, 1996 and 1997 are derived from the unaudited consolidated financial statements of Earlychildhood not included in this proxy statement-prospectus. In the opinion of Earlychildhood's management, the unaudited consolidated financial statements have been prepared on a basis consistent with the audited consolidated financial statements which appear elsewhere in this proxy statement-prospectus and include all adjustments, which are only normal recurring adjustments, necessary for the fair presentation of the financial position and the results of operations for the unaudited periods. The historical results presented herein are not necessarily indicative of future results.
Nine Months Nine Months Year Ended Ended Year Ended Ended March 31, December 31, December 31, September 30, ---------------------- ------------ ------------ --------------- 1996 1997 1998 1998(1) 1999(2) 1999 2000 ------ ------- ------- ------------ ------------ ------- ------- Statement of Operations Data: Revenues............... $8,730 $12,698 $18,597 $20,786 $61,034 $49,256 $67,814 Income from operations............ 539 496 22 2,022 4,224 6,136 2,350 Net income (loss)...... 342 128 (140) 1,649 1,902(3) 4,174 587(3) Pro forma basic and diluted net income per common share(4)....... $ 0.05 $ 0.01 Shares used to compute pro forma net income per common share (4) --Basic............... 35,909 44,738 --Diluted............. 35,909 44,739
As of As of As of March 31, December 31, September 30, ----------------- ------------ ------------- 1996 1997 1998 1998 1999 2000 ----- ----- ----- ----- ------ ------------- Balance Sheet Data: Cash and cash equivalents........ $ 110 $ 92 $ -- $ 29 $ 151 $ -- Working capital.................. 564 554 301 884 7,959 16,941 Total assets..................... 3,583 4,851 6,116 8,443 28,915 39,343 Long term debt, net of current portion......................... 1,595 1,911 1,986 2,116 9,087 7,750 Members' equity.................. 641 736 590 2,054 10,494 22,265
(1) Prior to April 1, 1998, the fiscal years of both Earlychildhood and its affiliate, QTL Corporaton, or QTL, ended March 31. On April 1, 1998, both Earlychildhood and QTL changed their fiscal years to end on December 31. Accordingly, the fiscal year ended December 31, 1998 consists of nine months. (2) On May 5, 1999, Earlychildhood acquired EPI, a Texas-based wholesaler of educational products. The financial information reflects the combined results of Earlychildhood's operations and the operations of EPI subsequent to May 5, 1999. (3) Net income for the year ended December 31, 1999 and the nine months ended September 30, 2000 reflect the pro forma income tax effect of Earlychildhood's income being subject to federal and state income taxes as a C corporation. See Note 13 to the consolidated financial statements of Earlychildhood included elsewhere inthis proxy-statement prospectus. (4) Assumes the exchange of the weighted average membership interests outstanding in Earlychildhood for common stock of LearningStar at the exchange ratios set forth in the combination agreement. See the section entitled "The Combination--General" in this proxy statement-prospectus. 15 SUMMARY SELECTED UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION (In thousands, except per share data) Presented below is summary selected unaudited pro forma condensed combined financial information that is intended to give you a better understanding of what the SmarterKids.com and Earlychildhood results might have looked like had they always been combined. The companies would have performed differently had they been combined, and you should not rely on the pro forma information as being indicative of the historical results that would have been achieved or the future results that we will experience after the combination. The information below does not reflect cost savings that are expected as a result of the combination or any charges that may be incurred as a result of the combination. This summary selected unaudited pro forma condensed combined financial information should be read in conjunction with the Unaudited Pro Forma Condensed Combined Financial Information included elsewhere in this proxy statement-prospectus.
Nine Months Year Ended Ended December 31, September 30, 1999 2000 ------------ ------------- Unaudited Pro Forma Condensed Combined Statement of Operations Data: Revenues......................................... $ 69,162 $ 72,318 Loss from operations............................. (34,309) (24,294) Net loss attributable to common stockholders..... (34,657) (23,297) Basic and diluted net loss per share............. $ (0.61) $ (0.36) Weighted average number of basic and diluted shares outstanding..................................... 57,154 65,379
As of September 30, 2000 ------------- Unaudited Pro Forma Condensed Combined Balance Sheet Data: Cash and cash equivalents...................................... $17,754 Short-term investments......................................... 15,201 Working capital................................................ 47,356 Restricted cash................................................ 1,028 Total assets................................................... 94,139 Long-term debt and capital lease obligations, net of current portion....................................................... 8,617 Stockholders' equity........................................... 66,806
16 COMPARATIVE PER SHARE DATA The table below summarizes certain per share information of SmarterKids.com and Earlychildhood. In addition, we have summarized certain per share information of the combined company on an unaudited pro forma basis assuming that the combination had been completed at the beginning of the periods presented. The equivalent pro forma per share information for SmarterKids.com is the same as the pro forma combined per share information, because SmarterKids.com common shares convert into shares of the combined company on a one-for-one basis. Pro forma combined dividends declared are not presented because LearningStar does not expect to pay dividends. All per share information relating to Earlychildhood assumes exchange of the membership interests for common stock of the combined company at the exchange ratios set forth in the combination agreement. SmarterKids.com paid no dividends during the periods presented below. This comparative per share information should be read together with the Unaudited Pro Forma Combined Condensed Financial Information and the separate historical financial statements of each of SmarterKids.com, Earlychildhood and EPI and the respective notes thereto, included elsewhere in this proxy statement-prospectus. The pro forma information is presented for illustrative purposes only and does not necessarily indicate what the operating results or financial position of the combined company would have been if the combination had been completed at the beginning of the periods presented.
Nine Months Year Ended Ended December 31, September 30, 1999 2000 ------------ ------------- SMARTERKIDS.COM--HISTORICAL: Net loss per share--basic and diluted.............. $(9.20) $(1.15) Book value per share(1)............................ $(3.13) $(2.01) EARLYCHILDHOOD--HISTORICAL: Net income per share--basic and diluted(2)......... $ 0.05 $ 0.01 Book value per share(1)............................ $ 0.24 $ 0.50 Equity distributions............................... $ 0.09 $ 0.01 PRO FORMA COMBINED: Net loss per share--basic and diluted.............. $(0.61) $(0.36) Book value per share(3)............................ $ 1.02
- -------- (1) The historical book value per share is computed by dividing total stockholders' equity (deficit) by the number of common shares assumed to be outstanding at the end of the period. (2) See Note 2 to the consolidated financial statements of Earlychildhood included elsewhere in this proxy statement-prospectus. (3) The pro forma combined book value per share is computed by dividing total pro forma stockholders' equity by the pro forma number of shares outstanding at the end of the period. 17 RISK FACTORS In addition to the other information contained in this proxy statement- prospectus, you should carefully consider the following risk factors in deciding whether to vote for approval and adoption of the combination agreement and the transactions contemplated thereby. Actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in the following risk factors and elsewhere in this proxy statement-prospectus. Risks Related to the Combination LearningStar may fail to realize the anticipated benefits of the combination. The combination involves the integration of two companies that have previously operated independently. We cannot assure you that the respective operations of SmarterKids.com and Earlychildhood can be integrated without encountering difficulties. The success of the combination will depend, in large part, on the ability of SmarterKids.com, Earlychildhood and LearningStar to realize the anticipated growth opportunities and synergies from combining the business of SmarterKids.com with the business of Earlychildhood. To realize the anticipated benefits of this combination, members of the LearningStar management team must develop strategies and implement a business plan that will: . effectively combine Earlychildhood's children's product catalog and school fund-raising programs with SmarterKids.com's e-commerce technology and infrastructure; . successfully take advantage of the anticipated opportunities for cross- promoting and cross-selling Earlychildhood's and SmarterKids.com's products and services and for increasing revenues from the sale of products, services and information; . effectively and efficiently integrate SmarterKids.com's and Earlychildhood's policies, procedures and operations; . successfully retain and attract key employees, including operating management and key technical personnel, during a period of transition and in light of the competitive employment market; and . while integrating Earlychildhood's and SmarterKids.com's operations and significant facilities, which are located in California, Florida, Georgia, Massachusetts, Pennsylvania and Texas, maintain adequate focus on the core businesses of the combined company in order to take advantage of competitive opportunities and to respond to competitive challenges. If members of the LearningStar management team are not able to develop strategies and implement a business plan that achieves these objectives, the anticipated benefits of the combination may not be realized. In particular, anticipated growth in revenue, earnings before interest, taxes, depreciation and amortization, or "EBITDA," and cash flow may not be realized, which would have an adverse impact on LearningStar and the market price of shares of LearningStar common stock. We cannot assure you whether and to what extent the integration and consolidation of Earlychildhood and SmarterKids.com will achieve increased revenues, cost savings or operating synergies. Fluctuations in market prices may cause the value of the shares of LearningStar common stock that you receive in the combination to be less than the value of your shares of SmarterKids.com common stock. Upon completion of the combination, each outstanding share of SmarterKids.com common stock will be converted into, and each outstanding membership interest in Earlychildhood will be exchanged for, shares of LearningStar common stock. The ratios at which the shares and membership interests will be converted or exchanged, as applicable, are fixed. There will be no adjustment for changes in the market price of SmarterKids.com common stock. As a result, the perceived or actual value of the shares of LearningStar common stock received by SmarterKids.com stockholders in the combination could vary depending on 18 fluctuations in the market price of SmarterKids.com common stock. SmarterKids.com common stock has historically experienced significant volatility and its market price has recently fallen below $1.00. Stock price volatility may result from a variety of factors that are beyond SmarterKids.com's or LearningStar's control, including changes in its businesses, operations and prospects, regulatory considerations, general market and economic conditions and specific conditions in the e-retailing market, the children's educational products market and the market for stock of Internet business-to-consumer companies. Earlychildhood's membership interests are not publicly traded and, as such, the value of the shares of LearningStar common stock received by holders of Earlychildhood membership interests in the combination will not vary as a result of market fluctuations. However, the value attributed to Earlychildhood and to its membership interests may be impacted by changes in the market price of SmarterKids.com common stock. Earlychildhood is not permitted to "walk away" from the combination or resolicit the vote of the holders of its membership interests solely because of a decrease or successive decreases in the market price of SmarterKids.com common stock. The price of SmarterKids.com common stock at the closing of the combination may vary from its price on the date of this proxy statement-prospectus and on the date of the special meeting. Because the closing date of the combination will be later than the date of the special meeting, the price of SmarterKids.com common stock on the date of the special meeting may not be indicative of its price on the closing date. Combining SmarterKids.com and Earlychildhood to form a provider of children's educational products creates a new business model that the marketplace may have difficulty valuing. The market value of shares of common stock generally reflects a "multiple" of selected measures of financial performance, such as operating profits or earnings per share. The multiple for shares of LearningStar common stock may be based on the financial performance of SmarterKids.com, or it may be based on the financial performance of Earlychildhood, or it may reflect a "blending" of the two. LearningStar will be a provider of children's educational products and its business model will include both web-based and traditional catalog sales of products and services to the school and consumer markets. Financial analysts and investors may have difficulty identifying and applying measures of financial performance that reflect the value of the combined company. As a result, shares of LearningStar common stock may not achieve a valuation in the public market that fully reflects the true value of the combined company, including its synergies and benefits. If we do not complete the combination, it could negatively impact SmarterKids.com and the price of its common stock. If the combination is not completed, SmarterKids.com may be subject to a number of material risks, including the following: . SmarterKids.com may be required to pay Earlychildhood a termination fee of $1,300,000 or reimburse Earlychildhood's out-of-pocket expenses incurred in connection with the combination up to a maximum of $350,000; . the market price of SmarterKids.com common stock may decline to the extent that the current market price of SmarterKids.com common stock reflects a market assumption that the transaction will be completed; and . SmarterKids.com must pay certain costs related to the transaction, such as legal and accounting fees and expenses and financial advisor expenses, even if the combination is not completed. As a result of the combination, you will experience immediate and substantial dilution with respect to your shares of SmarterKids.com common stock. The completion of the combination will result in immediate and substantial dilution to the SmarterKids.com stockholders because, as a result of the combination, the ownership of SmarterKids.com 19 stockholders will decrease from 100% of SmarterKids.com to approximately one- third of LearningStar. Dilution refers to a decrease in the percentage ownership interest of a company that a share of stock represents. Certain SmarterKids.com executive officers and directors have conflicts of interest that may influence them to support the combination. A number of executive officers and directors of SmarterKids.com have employment or severance agreements or benefit arrangements that provide them with interests in the combination that differ from yours as a stockholder of SmarterKids.com generally. Following the completion of the combination, Al Noyes, Chief Operating Officer of SmarterKids.com, will serve as Chief Executive Officer of LearningStar and Robert Cahill, Vice President of Finance and Chief Financial Officer of SmarterKids.com, will serve as Chief Financial Officer of LearningStar. Al Noyes and Michael Kolowich, a current director of SmarterKids.com, will become directors of LearningStar as the two designees of SmarterKids.com. Upon the completion of the combination, David Blohm, President and Chief Executive Officer of SmarterKids.com, will enter into an 18-month consulting agreement with LearningStar. Upon expiration of the 18-month consulting period, LearningStar shall provide Mr. Blohm with severance payments for 24 months. For more information on this arrangement, please see the section entitled "The Combination--Interests of Certain Persons in the Combination." The receipt of compensation or other benefits in the combination, including the accelerated vesting of stock options, the provision of employment or consulting arrangements or other severance packages, or the continuation of indemnification arrangements for current officers and directors of SmarterKids.com following completion of the combination, may influence SmarterKids.com's executive officers and directors to support the combination. See the section entitled "The Combination--Interests of Certain Persons in the Combination" for a more detailed description of the interests of certain SmarterKids.com officers and directors. There may be sales of a substantial amount of LearningStar common stock 180 days after the combination is completed, and these sales could cause the price of LearningStar common stock to decline. In connection with the combination agreement, each of the directors and executive officers and certain significant stockholders of SmarterKids.com, as well as each of the members of the Earlychildhood management committee, executive officers and holders of membership interests in Earlychildhood, entered into lock-up agreements with LearningStar. Pursuant to these lock-up agreements, all of the shares of LearningStar common stock received by these persons in connection with the combination may not be sold for a period of 180 days from the date on which the registration statement on Form S-4 of LearningStar, of which this proxy statement-prospectus is a part, is declared effective by the Securities and Exchange Commission. Upon the expiration of the lock-up agreements, these securities may be sold in the future without registration under the Securities Act to the extent permitted under Rule 144, Rule 145 or another exemption under the Securities Act. Sales of a substantial number of shares of LearningStar common stock after the combination is completed and after the lock-up period has expired could cause the price of LearningStar's common stock to fall which could have a material adverse effect on LearningStar. Risks Relating to the Combined Company On a pro forma basis, SmarterKids.com's operating losses to date exceed Earlychildhood's operating profits, and failure to increase SmarterKids.com's revenues while reducing operating costs could prevent LearningStar from achieving profitability. SmarterKids.com has incurred significant losses since its inception and may incur losses in the future. SmarterKids.com incurred net losses of $23.5 million for the nine months ended September 30, 2000 and has not achieved profitability on a quarterly or annual basis. Earlychildhood generated net income of $366,000 20 for the same nine month period ended September 30, 2000. LearningStar will need to generate greater revenues and operating profits while significantly reducing costs and operating expenses to achieve profitability on a combined basis. SmarterKids.com's revenues may not continue to grow and SmarterKids.com may never generate sufficient revenues to achieve profitability, which could have a material adverse effect on LearningStar. If SmarterKids.com or Earlychildhood fails to obtain all required consents or waivers, third parties may alter or terminate existing contracts. Earlychildhood is required to obtain the consent of the lenders under its existing credit facility to complete the combination. If Earlychildhood is unable to obtain the lenders' consent, the credit facility could be declared in default and any borrowings under the credit facility would become due and payable. In addition, certain other agreements with tenants, suppliers, customers, landlords or other parties may require Earlychildhood or SmarterKids.com to obtain the consents or waivers of these parties in connection with the combination. If Earlychildhood or SmarterKids.com fails to obtain all of the necessary consents and waivers, third parties may alter or terminate existing contracts, require accelerated payment of funds, attach penalties and, potentially, assert other claims with respect thereto. Any one or more of the foregoing events could materially harm LearningStar's business following the combination. Additional financing may not be available when needed or may only be available on terms that could adversely affect LearningStar's business. The businesses of SmarterKids.com and Earlychildhood are capital intensive. The integration and expansion of their businesses will require a significant commitment of resources. If cash from available sources is insufficient for these purposes, or if additional cash is necessary for unanticipated needs, including the prepayment of borrowings under Earlychildhood's existing credit facility, LearningStar may need to raise additional capital. Additional financing, if needed, may not be available on satisfactory terms or at all. In addition, any additional issuance of equity or equity-related securities to raise capital would be dilutive to existing LearningStar stockholders. Any debt financing may result in additional restrictions on SmarterKids.com's, Earlychildhood's or LearningStar's spending ability to pay dividends, which could have a material adverse effect on LearningStar. Affiliates of Earlychildhood will have significant influence over LearningStar which could limit other LearningStar stockholders' ability to influence corporate decisions. After completion of the combination two of the largest holders of membership interests in Earlychildhood will own, in the aggregate, approximately 59.3% of the common stock of LearningStar on a fully-diluted basis. As a result, these stockholders, if they act together will be able to control all matters requiring approval of a majority of the LearningStar stockholders, including any merger, sale of assets and other significant corporate transactions. This control could: . delay or prevent a change of control of LearningStar; . deprive LearningStar stockholders of an opportunity to receive a premium for their common stock as a part of a sale of LearningStar or its assets; and . affect the market price of the LearningStar common stock. Each of SmarterKids.com's and Earlychildhood's businesses are highly seasonal. Seasonal shopping patterns affect SmarterKids.com's business. A significant portion of SmarterKids.com's sales occurs in the fourth quarter, coinciding with the holiday shopping season. As such, SmarterKids.com's 21 results of operations for the entire year depend largely on its fourth quarter results. Factors that could cause SmarterKids.com's sales and profitability to suffer include: . the availability of and customer demand for particular products; . unfavorable economic conditions; . the inability to hire adequate temporary personnel; . the inability to maintain appropriate inventory levels; and . a late Thanksgiving, which reduces the number of shopping days between Thanksgiving and the holiday season. Earlychildhood's business is also subject to seasonality. A significant portion of Earlychildhood's sales occurs in the third quarter, coinciding with the start of the school year. As a result, Earlychildhood's results of operations for the entire year depend largely on its third quarter results. Factors that could cause Earlychildhood's sales and profitability to suffer include: . the availability of and customer demand for particular products; . unfavorable economic conditions; and . the inability to maintain appropriate inventory levels. LearningStar's operations could be disrupted if SmarterKids.com's or Earlychildhood's information systems fail independently or as part of the integration. Both SmarterKids.com's and Earlychildhood's businesses depend on the efficient and uninterrupted operation of their computer and communications software and hardware systems. Both companies regularly make investments to maintain, enhance and replace their individual systems. Each must assess and, if deemed necessary, appropriately expand the capacity of their information systems to accommodate the anticipated growth of the combined company or its operations could suffer. In addition, continued customer access to both SmarterKids.com's and Earlychildhood's websites is important to LearningStar's success and the perception of its brand. Both websites may experience occasional system interruptions that make their website unavailable or prevent their company from efficiently fulfilling orders. These interruptions may reduce the volume of goods sold, the attractiveness of products and services offered and damage Earlychildhood's, SmarterKid.com's and LearningStar's reputation. Earlychildhood and SmarterKids.com may require additional software and hardware to upgrade the systems and network infrastructure of their websites to accommodate increased traffic and sales volume. Neither SmarterKids.com nor Earlychildhood can accurately project the rate or timing of any increases in traffic or sales volume on their individual websites and, therefore, the integration and timing of these upgrades are uncertain. Earlychildhood also depends heavily on software which is utilized in its order-taking, customer service, inventory management, and fulfillment operations. If problems with this software develop, Earlychildhood's operations could be slowed or interrupted, reducing the volume of goods sold and shipped and the attractiveness of products, services and information offered, causing damage to its reputation. Neither SmarterKids.com nor Earlychildhood have a formal recovery plan to prevent delays or other complications arising from information systems failure. Neither company's business interruption insurance may adequately compensate them for losses that may occur. LearningStar's success will be highly dependent upon the successful integration of each of SmarterKids.com's and Earlychildhood's hardware and software systems. Failure to successfully integrate these technologies could result in LearningStar's operations being slowed or interrupted, including the performance of websites, fulfillment operations and customer service. 22 Each of SmarterKids.com and Earlychildhood is dependent on executive management and key technical and sales personnel. SmarterKids.com's and Earlychildhood's officers have substantial experience and expertise and make significant contributions to SmarterKids.com's and Earlychildhood's respective growth and success. Each company believes that the growth and profitability of LearningStar depends on the continued employment of certain officers of both SmarterKids.com's and Earlychildhood's management team. Furthermore, the ultimate successful combination of SmarterKids.com and Earlychildhood will be largely dependent on the leadership of the combined management team. If one or more members of LearningStar's management team were unable or unwilling to serve in positions at LearningStar as contemplated, LearningStar's profitability could suffer. In addition the combined company's growth and profitability depends on the hiring and retention of technical personnel for both SmarterKids.com and Earlychildhood, as well as a field sales force for Earlychildhood products. If SmarterKids.com or Earlychildhood are unable to hire and retain technical personnel or Earlychildhood is unable to hire and retain sales personnel, it could have a material adverse effect on LearningStar's business, results of operations and financial condition. SmarterKids.com and Earlychildhood are subject to intense competition. Some of SmarterKids.com's direct competitors are specialty educational and creative toy and game retailers such as Zany Brainy and Learning Express. These retailers are continuing to expand and could impede SmarterKids.com's ability to increase its sales. SmarterKids.com is also subject to competition from mass market retailers and discounters such as Toys "R" Us, WalMart and Target which have greater brand recognition and greater financial, marketing and other resources than SmarterKids.com. SmarterKids.com could be at a disadvantage in responding to these competitors' merchandising and pricing strategies, advertising campaigns and other initiatives. Several of these competitors, including Toys "R" Us, have launched successful Internet shopping sites that compete with SmarterKids.com and educational "boutique" areas within their retail sites. In addition, an increase in focus on the specialty retail market or the sale by these competitors of additional products similar to SmarterKids.com's could cause SmarterKids.com to lose market share. SmarterKids.com faces growing competition from Internet-only retailers, such as eToys and Amazon.com, which may have a cost advantage over SmarterKids.com and reach a broader market, as well as non-toy specialty retailers, which compete with SmarterKids.com's children's educational product business and could limit SmarterKids.com's ability to expand in these markets. SmarterKids.com's sales and profitability could suffer if: . new competitors enter markets in which SmarterKids.com is currently operating; . SmarterKids.com's competitors implement aggressive pricing strategies; . SmarterKids.com's competitors expand their operations; . SmarterKids.com's suppliers sell their products directly or enter into exclusive arrangements with SmarterKids.com's competitors; or . SmarterKids.com's competitors adopt innovative merchandising strategies that are similar to those of SmarterKids.com. Earlychildhood's direct competitors are educational supply companies such as School Specialty, Inc., Lakeshore Learning Materials, The Kaplan Companies, ABC School Supply, Inc., Beckley Cardy Co., U.S. Toy Company, Childcraft Education Corp., and J.L. Hammett Co.'s Earlychildhood Division. There has been consolidation among these competitors over the last several years; specifically, Beckley Cardy and Childcraft Education have all been purchased by School Specialty, Inc. This consolidation could continue and result in one company's dominance in the marketplace and Earlychildhood's loss of market share. Some of Earlychildhood's competitors, such as The Kaplan Companies and School Specialty, Inc., have 23 launched successful websites which offer both products and information that compete with Earlychildhood's website. Earlychildhood manufactures products domestically and develops products internationally to offer low-cost, higher margin company-developed products. If one of its competitors pursued an aggressive manufacturing program, a competing line of similar company-developed products could cause Earlychildhood to lose market share. In addition, capital requirements in the school supply distribution industry are low, and there are few barriers to entry. A number of industry participants (including Discount School Supply and EPI) have grown consistently, buoyed by strong industry fundamentals. Attracted by this growth, entrants could potentially re-create Earlychildhood's successful operating strategies, which could materially adversely affect LearningStar. Earlychildhood's sales and profitability could suffer if: . new competitors enter markets in which Earlychildhood is currently operating; . Earlychildhood's competitors implement aggressive pricing strategies; . Earlychildhood's competitors expand their operations; or . Earlychildhood's competitors recreate its operating strategies, specifically the importation and manufacture of company-developed products. If LearningStar's suppliers and distributors do not provide sufficient quantities of products, LearningStar's sales and profitability will suffer. LearningStar's dependence on its principal suppliers and distributors involves risk, and if there is a disruption in supply from a principal supplier or distributor, LearningStar may be unable to obtain the merchandise it desires to sell. LearningStar's sales also could decline if key specialty suppliers sell more products through mass-market retailers. Many of SmarterKids.com's and Earlychildhood's suppliers currently provide them with incentives, such as return privileges, volume purchasing allowances and cooperative advertising. A reduction or discontinuation of these incentives could adversly affect LearningStar's financial performance. If a shipment of products that LearningStar imports is interrupted or delayed, inventory levels and sales could decline. LearningStar will import some of its product offerings. LearningStar will be subject to the following risks inherent in relying on foreign manufacturers: . the inability to return products; . fluctuations in currency exchange rates; . economic and political instability; . transportation delays; . trade restrictive actions by foreign governments; . the laws and policies of the United States affecting importation of goods, including duties, quotas and taxes; . foreign trade and tax laws; . foreign labor practices; 24 . trade infringement claims; and . increased liability as importer of record. Interruptions or delays in LearningStar's imports could cause shortages in product inventory and a decline in LearningStar's sales unless it secures alternative supply arrangements. Even if LearningStar could locate alternative sources, these alternative products may be of lesser quality or more expensive. LearningStar's sales could also suffer if its suppliers experience similar problems with foreign manufacturers. If LearningStar is unable to predict or react to changes in customer demand, it may lose customers and sales may decline. LearningStar's success will depend on its ability to anticipate and respond in a timely manner to changing consumer demand and preferences. LearningStar's products must appeal to a broad range of consumers whose preferences cannot be predicted with certainty and are subject to change. If LearningStar incorrectly forecasts the demand for its merchandise, it may overstock certain products and be forced to take significant inventory markdowns, which may have a negative impact on LearningStar's profitability, or return overstocked products to vendors, which may have a negative impact on LearningStar's relationships with its vendors. If LearningStar is unable to identify new products that will enjoy strong consumer demand, it may lose customers and sales may decline. The introduction of new products may also depress sales of existing products. Moreover, because LearningStar will sell only those products that conform to its product mission, LearningStar may choose not to sell some products that its customers desire and thus lose potential sales. SmarterKids.com, Earlychildhood and LearningStar may be exposed to product liability lawsuits and other claims if they fail to comply with government and toy industry safety standards. Children can sustain injuries from educational products. Each of SmarterKids.com, Earlychildhood and LearningStar may be subject to claims or lawsuits resulting from such injuries. There is a risk that claims or liabilities may exceed all of SmarterKids.com's, Earlychildhood's and LearningStar's insurance coverage. Moreover, each of SmarterKids.com, Earlychildhood and LearningStar may be unable to retain adequate liability insurance in the future. SmarterKids.com, Earlychildhood and LearningStar are subject to regulation by the Consumer Product Safety Commission and similar state regulatory authorities. SmarterKids.com, Earlychildhood and LearningStar may be unable to protect their respective intellectual property, which could impair brand and reputation. Efforts by SmarterKids.com, Earlychildhood and LearningStar to protect their proprietary rights may be inadequate. Each company regards its intellectual property as important to the marketing strategy of the combined company. To protect their proprietary rights, SmarterKids.com, Earlychildhood and LearningStar generally rely on copyright, trademark and trade secret laws, confidentiality agreements with employees and third parties and license agreements with consultants and suppliers. However, a third party could, without authorization, copy or otherwise appropriate information from any of the companies. Employees, consultants and others who participate in development activities could breach their confidentiality agreements, and the companies may not have adequate remedies for any such breach. Each of the companies' failure or inability to protect its proprietary rights could materially decrease their value, and each of the company's individual, as well as the combined company's brand and reputation could be impaired. The cost of materials used to manufacture products is subject to volatility which could adversely effect LearningStar's results of operations. Currently, Earlychildhood manufactures certain products, including non-toxic tempera paints, finger paints, glues and other water-based art mediums. The raw materials used in the manufacture process for these products may not be available from regular commercial sources of supply or may only be available from a single 25 supplier. Earlychildhood may, from time to time, experience difficulty in obtaining adequate raw material requirements at competitive prices, and experience shortages of raw materials used in its manufacturing process. The unavailability of raw materials or a substantial increase in their prices would have an adverse affect on Earlychildhood's, and ultimately LearningStar's, business, results of operations and financial condition. Earlychildhood is subject to regulation by federal and state environmental authorities and may be subject to environmental claims relating to its manufacturing processes. Earlychildhood's manufacturing operations are subject to numerous federal, state, and local environmental and occupational health and safety laws and regulations, which include laws and regulations governing waste disposal, air and water emissions, the handling of hazardous substances, workplace exposure, and other matters. If Earlychildhood fails to comply with these environmental laws and regulations, it may incur material liabilities in the form of administrative, civil, or criminal enforcement by government agencies or other parties which would adversely affect Earlychildhood's, and ultimately LearningStar's business, results of operations and financial condition. Earlychildhood and/or LearningStar may be required to make material capital expenditures to remain in compliance with applicable environmental laws and regulations. In addition, the adoption of new environmental laws and regulations, changes in existing laws and regulations, or their interpretation, stricter enforcement of existing laws and regulations, or governmental or private claims for damage to persons, property, or the environment resulting from Earlychildhood's current or former operations, may have a material adverse effect on Earlychildhood's business by forcing it to expend additional capital and resources on environmental compliance. Provisions of LearningStar's charter and bylaws and Delaware law may have anti- takeover effects that could prevent a change in control of LearningStar. The LearningStar restated certificate of incorporation authorizes the LearningStar board of directors to issue, without shareholder approval shares of preferred stock with voting, conversion and other rights and preferences that could adversely affect the voting power or other rights of the holders of LearningStar common stock. The issuance of LearningStar preferred stock or of rights to purchase preferred stock could be used to discourage an unsolicited acquisition proposal. In addition, the possible issuance of preferred stock could discourage a proxy contest, make more difficult the acquisition of a substantial block of LearningStar's common stock or limit the price that investors might be willing to pay in the future for shares of LearningStar's common stock. The LearningStar restated certificate of incorporation and amended and restated bylaws also provide that: . the LearningStar board of directors may adopt, amend or repeal the bylaws or any provision of the restated certificate of incorporation of LearningStar, however, the affirmative vote of the holders of at least 75% of the voting power of all outstanding shares of the capital stock of LearningStar voting as a single class is required to adopt, amend or repeal the amended and restated bylaws or any provision of the LearningStar restated certificate of incorporation or; . LearningStar stockholders may not take any action by written consent; . special meetings of LearningStar stockholders may be called only by the chairman of the board of directors or a majority of the LearningStar board of directors and business transacted at any special meeting shall be limited to matters relating to the purposes set forth in the notice of the special meeting; and . the LearningStar board of directors will be divided into three classes serving staggered three-year terms. In addition, following the completion of the combination, LearningStar will be subject to certain "anti-takeover" provisions of the Delaware General Corporation Law which, subject to certain exceptions, restrict certain transactions and business combinations between a corporation and a shareholder owning 15% or more 26 of the corporation's outstanding voting stock (an "interested shareholder") for a period of three years from the date the shareholder becomes an interested shareholder. These provisions of the LearningStar restated certificate of incorporation, the amended and restated bylaws and Delaware law may have the effect of delaying or preventing a change of control of LearningStar and, therefore, could adversely affect the price of the LearningStar common stock. For more information, please see the section entitled "Description of Capital Stock of LearningStar--Anti-Takeover Effects of Certain Provisions of LearningStar's Charter and Bylaws and Delaware Law." The imposition of state sales tax and other tax obligations on e-commerce could affect LearningStar's financial performance and limit SmarterKids.com's and Earlychildhood's growth. Neither SmarterKids.com nor Earlychildhood currently collects state sales and use taxes or other similar taxes with respect to its marketing of products to customers in states where it does not have a tax "nexus." It is possible that the combination and potential changes in the way that SmarterKids.com and Earlychildhood do business after the combination could result in LearningStar being more broadly subject to sales and use tax collection responsibilities or to state income taxes. A number of proposals have been made at the federal, state, local and international levels that would impose taxes on the sale of goods and services through the Internet in circumstances where no tax or tax collection responsibility is presently thought to be imposed. These proposals, if adopted, could substantially impair the growth of e-commerce and could adversely affect the combined companies' future results of operations and financial condition. There is currently in effect in the United States a three-year moratorium expiring on October 20, 2001 on new state and local taxes on Internet access and "multiple or discriminatory" taxes on e-commerce. Sales or use taxes imposed on those buying or selling products or services over the Internet are not generally affected by this moratorium. The full effect of this moratorium on SmarterKids.com's and Earlychildhood's business is not clear. To the extent that the moratorium provides a material benefit, its expiration on October 20, 2001 could adversely affect LearningStar's business, results of operations and financial condition. In addition, for a discussion of certain state tax and other tax considerations applicable to the Earlychildhood business, please see the section entitled "Earlychildhood -- Business." 27 CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS This proxy statement-prospectus and the documents incorporated by reference in this proxy-statement prospectus contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements as a result of certain factors, including those set forth in the section entitled "Risk Factors." Reference is made to the particular discussions set forth under the sections entitled "SmarterKids.com's Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Earlychildhood's Management's Discussion and Analysis of Financial Condition and Results of Operations." Forward-looking statements include information regarding: . synergies; . efficiencies; . cost-savings; . revenue enhancements; . projected funds from operations; and . the timetable for completion of the combination. The sections of this proxy statement-prospectus which contain forward- looking statements include, among others: . "Questions and Answers About the Combination"; . "Summary"; . "Summary Selected Unaudited Pro Forma Condensed Combined Financial Information"; . "The Combination--Background of the Combination"; . "The Combination--Joint Reasons for the Combination"; . "The Combination--SmarterKids.com's Reasons for the Combination"; . "The Combination--Earlychildhood's Reasons for the Combination"; . "Opinion of J.P. Morgan H&Q, Financial Advisor to SmarterKids.com"; and . "Unaudited Pro Forma Condensed Combined Financial Information." Forward-looking statements in this document or those documents incorporated by reference also include, among other things, statements regarding the intent, belief or expectations of SmarterKids.com, Earlychildhood or LearningStar and can be identified by the use of words such as "may," "will," "should," "believes," "expects," "anticipates," "intends," "estimates" and other comparable terms. For those statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. You should understand that the following important factors, in addition to those discussed elsewhere in this document could affect the future results of SmarterKids.com, Earlychildhood, and LearningStar after completion of the combination, and could cause actual results or other outcomes to differ materially from those expressed in the forward-looking statements: . inability to manage growth, diversify product offerings and expand in new and existing markets; . inability to integrate the operations, brands, personnel and information systems of Earlychildhood and SmarterKids.com or realize the business synergies expected from the combination; 28 . changes in general economic and business conditions and in the e- retailing or educational children's products industry in particular; . actions by SmarterKids.com competitors; . unanticipated costs of the combination; . the level of demand for products of Earlychildhood and SmarterKids.com; . changes in SmarterKids.com business strategies; and . other factors discussed under "Risk Factors." We urge you not to place undue reliance on forward-looking statements, which speak only as of the date of this document. All subsequent written and oral forward-looking statements attributable to SmarterKids.com, Earlychildhood or LearningStar or any person acting on their behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. None of SmarterKids.com, Earlychildhood or LearningStar undertakes any obligation to release publicly any revisions to the forward-looking statements in this proxy statement- prospectus to reflect events or circumstances after the date of this proxy statement-prospectus or to reflect the occurrence of unanticipated events. 29 THE SMARTERKIDS.COM SPECIAL MEETING Proxy Statement-Prospectus; Date, Time and Place of Special Meeting This proxy statement-prospectus is being furnished to you in connection with the solicitation of proxies from holders of SmarterKids.com common stock by the SmarterKids.com board of directors for use at the special meeting to be held at the offices of Testa, Hurwitz & Thibeault, LLP, 125 High Street, High Street Tower, 20th Floor, Boston, Massachusetts 02110 on , 2001 at 10:00 a.m., local time and at any and all adjournments or postponements of the special meeting. This proxy statement-prospectus is first being furnished to SmarterKids.com stockholders on or about , 2001. The information concerning SmarterKids.com has been furnished by SmarterKids.com and the information set forth herein concerning Earlychildhood has been furnished by Earlychildhood. The information concerning LearningStar has been jointly furnished by SmarterKids.com and Earlychildhood. Purpose of the Special Meeting--Approval and Adoption of the Combination Agreement The special meeting is being held so that stockholders of SmarterKids.com may consider and vote upon a proposal to approve and adopt the combination agreement pursuant to which SmarterKids.com and Earlychildhood will each become a wholly-owned subsidiary of LearningStar. SmarterKids.com stockholders will consider and vote upon any other business that properly comes before the special meeting or any adjournment or postponement of the special meeting. Approval and adoption of the combination agreement will also constitute approval of the combination and the other transactions contemplated by the combination agreement. If the stockholders of SmarterKids.com approve and adopt the combination agreement and the transactions contemplated thereby, upon completion of the combination, each outstanding share of SmarterKids.com common stock will be converted into the right to receive one share of LearningStar common stock. Recommendation of the SmarterKids.com Board of Directors The SmarterKids.com board of directors has unanimously determined that the combination of SmarterKids.com and Earlychildhood is advisable and in the best interests of its stockholders. The SmarterKids.com board of directors has unanimously approved the combination agreement and the combination and unanimously recommends that you vote FOR approval and adoption of the combination agreement and the transactions contemplated thereby. Record Date for the SmarterKids.com Special Meeting; Quorum SmarterKids.com's board of directors has fixed the close of business on , 2001 as the record date for determination of SmarterKids.com stockholders entitled to notice of, and to vote at, the special meeting. On the record date, there were shares of SmarterKids.com common stock outstanding, held by approximately holders of record. A majority of the outstanding shares of the SmarterKids.com common stock must be represented either in person or by proxy to constitute a quorum at the SmarterKids.com special meeting. 30 Vote Required for Approval and Adoption of the Combination Agreement The affirmative vote of a majority of the shares of SmarterKids.com common stock outstanding on the record date for the special meeting is required to approve and adopt the combination agreement and the transactions contemplated thereby. Each share of SmarterKids.com common stock is entitled to one vote on all matters properly submitted to the SmarterKids.com stockholders at the special meeting. Each of SmarterKids.com's directors, executive officers and certain significant stockholders of SmarterKids.com who owned, in the aggregate, approximately % of the shares of SmarterKids.com common stock outstanding on the record date for the special meeting have entered into a stockholder support agreement with Earlychildhood pursuant to which, among other things, they have agreed to vote all their shares of SmarterKids.com common stock in favor of the approval and adoption of the combination agreement and the transactions contemplated thereby. Proxies All shares of SmarterKids.com common stock represented by properly executed proxies at the special meeting will, unless the proxies are subsequently revoked, be voted in accordance with the instructions indicated on those proxies. If no instructions are indicated on a properly executed proxy card, the shares will be voted FOR approval and adoption of the combination agreement. You are urged to mark the box on the proxy card to indicate how to vote your shares. If a properly executed proxy card is returned and the stockholder has abstained from voting, the SmarterKids.com common stock represented by that proxy will be considered present at the special meeting for purposes of determining a quorum, but will not be considered to have been voted in favor of approval and adoption of the combination agreement. If your shares are held in an account at a brokerage firm or bank, you must instruct them on how to vote your shares. If an executed proxy card is returned by a broker or bank holding shares which indicates that the broker or bank does not have discretionary authority to vote on approval and adoption of the combination agreement, the shares will be considered present at the meeting for purposes of determining the presence of a quorum, but will have the same effect as a vote against the approval and adoption of the combination agreement and the transactions contemplated thereby. Your broker or bank will vote your shares only if you provide instructions on how to vote by following the information provided to you by your broker. Because approval and adoption of the combination agreement requires the affirmative vote of at least a majority of the shares of SmarterKids.com's common stock outstanding on the record date for the special meeting, failures to vote will also have the same effect as a vote against the approval and adoption of the combination agreement and the transactions contemplated thereby. The SmarterKids.com special meeting may be adjourned or postponed, including by its chairman, in order to permit further solicitation of proxies. No proxy voted against the proposal to approve the combination agreement will be voted on any proposal to adjourn or postpone the special meeting that is submitted to the stockholders for a vote. SmarterKids.com does not expect that any matter other than approval and adoption of the combination agreement and the transactions contemplated thereby will be brought before the special meeting. If, however, other matters are properly presented, the persons named as proxies on the proxy card will vote in accordance with their judgment with respect to those matters, unless authority to do so is specifically withheld on the proxy card. 31 Revocability of Proxies A SmarterKids.com stockholder may revoke his or her proxy at any time before it is voted by: . filing a written notice of revocation of proxy with SmarterKids.com at or prior to the taking of the vote at the special meeting; . executing a later dated proxy and delivering it to SmarterKids.com prior to the special meeting; or . if the stockholder is a holder of record, appearing in person and voting at the special meeting. All written notices of revocation and other communications regarding revocation of proxies should be addressed to SmarterKids.com, 15 Crawford Street, Needham, Massachusetts 02494, Attention: Secretary. Attendance at the special meeting will not, in and of itself, constitute revocation of a proxy. Solicitation of Proxies SmarterKids.com will bear the expenses incurred in connection with the printing and mailing of this proxy statement-prospectus. SmarterKids.com will request banks, brokers and other intermediaries holding shares of SmarterKids.com common stock beneficially owned by others to send this proxy statement-prospectus to, and obtain proxies from, the beneficial owners and will reimburse the holders for their reasonable expenses in so doing. Solicitation of proxies by mail may be supplemented by telephone, telegram and other electronic means, advertisements and personal solicitation by the directors, officers or employees of SmarterKids.com. No additional compensation will be paid to directors, officers or employees for this solicitation. YOU SHOULD NOT SEND IN ANY STOCK CERTIFICATES WITH YOUR PROXY CARD. A TRANSMITTAL LETTER WITH INSTRUCTIONS FOR THE SURRENDER OF STOCK CERTIFICATES WILL BE MAILED TO YOU AS SOON AS PRACTICABLE AFTER COMPLETION OF THE COMBINATION. 32 THE COMBINATION The following discussion summarizes the material aspects of the proposed combination. Detailed terms of, and conditions to, the combination are contained in the combination agreement, a copy of which is attached to this proxy statement-prospectus as Annex A and incorporated herein by reference. Statements made in this proxy statement-prospectus with respect to the terms of the combination are qualified in their entirety by reference to the more detailed information set forth in the combination agreement and the other annexes hereto, each of which is incorporated herein by reference. While we believe that the following description covers the material aspects of the combination, this summary may not contain all of the information that is important to you. You should read this entire proxy statement-prospectus and the other documents we refer to carefully for a more complete understanding of the combination. General The combination will become effective upon: . the contribution of all of the outstanding membership interests of Earlychildhood to LearningStar by the holders of those membership interests; and . the filing of a certificate of merger with the Secretary of State of Delaware with respect to the merger of S-E Educational Merger Corp., a wholly-owned subsidiary of LearningStar, with and into SmarterKids.com. We are working toward completing the combination as quickly as possible. We expect to complete the combination during the spring of 2001. At the effective time of the combination, each share of SmarterKids.com common stock outstanding immediately prior to the effective time will be converted into the right to receive one share of LearningStar common stock. Shares of SmarterKids.com common stock, if any, held in the treasury of SmarterKids.com will be cancelled. The outstanding membership interests of Earlychildhood currently consist of Class A interests, Class B interests and Class C interests. Upon the completion of the combination, each class of the outstanding membership interests of Earlychildhood will be exchanged for shares of LearningStar common stock according to the following exchange ratios: . each .00001% of a Class A membership interest will be exchanged for 4.9951 shares of LearningStar common stock; . each .00001% of a Class B membership interest will be exchanged for 4.6781 shares of LearningStar common stock; and . each .00001% of a Class C membership interest will be exchanged for 2.3365 shares of LearningStar common stock. LearningStar will pay cash with respect to any fractional shares of LearningStar common stock to which a SmarterKids.com stockholder or Earlychildhood member would otherwise be entitled based on the market price of the LearningStar common stock on its first trading day. As a result of the combination, former holders of SmarterKids.com common stock and options and warrants therefor will own approximately one-third of the capital stock of LearningStar and former holders of membership interests in Earlychildhood and options therefor will own approximately two-thirds of the capital stock of LearningStar. 33 Background of the Combination In early December 1999, SmarterKids.com received an unsolicited letter from Thomas Weisel Partners, LLP acting on behalf of its client Earlychildhood, regarding a potential transaction between SmarterKids.com and Earlychildhood. The market addressed by Earlychildhood, and its complementary distribution channels, were appealing to SmarterKids.com management. In early January 2000, Dan Davis, Vice President of Business Development for SmarterKids.com, telephoned Thomas Weisel Partners, LLP to preliminarily discuss the matters described in its letter. By the middle of January 2000, additional discussions had been initiated directly between principals of SmarterKids.com and Earlychildhood relating to the strategic rationale for a merger of the two companies. On January 19, 2000, Mr. Davis visited the offices of Earlychildhood in Monterey, California to meet with Robert Healy, a member of the Earlychildhood management committee and, at that time, a Principal of the Private Equity Group of William E. Simon & Sons, LLC, an affiliate of the largest equity holder of Earlychildhood, and Ronald Elliott, the President and Chief Executive Officer of Earlychildhood. On January 21, 2000, in order to facilitate additional discussions and the exchange of confidential information between the parties, SmarterKids.com, Earlychildhood and Thomas Weisel Partners, LLP entered into a nondisclosure and confidentiality agreement. In February 2000, SmarterKids.com senior management met to discuss the structure and implementation of a stock-for-stock merger of SmarterKids.com and Earlychildhood. In early March, 2000, Mr. Davis and David Blohm, President and Chief Executive Officer of SmarterKids.com, met in San Francisco, California with Mr. Healy and Scott Graves, a member of the Earlychildhood management committee and a Principal of the Private Equity Group of William E. Simon & Sons, LLC, to discuss material terms of a possible transaction. In conjunction with these discussions, the companies began consulting with their respective financial and legal advisors regarding the possible transaction. On March 14, 2000, SmarterKids.com engaged J.P. Morgan H&Q to assist in the merger negotiations with Earlychildhood. At the same time, in response to a continuing decline in the market price of SmarterKids.com common stock, which closed at $4.31 per share on March 14, 2000 down from its initial public offering price of $14.00 per share on November 23, 1999, the widespread decline in market value of Internet-based retail or "dot.com" stocks in general, as well as the deteriorating cash position of SmarterKids.com, SmarterKids.com entered into a separate engagement letter with J.P. Morgan H&Q engaging J.P. Morgan H&Q to identify other potential strategic partners for SmarterKids.com. Working with their advisors, SmarterKids.com and Earlychildhood conducted due diligence investigations using publicly available materials and non-public materials provided pursuant to the nondisclosure and confidentiality agreement and began analyses of a possible merger. On March 24, 2000, SmarterKids.com presented an offer letter to Earlychildhood containing specific proposed terms and conditions of a merger of the two companies. In April, 2000, senior managers of SmarterKids.com met with principals of Earlychildhood.com to discuss the specific terms of SmarterKids.com's offer letter, including the valuation of the two companies, and issues surrounding the structure of the merger and post-merger corporate governance. Thereafter, on April 20, 2000, Messrs. Elliott and Graves, and Judith McGuinn, Chief Operating Officer of Earlychildhood visited the SmarterKids.com management team at the offices of SmarterKids.com in Needham, Massachusetts. At the meeting, the parties were unable to agree on a valuation of the respective companies, and decided to suspend further negotiations. On May 3, 2000, Earlychildhood sent SmarterKids.com an additional letter containing a new valuation proposal for the respective companies to which SmarterKids.com did not reply. All discussions and due diligence efforts were terminated after the parties suspended their negotiations. 34 In July 2000, SmarterKids.com initiated a telephone call to Earlychildhood to discuss re-opening negotiations relating to a business combination of the two companies. Shortly thereafter, Mr. Healy and Mr. Blohm had a telephone discussion focusing on the possible management configuration for the combined company. Mr. Healy indicated that a change in chief executive officer might be appropriate and they discussed possible candidates. Following discussion between Mr. Blohm and Al Noyes, at that time SmarterKids.com's Executive Vice President of Sales and Marketing, Mr. Blohm advised Mr. Healy that Mr. Noyes was prepared to accept the position of chief executive officer of the combined company. Discussions between representatives of the two companies continued during September 2000. Throughout the course of the summer and early fall of 2000, J.P. Morgan H&Q continued its process to seek out other potential strategic partners for SmarterKids.com. During this time, J.P. Morgan H&Q contacted a variety of companies which it believed could provide an interesting strategic fit with SmarterKids.com, including various conventional retailers, Internet-based retailers and content providers, companies focused on educational products and services, and others. Seven of the companies contacted executed confidentiality agreements and reviewed confidential information relating to SmarterKids.com, and six engaged in discussions with J.P. Morgan H&Q representatives. On September 29, 2000, Earlychildhood sent SmarterKids.com a proposal outlining the terms of a possible combination of the two companies whereby the members of Earlychildhood and SmarterKids.com would receive approximately two- thirds and one-third, respectively, of the post-combination equity of the combined company. The outline also contemplated that Al Noyes would become Chief Executive Officer of the combined company. On September 30, 2000, the SmarterKids.com board of directors met to discuss the proposal. Also in attendance were Mr. Davis and Robert Cahill, Chief Financial Officer of SmarterKids.com. On October 3, 2000, the SmarterKids.com board of directors was convened via conference call to discuss the terms of the proposed combination with Earlychildhood.com. The SmarterKids.com board of directors questioned Messrs. Blohm, Noyes and Cahill about the valuation of SmarterKids.com, the proposed equity allocation and the strategic value of a combination with Earlychildhood. The board of directors reviewed information provided by Messrs. Blohm, Noyes and Cahill about the relative revenues, operating income and other financial and operating aspects of the two companies, and discussed other alternatives to a transaction with Earlychildhood. Representatives of J.P. Morgan H&Q reviewed relative advantages and disadvantages of the combination, various pro forma financial aspects of the proposed combination, and operating statistics of comparable companies. Following the board meeting, SmarterKids.com and Earlychildhood and their respective advisors intensified due diligence activities, communications coordination and preparation of successive drafts of definitive documentation. On October 4, 2000, an alternative preliminary acquisition proposal was received by SmarterKids.com. Thereafter, representatives of SmarterKids.com engaged in telephone discussions with the party submitting the proposal. On October 11, 2000, the SmarterKids.com board of directors met. Representatives of J.P. Morgan H&Q and Gordon Hayes of Testa, Hurwitz and Thibeault, LLP also attended the meeting at the invitation of the SmarterKids.com board. Discussion ensued regarding the two pending acquisition proposals. On October 12, 2000, the SmarterKids.com board directors reconvened to discuss the progress of negotiations and the relative strengths and weaknesses of the two acquisition proposals received. After extended consideration and discussion, the SmarterKids.com board of directors decided to pursue a combination with Earlychildhood as the best means to enhance shareholder value for SmarterKids.com's stockholders. After the SmarterKids.com board of directors meeting on October 12, 2000, Robert MacDonald, Managing Director and President of the Private Equity Group of William E. Simon & Sons, LLC and a member of the 35 management committee of Earlychildhood, had a telephone conversation with Mr. Blohm to discuss the proposed composition of senior management and the board of directors of the combined company in the post-combination period. Mr. MacDonald expressed his desire that, while Al Noyes would become Chief Executive Officer of the combined company, that Mr. Blohm would agree to lend his active support and leadership through an initial transition period and make himself available to provide guidance on a consulting basis going forward. Initially, discussion focused on having Mr. Blohm serve as Chairman of the Board of LearningStar for a number of months following the closing of the combination, to be followed by a consulting period. Subsequent to that date, Mr. MacDonald and Mr. Blohm agreed instead that Mr. Blohm would perform consulting services for an extended period following the combination. These discussions led to the preparation of a consulting agreement to be entered into by the combined company and Mr. Blohm following the effective date of the combination. On October 23, 2000, the SmarterKids.com board of directors met again to discuss the terms of the proposed combination and the status of the negotiations. The SmarterKids.com board of directors listened to the report of the senior managers and directed that they continue to attempt to arrive at a definitive agreement. On November 8, 2000, the SmarterKids.com board of directors met a final time to consider the proposed transaction and review drafts of the definitive agreements. In attendance at this meeting by the invitation of the SmarterKids.com board of directors were Messrs. Cahill and Noyes, representatives of Testa, Hurwitz & Thibeault, LLP and representatives of J.P. Morgan H&Q. At this meeting, Mr. Blohm and other members of management reviewed the transaction with the board of directors, including the strategic reasons for the proposed transaction, the principal terms of the proposed transaction, a financial review of the proposed transaction, a review of Earlychildhood's financial condition and business operations and the results of SmarterKids.com's due diligence review of Earlychildhood and its subsidiaries. Representatives of Testa, Hurwitz & Thibeault, LLP, SmarterKids.com's outside legal counsel, discussed the board of director's fiduciary duties in considering a strategic business combination and further discussed the terms of the combination agreement and related documents. Representatives of J.P. Morgan H&Q presented to SmarterKids.com's board of directors a summary of its analyses on the strategic rationale for, and financial analyses related to the proposed transaction. In addition, J.P. Morgan H&Q delivered a draft of its opinion that the consideration to be given SmarterKids.com stockholders of an aggregate of approximately one-third of the capital stock of LearningStar pursuant to the combination agreement was fair, from a financial point of view, to the SmarterKids.com stockholders. Upon completing its deliberations, the board of directors of SmarterKids.com unanimously approved and adopted the combination agreement and the combination and the related agreements and the transactions contemplated by those agreements, and declared them advisable and in the best interests of the SmarterKids.com stockholders. After the November 8, 2000 meeting of the SmarterKids.com board of directors, respective counsel for SmarterKids.com and Earlychildhood worked to finalize the definitive agreement and related agreements. On November 14, 2000, representatives of SmarterKids.com and representatives of Earlychildhood executed the combination agreement and additional ancillary agreements, including the stockholder support agreement. On the morning of November 15, 2000, SmarterKids.com and Earlychildhood issued a joint press release announcing the proposed combination of SmarterKids.com and Earlychildhood. Joint Reasons for the Combination The board of directors of SmarterKids.com and the management committee of Earlychildhood have identified potential mutual benefits of the combination that they believe will contribute to the success of LearningStar. These potential benefits include the following: . Broadened End Markets. Combining the existing and targeted customer bases of Earlychildhood and SmarterKids.com provides the opportunity to broaden the market exposure of the combined company beyond that of either company on a standalone basis. Earlychildhood's business model focuses primarily on providing children's educational products, services and information 36 to schools, educational professionals, and secondarily, to parents. SmarterKids.com's business model focuses on providing goods and services to the parent market. . Diversified Sales and Distribution Channels. Combining the sales and distribution capabilities and strategies of Earlychildhood and SmarterKids.com is anticipated to expand the number of methods through which the combined company is able to reach and interact with its customers. On a standalone basis, Earlychildhood maintains sales and distribution capabilities through its catalogs, fund-raising programs, direct sales force and, to a limited extent, its website. SmarterKids.com sells and distributes exclusively through its online retail store. . Expanded Technology Capabilities. The combination of internally- developed technology and information system capabilities of SmarterKids.com and Earlychildhood will result in stronger online and traditional operations for the combined company. Earlychildhood maintains specialized technology systems to procure, fulfill and measure operating efficiencies across its traditional catalog, direct sales and other business channels. SmarterKids.com possesses an internally- developed, patent pending technology that optimizes a customer's ability to evaluate and identify children's learning capabilities, strengths and weaknesses relative to age, and then matches those characteristics with recommended product and content purchases. . Enhanced Marketing Efforts. The combination of Earlychildhood and SmarterKids.com provides the combined company the opportunity to enhance its marketing efforts and enables it to influence customers over a broadened variety of marketing media. Existing marketing efforts are anticipated to become more efficient and new marketing methodologies are anticipated to become available that could not exist in each of the standalone entities. Specifically, marketing of online operations is anticipated to be executed at reduced costs through the use of Earlychildhood's traditional marketing strategies: . the Discount School Supply catalogs; . Earlychildhood NEWS magazine; . EPI SchoolWrapPacks; and . its direct sales force. Additionally, Earlychildhood's traditional business is anticipated to benefit from the targeted marketing opportunities associated with SmarterKids.com's online presence and database marketing capabilities. . Increased Product Development Capabilities. The combination of Earlychildhood and SmarterKids.com joins two well-developed in-house product development operations. Earlychildhood researches, develops, manufactures its own company-developed children's paint and other educational art materials, as well as a variety of school supplies and educational toys. SmarterKids.com views its primary product to be unique web and systems technologies that create a user experience which gives SmarterKids.com a competitive advantage in the marketplace. The product development operations of the two companies will enable the combined company to leverage its company-developed products into an effective way to differentiate itself from its competitors in the educational market. . Combined Management Expertise. Combining the management expertise of SmarterKids.com and Earlychildhood will enable the combined company to further leverage the individual strengths and assets of each company to become a stronger combined entity. . Reduced Operating Costs. Elimination of operating redundancies of the two companies is expected to provide greater revenue-generating opportunities and the potential to reduce operating costs in marketing, payroll, warehouse, general operating overhead and other areas as it deems appropriate. 37 . Enhanced Capability to Raise Funds in the Public Market. LearningStar's ability to raise capital in the private and public markets will be greater than either SmarterKids.com's or Earlychildhood's ability alone. SmarterKids.com's Reasons for the Combination In addition to the anticipated joint benefits of the combination described above, SmarterKids.com's board of directors believes that the following are additional reasons the combination will be beneficial to SmarterKids.com and in the best interests of its stockholders: . Ability to Leverage Earlychildhood's Operational Infrastructure. As a result of the combination, SmarterKids.com will be able to leverage the operating infrastructure that Earlychildhood has created over its 15- year operating history. This infrastructure includes all facets of business operations such as sales, marketing, inventory procurement, product fulfillment, operational reporting and management expertise. . Access to Unique Products. Earlychildhood possesses a unique mix of company-developed and internationally sourced products, as well as established long-term vendor relationships. Leveraging these assets is anticipated to provide a more unique, higher gross margin product base than SmarterKids.com could achieve on a standalone basis. . Diversified Fulfillment Expertise. Combining with Earlychildhood will allow SmarterKids.com to capitalize on Earlychildhood's distribution facilities and fulfillment operations which are located to optimize shipping and delivery efficiencies. Access to these facilities and operations will provide SmarterKids.com the opportunity to deliver its products to customers faster and more cost effectively. . Create Greater Analyst Following. A public company the size of LearningStar with the added revenue streams of Earlychildhood may be a more attractive investment than SmarterKids.com alone and may more likely be followed by analysts and investors. Earlychildhood's Reasons for the Combination In addition to the anticipated joint benefits for the combination described above, the Earlychildhood management committee believes that the following are additional reasons the combination will be beneficial to Earlychildhood and in the best interests of its equity holders: . Ability to Leverage SmarterKids.com's Internet Infrastructure. The combination will allow Earlychildhood to leverage SmarterKids.com's Internet technologies, web engineering resources and overall technology expertise. The SmarterKids.com website has received multiple accolades, and SmarterKids.com's technology-centric focus has been a business differentiator since inception. Earlychildhood anticipates augmenting its traditional catalog and marketing expertise with SmarterKids.com's Internet specific technology capabilities. This integration of capabilities is anticipated to expand Earlychildhood's successful track record of developing competitive advantages into both the combined company and the individual business divisions. . Broadened Customer Exposure. The combination will provide Earlychildhood with an immediate and established entry into the consumer portion of the early childhood market. Historically, Earlychildhood has focused primarily on providing children's educational products, services and information to schools, educational professionals and secondarily, to parents. The combination with SmarterKids.com provides Earlychildhood the opportunity to diversify its customer base into the parents and individual consumer market. . Improved Capital Availability and Access to Public Markets. The combination will provide Earlychildhood with immediate access to the public markets. Because Earlychildhood is currently a privately-held limited liability company, it has limited access to new sources of capital. Upon completion of the combination, LearningStar's common stock will be publicly traded. Earlychildhood will also have access to SmarterKids.com's cash, cash equivalents, restricted cash and short-term 38 investments which were approximately $34.0 million as of September 30, 2000, and to additional financial resources to accelerate its growth. Opinion of J.P. Morgan H&Q, Financial Advisor to SmarterKids.com The board of directors of SmarterKids.com retained J.P. Morgan H&Q to deliver an opinion in connection with a possible business combination transaction with Earlychildhood. J.P. Morgan H&Q was selected by SmarterKids.com's board of directors to provide an opinion based on J.P. Morgan H&Q's qualifications as a nationally-known investment bank of unquestioned expertise and reputation and its ongoing relationship with SmarterKids.com. In connection with its engagement, SmarterKids.com instructed J.P. Morgan H&Q to evaluate the fairness, from a financial point of view, of the consideration to be received by the holders of the SmarterKids.com common stock in the combination. At the meeting of the SmarterKids.com board of directors on November 8, 2000, J.P. Morgan H&Q rendered its preliminary opinion that as of November 8, 2000, based upon and subject to the various considerations set forth in the J.P. Morgan H&Q opinion, the consideration to be received by the SmarterKids.com stockholders in the combination is fair from a financial point of view. On November 14, 2000, SmarterKids.com's board of directors received J.P. Morgan H&Q's definitive written opinion dated the same date and reaffirming that the consideration to be received by the SmarterKids.com stockholders in the combination is fair from a financial point of view. The consideration to be given to SmarterKids.com stockholders was the result of arms-length negotiations between SmarterKids.com and Earlychildhood. The full text of the definitive written J.P. Morgan H&Q opinion, dated November 14, 2000, which sets forth the assumptions made, the procedures followed, the matters considered and the limitations on the scope of the review undertaken by J.P. Morgan H&Q in rendering its opinion is attached as Annex C to this proxy statement-prospectus. SmarterKids.com stockholders are urged to read the J.P. Morgan H&Q opinion carefully and in its entirety. J.P. Morgan H&Q was not asked to consider, and its opinion does not address the relative merits of the combination as compared to any alternative business strategy that might exist for SmarterKids.com or of the effect of any other business combinations in which SmarterKids.com might engage. The J.P. Morgan H&Q opinion only addresses the fairness of the financial terms from a financial point of view to the SmarterKids.com stockholders as of the date of the J.P. Morgan H&Q opinion, and does not constitute a recommendation to any stockholder of SmarterKids.com as to how the stockholder should vote at the special meeting. The summary of the J.P. Morgan H&Q opinion set forth in this proxy statement-prospectus is qualified in its entirety by reference to the full text of the opinion. In reviewing the proposed transaction, and in arriving at its opinion, J.P. Morgan H&Q, among other things: . reviewed the publicly available consolidated financial statements of SmarterKids.com for recent years and interim periods to date and certain other relevant financial and operating data of SmarterKids.com made available to J.P. Morgan H&Q from published sources, including Wall Street analysts' research reports, and from the internal records of SmarterKids.com; . reviewed the financial statements of Earlychildhood for recent years and interim periods to date and certain other relevant financial and operating data of Earlychildhood made available to J.P. Morgan H&Q from the internal records of Earlychildhood; . reviewed certain internal financial and operating information relating to SmarterKids.com and Earlychildhood prepared by the senior management of SmarterKids.com and Earlychildhood; . discussed the business, financial condition and prospects of SmarterKids.com, Earlychildhood and LearningStar with certain members of the senior management of SmarterKids.com and Earlychildhood; . reviewed the recent reported prices and trading activity for the common stock of SmarterKids.com and compared such information and certain financial information for SmarterKids.com with similar 39 information for certain other companies engaged in businesses J.P. Morgan H&Q considered comparable; . reviewed the financial terms, to the extent publicly available, of certain comparable merger and acquisition transactions; . reviewed a draft of the combination agreement dated November 8, 2000; . reviewed the final version of the combination agreement dated November 14, 2000; and . performed such other analyses and examinations and considered such other information, financial studies, analyses and investigations and financial, economic and market data as J.P. Morgan H&Q deemed relevant. J.P. Morgan H&Q did not assume responsibility for independent verification of, and did not independently verify, any of the information concerning SmarterKids.com considered in connection with its review of the proposed transactions, including without limitation any financial information, forecasts or projections, considered in connection with the rendering of its opinion. Accordingly, for purposes of its opinion, J.P. Morgan H&Q assumed and relied upon the accuracy and completeness of all such information. In connection with its opinion, J.P. Morgan H&Q did not prepare or obtain any independent valuation or appraisal of any of the assets or liabilities of SmarterKids.com, and it did not conduct a physical inspection of the properties and facilities of SmarterKids.com or Earlychildhood. With respect to the financial forecasts and projections used in its analysis, J.P. Morgan H&Q assumed that they reflected the best currently available estimates and judgments of the expected future financial performance of SmarterKids.com, and J.P. Morgan H&Q expressed no view as to the reasonableness of such forecasts and projections or the assumptions on which such forecasts or projections were based. For the purposes of its opinion, J.P. Morgan H&Q also assumed that neither SmarterKids.com nor Earlychildhood was a party to any pending transactions, including without limitation external financings, recapitalizations or material merger or acquisition discussions, other than the proposed combination and transactions in the ordinary course of conducting their respective businesses. SmarterKids.com advised J.P. Morgan H&Q that it may assume for purposes of its opinion and J.P. Morgan H&Q did assume, that the proposed merger of S-E Educational Merger Corp. into SmarterKids.com will be treated for U.S. federal income tax purposes as a reorganization under Section 368(a) of the Internal Revenue Code or, taken together with the contribution of all of the outstanding membership interests in Earlychildhood to LearningStar, as a transfer of property to LearningStar qualifying under Section 351 of the Internal Revenue Code. In performing its analyses, J.P. Morgan H&Q used published Wall Street estimates of calendar year 2000 and 2001 financial performance of SmarterKids.com. J.P. Morgan H&Q also made numerous assumptions with respect to industry performance, general business and economic conditions and other matters, many of which are beyond the control of SmarterKids.com, Earlychildhood or J.P. Morgan H&Q. The analyses performed by J.P. Morgan H&Q and summarized below are not necessarily indicative of actual values or actual future results, which may be significantly more or less favorable than suggested by such analyses. Because such analyses are inherently subject to uncertainty, being based upon numerous factors or events beyond the control of SmarterKids.com, Earlychildhood or their respective advisors, neither SmarterKids.com, J.P. Morgan H&Q nor any other person assumes responsibility if future results or actual values are materially different from the results of analyses based on forecasts or assumptions. Additionally, analyses relating to the values of businesses do not purport to be appraisals or to reflect the prices at which businesses or securities actually may be acquired or bought or sold. J.P. Morgan H&Q's opinion is necessarily based upon market, economic, financial and other conditions as they existed and can be evaluated as of the date of the opinion and any subsequent change in such conditions would require a reevaluation of such opinion. J.P. Morgan H&Q expressed no opinion as to the price at which LearningStar common stock will trade. In rendering its opinion, J.P. Morgan H&Q assumed that the proposed combination would be completed substantially on the terms contained in the combination agreement, without any waiver of any material terms or conditions by any party thereto. 40 The preparation of a fairness opinion is a complex process and is not necessarily susceptible to summary description. The summary of J.P. Morgan H&Q's analyses set forth below summarizes the material analyses presented to the SmarterKids.com board of directors but is not a complete description of the presentation by J.P. Morgan H&Q to the SmarterKids.com board of directors or the analysis performed by J.P. Morgan H&Q in connection with preparing its opinion. In arriving at its opinion, J.P. Morgan H&Q did not attribute any particular weight to any analyses or factors considered by it, but rather made subjective, qualitative judgments as to the significance and relevance of each analysis and factor. Accordingly, J.P. Morgan H&Q believes that its analyses and the summary set forth below must be considered as a whole and that selecting portions of its analyses, without considering all analyses, or of the following summary, without considering all factors and analyses, could create an incomplete view of the processes underlying the analyses set forth in the J.P. Morgan H&Q presentation to the SmarterKids.com board of directors and J.P. Morgan H&Q's opinion. The terms of the proposed combination were determined through arms-length negotiations between SmarterKids.com and Earlychildhood and were approved by the SmarterKids.com board of directors. Although J.P. Morgan H&Q provided advice to SmarterKids.com during the course of these negotiations, the decision to enter into the combination agreement was solely that of the SmarterKids.com board of directors. As described in the section entitled "--Recommendation of the SmarterKids.com Board of Directors," the opinion of J.P. Morgan H&Q and its presentation to the SmarterKids.com board of directors was only one of a number of factors taken into consideration by the SmarterKids.com board of directors in making its determination to approve the proposed combination. The following is a brief summary of the material financial analyses performed by J.P. Morgan H&Q in connection with providing its preliminary opinion to the SmarterKids.com board of directors on November 8, 2000 and the definitive written opinion provided to the SmarterKids.com board of directors and dated November 14, 2000. Valuation Analysis of SmarterKids.com Analysis of Publicly Traded Companies Considered Comparable to SmarterKids.com. This analysis reviews a business' operating performance and outlook relative to a group of peer companies to determine an implied value. Using published Wall Street estimates, J.P. Morgan H&Q compared, among other things, the enterprise values and projected revenues and EBITDA for calendar years 2000 and 2001 for SmarterKids.com to corresponding measures for certain publicly traded education technology and electronic commerce companies that J.P. Morgan H&Q considered comparable to SmarterKids.com. J.P. Morgan H&Q used revenues and price to EBITDA when making its comparisons, because valuations based on revenues and EBITDA are generally accepted in the analysis of education product distribution and information technology companies. The companies that J.P. Morgan H&Q considered comparable to SmarterKids.com were:
EV/CY00E EV/CY01E P/E P/E Revenues Revenues Multiples Multiples Company Multiples Multiples CY00E CY01E - ------- --------- --------- --------- --------- School Specialty........................ 0.7 0.6 14.8 13.2 ZapMe................................... 1.9 0.7 N/A N/A Riverdeep............................... 50.1 13.7 N/A N/A Amazon.com.............................. 5.4 3.6 29.3 62.0 Barnes and Noble.com.................... 1.9 1.0 N/A N/A eToys................................... 1.6 0.9 N/A N/A
J.P. Morgan H&Q determined mean and median enterprise value-to-revenue and price-to-earnings multiples for these companies. These multiples were used in analyses discussed below. 41 Furthermore, J.P. Morgan H&Q reviewed the relative common stock price performance of certain publicly traded education technology and electronic commerce companies that J.P. Morgan H&Q considered comparable to SmarterKids.com from January 3, 2000 to October 31, 2000 and compared such performance to the Nasdaq Composite Index and the Dow Jones Industrial Average. J.P. Morgan H&Q noted that the Dow Jones Industrial Average had declined 4.8% during that period, the Nasdaq Composite Index had declined 16.4%, the index of education technology companies had declined 70.1% and the index of electronic commerce companies had declined 79.2%. Pro Forma Contribution Analysis. J.P. Morgan H&Q determined the implied pro forma ownership of the combined company, assuming an exchange ratio in the combination of one share of common stock of LearningStar per share of SmarterKids.com common stock. J.P. Morgan H&Q then computed the portion of the combined company's pro forma calendar year 2000 and 2001 revenues contributed by SmarterKids.com, based on estimates provided by the companies' management. J.P. Morgan H&Q noted that stockholders of SmarterKids.com would own approximately 33.3% of the capital stock of the combined company on a pro forma basis, and that SmarterKids.com would account for 10.7% of the combined company's estimated consolidated calendar year 2001 revenues. Also, J.P. Morgan H&Q determined the relative contribution to the equity value of the combined company by Earlychildhood and SmarterKids.com. In the case of Earlychildhood, calendar year 2001 estimated revenues and EBITDA were converted into equity values using revenue and EBITDA multiples from comparable companies. An equity value for SmarterKids.com was determined by reference to total market capitalization of its common stock as of November 14, 2000, adjusted for any anticipated free cash balance as of the completion of the combination. J.P. Morgan H&Q noted that stockholders of SmarterKids.com would own approximately 33.3% of the capital stock of the combined company on a pro forma basis, and that SmarterKids.com would account for as low as 26.6% and as high as 41.6% of the combined company's equity value. Pro Forma Trading Value Analysis. Based upon forecasts provided by the management of SmarterKids.com and Earlychildhood, which reflected the consummation of the proposed combination, J.P. Morgan H&Q estimated the pro forma trading value per share of LearningStar using a variety of enterprise value to revenue multiples from the above analysis of publicly traded companies considered comparable to SmarterKids.com. J.P. Morgan H&Q then used a variety of equity values derived from the multiples to calculate the value of each share of LearningStar common stock. J.P. Morgan H&Q then performed a sensitivity analysis that derived a range of hypothetical pro forma share prices based on these pro forma financials and noted that each share could have a pro forma trading value of between $1.41 and $2.17. The hypothetical pro forma trading value analysis does not take into account qualitative factors such as market conditions, potential investor reaction to the transaction or any other factors not mentioned above. J.P. Morgan H&Q indicated the hypothetical valuation range which results from this analysis does not represent J.P. Morgan H&Q's opinion regarding the price at which LearningStar will trade subsequent to consummation of the transaction. J.P. Morgan H&Q did not, in any of its verbal or written communications to the board of directors of SmarterKids.com, provide such an opinion or estimate. Other Considerations. J.P. Morgan H&Q also took into account many factors relating to the negotiation of the transaction. J.P. Morgan H&Q and SmarterKids.com first initiated discussions regarding strategic alternatives in January 2000. SmarterKids.com engaged J.P. Morgan H&Q to contact organizations regarding potential interest in a strategic transaction which led to the execution of seven nondisclosure agreements and preliminary discussions with six parties. Following the submission of two indications of interest, the SmarterKids.com board of directors decided to pursue a transaction with Earlychildhood and terminate discussions with all other parties. J.P. Morgan H&Q also observed that no company used in the above analyses is identical to SmarterKids.com or the proposed combination, and the reasons for and circumstances surrounding each of the analyzed transactions are inherently different. Accordingly, an analysis of the results of the foregoing is not 42 mathematical; rather it involves complex, qualitative considerations and judgments, reflected in J.P. Morgan H&Q's opinion, concerning differences in the financial and operating characteristics of the compared companies, the characteristics of the selected transactions and other factors that could affect the public trading values of the comparable companies and SmarterKids.com. J.P. Morgan H&Q, as part of its investment banking services, is regularly engaged in the valuation of businesses and their securities in connection with mergers and acquisitions, strategic transactions, corporate restructurings, negotiated underwritings, secondary distributions of listed and unlisted securities, private placements and valuations for corporate and other purposes. J.P. Morgan H&Q has previously provided investment banking and other financial advisory services to SmarterKids.com, and has received fees for rendering these services. In the ordinary course of business, J.P. Morgan H&Q acts as a market maker and broker in the publicly traded securities of SmarterKids.com and receives customary compensation in connection therewith and has provided research coverage of SmarterKids.com in the past. In the ordinary course of business, J.P. Morgan H&Q actively trades in the equity and derivative securities of SmarterKids.com for its own account and for the accounts of its customers and, accordingly, may at any time hold a long or short position in these securities. J.P. Morgan H&Q may in the future provide investment banking or other financial advisory services to SmarterKids.com, Earlychildhood or LearningStar. SmarterKids.com has agreed to pay J.P. Morgan H&Q a financial advisory fee of $350,000 upon execution of the combination agreement and, upon completion of the combination an additional $650,000. SmarterKids.com has also agreed to reimburse J.P. Morgan H&Q for its expenses incurred in performing its services and to indemnify J.P. Morgan H&Q and its affiliates, their respective directors, officers, agents and employees and each person, if any, controlling J.P. Morgan H&Q or any of its affiliates against certain liabilities and expenses, including certain liabilities under federal securities laws, related to or arising out of J.P. Morgan H&Q's engagement and any related transactions. Recommendation of the SmarterKids.com Board Of Directors The SmarterKids.com board of directors has unanimously determined that the combination of SmarterKids.com and Earlychildhood is advisable and in the best interests of its stockholders. The SmarterKids.com board of directors has unanimously approved the combination agreement and the combination and unanimously recommends that you vote FOR approval and adoption of the combination agreement and the transactions contemplated thereby. In making its recommendation, in addition to the reasons for the combination set forth above, the SmarterKids.com board of directors took into account the following: . Expected Impact of the Combination. The board of directors of SmarterKids.com noted that the combination of SmarterKids.com and Earlychildhood is expected to strengthen the financial condition of both SmarterKids.com and Earlychildhood. The SmarterKids.com board of directors also noted that the combination of SmarterKids.com and Earlychildhood would be accounted for as a purchase transaction. . Opinion of J.P. Morgan H&Q, SmarterKids.com's Financial Advisor. SmarterKids.com retained J.P. Morgan H&Q to act as its financial advisor in connection with a possible business combination transaction with Earlychildhood. In connection with its engagement, SmarterKids.com instructed J.P. Morgan H&Q to evaluate the fairness, from a financial point of view of the proposed combination. At the November 8, 2000 meeting of the board of directors of SmarterKids.com, J.P. Morgan H&Q delivered its preliminary opinion to the board of directors of SmarterKids.com to the effect that, as of the date of such opinion and based upon the various qualifications and assumptions set forth therein, the consideration to be received by the SmarterKids.com stockholders 43 in the combination is fair, from a financial point of view. The J.P. Morgan H&Q opinion was reaffirmed in a definitive, written opinion dated November 14, 2000. . Continuing Equity Interest of SmarterKids.com. The board of directors of SmarterKids.com considered the fact that by providing for the conversion of shares of common stock of SmarterKids.com into shares of common stock of LearningStar, the combination agreement allows holders of SmarterKid.com common stock to participate in the value generated by the combination of SmarterKids.com and Earlychildhood. The board of directors of SmarterKids.com also noted that the proposed ratio of converting shares of SmarterKids.com into shares of common stock of LearningStar would result in holders of SmarterKids.com common stock receiving a significant equity stake in LearningStar, equal to approximately one-third of the capital stock of LearningStar on a fully- diluted basis after completion of the combination. . Corporate Governance Arrangements. The board of directors of SmarterKids.com noted that pursuant to, and in accordance with, the combination agreement, the board of directors of LearningStar will initially consist of nine individuals, two of whom will be designated by SmarterKids.com, four of whom will be designated by Earlychildhood and three of whom will be independent directors designated by the Earlychildhood and SmarterKids.com jointly. In addition, the SmarterKids.com board of directors noted that the combination agreement provides that Al Noyes, currently the Chief Operating Officer of SmarterKids.com, will initially serve as Chief Executive Officer and a director of LearningStar; Robert Cahill, currently the Chief Financial Officer of SmarterKids.com, will initially serve as Chief Financial Officer of LearningStar; and Michael Kolowich, a current director of SmarterKids.com, will serve as a director of LearningStar. The SmarterKids.com board of directors concluded that these arrangements would allow a strong management team drawn from both Earlychildhood and SmarterKids.com to work together to integrate the two companies. . Alternatives to the Combination. The board of directors of SmarterKids.com considered information presented by senior members of the SmarterKids.com management team that, in seeking the re-positioning of SmarterKids.com, they had explored alternatives to the proposed combination of Earlychildhood and SmarterKids.com, including alternative merger transactions. The SmarterKids.com board of directors considered management's view that the combination of Earlychildhood and SmarterKids.com provides significant cost savings and synergies with greater distribution capabilities, opportunities for cross-marketing products and potential to offer consumers new and innovative products. . Integration of Earlychildhood and SmarterKids.com. The board of directors of SmarterKids.com considered the fact that the combination of the businesses of Earlychildhood and SmarterKids.com would be challenging, and the success of the combination is not certain. The SmarterKids.com board of directors noted, however, that the management teams of Earlychildhood and SmarterKids.com have a shared vision of the potential created by the combination of traditional and new commerce methods. The SmarterKids.com board of directors further noted that the businesses of both Earlychildhood and SmarterKids.com are based, in part, on the acquisition and retention of customers. In addition, the SmarterKids.com board of directors noted that both management teams share a marketing focus and a service orientation. The SmarterKids.com board of directors then noted that these similarities in experiences and views are likely to facilitate the efforts of the management teams of Earlychildhood and SmarterKids.com to integrate their businesses effectively and efficiently. . Conditions; Termination Provisions; Termination Fee. The board of directors of SmarterKids.com reviewed the conditions to the completion of the combination and the circumstances under which either party would have the right to terminate the combination agreement. In addition, the SmarterKids.com board of directors reviewed the provisions of the combination agreement that prohibit each of Earlychildhood and SmarterKids.com from soliciting any third-party proposal or offer regarding any acquisition of Earlychildhood or SmarterKids.com, as the case may be. The board 44 of directors of SmarterKids.com also reviewed the provisions of the combination agreement that require the board of directors of SmarterKids.com to recommend the approval and adoption of the combination agreement and the transactions contemplated thereby to the stockholders of SmarterKids.com and prohibit the board of directors of SmarterKids.com from withdrawing or modifying its recommendation unless, subject to specified conditions, it has received an unsolicited acquisition proposal which would, if completed, result in a transaction that is more favorable to the SmarterKids.com stockholders from a financial point of view than the proposed combination. The SmarterKids.com board of directors also reviewed the termination fee and expenses that might be payable in the event the combination agreement is terminated under specified circumstances. The SmarterKids.com board of directors noted that while these provisions could have an impact on a third party considering an unsolicited acquisition proposal for SmarterKids.com, the provisions were reasonably necessary to protect Earlychildhood's interests in the context of the proposed combination. In addition, the SmarterKids.com board of directors found reasonable the views of its legal and financial advisors that the fees were within the range of fees payable in comparable transactions and would not be expected to preclude an unsolicited acquisition proposal for SmarterKids.com. . Stockholder Support Agreement. The board of directors of SmarterKids.com considered the terms of the stockholder support agreement entered into by each of the SmarterKids.com directors and executive officers and certain significant stockholders of SmarterKids.com in connection with the combination. The SmarterKids.com board of directors noted that, under the stockholder support agreement, these stockholders have agreed to vote all of their shares of SmarterKids.com's common stock, representing approximately % of the voting power of the SmarterKids.com common stock entitled to vote at the special meeting, in favor of approval and adoption of the combination agreement and the transactions contemplated thereby. . Potential Adverse Consequences of the Combination. The board of directors of SmarterKids.com considered several risks associated with the combination of Earlychildhood and SmarterKids.com that have the potential to create adverse consequences for SmarterKids.com. In particular, the SmarterKids.com board of directors considered the risk that the attention and efforts of senior members of SmarterKids.com's management team may be diverted from SmarterKids.com's businesses while they are working to implement the combination and that valuable strategic opportunities may be lost. The SmarterKids.com board of directors also considered the risk that the combination of SmarterKids.com and Earlychildhood may not be completed. This summary of the factors considered by the board of directors of SmarterKids.com in evaluating the merits of the combination of SmarterKids.com and Earlychildhood is not intended to be exhaustive, but is believed to include all material factors considered by the SmarterKids.com board of directors. Due to the wide variety of factors that the SmarterKids.com board of directors considered in evaluating the merits of the combination of SmarterKids.com and Earlychildhood, the SmarterKids.com board of directors did not find it practicable to, and did not attempt to, quantify or otherwise assign relative weights to the specific factors considered in its evaluation. In addition, the SmarterKids.com board of directors did not undertake to make any specific determination as to whether any particular factor, or any aspect of any particular factor, should be regarded as favorable or unfavorable; instead the SmarterKids.com board of directors analyzed all of the factors as a whole and determined that, overall, the factors support its unanimous conclusion that the combination of SmarterKids.com and Earlychildhood is advisable and in the best interests of SmarterKids.com and its stockholders. Individual members of the SmarterKids.com board of directors may have considered some factors to be more important than other factors and may have considered some factors, or aspects of some factors, to be favorable while other members considered them to be unfavorable. In considering the recommendation of the board of directors of SmarterKids.com that you to vote for the approval and adoption of the combination agreement and the transactions contemplated thereby, you should be aware that certain members of the SmarterKids.com board of directors and certain members of SmarterKids.com's management team have agreements or arrangements that provide them with interests in the 45 transaction that differ from yours generally as a stockholder of SmarterKids.com. Please see the section entitled "--Interests of Certain Persons in the Combination" that follows. Interests of Certain Persons in the Combination In considering the recommendation of the board of directors of SmarterKids.com that you to vote for the approval and adoption of the combination agreement and the transactions contemplated thereby, you should be aware that certain SmarterKids.com directors and executive officers and their affiliates, certain Earlychildhood executive officers and members of Earlychildhood's management committee and their affiliates have agreements or arrangements that provide them with interests in the transaction that differ from yours generally as a stockholder of SmarterKids.com. The SmarterKids.com board of directors was aware of these agreements and arrangements during its deliberations of the merits of the combination and in determining unanimously that the combination of SmarterKids.com and Earlychildhood is advisable, and in the best interest of its stockholders and to unanimously recommend that you vote to approve and adopt the combination agreement and the transactions contemplated thereby. Ownership and Voting Stock. As of December 31, 2000, the directors, executive officers of SmarterKids.com and their affiliates beneficially owned 8,089,789 shares of SmarterKids.com common stock, including stock options to purchase 1,860,562 shares of SmarterKids.com common stock, exercisable within 60 days of December 31, 2000, representing in the aggregate approximately 38.7% of the outstanding shares of SmarterKids.com common stock. As of December 31, 2000, members of Earlychildhood's management committee, executive officers of Earlychildhood and their affiliates beneficially owned 95.9% of the outstanding membership interests in Earlychildhood and options to purchase 3.33% of Earlychildhood membership interests giving effect to the exchange ratios set forth in the combination agreement. Stock Options and Accelerated Vesting. Assuming the completion of the combination as of March 30, 2001, 1,049,242 options to purchase shares of SmarterKids.com common stock will vest and become exercisable upon the completion of the combination, including options to purchase SmarterKids.com common stock that will vest upon the termination without cause or constructive termination of certain optionholders within 12 months of the completion of the combination. As of March 30, 2001, the number of unvested stock options held by executive officers and directors of SmarterKids.com is expected to total 695,832. Assuming the combination is completed on March 30, 2001, the number of stock options held by executive officers and directors of SmarterKids.com that would vest by that date is expected to total 616,667 pursuant to the acceleration of the vesting of options triggered by stock option agreements and change of control agreements upon completion of the combination. None of the Earlychildhood options are subject to accelerated vesting. As of December 31, 2000, the number of unvested stock options held by members of the Earlychildhood management committee and Earlychildhood executive officers is expected to total 3.33% of the membership interests in Earlychildhood giving effect to the exchange ratios set forth in the combination agreement. Employment, Consulting and Severance Agreements. Upon completion of the combination, David Blohm, the current President and Chief Executive Officer of SmarterKids.com, will execute an 18-month consulting agreement with LearningStar pursuant to which he will be paid $18,750 per month. The consulting agreement also provides that at the end of the consulting period, LearningStar will provide Mr. Blohm severance payments of $4,166.67 per month for 24 months. Ronald Elliott, the current President and Chief Executive Officer of Earlychildhood and Judith McGuinn, Earlychildhood's Chief Operating Officer, both have employment agreements with Earlychildhood. Ms. McGuinn's employment agreement provides that if at any time Ronald Elliott is not President or Chairman of the Board of Earlychildhood or any successor entity, Ms. McGuinn may resign from her position and be entitled to severance payments from Earlychildhood for the time remaining under her employment agreement. 46 At this time, it is not anticipated that any member of the Earlychildhood management committee or Earlychildhood executive officer will enter into a consulting or severance agreement with LearningStar in connection with the combination. Stock Option Agreements. Each of the following SmarterKids.com officers: David Blohm, Al Noyes, Chief Operating Officer, Jeff Pucci, Co-Chief Executive Officer, Robert Cahill, Vice President of Finance and Chief Financial Officer, Richard Viard, Vice President of Product Development, and Richard Secor, Vice President of MIS and Chief Information Officer, has a stock option agreement with SmarterKids.com which provides that in the event of a change of control of SmarterKids.com, a portion of the options held by these executive officers will be subject to accelerated vesting. Pursuant to these stock option agreements and as a result of the combination, options held by these executive officers to purchase an aggregate of 541,667 shares of SmarterKids.com common stock will immediately vest and become exercisable, assuming the combination is completed on March 30, 2001. Earlychildhood does not have any option agreements that are affected by a change of control of Earlychildhood. Change of Control Agreements. In September 2000, each of Al Noyes, Robert Cahill, Richard Viard, Richard Secor, and several key employees (Lisa Tanzer, Dan Davis, Mark DeChambeau, Joe Panepinto, Evelyn Somers, and John Zimmerman), each referred to in this section as an "Executive" and SmarterKids.com executed a change of control agreement pursuant to which, if the Executive is terminated by SmarterKids.com as a result of a change of control (as defined in the change of control agreements) within three years from the date of such agreement, SmarterKids.com would: . pay the Executive's base salary until the earlier of six months and the date the Executive is employed by a subsequent employer or is engaged as a consultant; . pay the Executive's monthly premium for continued medical and dental insurance coverage if the Executive elects to continue such coverage under the Consolidated Omnibus Budget Reconciliation Act of 1985, or COBRA, until the earlier of six months and the date of the Executive's COBRA coverage would terminate in accordance with the provisions of COBRA; and . accelerate the vesting of the Executive's incentive and non-qualified options by six months. Pursuant to these change of control agreements, assuming the combination is completed on March 30, 2001, options to purchase an aggregate of 124,688 shares of SmarterKids.com common stock will vest and become exercisable. In September 2000, each of David Blohm and Jeff Pucci, each referred to in this section as a "Senior Executive," and SmarterKids.com executed a change of control agreement pursuant to which, if the Senior Executive is terminated by SmarterKids.com as a result of a change of control (as defined in the change of control agreements) within three years from the date of such agreement, SmarterKids.com will: . pay the Senior Executive's base salary until the earlier of 12 months and the date the Senior Executive is employed by a subsequent employer or is engaged as a consultant; . pay the Senior Executive's monthly premium for continued medical and dental insurance coverage if the Senior Executive elects to continue such coverage under COBRA until the earlier of 12 months and the date the Senior Executive's COBRA coverage would terminate in accordance with the provisions of COBRA; and . accelerate the vesting of the Senior Executive officers incentive and non-qualified options by 12 months. 47 Pursuant to these change of control agreements, assuming the combination is completed on March 30, 2001 and the termination of both Messrs. Blohm and Pucci immediately thereafter, options to purchase an additional 75,000 shares of SmarterKids.com common stock will vest and become exercisable, exclusive of Mr. Blohm's options pursuant to his change of control agreement which will be superceded by the consulting agreement between Mr. Blohm and LearningStar to be executed after completion of the combination. Earlychildhood does not have any change of control agreements. Governance Structure and Management Positions. Pursuant to the terms of the combination agreement, upon completion of the combination the board of directors of LearningStar will be fixed at nine; two members of the LearningStar board of directors will be designated by SmarterKids.com; four members of the LearningStar board of directors will be designated by Earlychildhood; and the remaining three members of the LearningStar board of directors will be independent directors designated jointly by Earlychildhood and SmarterKids.com. Al Noyes, Chief Operating Officer of SmarterKids.com, and Michael Kolowich, a current director of SmarterKids.com, will serve on the LearningStar board of directors as the two designees of SmarterKids.com. Ronald Elliott, President and Chief Executive Officer of Earlychildhood, Robert MacDonald, Managing Director and President of the Private Equity Group of William E. Simon & Sons, LLC, an affiliate of Educational Simon, L.L.C., the largest stockholder of Earlychildhood, Scott Graves, a Principal of the Private Equity Group of William E. Simon & Sons, LLC, and Stephen Kaplan, each a current member of the management committee of Earlychildhood will serve on the LearningStar board of directors as the four designees of Earlychildhood. The combination agreement also provides that, upon completion of the combination: . Al Noyes will serve as Chief Executive Officer of LearningStar; . Robert Cahill, Vice President of Finance and Chief Financial Officer of SmarterKids.com, will serve as Chief Financial Officer of LearningStar; . Ronald Elliott will serve as Chairman of the Board of LearningStar; and . Judith McGuinn, the Chief Operating Officer of Earlychildhood, will serve as Chief Operating Officer of LearningStar. Please see the section entitled "LearningStar" for additional information regarding the governance structure and executive management positions of LearningStar following the combination. Indemnification and Insurance. The combination agreement provides that, upon completion of the combination, LearningStar will indemnify and hold harmless, and provide advancement of expenses to, all past and present directors and officers of SmarterKids.com and members of the Earlychildhood management committee and Earlychildhood officers incurred in connection with any claim, action suit or legal proceeding arising out of or pertaining to matters existing or occurring prior to completion of the combination: . to the fullest extent they were indemnified or had the right to advancement of expenses as of November 14, 2000, which is the date of the combination agreement, pursuant to SmarterKids.com's restated certificate of incorporation, restated bylaws and indemnification agreements with any directors and officers of SmarterKids.com; or the Earlychildhood operating agreement, bylaws and indemnification agreements with any members of the Earlychildhood management committee and Earlychildhood officers, as the case may be; and . to the fullest extent permitted by law. The combination agreement also provides that, upon completion of the combination, LearningStar will cause to be maintained, for a period of six years after completion of the combination, the current policies of directors' and officers' liability insurance and fiduciary liability insurance maintained by SmarterKids.com and Earlychildhood, or policies of at least the same amount and scope containing terms and conditions which are at 48 least as favorable as SmarterKids.com's and Earlychildhood's existing coverage with respect to claims arising from facts or events that occurred on or before the completion of the combination, although LearningStar will not be required to expend in any one year an amount in excess of 200% of the higher of annual premiums currently paid by either SmarterKids.com or Earlychildhood, as applicable, for directors' and officers' liability insurance and fiduciary liability insurance. Securities and Exchange Commission Position on Indemnification for Securities Act Liabilities Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers or persons controlling SmarterKids.com pursuant to the combination agreement, LearningStar has been informed that, in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. Material United States Federal Income Tax Consequences of the Combination The following summary discusses the material U.S. federal income tax consequences of the combination to U.S. Holders of SmarterKids.com common stock. For purposes of this discussion, a U.S. Holder means: . a citizen or resident of the United States; . a corporation or other entity taxable as a corporation created or organized under the laws of the United States, any state thereof or the District of Columbia; . a trust, if a U.S. court is able to exercise primary supervision over the administration of the trust and one or more U.S. persons have the authority to control all substantial decisions of the trust; or . an estate that is subject to U.S. federal income tax on its income regardless of its source. This discussion is based upon the Internal Revenue Code of 1986, as amended, Treasury regulations, administrative rulings and judicial decisions currently in effect, all of which are subject to change, possibly with retroactive effect. The discussion assumes that SmarterKids.com stockholders hold their SmarterKids.com common stock and will hold their LearningStar common stock as a capital asset within the meaning of Section 1221 of the Internal Revenue Code. Further, the discussion does not address all aspects of U.S. federal income taxation that may be relevant to a particular stockholder in light of his, her or its personal investment circumstances or to stockholders subject to special treatment under the U.S. federal income tax laws, including: . insurance companies; . tax-exempt organizations; . dealers in securities or foreign currency; . banks or trusts; . persons that hold their SmarterKids.com common stock as part of a straddle, a hedge against currency risk or a constructive sale or conversion transaction; . persons that have a functional currency other than the U.S. dollar; . investors in partnerships, limited liability companies, and other pass- through entities; . stockholders who acquired their SmarterKids.com common stock through the exercise of options or otherwise as compensation or through a tax- qualified retirement plan; or . holders of options granted under any SmarterKids.com option or benefit plan. Furthermore, this discussion does not consider the potential effects of any state, local or foreign tax laws. 49 All SmarterKids.com stockholders are urged to consult their tax advisors regarding the tax consequences of the combination to them in their particular situations, including the effects of U.S. federal, state, local, foreign and other tax laws. In connection with the filing of the registration statement on Form S-4, of which this proxy statement- prospectus is a part, Testa, Hurwitz & Thibeault, LLP, counsel to SmarterKids.com, has delivered to SmarterKids.com, an opinion dated on or about the effective date of this proxy statement-prospectus to the effect that this discussion is a fair and adequate summary of the material anticipated U.S. federal income tax consequences of the combination to the SmarterKids.com stockholders. Counsel to SmarterKids.com has rendered its opinion on the basis of certain assumptions and representations described in such opinion, unverified by counsel, including factual representations contained in certificates from SmarterKids.com, Earlychildhood, LearningStar, S-E Educational Merger Corp. and certain of their officers. The obligation of Earlychildhood to consummate the combination is subject to the condition that it receive at the closing date an opinion from its counsel, Latham & Watkins, to the effect that the contribution to LearningStar of all of the membership interests in Earlychildhood will be treated for U.S. federal income tax purposes as a transfer of property to LearningStar qualifying under Section 351 of the Internal Revenue Code. The obligation of SmarterKids.com to consummate the combination is subject to the condition that it receive at the closing date an opinion from its counsel, Testa, Hurwitz & Thibeault, LLP, to the effect that the merger of S-E Educational Merger Corp. into SmarterKids.com will be treated for U.S. federal income tax purposes as a reorganization within the meaning of Section 368(a) of the Internal Revenue Code, or, taken together with the contribution of all of the outstanding membership interests of Earlychildhood, as a transfer of property to LearningStar qualifying under Section 351 of the Internal Revenue Code. In rendering those opinions, such counsel may make certain assumptions and require and rely on representations, unverified by counsel, including factual representations contained in certificates from SmarterKids.com, Earlychildhood, LearningStar, S-E Educational Merger Corp. and certain of their officers. Both SmarterKids.com and Earlychildhood (for itself and its subsidiaries) have represented in the combination agreement that they will not incur any tax liability in connection with the combination. In the combination agreement, Earlychildhood has also represented, to its knowledge that: . none of Earlychildhood, any of its subsidiaries or other affiliates, and any holders of the equity interests of Earlychildhood have taken or agreed to take any action (or failed to take or agreed not to take any action) which such action or inaction, as the case may be, would prevent: . the contribution of the equity interests of Earlychildhood to LearningStar from constituting a transaction qualifying as a transfer of property to LearningStar by the holders of such equity interests under Section 351 of the Internal Revenue Code; and . the merger of S-E Educational Merger Corp. into SmarterKids.com from qualifying as a "reorganization" described in Section 368(a) of the Internal Revenue Code; and . that the holders of such equity interests have no present plan, intention or arrangement to sell or otherwise dispose of any of the LearningStar common stock received in exchange for the contribution of the membership interests of Earlychildhood that would cause the contribution of such membership interests and the merger of S-E Educational Merger Corp. into SmarterKids.com to fail to qualify as transfers under Section 351 of the Internal Revenue Code. In the combination agreement, SmarterKids.com has also represented, to its knowledge: . that none of SmarterKids.com, its affiliates, and any of SmarterKids.com's stockholders have taken or agreed to take any action (or failed to take or agreed not to take any action) which such action or inaction, as the case may be, would prevent the merger of S-E Educational Merger Corp. into SmarterKids.com from qualifying: 50 . as a reorganization described in Section 368(a) of the Internal Revenue Code; and . taken together with the contribution of the equity interests of Earlychildhood, as a transfer of property to LearningStar covered by Section 351 of the Internal Revenue Code; and . that the stockholders of SmarterKids.com have no present plan, intention or arrangement to sell or otherwise dispose of any of the LearningStar common stock received in the merger of S-E Educational Merger Corp. into SmarterKids.com that would cause the contribution of the membership interests of Earlychildhood and the merger of S-E Educational Merger Corp. into SmarterKids.com to fail to qualify as transfers under Section 351 of the Internal Revenue Code. Earlychildhood, SmarterKids.com, and LearningStar have also agreed in the combination agreement that neither they nor any of their subsidiaries or other affiliates will knowingly take any action, or knowingly fail to take any action, that is reasonably likely to jeopardize the treatment of the merger of S-E Educational Merger Corp. into SmarterKids.com and the contribution of membership interests in Earlychildhood to LearningStar as transfers of property described in Section 351 of the Internal Revenue Code or the merger of S-E Educational Merger Corp. into SmarterKids.com as a reorganization described in Section 368(a) of the Internal Revenue Code. Assuming that the merger of S-E Educational Merger Corp. into SmarterKids.com qualifies as a "reorganization" within the meaning of Section 368(a) of the Internal Revenue Code, or, taken together with the contribution of all of the outstanding equity interests in Earlychildhood, as a transfer of property to LearningStar qualifying under Section 351 of the Internal Revenue Code, the material U.S. federal income tax consequences to the SmarterKids.com stockholders are expected to be as follows: . no gain or loss will be recognized, as the result of the merger of S-E Educational Merger Corp. into SmarterKids.com, by LearningStar, S-E Educational Merger Corp. or SmarterKids.com; . no gain or loss will be recognized by U.S. Holders of SmarterKids.com common stock on the exchange of their SmarterKids.com common stock for LearningStar common stock, except with respect to cash received in lieu of any fractional share of LearningStar common stock; . the aggregate adjusted basis of the LearningStar common stock received by a U.S. Holder in exchange for his, her or its SmarterKids.com common stock, including any fractional share deemed received and redeemed as described below, will be equal to the aggregate adjusted basis of the U.S. Holder's SmarterKids.com common stock exchanged for LearningStar common stock; and . the holding period of the LearningStar common stock received in exchange for a U.S. Holder's SmarterKids.com common stock will include the holding period of the U.S. Holder's SmarterKids.com common stock, provided that the U.S. Holder held the SmarterKids.com common stock as a capital asset. None of the opinions to be delivered to the parties in connection with the combination as described in this summary is binding on the Internal Revenue Service or the courts, and the parties do not intend to request a ruling from the Internal Revenue Service with respect to the combination. Accordingly, there is no assurance that the Internal Revenue Service will not challenge the conclusions reflected in those opinions or that a court will not sustain such a challenge. If the Internal Revenue Service were successfully to challenge both: . the "reorganization" status of the merger of S-E Educational Merger Corp. into SmarterKids.com; and . the treatment of the merger, taken together with the contribution of all of the outstanding membership interests in Earlychildhood, as a transfer of property under Section 351 of the Code; 51 each U.S. Holder of SmarterKids.com common stock would recognize taxable gain or loss with respect to the SmarterKids.com common stock surrendered, measured by the difference between: . the fair market value, as of the time of the combination, of the LearningStar common stock received in the combination; and . the tax basis of the SmarterKids.com common stock surrendered in the combination. In that event, a stockholder's aggregate basis in the LearningStar common stock so received would equal its fair market value as of the time of the combination and the holding period for that stock would begin the day after the combination. Any change in currently applicable law, which change may or may not be retroactive, or any failure of any factual representations or assumptions to be true, correct and complete in all material respects, could affect the validity of the opinions discussed in this summary. Cash Instead of Fractional Shares. The receipt of cash instead of fractional shares of LearningStar common stock by a U.S. Holder of SmarterKids.com common stock will result in taxable gain or loss to the U.S. Holder for U.S. federal income tax purposes based upon the difference between the amount of cash received by the U.S. Holder and the U.S. Holder's adjusted tax basis in the fractional shares as set forth above. The gain or loss is expected to constitute capital gain or loss and to constitute long-term capital gain or loss if the U.S. Holder's holding period is more than one year as of the effective date of the combination. For non-corporate U.S. Holders, this long- term capital gain generally will be taxed at a maximum U.S. federal income tax rate of 20%. The deductibility of capital losses is subject to limitations. Backup Withholding. Certain non-corporate SmarterKids.com stockholders may be subject to backup withholding at a 31% rate on cash payments received instead of fractional shares of LearningStar common stock. Backup withholding will not apply, however, to a SmarterKids.com stockholder who: . furnishes a correct taxpayer identification number and certifies that he, she or it is not subject to backup withholding on the substitute Form W-9 or successor form included in the letter of transmittal to be delivered to SmarterKids.com stockholders following the date of completion of the combination; . provides a certification of foreign status on Form W-BEN; or . is otherwise exempt from backup withholding. Reporting Requirements. A U.S. Holder of SmarterKids.com common stock receiving LearningStar common stock as a result of the combination will be required to retain certain records for U.S. federal income tax purposes and to file with its U.S. federal income tax return a statement setting forth facts relating to the combination. SmarterKids.com stockholders are urged to consult their tax advisors with respect to these record keeping, filing, and any other tax reporting requirements. Tax Attributes. SmarterKids.com has substantial accumulated net operating loss carryovers, which are available (subject to complex rules and limitations) to reduce U.S. federal income tax liabilities in future taxable years. Sections 382 and 383 of the Internal Revenue Code impose significant limitations on the use of carryovers of net operating losses and other items following an "ownership change" as defined in Section 382 of the Internal Revenue Code. SmarterKids.com will likely undergo an ownership change for purposes of these tax rules at the time of the combination. The impact of an ownership change on the ability of a corporation to utilize carryovers involves inherently factual questions, some of which cannot be currently known (including future profitability). In any event, however, while the extent to which the ownership change occurring as a result of the combination will materially affect the utilization of any carryovers cannot be predicted with certainty, this utilization is likely to be significantly limited. SmarterKids.com's stockholders and their advisers should evaluate the combination with the expectation that net operating loss carryovers and all other carryover items of SmarterKids.com will not be materially available to offset future income tax. 52 This discussion is intended to provide only a summary of the material U.S. federal income tax consequences of the combination to the SmarterKids.com stockholders. It does not purport to be a complete analysis or description of all potential U.S. federal income tax consequences of the combination. It does not address certain categories of stockholders, and it does not address state, local or foreign tax consequences. In addition, as noted above, this summary does not address tax consequences that may vary with, or be contingent upon, the individual circumstances of stockholders. The summary does not address the tax consequences of any transaction other than the combination. Accordingly, SmarterKids.com stockholders should consult their individual tax advisor(s) to determine their particular U.S. federal, state, local or foreign income or other tax consequences resulting from the combination, in light of their individual circumstances. Accounting Treatment of the Combination We intend to account for the combination under the purchase method of accounting for business combinations as if Earlychildhood were acquiring SmarterKids.com. For more information on the accounting treatment of the combination, please see the section entitled "Unaudited Pro Forma Condensed Combined Financial Information." Dissenters' Rights of Appraisal Under Delaware law, SmarterKids.com stockholders are not entitled to appraisal rights in connection with the combination. Regulatory Matters Neither SmarterKids.com nor Earlychildhood are required to file any information with the Federal Trade Commission or the Antitrust Division of the Department of Justice under the provisions of the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, in connection with the combination and the transactions contemplated by the combination agreement. SmarterKids.com and Earlychildhood are not aware of any of governmental approvals or actions that are required to complete the combination. Should any approval or action be required, SmarterKids.com and Earlychildhood currently plan to seek the approval or take any necessary action. Failure to obtain the approval or take any necessary action is not anticipated to have a material effect on the combination or on LearningStar. Restrictions on Sales of Shares by Affiliates of SmarterKids.com and Earlychildhood The shares of LearningStar common stock to be issued in connection with the combination will be freely transferable under the Securities Act, except for shares of LearningStar common stock issued to any person who is deemed to be an "affiliate" of either SmarterKids.com or Earlychildhood at the time of the special meeting. Persons who may be deemed to be affiliates include individuals or entities that control, are controlled by, or are under the common control of either SmarterKids.com or Earlychildhood and include SmarterKids.com directors and executive officers, significant stockholders of SmarterKids.com (greater than 5%), members of the Earlychildhood management committee, Earlychildhood executive officers and significant equity holders of Earlychildhood (greater than 5%). Affiliates may not sell their shares of LearningStar common stock acquired in connection with the combination except pursuant to: . an effective registration statement under the Securities Act covering the resale of those shares; . an exemption under paragraph (d) of Rule 145 under the Securities Act; or . any other applicable exemption under the Securities Act. LearningStar's registration statement on Form S-4, of which this proxy statement-prospectus forms a part, does not cover the resale of shares of LearningStar common stock to be received by affiliates in the 53 combination. Each of the affiliates of SmarterKids.com and Earlychildhood also entered into agreements with LearningStar pursuant to which each affiliate agreed to comply with Rule 145 of the Securities Act of 1933 in connection with the sale of any common stock of LearningStar acquired in the combination. For more information on restrictions on the sale of LearningStar common stock acquired by affiliates and the affiliate agreements please see the section entitled "Terms of the Combination--Other Agreements." Nasdaq National Market Listing of LearningStar Common Stock to be Issued in the Combination LearningStar will use its reasonable best efforts to cause the shares of LearningStar common stock to be issued in connection with the combination to be approved for listing on the Nasdaq National Market, subject to official notice of issuance, before the completion of the combination. Delisting and Deregistration of SmarterKids.com Common Stock following the Combination When the combination is completed, SmarterKids.com common stock will be delisted from the Nasdaq National Market and will be deregistered under the Securities Exchange Act of 1934. 54 TERMS OF THE COMBINATION AGREEMENT The following is a brief summary of the material provisions of the combination agreement, a copy of which is attached hereto as Annex A and is incorporated by reference in this proxy statement-prospectus. The summary is qualified in its entirety by reference to the combination agreement. We urge you to read the combination agreement in its entirety for a more complete description of the terms and conditions of the combination. Structure of the Combination, Conversion of SmarterKids.com Common Stock and Exchange of Earlychildhood Membership Interests Structure. To accomplish the combination of their businesses, SmarterKids.com and Earlychildhood jointly formed a new company, LearningStar, with one wholly-owned subsidiary, S-E Educational Merger Corp. In order to effect the combination: . all outstanding membership interests of Earlychildhood will be contributed to LearningStar; and . S-E Educational Merger Corp. will be merged with and into SmarterKids.com, with SmarterKids.com as the surviving corporation. As a result of the contribution and the merger, SmarterKids.com and Earlychildhood will each become a wholly-owned subsidiary of LearningStar. Conversion of SmarterKids.com Common Stock and Exchange of Earlychildhood Membership Interests. In the combination: . Earlychildhood members will receive shares of LearningStar common stock according to the following exchange ratio applicable to the class of each outstanding Earlychildhood membership interest they own as of the closing date of the combination: . each .00001% of a Class A membership interest will be exchanged for 4.9951 shares of LearningStar common stock; . each .00001% of a Class B membership interest will be exchanged for 4.6781 shares of LearningStar common stock; . each .00001% of a Class C membership interest will be exchanged for 2.3365 shares of LearningStar common stock; and . SmarterKids.com common stockholders will receive one share of LearningStar common stock for each share of SmarterKids.com common stock owned as of the effective date of the combination. As a result of the combination, former holders of SmarterKids.com common stock and options and warrants therefor will own approximately one-third of the capital stock of LearningStar and former holders of membership interests in Earlychildhood and options therefor will own approximately two-thirds of the capital stock of LearningStar. The number of shares of LearningStar common stock issuable in the combination will be proportionately adjusted for any stock split, stock dividend or similar event with respect to the SmarterKids.com common stock or Earlychildhood membership interests effected between the date of the combination agreement and the date the combination is completed. Exchange of SmarterKids.com Stock Certificates for LearningStar Stock Certificates When the combination is completed, the exchange agent will deliver a letter of transmittal and instructions for surrendering SmarterKids.com stock certificates and certificates representing Earlychildhood membership interests, if any, for LearningStar stock certificates. When you deliver your SmarterKids.com stock certificates to the exchange agent, along with a properly executed letter of transmittal and any other required documents, your SmarterKids.com stock certificates will be cancelled and you will receive stock certificates representing 55 the number of full shares of LearningStar common stock to which you are entitled under the combination agreement. SmarterKids.com stockholders and Earlychildhood members will receive payment in cash, without interest, in lieu of any fractional shares of LearningStar common stock to which they would have been otherwise entitled as a result of the combination. You should not submit your SmarterKids.com stock certificates for exchange until you receive the transmittal instructions and a form of letter of transmittal from the exchange agent. You are not entitled to receive any dividends or other distributions on LearningStar common stock until the combination is completed and you have surrendered your SmarterKids.com stock certificates in exchange for LearningStar stock certificates. If there is any dividend or other distribution on LearningStar common stock with a record date after the date on which the combination is completed and a payment date before the date you surrender your SmarterKids.com stock certificates in exchange for LearningStar stock certificates, you will receive the dividend or distribution with respect to the whole shares of LearningStar common stock issued to you promptly after the dividend or distribution is issued. If there is any dividend or other distribution on LearningStar common stock with a record date after the date on which the combination is completed and a payment date after the date you surrender your SmarterKids.com stock certificates in exchange for LearningStar stock certificates, you will receive the dividend or distribution with respect to the whole shares of LearningStar common stock issued to you promptly after the payment date. LearningStar will issue a LearningStar stock certificate and/or a check in lieu of a fractional share in a name other than the name in which a surrendered SmarterKids.com stock certificate is registered only if the exchange agent is presented with all documents required to effect the unrecorded transfer of ownership and show payment of any applicable stock transfer taxes. Treatment of Options to Purchase SmarterKids.com Common Stock and Earlychildhood Membership Interests, SmarterKids.com Warrants and the SmarterKids.com Employee Stock Purchase Agreement Options to Purchase SmarterKids.com Common Stock and Earlychildhood Membership Interests. When the combination is completed, each option to purchase SmarterKids.com common stock or Earlychildhood membership interests, as the case may be, will be converted into an option to purchase the same number of shares of LearningStar common stock (rounded down to the nearest whole number) as the holder of the option would have been entitled to receive had the optionholder exercised the option in full immediately prior to the effective date of the combination, at an exercise price equal to: . the aggregate exercise price for the shares of SmarterKids.com common stock or Earlychildhood membership interests, as the case may be, purchasable pursuant to the option, divided by . the number of full shares of LearningStar common stock deemed purchasable pursuant to the option in accordance with the combination agreement (rounded up to nearest whole cent). LearningStar intends to file a registration statement on Form S-8 covering the issuance of the shares of LearningStar common stock subject to each SmarterKids.com and Earlychildhood option and intends to maintain the effectiveness of that registration statement for as long as any of the options remain outstanding. SmarterKids.com Warrants. Upon consummation of the combination, each outstanding warrant for SmarterKids.com common stock will be converted into the right to acquire the same number of shares of LearningStar common stock (rounded down to the nearest whole number) as the holder of the warrants would have been entitled to purchase had the warrantholder exercised the warrants immediately prior to the effective date of the combination, at an exercise price equal to: . the aggregate exercise price for the shares of SmarterKids.com common stock purchasable pursuant to the warrant, divided by 56 . the number of full shares of LearningStar common stock deemed purchasable pursuant to the warrant in accordance with the combination agreement (rounded up to the nearest whole cent). Employee Stock Purchase Plan. When the combination is completed, it is intended that SmarterKids.com employees and Earlychildhood employees will be able to participate in the LearningStar employee stock purchase plan, and the SmarterKids.com 1999 employee stock purchase plan will be terminated. Conditions to the Combination Each of SmarterKids.com's and Earlychildhood's obligations to complete the combination are subject to the satisfaction or written waiver of specified conditions, including the following: . the receipt of all approvals and consents of, and the completion of filings with, or notices to, any governmental authority necessary for completion of the combination, the failure of which to obtain, individually or in the aggregate, would reasonably be likely to have a material adverse effect, individually or in the aggregate, on SmarterKids.com, Earlychildhood or LearningStar; . the declaration of effectiveness of the registration statement on Form S-4, of which this proxy statement-prospectus is a part, by the Securities and Exchange Commission, and the absence of any stop order or proceedings seeking a stop order; . the absence of any order, executive order, stay, decree, judgment or injunction prohibiting completion of the combination issued by any governmental entity; . the approval for listing on a national securities exchange or for quotation on the Nasdaq National Market of the shares of LearningStar common stock to be issued, or to be reserved for issuance, in connection with the combination, subject to official notice of issuance; . the receipt by both parties of the respective required consents of any person whose consent is required in order to complete the combination, except those consents that, if not obtained, would not, individually or in the aggregate, have a material adverse effect on SmarterKids.com or Earlychildhood, as applicable, or a material adverse effect on LearningStar; . the taking of all necessary actions by both parties to amend the certificate of incorporation and bylaws of LearningStar and to compose the board of directors of LearningStar as required by the combination agreement; and . each of the transaction documents must have been executed and be in full force and effect and no material breach by any party shall have occurred thereunder. The term "material adverse effect" when used in this section in reference to any entity means any event, change, circumstance or effect that is or is reasonably likely to be materially adverse to the business, assets, properties, financial condition or results of operations of the entity and its subsidiaries, if any, taken as a whole. However, with respect to SmarterKids.com no decrease or successive decreases in the market price of SmarterKids.com common stock will, in and of itself, constitute a material adverse effect. SmarterKids.com's obligation to complete the combination is subject to the satisfaction or waiver of the following additional conditions: . Earlychildhood's representations and warranties must be true and correct as of the date of the combination agreement and as of the date of completion of the combination, except for: . changes contemplated by the combination agreement; and . inaccuracies which, individually or in the aggregate, have not had and are not reasonably likely to have a material adverse effect on Earlychildhood or LearningStar or a material adverse effect on the consummation of the transactions contemplated by the combination agreement; 57 . Earlychildhood must have performed in all material respects all material obligations required to be performed by it under the combination agreement; and . no material adverse effect or material adverse change with respect to Earlychildhood shall have occurred since the date of the combination agreement and be continuing; . SmarterKids.com must have received from Testa, Hurwitz & Thibeault, LLP, a written opinion to the effect that the merger of S-E Educational Merger Corp. with and into SmarterKids.com will be treated for U.S. federal income tax purposes as either a "reorganization" within the meaning of Section 368(a) of the Internal Revenue Code or, when taken together with the contribution of all of the outstanding membership interests in Earlychildhood to LearningStar, as a transfer of property qualifying under Section 351 of the Internal Revenue Code; and . Earlychildhood must have executed each of the transaction documents to which it is a party, which agreements must be in full force and effect and no material breach by Earlychildhood may have occurred thereunder. Earlychildhood's obligation to complete the combination is subject to the satisfaction or waiver of the following additional conditions: . the adoption of the combination agreement by the affirmative vote of the holders of a majority of the outstanding shares of SmarterKids.com common stock; . SmarterKids.com's representations and warranties, must be true and correct as of the date of the combination agreement and as of the date of completion of the combination, except for: . changes contemplated by the combination agreement; and . inaccuracies which, individually or in the aggregate, have not had and are not reasonably likely to have a material adverse effect on SmarterKids.com or LearningStar or a material adverse effect on the consummation of the transactions contemplated by the combination agreement; . SmarterKids.com must have performed or complied with all material obligations required to be performed by it under the combination agreement; . no material adverse effect or material adverse change with respect to SmarterKids.com shall have occurred since the date of the combination agreement and be continuing; . SmarterKids.com shall have Cash on Hand (as defined by U.S. generally accepted accounting principles) of not less than $18,000,000 after deducting certain fees and expenses of both parties incurred in connection with the combination, including costs relating to the integration of the two businesses and their technologies; and . Earlychildhood must have received from Latham & Watkins a written opinion to the effect that for U.S. federal income tax purposes, the contribution of all the outstanding membership interests of Earlychildhood to LearningStar will be treated as a transfer of property qualifying under Section 351 of the Internal Revenue Code. No Other Transactions Involving SmarterKids.com or Earlychildhood The combination agreement contains detailed provisions prohibiting SmarterKids.com and Earlychildhood from seeking an alternative transaction. Under these "no solicitation" and "no negotiation" provisions, each of SmarterKids.com and Earlychildhood has agreed that neither it nor any of its subsidiaries, officers, directors, employees, financial advisors, attorneys, accountants or other agents or representatives will, directly or indirectly: . solicit, initiate, facilitate or encourage any inquires, offers or proposals by any third party with respect to an Acquisition Proposal, as described below; 58 . enter into or execute any agreement with respect to an Acquisition Proposal; . engage in or continue any discussion with, or otherwise communicate any non-public information to any third party relating to an Acquisition Proposal, except pursuant to a governmental request for information; . make or authorize any public statement, recommendation or solicitation in support of any Acquisition Proposal; or . take any other action inconsistent with its non-solicitation obligations or commitments. The term "Acquisition Proposal" means, with respect to any entity: . any transaction pursuant to which any third party acquires more than 20% of the outstanding equity securities of that entity pursuant to a tender offer or exchange offer or otherwise; . a merger or other business combination, recapitalization, restructuring or similar transaction involving that entity; . any other transaction pursuant to which any third party acquires more than 20% of the fair market value of all assets of the entity, including stock of its subsidiaries, taken as a whole; or . any public announcement of a proposal, plan or intention to do any of the foregoing. However, the combination agreement does not prevent SmarterKids.com and its board of directors from, with respect to a bona fide written unsolicited Acquisition Proposal: . furnishing non-public information to the third party; . otherwise facilitating any effort or attempt by the third party to make an Acquisition Proposal; . agreeing to recommend or endorse the Acquisition Proposal by the third party; . withdrawing, modifying or proposing to withdraw or modify its approval and recommendation of the combination agreement and the transactions contemplated thereby; . participating in any discussions or negotiations with the third party relating to the Acquisition Proposal; and . entering into an agreement implementing the Acquisition Proposal, if SmarterKids.com at the same time terminates the combination agreement and pays Earlychildhood the termination fee described below. However, SmarterKids.com may take the foregoing actions if and only to the extent that: . the SmarterKids.com board of directors, after consultation with a financial advisor of nationally recognized reputation, reasonably determines in good faith that the unsolicited Acquisition Proposal is more favorable or reasonably likely to lead to an Acquisition Proposal more favorable to the SmarterKids.com stockholders from a financial point of view than the transactions contemplated by the combination agreement and is made by a third party reasonably believed by the SmarterKids.com board of directors to be financially capable of completing the Acquisition Proposal; . the SmarterKids.com board of directors, after consultation with outside counsel, reasonably determines in good faith that the failure to take such action would cause the members of the SmarterKids.com board of directors to breach their fiduciary duties to the SmarterKids.com stockholders under applicable law; 59 . before providing any non-public information to, or entering into discussions or negotiations with, the third party in connection with an unsolicited Acquisition Proposal by that person, the SmarterKids.com board of directors receives from that third party an executed confidentiality agreement with terms no less favorable than those contained in the confidentiality agreement among SmarterKids.com, Earlychildhood and Thomas Weisel Partners, LLP and provided that the confidentiality agreement does not contain any exclusive right to negotiate with SmarterKids.com or any payments by SmarterKids.com; and . before providing any information to any person or entering into discussions or negotiations with the third party with respect to the Acquisition Proposal, it promptly notifies Earlychildhood of: . inquiries, proposals or offers received with respect to the Acquisition Proposal, any non-public information requested from, or any discussions or negotiations sought to be initiated or continued with, any of its representatives; . the name of the third party making the Acquisition Proposal and the terms and conditions of any proposal or offer; and . SmarterKids.com does not accept or enter into any agreement concerning an Acquisition Proposal for at least three business days after Earlychildhood's receipt of notice of the terms of the Acquisition Proposal. In addition, the combination agreement does not prevent SmarterKids.com from complying with Rule 14e-2 promulgated under the Securities Exchange Act of 1934 with regard to an Acquisition Proposal. The SmarterKids.com board of directors may only change its recommendation that the SmarterKids.com stockholders vote in favor of the approval and adoption of the combination agreement and the transactions contemplated thereby as provided in the "no solicitation" provision of the combination agreement. Each of SmarterKids.com and Earlychildhood has agreed under the provisions of the combination agreement that: . it will promptly keep the other party informed of the status and terms of any proposals, offers, discussions or negotiations covered by the "no solicitation" and "no negotiation" provisions of the combination agreement; . it will, and its officers, directors, managers and representatives will, immediately cease and terminate any activities, discussions or negotiations existing as of November 14, 2000, the date of the execution of the combination agreement, with any parties conducted before that date with respect to any Acquisition Proposal; and . it will use reasonable best efforts to promptly inform its directors, officers, key employees, agents and representatives of the obligations of the "no solicitation" provision of the combination agreement, in the case of SmarterKids.com, and "no negotiation" provision of the combination agreement, in the case of Earlychildhood. Nothing contained in the "no solicitation" or "no negotiation" provisions of the combination agreement will: . permit SmarterKids.com or Earlychildhood to terminate the combination agreement, except as specifically provided in the combination agreement; or . affect any other obligation of SmarterKids.com or Earlychildhood under the combination agreement. Termination The combination agreement may be terminated at any time prior to the completion of the combination, whether before or after SmarterKids.com stockholder approval has been obtained: 60 . by mutual written consent of SmarterKids.com and Earlychildhood; . by either SmarterKids.com or Earlychildhood if the combination is not completed by April 30, 2001, except that if the combination has not been completed by April 30, 2001 due to failure to obtain any governmental approval, the date for completion of the combination will be extended to July 31, 2001; . by either SmarterKids.com or Earlychildhood if any court of competent jurisdiction issues an non-appealable final order, decree or ruling or takes any other non-appealable, final action permanently restraining, enjoining or otherwise prohibiting the combination; . by either SmarterKids.com or Earlychildhood if there has been a breach of any representation, warranty, covenant or agreement on the part of the other party that is material and not cured within 30 business days following receipt by the breaching party of written notice of the breach; . by Earlychildhood, if: . at the SmarterKids.com special meeting of stockholders (including any adjournment or postponement of the special meeting), the requisite vote of the stockholders of SmarterKids.com in favor of the approval and adoption of this combination agreement and the transactions contemplated thereby is not obtained; . the SmarterKids.com board of directors has withdrawn or modified in any manner its recommendation that its stockholders vote in favor of approval and adoption of the combination agreement and the transactions contemplated thereby; . SmarterKids.com fails to include in this proxy statement-prospectus the recommendation of its board of directors in favor of the approval of the combination agreement and the transactions contemplated thereby; . after the receipt by SmarterKids.com of an Acquisition Proposal, Earlychildhood requests in writing that the SmarterKids.com board of directors reconfirm its recommendation that the SmarterKids.com stockholders are in favor of approval and adoption of the combination agreement and the transactions contemplated thereby and the SmarterKids.com board of directors fails to do so within ten business days after its receipt of Earlychildhood's request; . the SmarterKids.com board of directors or any committee thereof approves or recommends to the stockholders of SmarterKids.com an Acquisition Proposal other than the proposed combination; . a tender offer or exchange offer for 20% or more of the outstanding shares of SmarterKids.com common stock is commenced (other than by Earlychildhood or an affiliate of Earlychildhood) and the SmarterKids.com board of directors does not oppose the tender or exchange offer; . SmarterKids.com enters into any letter of intent or similar document or any agreement, contract or commitment accepting or expressing an intent to accept an Acquisition Proposal; . SmarterKids.com fails to call and hold the special meeting of SmarterKids.com stockholders by April 30, 2001; or . by SmarterKids.com, prior to the approval and adoption by its stockholders of the combination agreement, if SmarterKids.com receives a bona fide written unsolicited Acquisition Proposal and: . the SmarterKids.com board of directors reasonably determines in good faith (after consultation with a financial advisor of nationally recognized reputation) that the Acquisition Proposal is more favorable or is reasonably likely to lead to an Acquisition Proposal that is more favorable to the SmarterKids.com stockholders from a financial point of view than the proposed combination and is made by a third party reasonably believed by the SmarterKids.com board of directors to be financially capable of completing the Acquisition Proposal; and 61 . the SmarterKids.com board of directors reasonably determines in good faith (after having consulted with and considered the advice of its outside legal counsel) that the failure to take actions in connection with the Acquisition Proposal would cause the members of the SmarterKids.com board of directors to breach their fiduciary duties to the SmarterKids.com stockholders under applicable law; provided, that SmarterKids.com must have given Earlychildhood three business days' notice before the termination, otherwise complied with the "no solicitation" provisions and paid Earlychildhood the termination fee described below. Termination Fees As set forth in more detail below, the combination agreement requires SmarterKids.com to pay a termination fee of $1,300,000 to Earlychildhood if: . Earlychildhood terminates the combination agreement due to the failure of SmarterKids.com to receive the requisite vote of its stockholders to approve the combination agreement; and: . at the time of this termination, a definitive proposal for an Acquisition Proposal has been provided to SmarterKids.com by a third party; and . within 12 months of this termination, either SmarterKids.com shall have entered into a definitive agreement with respect to, or have completed, a transaction in connection with the Acquisition Proposal; . SmarterKids.com terminates the combination agreement and at that time Earlychildhood would have been permitted to terminate the combination agreement as a result of the actions of the SmarterKids.com board of directors in connection with approval and adoption of the combination agreement and the transactions contemplated thereby by SmarterKids.com stockholders or an Acquisition Proposal; . Earlychildhood terminates the combination agreement due to SmarterKids.com's actions in connection with approval and adoption of the combination agreement and the transactions contemplated thereby by SmarterKids.com stockholders or an Acquisition Proposal; or . SmarterKids.com terminates the combination agreement having determined in good faith that an Acquisition Proposal: . is more favorable or is reasonably likely to lead to an Acquisition Proposal that is more favorable to the SmarterKids.com stockholders from a financial point of view than the combination and is made by a third party reasonably believed by the SmarterKids.com board of directors to be financially capable of completing the Acquisition Proposal; and . the failure to take alternative actions in connection with the Acquisition Proposal would cause the members of the SmarterKids.com board of directors to breach their fiduciary duties to the SmarterKids.com stockholders under applicable law. Expenses If the combination agreement is terminated by SmarterKids.com or Earlychildhood due to a breach by the other party of its representations, warranties, covenants and agreements, then the breaching party is required to pay the expenses incurred by the non-breaching party in connection with the combination, up to a maximum of $350,000 and subject to certain exceptions described in the combination agreement. A portion of the termination fee, if applicable, may be deemed to include reimbursement of termination expenses. Agreement to Cooperate to Complete the Combination Each of SmarterKids.com and Earlychildhood has agreed to cooperate with the other and to use its reasonable best efforts to take all actions and do all things necessary, proper and advisable under the 62 combination agreement and applicable laws to complete the combination as soon as practicable after November 14, 2000, which is the date of the combination agreement. Accordingly, each has agreed to use its reasonable best efforts to: . as promptly as practicable, prepare and file all applications, notices, petitions, filings, and other documents, and to obtain all waivers, licenses, orders, registrations, permits, rulings, authorizations and clearances from any third party or any domestic or foreign governmental entity necessary to complete the combination; and . take all reasonable steps to obtain all necessary consents and required approvals, including those required under applicable antitrust laws. The combination agreement also contains covenants relating to the cooperation between SmarterKids.com and Earlychildhood in the preparation of this proxy statement-prospectus and additional agreements between them relating to, among other things, access to information, mutual notice of specified matters and public announcements. Amendment, Extension and Waiver The combination agreement may be amended by SmarterKids.com and Earlychildhood, by action taken or authorized by their board of directors or management committee, as the case may be, at any time before or after approval of the combination agreement by the stockholders of SmarterKids.com has been obtained. After the approval has been obtained, no amendment may be made which by law requires further approval by the stockholders of SmarterKids.com, without their further approval. All amendments to the combination agreement must be in writing signed by SmarterKids.com and Earlychildhood. At any time before the effective date of the combination, SmarterKids.com and Earlychildhood may, by action taken or authorized by their board of directors or management committee, as the case may be, to the extent legally allowed: . extend the time for the performance of any of the obligations or other acts of the other parties to the combination agreement; . waive any inaccuracies in the representations and warranties of the other party contained in the combination agreement or in any document delivered pursuant to the combination agreement; and . waive compliance with any of the agreements or conditions of the other party contained in the combination agreement. All extensions and waivers must be in writing and signed by the party making the waiver. Representations and Warranties The combination agreement contains customary representations and warranties of SmarterKids.com and Earlychildhood relating to, among other things: . corporate organization and similar corporate matters; . subsidiaries and capital structure; . taxes; . properties; . intellectual property; . product warranty and liability; . material contracts; 63 . litigation; . environmental matters; . employee benefit plans and labor matters; . compliance with laws; . insurance; . no existing discussions with third parties; . authorization, absence of conflicts, required filings and consents; . absence of certain changes or events; . information supplied in connection with this proxy statement-prospectus and the registration statement of which it is a part; . board of directors and management committee approval, as the case may be, and applicable state takeover laws; . in the case of SmarterKids.com, the vote required to approve and adopt the combination agreement and the transactions contemplated thereby; and . in the case of SmarterKids.com, documents filed with the Securities and Exchange Commission and financial statements included in those documents. LearningStar Charter and Bylaws Upon completion of the combination, the restated certificate of incorporation of LearningStar will be in substantially the form set forth in Annex D to this proxy statement-prospectus and the amended and restated bylaws of LearningStar will be substantially in the form set forth in Annex E to this proxy statement-prospectus. For a summary of the material provisions of the restated certificate of incorporation and amended and restated bylaws of LearningStar, and the rights of stockholders of LearningStar under the restated certificate of incorporation and amended and restated bylaws, see the section entitled "Description of Capital Stock of LearningStar." Stockholder Support Agreement The following is a brief summary of the material provisions of the stockholder support agreement, a copy of which is attached as Annex B to this proxy statement-prospectus and is incorporated herein by reference. The summary is qualified in its entirety by reference to the stockholder support agreement. We urge you to read the stockholder support agreement in its entirety for a more complete description of its terms and conditions. In connection with the execution and delivery of the combination agreement, Earlychildhood entered into a stockholder support agreement with each of the directors and executive officers and certain significant stockholders of SmarterKids.com, pursuant to which these directors, executive officers and stockholders agreed to vote all their shares of SmarterKids.com common stock in favor of the approval and adoption of the combination agreement and the transactions contemplated thereby. As of the record date for the special meeting, these directors, executive officers and stockholders owned shares of SmarterKids.com common stock representing approximately % of the total voting power of the outstanding shares of the SmarterKids.com common stock. The stockholder support agreement prohibits, subject to limited exceptions, these stockholders from selling, transferring, pledging, encumbering, assigning or otherwise disposing of any shares of SmarterKids.com capital stock, except to a person who agrees in writing to be bound by the terms of the stockholder support agreement. 64 The stockholder support agreement terminates upon the earlier to occur of the completion of the combination and the termination of the combination agreement in accordance with its terms. Other Agreements The following is a brief summary of the material provisions of the other agreements entered into in connection with the combination agreement. Consent and Non-Contravention Agreement. In connection with the combination, each of the holders of membership interests in Earlychildhood entered into a consent and non-contravention agreement with SmarterKids.com pursuant to which the members agreed that they would, at the closing of the combination, contribute all of their membership interests in Earlychildhood to LearningStar and in exchange therefor accept the number of shares of LearningStar common stock in accordance with the exchange ratio applicable to the class of membership interests held. The consent and non-contravention agreement prohibits, subject to limited exceptions, the Earlychildhood members from selling, transferring, pledging, encumbering, assigning or otherwise disposing of any membership interests in Earlychildhood, except to a person who agrees in writing to be bound by the terms of the consent and non-contravention agreement. The consent and non-contravention agreement terminates upon the earlier to occur of the completion of the combination and the termination of the combination agreement in accordance with its terms. Affiliate Agreements. In connection with the combination, each of the affiliates of SmarterKids.com (the directors and executive officers and holders of 5% or more of the outstanding common stock of SmarterKids.com) and each of the affiliates of Earlychildhood (the management committee members, executive officers and holders of 5% or more of the outstanding membership interests in Earlychildhood) executed affiliate agreements pursuant to which each affiliate agreed to comply with Rule 145 of the Securities Act of 1933 in connection with the sale of any common stock of LearningStar acquired in the combination. For more information on the requirements of Rule 145 of the Securities Act of 1933, please see the section entitled "The Combination--Restrictions on Sales of Shares by Affiliates of SmarterKids.com and Earlychildhood." Lock-up Agreements. In connection with the combination, each of the directors and executive officers and certain significant stockholders of SmarterKids.com, as well as each of the holders of membership interests in Earlychildhood, entered into a lock-up agreement with LearningStar pursuant to which each agreed not to sell any shares of LearningStar common stock received in connection with the combination for a period of 180 days from the date on which the LearningStar registration statement on Form S-4, of which this proxy statement-prospectus is a part, is declared effective by the Securities and Exchange Commission. Registration Rights Agreements. Each of the persons or entities who executed a lock-up agreement in connection with the combination also entered into a registration rights agreement with LearningStar pursuant to which, under certain circumstances, LearningStar will be required to register the shares of LearningStar common stock acquired in the combination by these persons or entities. Consulting Agreement. Upon completion of the combination, David Blohm, the current President and Chief Executive Officer of SmarterKids.com, will enter into an 18-month consulting agreement with LearningStar and will be paid a fee of $18,750 per month for his services. Upon expiration of the 18-month consulting period, LearningStar shall provide Mr. Blohm with severance payments of $4,166.67 per month for 24 months. Completion and Effectiveness of the Combination The combination will be completed when all of the conditions to completion of the combination are satisfied or waived, including the approval and adoption of the combination agreement by the stockholders of SmarterKids.com. The combination will become effective upon: 65 . the contribution of all of the outstanding membership interests in Earlychildhood to LearningStar; and . the filing of a certificate of merger with the Secretary of State of the State of Delaware with respect to the merger of S-E Educational Merger Corp. with and into SmarterKids.com. We are working toward completing the combination as quickly as possible. We expect to complete the combination during the spring of 2001. No Provision for Unaffiliated Stockholder Access to SmarterKids.com Corporate Files No provision has been made by SmarterKids.com in connection with the combination to grant unaffiliated security holders access to the corporate files of SmarterKids.com or to obtain counsel or appraisal services at the expense of SmarterKids.com. Accountants The firms of PricewaterhouseCoopers, LLP, independent accountants and auditors of SmarterKids.com, and KPMG LLP, independent accountants and auditors of Earlychildhood, have each been invited to attend the SmarterKids.com special meeting and will have an opportunity to make a statement and respond to appropriate questions. 66 MARKET PRICE INFORMATION SmarterKids.com common stock is traded on the Nasdaq National Market under the symbol "SKDS." As of the record date for the special meeting, there were approximately holders of record of SmarterKids.com common stock. The following table sets forth the high and low closing prices per share of SmarterKids.com common stock as reported by the Nasdaq National Market for each quarter during the fiscal year ended December 31, 2000 and for the portion of the fourth quarter during the fiscal year ended December 31, 1999 following completion of SmarterKids.com's initial public offering on November 23, 1999. SmarterKids.com has not paid cash dividends on its common stock during these periods and SmarterKids.com does not presently intend to declare cash dividends on its common stock in the foreseeable future. Earlychildhood's membership interests are not publicly traded and, as such, no market price information is available regarding its membership interests. As of , 2001, the record date for the SmarterKids.com special meeting, there were approximately holders of outstanding membership interests in Earlychildhood.
SmarterKids.com Common Stock ---------------- High Low -------- ------- 1999 Fourth Quarter (November 23-December 31, 1999)............... $15.3125 $6.5625 2000 First Quarter................................................ $ 8.3750 $3.9375 Second Quarter............................................... $ 4.0625 $1.5000 Third Quarter................................................ $ 2.3125 $1.0625 Fourth Quarter............................................... $ 2.1250 $0.5312
MARKET DATA The table below presents trading information for SmarterKids.com common stock for November 13, 2000 and , 2001. November 13, 2000 was the last full trading date prior to the public announcement of the proposed combination. , 2001 was the last practicable trading day for which information was available prior to the date of the first mailing of this proxy statement- prospectus.
SmarterKids.com Common Stock --------------- High Low --------------- November 13, 2000............................................... $ 2.125 $ 1.875 , 2001...................................................
The market price of SmarterKids.com common stock fluctuates. As a result, we urge you to obtain current market quotations for SmarterKids.com common stock. 67 UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION On November 14, 2000, SmarterKids.com, Inc. entered into a Contribution Agreement and Plan of Reorganization and Merger, with Earlychildhood LLC, S-E Educational Holdings Corp. (subsequently renamed LearningStar Corp.) and S-E Educational Merger Corp. Pursuant to the combination agreement, each of Earlychildhood and SmarterKids.com will become a wholly-owned subsidiary of LearningStar. Upon completion of the combination, each issued and outstanding share of common stock of SmarterKids.com will be converted into the right to receive one newly-issued share of LearningStar common stock, and holders of outstanding common stock of SmarterKids.com and options and warrants therefor will acquire an aggregate of approximately one-third of the capital stock of LearningStar. In addition, in the combination, all of the issued and outstanding membership interests of Earlychildhood will be exchanged for newly- issued shares of LearningStar common stock in accordance with the exchange ratios set forth in the combination agreement, and holders of outstanding membership interests in Earlychildhood and options therefor will acquire approximately two-thirds of the capital stock of LearningStar. The following unaudited pro forma condensed combined financial information gives effect to the combination of Earlychildhood and SmarterKids.com by application of the pro forma adjustments described in the accompanying notes. The unaudited pro forma condensed combined balance sheet gives effect to the combination as if it had occurred on September 30, 2000. The unaudited pro forma condensed combined statement of operations for the nine month period ended September 30, 2000 gives effect to the combination as if it had occurred on January 1, 2000. The unaudited pro forma condensed combined statement of operations for the year ended December 31, 1999 gives effect to the combination and the acquisition of Educational Products, Inc., or EPI, by Earlychildhood in 1999 as if both had occurred on January 1, 1999. The combination will be accounted for under the purchase method, with Earlychildhood as the acquirer and SmarterKids.com as the acquired company. Under the purchase method of accounting, the purchase price will be allocated to the assets acquired and liabilities assumed of SmarterKids.com based upon management's estimates of fair values, with the excess of the fair value of the net assets over the purchase price being allocated to reduce ratably the recorded fair values of property and equipment and identifiable intangible assets. The pro forma adjustments related to the purchase price allocation represent management's best estimate of the effects of the pending combination and are subject to adjustment upon completion of a final independent valuation analysis to be obtained in connection with the closing of the combination. The pro forma adjustments are based upon estimates, currently available information and certain assumptions that management deems appropriate; management believes that finalization of the purchase accounting upon consummation of the combination will not significantly change the pro forma adjustments. On May 5, 1999, Earlychildhood acquired EPI, a Texas-based wholesaler of educational products, for approximately $8.6 million, including direct acquisition costs of approximately $217,000. The purchase price consisted of $6.8 million in cash and membership interests in Earlychildhood valued at $1.6 million. Earlychildhood accounted for this acquisition under the purchase method. Accordingly, the total cost of the business acquired is allocated to the underlying tangible and intangible assets acquired and liabilities assumed based on their respective fair values. The excess of the purchase price over the fair value of the net assets acquired, amounting to approximately $5.5 million, was treated as goodwill and is being amortized over ten years. The unaudited pro forma condensed combined financial information presented herein is not necessarily indicative of the results of operations or financial position of the combined companies had the transactions assumed therein occurred, nor are they necessarily indicative of the results of operations which may be expected to occur in the future. The unaudited pro forma condensed combined financial information should be read in conjunction with the audited financial statements and notes thereto of each of Earlychildhood, EPI and SmarterKids.com included elsewhere in this proxy statement-prospectus. 68 UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET As of September 30, 2000 (In thousands)
Pro Forma ----------------------- Earlychildhood SmarterKids.com Adjustments Total -------------- --------------- ----------- ------- Assets Current assets: Cash and cash equivalents........... $ -- $ 17,754 $ -- $17,754 Short-term investments........... -- 15,201 -- 15,201 Accounts receivable, net................... 10,032 175 -- 10,207 Inventories............ 14,023 4,161 -- 18,184 Prepaid expenses and other current assets.. 2,153 2,573 -- 4,726 ------- -------- --------- ------- Total current assets... 26,208 39,864 -- 66,072 Receivable from member.. 139 -- 139 Property and equipment, net.................... 4,495 5,469 (1,582)(b) 7,452 (930)(e) Other assets............ 1,086 1,761 2,847 Goodwill and other intangible assets, net.................... 7,415 362 (362)(c) 16,601 12,077 (d) (2,891)(e) Restricted cash......... -- 1,028 -- 1,028 ------- -------- --------- ------- Total assets........... $39,343 $ 48,484 $ 6,312 $94,139 ======= ======== ========= ======= Liabilities and Stockholders' Equity Current liabilities: Current portion of long term debt and capital lease obligations..... $ 1,383 $ 541 $ -- $ 1,924 Accounts payable....... 4,991 2,123 -- 7,114 Accrued expenses....... 1,240 2,983 630 (f) 7,953 3,100 (k) Deferred revenue....... -- 533 (533)(g) -- Income taxes payable... 1,015 -- -- 1,015 Deferred income taxes.. 475 -- -- 475 Other current liabilities........... 163 72 -- 235 ------- -------- --------- ------- Total current liabilities........... 9,267 6,252 3,197 18,716 Long term debt and capital lease obligations, net of current portion........ 7,811 806 -- 8,617 ------- -------- --------- ------- Total liabilities...... 17,078 7,058 3,197 27,333 ------- -------- --------- ------- Stockholders' equity: Members' equity......... 24,980 -- (24,980)(i) -- Common stock............ -- 206 (206)(h) 655 206 (a) 449 (i) Additional paid in- capital................ -- 112,374 (112,374)(h) 69,636 48,205 (a) 24,531 (i) (3,100)(k) Deferred stock compensation........... (2,715) (4,494) 4,494 (h) (3,485) (770)(j) Accumulated deficit..... -- (66,660) 66,660 (h) -- ------- -------- --------- ------- Total stockholders' equity................ 22,265 41,426 3,115 66,806 ------- -------- --------- ------- Total liabilities and stockholders' equity.. $39,343 $ 48,484 $ 6,312 $94,139 ======= ======== ========= =======
69 UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS For the year ended December 31, 1999 (In thousands, except per share data)
Pro Forma Pro Forma -------------------- ---------------------- Early Sub- Smarter childhood EPI (1) Adjustments total Kids.com Adjustments Total --------- ------- ----------- ------- -------- ----------- -------- Net revenues............ $61,034 $ 2,707 $-- $63,741 $ 5,421 $ -- $ 69,162 Cost of goods sold...... 37,226 1,961 -- 39,187 4,005 -- 43,192 ------- ------- ---- ------- -------- ------ -------- Gross profit........... 23,808 746 -- 24,554 1,416 -- 25,970 ------- ------- ---- ------- -------- ------ -------- Operating expenses: Selling, general and administrative, excluding stock-based compensation.......... 18,931 2,051 -- 20,982 33,491 (837)(p) 53,636 Stock-based compensation.......... -- -- -- -- 3,405 308 (q) 3,713 Amortization of goodwill and other intangibles........... 653 -- 232(m) 885 -- 2,045 (r) 2,930 ------- ------- ---- ------- -------- ------ -------- Total operating expenses.............. 19,584 2,051 232 21,867 36,896 1,516 60,279 ------- ------- ---- ------- -------- ------ -------- Income (loss) from operations............. 4,224 (1,305) (232) 2,687 (35,480) (1,516) (34,309) Interest and other (income) expense, net.. 829 63 208(n) 1,100 (752) -- 348 ------- ------- ---- ------- -------- ------ -------- Income (loss) before income taxes.......... 3,395 (1,368) (440) 1,587 (34,728) (1,516) (34,657) Income tax expense (benefit).............. 982 46 (538)(o) 490 -- (490)(s) -- ------- ------- ---- ------- -------- ------ -------- Net income (loss)...... 2,413 (1,414) 98 1,097 (34,728) (1,026) (34,657) Accretion of redeemable preferred stock........ -- -- -- -- (189) 189 -- ------- ------- ---- ------- -------- ------ -------- Net income (loss) attributable to common stockholders ......... $ 2,413 $(1,414) $ 98 $ 1,097 $(34,917) $ (837) $(34,657) ======= ======= ==== ======= ======== ====== ======== Basic and diluted net income (loss) per common share........... $ 0.05(t) $ 0.03(t) $ (9.20) $ (0.61)(u) Weighted average number of basic and diluted shares outstanding..... 35,909(t) 36,513(t) 3,796 57,154 (u)
70 UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS For the nine months ended September 30, 2000 (In thousands, except per share data)
Pro Forma ---------------------- Early Smarter childhood Kids.com Adjustments Total --------- -------- ----------- -------- Net revenues................... $67,814 $ 4,504 $ -- $ 72,318 Cost of goods sold............. 42,585 3,386 -- 45,971 ------- -------- ------ -------- Gross profit............... 25,229 1,118 -- 26,347 ------- -------- ------ -------- Operating expenses: Selling, general and administrative, excluding stock-based compensation.... 21,648 25,251 (628)(p) 46,271 Stock-based compensation..... 467 1,374 231 (q) 2,072 Amortization of goodwill and other intangibles........... 764 -- 1,534 (r) 2,298 ------- -------- ------ -------- Total operating expenses... 22,879 26,625 1,137 50,641 ------- -------- ------ -------- Income (loss) from operations.............. 2,350 (25,507) (1,137) (24,294) Interest and other (income) expense, net.................. 1,040 (2,037) -- (997) ------- -------- ------ -------- Income (loss) before income taxes..................... 1,310 (23,470) (1,137) (23,297) Income tax expense (benefit)... 944 -- (944)(s) -- ------- -------- ------ -------- Net income (loss).......... $ 366 $(23,470) $ (193) $(23,297) ======= ======== ====== ======== Basic and diluted net income (loss) per common share....... $ 0.01(t) $ (1.15) $ (0.36)(u) Weighted average number of shares outstanding: Basic...................... 44,738(t) 20,476 65,379 (u) Diluted.................... 44,739(t) 20,476 65,379 (u)
71 1. Notes to the Unaudited Pro Forma Condensed Combined Balance Sheet The following represents the components of the purchase price of SmarterKids.com as of September 30, 2000 for financial accounting purposes (in thousands): Fair value of 20,641,040 shares of LearningStar Corp. common stock exchanged for outstanding SmarterKids.com common stock........... $37,228 Fair value of stock options exchanged............................. 7,746 Fair value of warrants exchanged.................................. 337 Direct acquisition costs of Earlychildhood........................ 3,100 ------- Total purchase price............................................ $48,411 =======
The fair value of the common stock issued in the combination of $1.80 per share was based on the average market value of SmarterKids.com common stock during the period commencing three days before and ending three days after the announcement date of the combination. The following represents the preliminary allocation of the total purchase price to the estimated fair values of acquired assets and liabilities of SmarterKids.com at September 30, 2000 and is for illustrative purposes only. Assuming the transaction occurred on September 30, 2000, the purchase accounting allocation would have been as follows (in thousands): Working capital..................................................... $33,515 Property and equipment.............................................. 2,957 Other assets........................................................ 2,789 Other intangible assets............................................. 9,186 Long-term liabilities............................................... (806) Deferred compensation............................................... 770 ------- Total purchase price.............................................. $48,411 =======
The purchase accounting allocation summarized above is reflected in the following pro forma adjustments to the unaudited pro forma condensed combined balance sheet at September 30, 2000: (a) To record Earlychildhood's investment in SmarterKids.com equal to the total purchase price summarized above. (b) To reflect the fair value of the SmarterKids.com property and equipment acquired. (c) To eliminate the previously recorded value of intangible assets of SmarterKids.com. (d) To record the identifiable intangible assets at their fair values based on a preliminary independent appraisal. Upon completion of the combination, Earlychildhood will obtain a final independent professional valuation of the identifiable intangible assets acquired. Preliminarily, Earlychildhood expects such identifiable intangible assets to include primarily trade names, completed technology under patents and its customer lists. To a lesser extent, Earlychildhood also expects the identifiable intangible assets to include existing website technology, customer profiles, remaining workforce in-place, and content ratings. (e) To record a pro rated amount of negative goodwill resulting from the difference between the fair value of the net assets acquired and the total purchase price. (f) To record a liability for exit costs related to SmarterKids.com facilities to be closed in connection with the combination. 72 (g) To eliminate the previously recorded value of deferred revenue since there are no expected related post-combination performance costs. (h) To eliminate the historical stockholders' equity accounts of SmarterKids.com. (i) To reflect the recapitalization of Earlychildhood in connection with the combination whereby the Earlychildhood membership interests will be exchanged for common stock of LearningStar. (j) To record deferred compensation related to the intrinsic value of the unvested portion of SmarterKids.com employee stock options exchanged in the combination. (k) To record Earlychildhood's direct costs related to the combination. 2. Notes to the Unaudited Pro Forma Condensed Combined Statements of Operations (l) To record the results of EPI for the period January 1, 1999 through May 5, 1999, the pre-acquisition period for which EPI results were not consolidated with the results of operations of Earlychildhood. (m) To record additional goodwill amortization expense related to the acquisition of EPI for the period from January 1, 1999 through May 5, 1999. The goodwill is being amortized over ten years. (n) To reflect interest expense for the period January 1, 1999 through May 5, 1999 on the debt incurred by Earlychildhood to finance the acquisition of EPI. (o) To record an adjustment to tax expense relating to the inclusion of the pre-acquisition results of EPI for the period January 1, 1999 through May 5, 1999. (p) To reflect reduced depreciation expense resulting from negative goodwill allocated in the purchase accounting to reduce the recorded fair value of property and equipment. (q) To reflect amortization of the deferred stock compensation of $770,000 recorded in connection with the combination. (r) To reflect amortization of identifiable intangible assets of SmarterKids.com recorded in the purchase accounting for the combination, based on their expected useful lives ranging from three to six years. (s) To adjust the tax provision of the combined companies to reflect the net operating losses generated by SmarterKids.com in the periods presented. As of December 31, 1999, SmarterKids.com had net operating loss carryforwards for federal and state tax purposes of approximately $38 million, which expire through 2019, and has generated significant additional net operating losses in 2000. Utilization of these tax benefits in future years by the combined company will be subject to annual limitations. (t) Assumes exchange of the weighted average membership interests into common stock of LearningStar Corp. at the exchange ratios as stated in the combination agreement and includes a pro forma adjustment to income tax expense to reflect the effect of Earlychildhood's income being subject to federal and state income taxes. (u) Since the pro forma statement of operations results in a loss from continuing operations, the pro forma basic and diluted net loss per common share is computed by dividing the net loss by the weighted average number of common shares outstanding. The calculation of the pro forma weighted average number of common shares outstanding assumes that 20,641,040 shares of the combined company have been issued to acquire SmarterKids.com in the combination and 1,763,498 shares issued in the EPI acquisition were outstanding at the beginning of the periods presented. (v) To remove accretion relating to the preferred stock of SmarterKids.com as the preferred stock does not continue to be outstanding after the combination. 73 SMARTERKIDS.COM The information in this section describes the business of SmarterKids.com as it has historically been conducted, without giving effect to the combination. For a more detailed discussion of SmarterKids.com's business, you should read its most recent annual report on Form 10-K, which was filed by SmarterKids.com on March 30, 2000. Business Overview SmarterKids.com was incorporated in Delaware in March 1994. SmarterKids.com is a leading online educational store, launched in November 1998, dedicated to helping parents help their children learn, develop, and grow. The site offers one of the Internet's most personalized shopping experiences, linking teacher- reviewed toys, games, books, software, and hands-on activities through SmarterKids.com's patent-pending evaluation and recommendation process. SmarterKids.com provides educational content, including product reviews, learning styles surveys and personalized product recommendations, to help parents and gift givers find quality products and make informed purchase decisions tailored to a child's individual developmental needs and learning goals. SmarterKids.com serves as a resource for parents, offering specialty centers, the Grade Expectations! guide to education standards and thousands of educational products, including both well-known brands and hard-to-find quality offerings, for children ages infant through 15. SmarterKids.com integrates carefully selected products, helpful content and interactive tools with an intuitive and easy-to-use website to create a compelling and unique online shopping experience. SmarterKids.com only sells products that its full-time staff of certified educators believes have educational, developmental or learning value. SmarterKids.com's collection of products includes over 4,500 books, toys and games, and software titles from over 300 suppliers. Because SmarterKids.com is focused on education, many of its products, particularly toys and games, are often not found on many of the other websites that offer children's products. The MySmarterKids.com personalization area on the SmarterKids.com website allows parents to build a confidential educational profile of their child that can include information about the child's age and grade, learning styles, learning goals and performance on standardized tests. The SmarterKids.com SmartPicks technology then uses this profile to make product recommendations from SmarterKids.com's distinctive assortment of products tailored to a child's individual developmental profile and goals. SmarterKids.com's principal executive offices are located at 15 Crawford Street Needham, Massachusetts 02494. SmarterKids.com's telephone number is (781) 449-7567, and its website is www.smarterkids.com. Industry Background SmarterKids.com's business lies at the intersection of the consumer market for educational and developmental products for children and Internet-based commerce. The Educational Products Market. As a result of a number of societal trends, including constraints on school budgets and the increasing use of standardized tests, many parents are taking a more active role in their children's education. In their efforts to help their children learn, improve their children's standardized test scores and make learning fun, parents are increasingly purchasing educational books, toys and games, and software. Parents are faced with the challenge of finding quality educational products and selecting the right products for their children. With thousands of educational products to choose from and few reliable sources of information, finding the appropriate products for a specific child's needs and goals can be overwhelming and 74 confusing. Parents seek a resource for comprehensive and trusted educational content and product information to help them make informed purchase decisions. Limitations of the Traditional Retail Channel. The traditional retail channel, including mass-market retailers, has numerous participants and is highly fragmented. In general, store-based retailers face challenges in providing a shopping experience that meets the needs of parents, including: . narrow selection of products due to physical space limitations; . high costs from the need to build and operate multiple retail locations; . lack of flexibility in product display and merchandising capabilities; . lack of convenience due to limited hours of operation and geographic location; and . lack of focus on educational products and limited educational expertise. Specialty educational retailers and creative toy and game retailers that are focused on education often lack the sales expertise or time to analyze a child's specific needs. As a result, the traditional retail channel fails to satisfy parents' needs for selection, convenience, personalized service, and advice and information. Growth of the Internet and Consumer Electronic Commerce. Because of the inherent limitations of traditional retail channels of distribution, the Internet has dramatically affected the way consumers and businesses are buying and selling products and services. The Internet is well suited for consumer commerce for a number of reasons, including: . increased convenience due to the ability to access the Internet at any time from almost any location; . virtually unlimited "shelf" space to allow merchants to offer a wide selection of products and services; . low facilities and staffing costs; . merchandising flexibility due to the merchant's ability to quickly update and customize product selection and presentation, editorial content and prices; . enhanced knowledge of customers' needs from the merchant's ability to gather, process and store large amounts of customer information; and . the ability to provide a large amount of targeted information. In addition, consumers are also using the Internet to obtain information and manage personal needs. Limitations of Online Retailers That Offer Educational Products. Although online retailers have a number of advantages, those that offer educational products as a component of their larger product mix have been limited in a number of ways because they generally: . do not evaluate the products they offer; . lack extensive educational and editorial content; and . do not assess an individual child's needs to personalize the online experience. The limitations of traditional and online retailers create a significant opportunity for an educational resource that combines educational expertise and assessment tools, a wide range of quality educational products and the power of the Internet to help parents make informed purchase decisions. 75 The SmarterKids.com Solution SmarterKids.com is an online retailer focused on children's educational books, toys and games, and software. SmarterKids.com combines expertise in children's education with sophisticated product analysis to help parents make better purchase decisions. Key features of the SmarterKids.com solution include: Broad Assortment of Carefully Selected and Reviewed Educational Products. SmarterKids.com's collection of educational products includes over 4,500 books, toys and games, and software titles from over 300 suppliers. SmarterKids.com continues to carefully select and add products to its assortment that meet its quality standards. SmarterKids.com employs certified educators who select only products that have educational, developmental or learning value. SmarterKids.com products are also selected based on how a child uses the product, and whether the product is fun. Once selected, the SmarterKids.com review process then determines product suitability based on the skills taught, effectiveness in addressing each skill, the appropriate grade level(s), the teaching approach, learning style and the occasion for use, such as bedtime, travel or group play. Each product is assigned a rating for "fun," "ease of use" and "reusability" and is then given an overall "expert review." SmarterKids.com also provides product reviews prepared by third parties. Because it is focused on education, many of SmarterKids.com's products, particularly toys and games, are not found on many of the other popular websites that offer children's products. Compelling Educational Content and Contextual Merchandising. SmarterKids.com believes that it is an authority on educational products. Each member of the SmarterKids.com staff of full-time educators holds a degree in education, has teaching experience and has designed and implemented developmental and educationally appropriate curriculum for children. This staff of educators develops SmarterKids.com content, including educational articles, parenting advice and product reviews, and licenses educational content from third parties. The benefit SmarterKids.com provides parents comes, first, by selecting the best educational products in the marketplace to offer from the SmarterKids.com website and, second, by providing online advice and information about specific products to help parents and gift givers make appropriate selections. The SmarterKids.com website also integrates content with access to relevant products. For example, the Smarter Parents Resource Center suggests weekly and monthly educational activities parents can do with their children and then suggests products to expand on these activities. The SmarterKids.com Teacher Talk Glossary helps parents understand commonly used educational terms. SmarterTips helps parents prepare their children for standardized tests. Ask the Teacher enables parents to submit questions to SmarterKids.com's staff of teachers regarding their child's development and review archived answers to previous questions. SmarterSites connects parents to other relevant educational websites. SmarterKids.com's exclusive monthly columns, "TotTime" by Jean Warren and "Raising Smarter Kids" by Dr. Dorothy Rubin, are authored by education experts with more than 100 published books to their credit. In addition, parents can get daily education news headlines from the world's top news sources in Today's Headlines. In addition, SmarterKids.com launched specialty centers focused on the individual product and informational needs of Gifted & Talented and Special Needs children, furthering its mission to help all children learn, develop, and grow. Convenient and Easy-to-Use Website. SmarterKids.com integrates carefully selected products, helpful content and interactive tools with an intuitive and easy-to-use interface. SmarterKids.com organizes its website around age and grade levels, which is the way parents typically think about the educational development of their children. SmarterKids.com offers full search and browsing capabilities that enable parents to find products easily. Furthermore, SmarterKids.com notifies registered parents when it offers relevant new products or specials. SmarterKids.com provides customers the convenience and flexibility of shopping 24 hours a day, seven days a week, with dedicated customer service and reliable and timely product delivery. 76 Technology That Matches Products With a Child's Unique Educational Profile. Parents can use SmarterKids.com's proprietary technology to find products that meet their child's unique educational needs. The MySmarterKids.com personalization area allows parents to build an evolving and confidential educational profile of their child that can include information about the child's age and grade, learning goals and results from: . the Learning Styles Survey that parents can fill out online; . skills check-up assessment tests that children can take online; . CD-ROM based skills tests that parents can order from the SmarterKids.com website; and . scores from state-sponsored standardized tests. SmarterKids.com's proprietary SmartPicks technology then uses this developmental profile to make targeted product recommendations. SmartPicks "reshuffles" the entire store so that it emphasizes those products that the SmarterKids.com educational team believes are appropriate for the individual child's unique needs and individual goals. On subsequent visits, the SmarterKids.com website will recognize registered members and display products and services tailored to a child's developmental profile and goals. SmarterKids.com believes it is the first and presently the only educational products and services website to offer this level of personalization. Shopping at SmarterKids.com The SmarterKids.com website is designed to be easy and convenient to use. The SmarterKids.com website provides informative reviews of our products and other useful educational information and is organized in the same way that parents typically think about the educational development of their kids--by age and grade level. Website Design and Utility. The primary means by which SmarterKids.com's products and features are organized is by SmarterKids.com's five age and grade ranges--toddler, preschool through kindergarten, grades 1-3, grades 4-6 and grades 7-9, each grade range is referred to as an "aisle" on the SmarterKids.com website. Parents naturally think about their children in terms of their age and grade, and, by organizing its website in this manner, SmarterKids.com is able to emphasize its unique focus on the individual child. Within each age and grade range, or "aisle," visitors can browse through links organized by parents' or teachers' favorite, subject matter, brand, keyword or theme. Each aisle also has pictures and prices of highlighted products with links to teachers' reviews of these products. From the SmarterKids.com home page, or within each aisle, customers may access a number of helpful areas within the website, including: . product categories such as Parents' Favorites, Teachers' Favorites, Best Sellers, Monthly Picks, Great Gift Ideas, Kids' Favorites or Twenty under $20; . product groups, organized by well-known brands or favorite characters; . SmarterKids.com's Learning Styles Survey; . subject links, to find products which address a particular educational or developmental area; and . a keyword search box, where customers can enter a product name, manufacturer name or descriptive words to find a product. These areas are constantly evaluated and refined to reflect the feedback SmarterKids.com gathers from its customers and any seasonal, periodic or promotional opportunities SmarterKids.com pursues. Products. SmarterKids.com offers three product types--books, toys and games, and software--ranging in price from under $2.00 to $799.00. These products range from those based on popular brands and licensed 77 characters to hard-to-find specialty items. SmarterKids.com sets its prices on parity with the average prices of similar products offered by its online competitors. Each product listing has a picture of the product; narrative review; indication of skills developed, educational approach utilized, and best application; and ratings for ease of use, fun, reusability and depth of instruction. With one click, a user can see all applicable brands, categories and special offers for each product type. For example, a parent might select a vividly illustrated book that teaches letter recognition, software that uses an engaging interactive story to develop creativity, or a puzzle that teaches motor skills and spatial-relationship awareness. The Grade Expectations! section of the SmarterKids.com website allows parents to select products aligned to educational grade standards based on an interpretation of widely accepted national, state, and local curriculum guidelines. MySmarterKids.com offers what SmarterKids.com believes to be one of the most personalized shopping experiences in electronic commerce. Parents enter information related to their child's education and development to build a personal profile, and SmarterKids.com uses the information to present an educationally appropriate assortment of products. The more information that a parent enters, the more precise will be the product recommendations made by SmartPicks, SmarterKids.com's proprietary personalization technology. MySmarterKids.com incorporates a child's age and grade, learning goals and results from: . the Learning Styles Survey that parents fill out online; . a skills check-up assessment test that children can take online; . a CD-ROM-based skills test that parents can order from the SmarterKids.com website; and . scores from state-sponsored standardized tests. For example, when a parent wishes to focus a first grade child on pre- reading skills, SmartPicks presents only those products appropriate to that age and skill goal. Further individual customization can be achieved when a parent completes a Learning Styles Survey to determine whether a child learns best through a linguistic, visual, musical, interpersonal, intrapersonal, mathematical or physical style. If a child's learning style is visual, SmartPicks will customize this child's shopping area by suggesting products that teach pre-reading skills to a first grader through visual learning. SmartPicks retains a child's information for future reference by the parent. When a parent returns to the SmarterKids.com website, new products will automatically be suggested that achieve the learning goals and fit the learning style and age range of the child. SmarterKids.com protects all information entered into MySmarterKids.com and elsewhere and strictly adheres to commonly accepted privacy standards established by TrustE and the Better Business Bureau, non-profit organizations who are dedicated to establishing a trusting environment for making purchases and gathering information on the Internet. Information regarding TrustE and the Better Business Bureau can be found at www.truste.org and www.bbb.com. Product selection, check-out and payment functions are easy and intuitive. SmarterKids.com stocks each item that it sells and is able to show the customer the availability for each product. SmarterKids.com's credit card approval technology prevents customers from experiencing delays in check-out. Customers receive e-mail confirmations of their orders, notification of shipment, and the ability to track their shipment through the United Parcel Service. Website content is designed and selected to achieve SmarterKids.com's mission of helping parents help their children learn. SmarterKids.com's product reviews are prepared by a staff of full-time educators. To promote trust, SmarterKids.com encourages customers to access explanations of product review methodology. SmarterKids.com's Parents Center suggests weekly learning activities that parents can do with their children, helps parents prepare their children for standardized tests, and offers a Teacher Talk Glossary to explain terms used by education professionals. Ask the Teacher enables parents to submit questions regarding their child's development and review archived answers to previous questions. SmarterSites connects parents to relevant and 78 powerful information sources. Parents who register for MySmarterKids.com receive twice-monthly e-mailed newsletters. Marketing and Sales SmarterKids.com uses an aggressive and multi-faceted advertising and promotional strategy to build awareness and attract customers to its website. SmarterKids.com uses a personalized database marketing approach to build its customer base and encourage repeat transactions. SmarterKids.com emphasizes responsive and reliable customer service to earn customer loyalty. E-mail is the primary vehicle by which SmarterKids.com communicates with its customers and registered users. SmarterKids.com sends customers periodic newsletters and notification of private, customer-only offers. SmarterKids.com personalizes its information and offers to specific subsets of its customers, according to the products they have purchased and the information they have provided in their children's MySmarterKids.com profiles, enhancing the value added and SmarterKids.com's relationship with them. SmarterKids.com's online marketing efforts include relationships with companies who maintain websites that have a large, existing customer base. SmarterKids.com places banners, buttons and text links on its websites in return for a specified number of impressions, and jointly develops content, promotions and e-mail marketing programs. For example, SmarterKids.com has a persistent search box on the home page of Microsoft's Encarta encyclopedia website. These relationships generally include content sharing arrangements and require SmarterKids.com to pay a fee for delivery of Internet traffic. In these relationships, SmarterKids.com is usually the preferred, if not exclusive, online retailer of children's educational books, toys and games, and software. National Computer Systems, or NCS, is the largest processor of standardized tests for children in kindergarten through grade 12 in the United States. NCS provides processing and scoring for over 30 million student assessment tests, such as the Iowa Test of Basic Skills, in all 50 states and for the U.S. Department of Education. In May 1999, NCS launched its WeHelpKids.com website, offering a variety of electronic HelpTests and value-added services aimed at providing assessment and identification of a student's academic strengths and weaknesses. WeHelpKids.com contains several direct links to the SmarterKids.com website, which draws parents eager to support and encourage their children's learning. The links are promoted through both a banner promotion and the NCS ReportCard service. The NCS ReportCard service allows parents to enter the results of their children's state standardized tests on WeHelpKids.com and receive personalized product recommendations from SmarterKids.com's SmartPicks system based on those test results. WeHelpKids has commenced this service as a pilot program for Michigan standardized tests and intends to add tests and services for tests given in other states. The agreement with NCS provides that SmarterKids.com pay NCS a commission based upon a percentage of the gross margin on sales generated by customers originating from WeHelpKids.com and expires in March 2001 unless renewed. In connection with the establishment of its promotional services relationship with NCS, SmarterKids.com issued to NCS warrants to purchase 112,500 shares of SmarterKids.com common stock at an exercise price of $1.33 per share. With the consent of NCS, SmarterKids.com cancelled warrants to purchase 84,375 shares of SmarterKids.com common stock in November 2000. The remaining 28,125 warrants became exercisable upon the achievement by NCS of certain milestones. Through programs managed by LinkShare, SmarterKids.com has relationships with over 10,000 websites that feature links to SmarterKids.com in return for a commission based on net sales that result from such referrals. These websites range from online malls to individuals' websites. LinkShare recruits affiliates, collect commissions from SmarterKids.com and pays the participating websites. Offline marketing is an increasingly important component of SmarterKids.com's customer acquisition and branding efforts. SmarterKids.com advertises in a variety of parenting-oriented and other magazines and through direct mail and free-standing inserts. 79 SmarterKids.com obtains products from a network of large and small vendors, manufacturers and distributors. SmarterKids.com carries inventory of the products available for sale on its website. SmarterKids.com currently conducts its distribution operations through one facility operated by SmarterKids.com, consisting of approximately 139,000 square foot facility in Mansfield, Massachusetts. SmarterKids.com sends orders from its website to its distribution facilities over secure connections and warehouse management systems that optimize the pick, pack and ship process. The warehouse management system provides the website with data on inventory quantities, which enables SmarterKids.com to display information about the availability of the products on its website. The management system also enables SmarterKids.com to offer a variety of gift wrap choices, custom gift cards and custom to/from labels for each individual gift. In addition, SmarterKids.com offers an order tracking service for its customers on its website. SmarterKids.com offers three levels of shipping service in the United States: standard, premium and express. SmarterKids.com has developed strong relationships with United Parcel Service, the United States Postal Service and Federal Express to maximize its overall service level to all 50 states. Customer Service SmarterKids.com seeks to provide a customer experience that exceeds customer expectations. Its goals include: . prompt shipping; . responding to all e-mail inquiries within the same day; . maintaining a return rate of less than 1%; and . maintaining at least 99% of inventory items in stock at any time. SmarterKids.com maintains a toll-free telephone customer service center staffed with customer service representatives trained to assist customers with product selection, order processing, shipping and billing and any other questions or problems. SmarterKids.com trains its representatives to be competent and courteous. SmarterKids.com gives representatives wide discretion to ensure that customers are satisfied with their purchases and their purchasing experience. Technology SmarterKids.com has implemented a broad array of scalable systems for website management, search, customer service, electronic transaction management and data interchange, e-mail, order processing, payment processing, office administrative services, and accounting. These systems use a combination of proprietary and commercially-available technologies. SmarterKids.com focuses its internal development efforts on creating and improving specialized software that is unique and able to enhance its business. SmarterKids.com uses a set of applications for: . evaluating and reviewing products for eligibility in its store; . accepting and validating customer orders; . managing customer telephone and e-mail inquiries and requests for service; . transmitting order and related information among our website, headquarters, and fulfillment locations; . profiling customers' order histories and purchasing patterns; . conducting and managing customer payment transactions; and . interacting with its fulfillment center. 80 SmarterKids.com develops or selects systems that are based on industry- standard architectures that have been designed to minimize downtime in case of outages or catastrophic occurrences. They provide 24-hours-a-day, seven-days-a- week availability. The SmarterKids.com transaction processing methods and databases are designed without arbitrary capacity constraints and are scalable to any volume of demand that it expects to encounter. SmarterKids.com has implemented load balancing systems and redundant servers to provide for fault tolerance. Since September 1999, SmarterKids.com's systems infrastructure has been hosted at Exodus Communications in Waltham, Massachusetts. Exodus provides redundant communication lines from multiple providers, 24-hour monitoring and engineering support, its own generators and multiple back-up systems. Exodus also maintains private peering relationships. Private peering refers to a private network that Exodus built with major tier-one Internet providers. Customers who connect through those service providers will be routed faster through the private network and avoid the unpredictable performance of the public Internet. Competition SmarterKids.com's competitors can be divided into several groups, including: . mass market retail chains, such as Kmart, Target and Wal-Mart; . mass market book sellers, toy stores and computer hardware and software stores, such as Barnes & Noble, Toys "R" Us and CompUSA; . traditional regional or local bookstores, toy stores and computer and software stores; . traditional and online specialty educational retailers, such as Learning Express and Zany Brainy; . online book sellers, toy sellers and computer software sellers, such as Amazon.com, eToys, KBkids.com, and Beyond.com; and . educational catalog distributors, such as Scholastic. SmarterKids.com believes that the principal competitive factors in its market are: . brand recognition and trust; . ability to attract and retain consumers; . breadth of product selection; . product pricing; . availability of educational and authoritative information; and . quality and responsiveness of customer service. SmarterKids.com believes that it competes favorably on these factors. SmarterKids.com expects its brand recognition to increase as a result of current and future strategic relationships and marketing and advertising campaigns. SmarterKids.com will also continue to expand its product selection. Intellectual Property Rights SmarterKids.com regards the protection of its intellectual property as critical to its future success and relies on a combination of copyright, trademark, service mark and trade secret laws, license agreements and contractual restrictions to establish and protect its proprietary rights in SmarterKids.com website architecture and technology, products, content and services. SmarterKids.com has a pending patent application relating to the SmartPicks product selection algorithm it uses on its website. SmarterKids.com has entered into confidentiality and invention assignment agreements with its employees and contractors in order to limit disclosure of proprietary information and to protect SmarterKids.com's ownership interest in its website 81 architecture and technology. SmarterKids.com cannot assure you that these contractual arrangements or the other steps taken by it to protect its intellectual property will prove sufficient to prevent misappropriation of its technology or deter independent third-party development of similar technologies. Employees As of December 31, 2000, SmarterKids.com had 98 full-time employees, including 35 in marketing and sales, 16 in customer service, two in editorial and education review, 20 in development and 25 in general and administrative. From time to time, SmarterKids.com also employs independent contractors to support these operational areas. The employees of SmarterKids.com are not represented by a union, and it believes that its employee relations are good. Property SmarterKids.com is headquartered in Needham, Massachusetts, where it leases an office with approximately 39,152 square feet under a lease expiring in October 2004. SmarterKids.com believes that these facilities are adequate to meet its current requirements and that suitable additional or substitute space will be available as needed. In addition, during the second quarter of 2000, SmarterKids.com entered into a lease agreement for a 139,000 square foot distribution center in Mansfield, Massachusetts that expires in March 2005. The distribution center allows SmarterKids.com to better manage its fulfillment process. Legal Proceedings SmarterKids.com is not a party to any material legal proceedings, though it from time to time may become a party to various legal proceedings arising in the ordinary course of its business. 82 SmarterKids.com Management's Discussion and Analysis of Financial Condition and Results of Operations SmarterKids.com's Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying financial statements and related notes of SmarterKids.com for the periods specified, included elsewhere in this proxy statement-prospectus. The following discussion contains forward-looking statements which involve risks and uncertainties. SmarterKids.com makes such forward-looking statements under the provision of the "Safe Harbor" section of the Private Securities Litigation Reform Act of 1995. Any forward-looking statements should be considered in light of the factors described. Actual results may vary materially from those projected, anticipated or indicated in any forward-looking statements. In this section, the words "anticipates," "believes," "expects," "intends," "future," "could," and similar words or expressions (as well as other words or expressions referencing future events, conditions, or circumstances) identify forward-looking statements. Overview SmarterKids.com is an online retailer focused exclusively on children's educational books, toys and games, and software. From inception through March 1998, SmarterKids.com's activities consisted primarily of the conception, development, publishing, marketing and sales of its proprietary educational and entertainment CD-ROM software. In March 1998, SmarterKids.com began transitioning its business model to online sales of third-party educational products and commenced development of the SmarterKids.com website. In November1998, SmarterKids.com launched its website, discontinued the sale of its proprietary CD-ROM products through traditional retail channels and began offering its proprietary CD-ROM products on a limited basis through SmarterKids.com online channel. While SmarterKids.com's online retail revenues have grown rapidly since launching its website, total revenues decreased since the beginning of 1999 due to the curtailment of SmarterKids.com's proprietary CD-ROM business. Over the same period, marketing and sales expenses increased significantly as a result of SmarterKids.com's promotional activities. SmarterKids.com expects that the rate at which it incurs losses will depend on the extent it continues to incur additional expenses to advertise and promote its website, expand its product offerings and website content, enhance and upgrade its website and other systems, expand its fulfillment capabilities and hire additional personnel. Prior to November 1998, revenues consisted solely of sales of SmarterKids.com's proprietary CD-ROM products and were recognized upon shipment, net of return allowances as determined by historical trends of actual returns. Cost of revenues consisted primarily of production and shipping costs. Marketing and sales expenses consisted primarily of promotions and advertising of SmarterKids.com's products through national computer software retailers. Development costs consisted primarily of compensation for employees developing SmarterKids.com's proprietary CD-ROM software. General and administrative costs consisted primarily of compensation for employees and professional fees. Revenues in 1999 and 2000 consisted of online sales of third-party educational products and charges to customers for shipping. In the year ended December 31, 1999, and the nine months ended September 30, 2000, SmarterKids.com derived less than 2% of its revenues from outside of the United States. Revenues are recognized upon shipment to the customer and are net of promotional discounts, coupons and return allowances, which are determined by historical trends of actual returns. Under SmarterKids.com's online retail business model, its actual returns and therefore its allowance for returns are lower than the returns from its historical CD-ROM business which utilized an indirect sales channel. Cost of revenues consisted primarily of the cost of products sold to customers and SmarterKids.com's shipping costs. SmarterKids.com anticipates that its gross margins will fluctuate from quarter to quarter depending on consumer preferences for its mix of products. Marketing and sales expenses consisted primarily of the cost of advertising and promotional activities, fulfillment services fees to J.L. Hammett Co. through July 1, 2000 and costs to operate SmarterKids.com's own distribution facility thereafter, commissions to online marketing companies, and expenses for personnel engaged in marketing, merchandising and customer service activities. Fulfillment fees 83 paid to J.L. Hammett Co. were based on a percentage of the cost to SmarterKids.com's of its products. This percentage was fixed and did not vary with the prices of SmarterKids.com's products. Commissions to online marketing companies are based on a percentage of revenues generated through these relationships. Because SmarterKids.com pays commissions to online marketing companies based on a percentage of revenues derived from these relationships, SmarterKids.com expects SmarterKids.com's gross margins, as a percentage of revenues, to decrease if SmarterKids.com begins to derive increased revenue from online marketing relationships. Approximately 4% and 5% of SmarterKids.com's revenues in the year ended December 31, 1999 and the nine months ended September 30, 2000, respectively, were derived from these relationships. Development expenses consisted primarily of payroll and related costs for personnel performing website design, development and testing. SmarterKids.com believes that continued investment in website development is critical to attaining its strategic objectives. General and administrative expenses consisted primarily of payroll and related costs for executive and administrative personnel, professional service expenses and other general corporate expenses. In November 1999, SmarterKids.com incurred a one-time cost of $861,000 in connection with the settlement and legal expenses of a patent infringement lawsuit, which cost was included in general and administrative expenses for the quarter ended on December 31, 1999. Interest and other income (expense), net consisted primarily of interest expense related to short-term lease obligations and interest earned on the short-term investment of cash. With respect to SmarterKids.com's need to attract, retain and motivate qualified employees and certain marketing and service providers, since September 1995, SmarterKids.com has provided them with equity-based compensation. Stock compensation expenses represent non-cash charges related to stock options and warrants given to employees and directors, consultants, J.L. Hammett Co. and NCS. For employee and director grants, the compensation charge reflects the difference between the exercise price of the options and the estimated fair value of the underlying common stock on the date of the grant. This compensation charge is deferred initially and amortized to expense over the vesting period of the applicable options. For non-employee grants, the compensation charge reflects the fair value of the options and warrants on the initial measurement date (typically the date of grant for those exercisable immediately or with fixed vesting periods, or the date when vesting becomes fixed for those with variable vesting periods), as well as subsequent re- measurements of such fair value until the options and warrants vest. Accordingly, SmarterKids.com cannot currently estimate additional charges related to future re-measurement of unvested non-employee options and warrants. SmarterKids.com may in the future grant additional equity-based compensation to non-employees to secure marketing or other service relationships. As of September 30, 2000, $4.5 million of deferred stock compensation remained to be amortized to expense, generally over the next three years, for stock options and warrants granted through September 30, 2000. The market for children's educational books, toys and games, and software is highly seasonal. Accordingly, SmarterKids.com expects to experience seasonal fluctuations in its revenues. In particular, SmarterKids.com expects a disproportionate amount of its revenues to be realized during the fourth quarter of each calendar year. 84 Results of Operations
Twelve Months Ended Nine Months Ended December 31, September 30, -------------------------- ------------------ 1997 1998 1999 1999 2000 ------- ------- -------- -------- -------- (in thousands) Net Revenues: Online retail................ $ -- $ 22 $ 5,421 $ 1,108 $ 4,504 Proprietary CD-Rom........... 1,416 2,278 -- -- -- ------- ------- -------- -------- -------- Total net revenues......... 1,416 2,300 5,421 1,108 4,504 ------- ------- -------- -------- -------- Cost of revenues: Online retail................ -- 20 4,005 795 3,386 Proprietary CD-Rom........... 491 908 -- -- -- ------- ------- -------- -------- -------- Total cost of revenues..... 491 928 4,005 795 3,386 ------- ------- -------- -------- -------- Gross profit................. 925 1,372 1,416 313 1,118 ------- ------- -------- -------- -------- Operating expenses: Marketing and sales.......... 756 2,678 28,916 10,726 20,215 Development.................. 721 1,378 1,721 1,149 2,546 General and administrative... 430 490 2,854 1,091 2,490 Stock compensation........... 15 187 3,405 1,789 1,374 ------- ------- -------- -------- -------- Total operating expenses... 1,922 4,733 36,896 14,755 26,625 ------- ------- -------- -------- -------- Loss from operations......... (997) (3,361) (35,480) (14,442) (25,507) Interest and other income (expense), net.............. (17) 19 752 300 2,037 ------- ------- -------- -------- -------- Net loss..................... $(1,014) $(3,342) $(34,728) $(14,142) $(23,470) ======= ======= ======== ======== ========
Nine Months Ended September 30, 1999 and 2000 Revenues. Revenues primarily consist of online sales of third-party educational products and charges to customers for shipping. In the nine months ended September 30, 1999 and 2000, SmarterKids.com continued to derive substantially all of its revenues from sales within the United States. Revenues are recognized upon shipment to the customer and are net of promotional discounts, coupons and return allowances, which are determined by historical trends of actual returns. Revenues were $1.1 million and $4.5 million in the nine months ended September 30, 1999 and 2000, respectively. In the nine months ended September 30, 2000, SmarterKids.com recognized $228,000 of previously deferred gift certificate revenue on gift certificates expiring unused. The increase in revenue from the nine months ended September 30, 1999 to the nine months ended September 30, 2000 resulted from increased marketing efforts and brand-building during the more recent period as well as revenue recognized from expired gift certificates. Cost of revenues. Cost of revenues consists primarily of the cost of products sold to customers and the cost of shipping products to SmarterKids.com customers. SmarterKids.com anticipates that its gross margins will fluctuate from quarter to quarter depending on consumer preferences for its mix of products. The cost of revenues was $795,000 and $3.4 million in the nine months ended September 30, 1999 and 2000, respectively. During the nine months ended September 30, 2000, SmarterKids.com recorded an inventory obsolescence charge of $209,000 for software products held in inventory. SmarterKids.com's gross margin decreased from 28% in the nine months ended September 30, 1999 to 25% in the same nine month period in 2000, due to slightly lower gross margins on new products introduced, obsolescence charges and increased freight charges. Marketing and sales. Marketing and sales expenses consist primarily of the cost of advertising and promotional activities, fulfillment costs, commissions to online marketing companies, expenses for personnel 85 engaged in marketing, and merchandising activities. Fulfillment costs represent costs incurred in operating and staffing the distribution center and the customer service department, picking and packing customers' orders for shipment, responding to inquires from customers, credit card fees, as well as fees paid to J.L. Hammett Co., a fulfillment partner during the first six months of 2000 and all nine months of 1999. As of July 1, 2000, SmarterKids.com discontinued using J.L. Hammett Co. as a third party fulfillment partner due to the opening of its own distribution facility. Marketing and sales expenses were $10.7 million and $20.2 million in the nine months ended September 30, 1999 and 2000, respectively. The increase in the nine months ended September 30, 2000 was primarily attributable to increased advertising and promotional activities, fees to SmarterKids.com previous fulfillment partner, J.L. Hammett Co., as well as the hiring of employees to staff SmarterKids.com's distribution center which opened for operations on July 1, 2000. Fulfillment costs included in marketing and sales expense were $340,000 and $1,538,000 for the nine months ended September 30, 1999 and 2000, respectively. In September 2000, the Emerging Issues Task Force, or EITF, reached a final consensus on EITF Issue 00-10, "Accounting for Shipping and Handling Fees and Costs." This consensus states that all amounts billed to a customer in a sale transaction related to shipping and handling, if any, represent revenue and should be classified as revenue. SmarterKids.com already classifies shipping charges to customers as revenue. With respect to the classification of costs related to shipping and handling incurred by the seller, including fulfillment costs, the EITF determined that the classification and amount of such costs is an accounting policy decision that should be disclosed. SmarterKids.com classifies fulfillment costs in marketing and sales expenses. These costs are primarily composed of distribution facility expenses, including equipment and supplies, payroll and travel expenses for personnel engaged in distribution activities, third party fulfillment fees, credit card fees and the costs of customer support. These costs represent facility costs necessary for warehousing inventory, as well as costs incurred to pick and pack a customer order and the related packaging supplies. Development. Development expenses consist primarily of payroll and related costs for personnel performing website design, development, maintenance and testing. Development expenses were $1.1 million and $2.5 million in the nine months ended September 30, 1999 and 2000, respectively. The increase in development costs from the nine months ended September 30, 1999 to the nine months ended September 30, 2000 was attributable primarily to costs related to maintaining, testing and enhancing the features, content and functionality of SmarterKids.com's website, as well as the hiring of additional employees. General and administrative. General and administrative expenses consist primarily of payroll and related costs for executive and administrative personnel, professional service expenses and other general corporate expenses. General and administrative expenses were $1.1 million and $2.5 million in the nine months ended September 30, 1999 and 2000, respectively. The increase in general and administrative expenses from the nine months ended September 30, 1999 to the nine months ended September 30, 2000 was attributable primarily to the costs related to the expansion of SmarterKids.com's operations and infrastructure, as well as the hiring of additional employees. Stock compensation. SmarterKids.com recorded non-cash stock compensation expense of $1.8 million and $1.4 million in the nine months ended September 30, 1999 and 2000, respectively, related to amortization of deferred stock compensation for options and warrants granted to employees and non-employees. Included in the nine months ended September 30, 2000 was stock compensation of $242,000 recorded in connection with the acceleration of J.L. Hammett Co. warrants and $110,000 recorded in connection with the repricing of certain of SmarterKids.com's employee stock options. On September 7, 2000, SmarterKids.com completed a direct repricing of certain employee stock option grants. As part of the repricing, SmarterKids.com reduced the exercise price of all outstanding options with exercise prices of greater than $1.50 per share. The new exercise price of these repriced options was reset to 86 $1.50 per share, which was equal to the market value of the common stock on September 7, 2000. Options to purchase 2,325,574 shares of SmarterKids.com common stock were repriced. SmarterKids.com is accounting for the repriced options as a variable award. Interest and other income (expense), net. Interest and other income (expense), net consists primarily of interest income earned on SmarterKids.com's short-term investments offset by interest expense related to short-term lease obligations and borrowings under its equipment line of credit. Interest and other income (expense), net increased from $300,000 in the nine months ended September 30, 1999 to $2.0 million in the nine months ended September 30, 2000. The increase was primarily attributable to an increase in interest income generated from higher balances of capital invested in commercial paper, corporate and treasury notes and auction rates. The higher balances of capital were generated from SmarterKids.com's initial public offering. Years Ended December 31, 1997, 1998 and 1999 Revenues. Revenues in 1999 consisted of online sales of third-party educational products and SmarterKids.com's proprietary CD-ROM products and charges to customers for shipping. In the year ended December 31, 1999, SmarterKids.com derived less than 2% of its revenues from outside of the United States. Revenues are recognized upon shipment to the customer and are net of promotional discounts, coupons and return allowances, which are determined by historical trends of actual returns. Under SmarterKids.com's new online retail business model, its actual returns and therefore its allowance for returns are lower than the returns from its CD-ROM business which utilized an indirect sales channel. From inception through March 1998, SmarterKids.com's activities consisted primarily of the conception, development, publishing, marketing and sales of its proprietary educational and entertainment CD-ROM software. In March 1998, SmarterKids.com began transitioning its business model to online sales of third-party educational products. Revenues were $1.4 million, $2.3 million and $5.4 million in the years ended December 31, 1997, 1998 and 1999, respectively. The increase in revenue from 1997 to 1998 was primarily attributable to increased sales of CD-ROM products, which was a result of new product offerings and expanded marketing and sales efforts through traditional retail channels. The increase in revenue from 1998 to 1999 was primarily attributable to the transition of SmarterKids.com's business model to online sales of third-party educational products and reflected the results of its significant marketing efforts. Cost of revenues. Cost of revenues consists primarily of the cost of products sold to customers and SmarterKids.com's shipping costs. The cost of revenues were $491,000, $928,000 and $4.0 million in the years ended December 31, 1997, 1998 and 1999, respectively. The increase from 1997 to 1998 was primarily attributable to additional costs associated with increased sales of CD-ROM products. The increase from 1998 to 1999 was attributable to the increase in online sales of third-party educational products. SmarterKids.com's gross margin decreased from 65.3% in 1997 to 59.7% in 1998 to 26.1% in 1999 as a result of the new online retail business model. Marketing and sales. Marketing and sales expenses consist primarily of the cost of advertising and promotional activities, fulfillment service fees to J.L. Hammett Co., commissions to online marketing companies, and expenses for personnel engaged in marketing, merchandising and customer service activities. Marketing and sales expenses were $756,000 $2.7 million and $28.9 million in the years ended December 31, 1997, 1998 and 1999, respectively. The increase from 1997 to 1998 was primarily attributable to additional costs associated with promotions and advertising for SmarterKids.com's repositioned proprietary CD-ROM products and the launch of its website in November 1998. The increase from 1998 to 1999 was primarily attributable to the initiation of SmarterKids.com's advertising campaigns and promotional activities, fees to its fulfillment partner, J.L. Hammett Co., as well as the hiring of 22 employees and related expenses required to implement its Internet business model. Development. Development expenses consist primarily of payroll and related costs for personnel performing website design, development and testing. Development expenses were $721,000, $1.4 million and 87 $1.7 million in the years ended December 31, 1997, 1998 and 1999, respectively. The increase from 1997 to 1998 was primarily attributable to additional costs associated with development of the SmarterKids.com website. The increase from 1998 to 1999 was attributable primarily to the hiring of 17 employees and costs related to enhancing the features, content and functionality of SmarterKids.com's website. General and administrative. General and administrative expenses consist primarily of payroll and related costs for executive and administrative personnel, professional service expenses and other general corporate expenses. General and administrative expenses were $430,000, $490,000 and $2.9 million in the years ended December 31, 1997, 1998 and 1999, respectively. The increase from 1997 to 1998 was primarily attributable to increased headcount and related expenses of repositioning of SmarterKids.com's CD-ROM product line, which began in late 1997. The increase from 1998 to 1999 was attributable primarily to the hiring of nine employees as SmarterKids.com expanded its operations and infrastructure to support future growth and transition to being a public company. SmarterKids.com incurred a one-time cost of $861,000 in connection with the settlement and related legal expenses in November 1999 of a patent infringement lawsuit, which cost was included in general and administrative expenses in the quarter ending December 31, 1999. Stock compensation. With respect to stock options granted to employees, SmarterKids.com recorded deferred stock compensation of $62,000 and amortized $4,000 of stock compensation as an expense in 1997. SmarterKids.com recorded deferred stock compensation of $1.5 million and $5.7 million and amortized $81,000 and $2.2 million and of stock compensation as an expense in 1998 and 1999, respectively. SmarterKids.com recorded additional stock compensation of $11,000, $106,000 and $1.2 million as an expense in each of the years ended December 31, 1997, 1998 and 1999, respectively, related to options and warrants granted to non-employees. Interest and other income (expense), net. Interest and other income (expense), net consists primarily of interest expense related to short-term lease obligations and interest earned on the short-term investments. In 1998, interest and other income, net increased from net expense of $17,000 in 1997. Interest and other income, net increased to from $19,000 in 1998 to $752,000 in 1999. Both of the increases were primarily attributable to an increase in interest income from higher balances of invested capital. 88 Selected Quarterly Results of Operations The following table sets forth selected unaudited statement of operation data for the eight quarters in the period ended September 30, 2000. This data was derived from unaudited interim financial statements that, in SmarterKids.com's management's opinion, reflect all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of this quarterly information. This data should be read in conjunction with the audited financial statements and related notes of SmarterKids.com included elsewhere in this proxy statement-prospectus.
Quarter Ended (in thousands) ---------------------------------------------------------------------------------- Dec. 31, Mar. 31, June 30, Sept. Dec. 31, Mar. 31, June 30, Sept. 30, 1998 1999 1999 30, 1999 1999 2000 2000 2000 -------- -------- -------- -------- --------- --------- --------- --------- (unaudited) Net Revenues: Online retail.......... $ 22 $ 94 $ 293 $ 721 $ 4,313 $ 1,469 $ 1,528 $ 1,507 Proprietary CD-Rom..... 463 -- -- -- -------- ------- -------- -------- --------- --------- --------- --------- Total net revenues..... 485 94 293 721 4,313 1,469 1,528 1,507 -------- ------- -------- -------- --------- --------- --------- --------- Cost of revenues: Online retail.......... 20 69 210 516 3,210 1,101 1,149 1,136 Proprietary CD-Rom..... 288 -- -- -- -------- ------- -------- -------- --------- --------- --------- --------- Total cost of revenues.............. 308 69 210 516 3,210 1,101 1,149 1,136 -------- ------- -------- -------- --------- --------- --------- --------- Gross profit............ 177 25 83 205 1,103 368 379 371 -------- ------- -------- -------- --------- --------- --------- --------- Operating expenses: Marketing and sales.... 1,267 2,023 3,690 5,013 18,190 7,300 7,144 5,771 Development............ 546 367 396 328 572 943 821 782 General and administrative........ 160 155 244 750 1,763 906 816 768 Stock compensation..... 115 384 196 1,209 1,616 178 336 860 -------- ------- -------- -------- --------- --------- --------- --------- Total operating expenses.............. 2,088 2,929 4,526 7,300 22,141 9,327 9,117 8,181 -------- ------- -------- -------- --------- --------- --------- --------- Loss from operations.... (1,911) (2,904) (4,443) (7,095) (21,038) (8,959) (8,738) (7,810) Interest and other income (expense), net.. 30 24 28 248 452 828 654 555 -------- ------- -------- -------- --------- --------- --------- --------- Net loss............... $ (1,881) $(2,880) $ (4,415) $ (6,847) $ (20,586) $ (8,131) $ (8,084) $ (7,255) ======== ======= ======== ======== ========= ========= ========= ========= Basic and diluted net loss attributable to common stockholders... (1.32) (1.77) (2.66) (3.52) (2.10) (0.40) (0.39) (0.35)
Since SmarterKids.com's inception, it has incurred significant losses. SmarterKids.com has met its cash requirements primarily through the sale of capital stock and the use of capital leases. SmarterKids.com received capital from investors in three private venture capital financings totaling $37.0 million through July 1999. On November 23, 1999, SmarterKids.com completed an initial public offering of 4,500,000 shares of common stock resulting in net proceeds of $65.9 million. The primary purposes of the initial public offering were to increase SmarterKids.com's capitalization and financial flexibility, create a public market for its common stock, and facilitate future access to public markets. As of September 30, 2000, SmarterKids.com has used $32.9 million of the offering proceeds for working capital. Net cash used in operating activities was $9.5 million and $30.8 million in the nine months ended September 30, 1999 and 2000, respectively. The increase in net cash used in operating activities from the nine months ended September 30, 1999 to the nine months ended September 30, 2000 was primarily attributable to a larger net loss and payments to vendors for inventory, advertising expenses and the build out of SmarterKids.com's new distribution center. SmarterKids.com expects that operating cash requirements will increase and that a significant portion of its cash used in operating activities will be attributable to investments in inventory and advertising. 89 Net cash used in operating activities was $947,000, $2.0 million and $25.0 million in the years ended December 31, 1997, 1998 and 1999, respectively. The increase in cash used in operating activities from 1998 to 1999 was primarily attributable to increased expense associated with launching and promoting SmarterKids.com's new website and retail Internet business. Net cash used in investing activities has been primarily for purchases of fixed assets and short-term investments. Cash used in investing activities was $6.7 million and $8.2 million in the nine months ended September 30, 1999 and 2000, respectively. The increase in cash used in investing activities was primarily attributable to increased purchases of equipment for the build-out of SmarterKids.com's new distribution facility and the purchase of short-term investments. Net cash provided by investing activities was $181,000 in the year ended December 31, 1997. The cash generated from investing activities in 1997 reflected the release of a restricted cash deposit related to a prior lease arrangement. Net cash used in investing activities has been primarily for purchases of fixed assets and short-term investments and was $33,000 and $14.9 million in the years ended December 31, 1998 and 1999, respectively. The increase in cash used in investing activities was primarily attributable to increased purchases of equipment and the purchase of short-term investment of $11.7 million. Net cash provided by financing activities was $25.3 million and $1.1 million in the nine months ended September 30, 1999 and 2000, respectively. Net cash provided by financing activities in the nine months ended September 30, 1999 consisted of proceeds from the exercise of stock options. Net cash provided by financing activities in the nine months ended September 30, 2000 primarily reflects the net proceeds of $1.6 million from an equipment line of credit. Net cash provided by financing activities was $626,000, $6.0 million and $91.3 million in the years ended December 31, 1997, 1998 and 1999, respectively. In the year ended December 31, 1997, net cash provided by financing activities consisted primarily of proceeds of $710,000 derived from the issuance of Series B Redeemable Preferred Stock. Net cash provided by financing activities in the year ended December 31, 1998 consisted primarily of net proceeds of $6.1 million from the issuance of Series B Redeemable Preferred Stock. Net cash provided by financing activities in the year ended December 31, 1999 primarily reflects the net proceeds of $65.9 million from SmarterKids.com's initial public offering and $25.3 million from the issuance of Series C Redeemable Preferred Stock. During the first quarter of 2000, SmarterKids.com entered into a $1.5 million three-year equipment line of credit facility. Equipment collateralized under this agreement approximates $1.5 million at September 30, 2000. The interest on the agreement is equal to the three-year U.S. Treasury rate plus 3.5%. SmarterKids.com is making payments on this credit facility of $45,000 per month. During the second quarter of 2000, SmarterKids.com entered into a lease agreement for a 140,000 square foot distribution center in Mansfield, Massachusetts. The distribution center allows it to better manage its fulfillment process. As a result, SmarterKids.com discontinued using J.L. Hammett Co. as its fulfillment partner during the second quarter of 2000. The five-year operating lease for the warehouse will require minimum payments of approximately $900,000 per year. As of September 30, 2000, SmarterKids.com had $17.8 million of cash and cash equivalents, $15.2 million of short-term investments, $1.0 million of restricted cash. As of that date, SmarterKids.com's principal commitments consisted of obligations outstanding under an equipment line of credit and capital leases in the amount of $1.3 million, commitments for annual facility lease obligations of $2.0 million, and accounts payable of $2.1 million. SmarterKids.com anticipates that its business model will require it to commit significant resources to aggressively promote its brand, expand its product and service offerings and enhance its infrastructure. 90 SmarterKids.com currently anticipates that current cash, cash equivalents and short-term investments will be sufficient to meet its anticipated needs for working capital and capital expenditures through the next twelve months. SmarterKids.com anticipates that it is likely to need additional financing to execute its business model after the twelve months, or sooner if it needs to respond to business contingencies such as lower-than-anticipated revenues, funding additional advertising expenditures, developing new or enhancing existing content, features or services, enhancing its operating infrastructure, responding to competitive pressures, or acquiring complementary businesses or technologies. SmarterKids.com has transitioned customer order fulfillment to its own distribution facility during the second quarter in 2000. In conjunction with this transaction, SmarterKids.com invested capital for the infrastructure to support these fulfillment activities at the new distribution facility. If SmarterKids.com raises additional funds through the issuance of equity or convertible debt securities, the percentage ownership of SmarterKids.com's stockholders may be reduced, and these newly issued securities may have rights, preferences or privileges senior to those of existing stockholders. SmarterKids.com cannot be certain that additional financing will be available to it on favorable terms when required, or at all. SmarterKids.com Quantitative And Qualitative Disclosure About Market Risk The following discussion of the SmarterKids.com's market risk includes "forward-looking statements" that involve risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. SmarterKids.com does not use derivative financial instruments for speculative or trading purposes. Interest Rate Risk SmarterKids.com is exposed to market risk from changes in interest rates primarily through its investing activities. In addition, SmarterKids.com's ability to finance future acquisition transactions may be impacted if SmarterKids.com is unable to obtain appropriate financing at acceptable rates. SmarterKids.com's investment portfolio consists solely of held-to-maturity investments in high-grade, commercial bank money market accounts and certificates of deposit. As of September 30, 2000, SmarterKids.com had securities classified as held-to maturity investments with an amortized cost value of $29.6 million. SmarterKids.com also had $3.3 million in commercial bank money markets and $1.0 million of restricted cash in certificates of deposit. Credit Risk Financial instruments which potentially subject SmarterKids.com to concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments and accounts receivable. SmarterKids.com does not believe that it is subject to any unusual credit risk beyond the normal credit risk associated with commercial banking relationships. 91 Security Ownership of Certain Beneficial Owners and Management of SmarterKids.com The following table sets forth certain information as to the number of shares of SmarterKids.com common stock held by the following persons as of December 31, 2000: . each person or entity known by SmarterKids.com to beneficially own 5% of more of its common stock; . each director of SmarterKids.com; . each executive officer of SmarterKids.com; and . all SmarterKids.com directors and executive officers as a group. Except as otherwise indicated, SmarterKids.com believes that persons expected to be the beneficial owners of its common stock listed below, based on information furnished by such owners, have sole voting and investment power with respect to such shares. Unless otherwise indicated, the address of the following persons is c/o SmarterKids.com 15 Crawford Street, Needham, Massachusetts 02494.
Amount and Nature of Percent of Name and Address of Beneficial Owner Ownership(1) Common Stock - ------------------------------------ ------------ ------------ Executive Officers David Blohm(2).................................... 795,375 3.7% Jeff Pucci(3)..................................... 795,375 3.7 Richard Viard(4).................................. 793,875 3.7 Albert Noyes(5)................................... 461,875 2.2 Richard Secor(6).................................. 102,188 * Robert Cahill(7).................................. 91,875 * Directors Richard D'Amore(8)................................ 2,993,130 14.5 Michael Fitzgerald(9)............................. 1,884,221 9.1 Michael Kolowich.................................. 155,000 * Brian Hickey(10).................................. 16,875 * 225 Duncan Mill Road Don Mills, Ontario, Canada M3B 3K9 5% Holders North Bridge Venture Partners III, L.P.(8)........ 2,967,817 14.4 950 Winter Street, Suite 4600 Waltham, MA 02451 Commonwealth Capital Ventures II, L.P.(9)......... 1,858,908 9.0 20 William Street Wellesley, MA 02181 Brighter Vision Holdings, Inc. ................... 1,674,907 8.1 c/o Torstar Corporation One Yonge Street Toronto, Canada M5E IP9 All executive officers and directors as a group (10 persons)(11)................................. 8,089,789 35.9
- -------- * Less than 1% (1) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. Shares of common stock issuable by SmarterKids.com to a person or entity named below pursuant to options which may be exercised within 60 days after December 31, 2000 are deemed to be beneficially owned by that person or entity. However, these shares are not deemed to be outstanding for purposes of computing the percentage beneficially owned by any other person or entity. 92 (2) Consists of 795,375 shares issuable upon the exercise of options exercisable on December 31, 2000 or within 60 days thereafter. Mr. Blohm is also a director of SmarterKids.com. (3) Includes 294,375 shares issuable upon the exercise of options exercisable on December 31, 2000 or within 60 days thereafter. Mr. Pucci is also a director of SmarterKids.com. (4) Includes 294,375 shares issuable upon the exercise of options exercisable on the December 31, 2000 or within 60 days thereafter. (5) Includes 214,875 shares issuable upon the exercise of options exercisable on December 31, 2000 or within 60 days thereafter. (6) Consists of 102,188 shares issuable upon the exercise of options exercisable on December 31, 2000 or within 60 days thereafter. (7) Consists of 91,875 shares issuable upon the exercise of option exercisable on December 31, 2000 or within 60 days thereafter. (8) Includes of 25,313 shares issuable upon the exercise of options exercisable on December 31, 2000 or within 60 days thereafter and 2,967,817 shares held by North Bridge Venture Partners III, L.P. Mr. D'Amore is a general partner of the general partner of North Bridge Venture Partners III, L.P. and may be deemed to share voting and investment power with respect to all shares held by North Bridge Venture Partners III, L.P. Mr. D'Amore disclaims beneficial ownership of such shares, except to the extent of his pecuniary interest therein, if any. (9) Includes of 25,313 shares issuable upon the exercise of options exercisable on December 31, 2000 or within 60 days thereafter, 1,771,500 shares held by Commonwealth Capital Ventures II, L.P. and 87,408 shares held by CCV II Associates Fund, L.P. Mr. Fitzgerald is a general partner of the general partner of Commonwealth Capital Ventures II, L.P. and the general partner of CCV II Associates Fund, L.P. and may be deemed to share voting and investment power with respect to all shares held by Commonwealth Capital Ventures II, L.P. and CCV II Associates Fund, L.P. Mr. Fitzgerald disclaims beneficial ownership of such shares, except to the extent of his pecuniary interest therein, if any. (10) Includes 16,875 shares issuable upon the exercise of options exercisable on December 31, 2000 or within 60 days thereafter. Excludes 1,674,907 shares held by Brighter Vision Holdings, Inc. Mr. Hickey is the Chairman and Chief Executive Officer of Harlequin Enterprises Limited. Harlequin Enterprises Limited and Brighter Vision Holdings, Inc. are both wholly- owned subsidiaries of Torstar Corporation. Mr. Hickey disclaims beneficial ownership of such shares except to the extent of his pecuniary interest therein, if any. (11) See footnotes (1) through (10) above. Includes options to purchase an aggregate of 1,860,564 shares of SmarterKids.com common stock issuable upon the exercise of options exercisable on December 31, 2000 or within 60 days thereafter. 93 EARLYCHILDHOOD Business Overview Earlychildhood LLC is a fully integrated, multi-channel supplier of educational products, services and information to schools, educational professionals and parents serving the early childhood and elementary school communities. Through a predecessor entity, Earlychildhood LLC, a California limited liability company, began operations in 1985. Earlychildhood manufactures, imports and sells company-developed products as part of its diverse mix of school supplies and educational toys, while also distributing and selling a carefully selected range of third party brands such as Crayola(R), Lego(R) and Elmer's(R). Earlychildhood utilizes multiple sales, marketing and distribution channels, including: . catalogs issued under its tradename Discount School Supply, or DSS; . sales programs conducted through its wholly-owned subsidiary, Educational Products, Inc., or EPI; . the Earlychildhood website; and . Earlychildhood NEWS, a professional content resource published in print and online. All of the foregoing are supported by a national sales force which, as of December 31, 2000, numbered 93 people. Earlychildhood's principal executive offices are located at 2 Lower Ragsdale Drive, Suite 200, Monterey, California 93940. Earlychildhood has five warehouse distribution facilities located to optimize shipping and delivery efficiencies. These facilities are located in Salinas, California; Harrisburg, Pennsylvania; Jacksonville, Florida; Dallas, Texas; and Houston, Texas. Additionally, Earlychildhood maintains two facilities dedicated to the manufacturing of children's art products located in Jacksonville, Florida and Salinas, California. Discount School Supply Under the trade name "Discount School Supply," Earlychildhood manufactures, imports and sells company-developed and third party products within the following categories: . arts & crafts; . manipulatives; . active play; . math; . carpets; . music; . dramatic play; . puzzles; . furniture; . sand & water; . infant & toddler; . science; and . language; . teacher resources. Discount School Supply began operations in 1985 and was one of the first companies to focus on offering discounted school supplies to the early childhood market. The Discount School Supply catalog has been the primary vehicle for customer acquisition and sales by DSS. Earlychildhood mails out three DSS catalogs annually to a growing customer base of educational professionals, schools and parents. A refresher version of each of these catalogs is typically redistributed 45 to 75 days after the initial distribution. The distribution of three catalogs enables Earlychildhood to adjust pricing 94 and product strategies faster than competitors mailing catalogs less frequently. For the year ended December 31, 2000, over 1.9 million catalogs were mailed. Included within the catalog are projects and curriculum ideas for using Discount School Supply products targeted to assist customers in educating and fostering the learning process. This educational content enables Earlychildhood to position the Discount School Supply catalog not only as a sales tool, but also as a learning resource for educational professionals, teachers and parents. It also fosters an extended useful life for the catalog that competing catalogs exclusively selling products might not be able to attain. As of December 31, 2000, 57 members of Earlychildhood's national sales force were educational consultants dedicated to DSS operations and were located in major metropolitan areas throughout the United States. Most educational consultants are former teachers, familiar with the preschool environment and the demands on each early childhood educator's time and available resources. Their job is to help educational professionals, teachers and parents optimize their time spent in and out of the classroom by giving workshops intended to offer potential options and ideas for using Discount School Supply products. These programs result in increased sales, retention of the customer and competitive margins, as many of the products demonstrated are company-developed and exclusively distributed by Earlychildhood. The programs also provide a "human face" to Discount School Supply that a catalog alone cannot reproduce. Earlychildhood has warehouses across the United States located to optimize shipping and delivery efficiencies to permit Earlychildhood to deliver an order within 48 hours to over 90% of the U.S. population at regular UPS ground rates. During the year ended December 31, 2000, Discount School Supply achieved a greater than 99% success rate in sending out orders on the same day that were placed by 2 p.m., customer's local time. Earlychildhood's ability to ship and deliver effectively has been a consistent competitive differentiator throughout its operating history. Educational Products, Inc. Earlychildhood sells school supplies to elementary schools, teachers and organizations through its subsidiary, Educational Products, Inc. These supplies are specifically targeted for use by children in first through sixth grades. Products purchased from EPI provide these schools, teachers and educational organizations the opportunity to implement fund-raising programs which can benefit particular schools or other community or student programs by providing them with a percentage of the proceeds from the sale of the products. Through its acquisition of EPI in May 1999, Earlychildhood expanded its presence in the elementary school market and expanded its geographic reach by doubling its direct sales force. As of December 31, 2000, 36 members of Earlychildhood's sales force were dedicated to EPI and located primarily in Texas. EPI offers products and programs to support several different fund-raising alternatives, including traditional school-based sales programs of gift wrap or candy and EPI's company-developed innovation, the "SchoolWrapPacks." SchoolWrapPacks are school supply sets individually packaged to meet the specifications of individual teachers for their classrooms. EPI typically sells SchoolWrapPacks to PTAs, which then resell the product to parents at a small mark-up as a fund-raising activity. This program provides parents and teachers with a convenient and cost-effective way to purchase school supplies, while simultaneously supporting the school's fund-raising efforts. During the back-to-school season of 1999, Earlychildhood sold nearly one million SchoolWrapPacks. Earlychildhood News Earlychildhood NEWS is a print- and web-based content resource connecting the commerce segments of Earlychildhood and offering information and services to early childhood professionals, elementary school teachers and parents. Earlychildhood NEWS exists in print form as Earlychildhood NEWS magazine, published six times annually, with the most recently published version mailed to approximately 50,000 readers. Earlychildhood NEWS is also published continually online at www.earlychildhoodnews.com. Earlychildhood NEWS contains articles about: . issues facing teachers and parents, as well as pre-school and school-age children; . illustrated arts and crafts; 95 . developmentally appropriate activities; . news and information; and . expert perspectives on a variety of topics. Readers may participate in sharing boards, browse a reading room of selected articles, and ask questions or participate in opinion polls. The objective of Earlychildhood NEWS is to bring together parents and teachers to share information, ideas and products, thereby creating a continuum of care for young children across their homes and schools. Earlychildhood NEWS also sponsors Newslink, a weekly opt-in e-mail program that brings its subscribers a collection of topical articles gathered from an array of news media. In addition, Newslink includes seasonal crafts and product specials linked to the Earlychildhood NEWS website. Earlychildhood NEWS sponsors a respected Professional Development Program through the University of Wisconsin-Stout, home of the nation's second largest early childhood education program. The Professional Development Program enables early childhood educators to improve their professionalism and to keep their credentials current. Since the Professional Development Program started in 1995, over 10,000 teachers have participated in the program. Program materials are available to interested parents as auditors. The Professional Development Program reinforces Earlychildhood's position as an educational resource for information and products. The Early Childhood Market The market for educational school supplies and furniture (excluding textbooks) is currently estimated at approximately $6.1 billion annually. The child-care segment of the overall educational and training market is estimated to grow at a five year compound annual growth rate of 8.3% from 2000 to 2005. Propelling this growth are multiple forces that are currently prevalent in the early childhood market and that are likely to continue for the foreseeable future. Political support in education is gaining momentum. The federal government has responded to industry research, cultural pressure and recent decreases in welfare by spending more on early learning. Specifically, the Head Start program, a multi-billion dollar governmental early learning initiative, has been receiving accelerating political attention and support, both financial and otherwise. Under this program, early education has been provided to nearly 950,000 children and since 1993, this type of educational funding has increased at an annual rate of 9.6%, reaching an estimated $5.3 billion in the 1999-2000 school year. The demand for early childhood learning centers is growing at an increasing rate. The growing population of children ages five years and younger and the growth in two income families is creating economic imperatives and sociological change. The Bureau of Labor Statistics anticipates the zero to five year-old age group will grow by over one million children domestically and will reach 24 million in 2010. Additionally, the National Child Care Information Center estimates that only 7% of families have a parent at home while the other spouse works, 62% of women with children under the age of six are in the workforce, and that 78% of women with school-age children are working. As a result of these trends, the demand for outsourced childcare and learning environments is increasing. The nature and quality of early learning within outsourced environments is under tremendous evaluation and scrutiny. Pre-primary school enrollment rates in center-based programs have steadily risen over the last few decades from 6% in 1965 to well over 50% in 1999 and, in 1998, $34 billion was spent on the child-care segment of the overall educational and training market. A transformational shift in the traditional early learning education distribution channel is occurring. Historically, preschools, daycares and regulated child care centers have been largely dependent on paper-based procurement of educational tools and materials through retail, field sales and catalogs. Today, new technology is making learning materials easier to deliver. Specifically, the e-commerce channel is emerging at a rapid pace, cutting costs and promoting best practices, to make the delivery of early childhood learning and educational materials easier and more efficient. 96 The market is undergoing significant parental pressure. Academic research continues to highlight the importance of learning in the early age groups, i.e. ages one through seven, and the media is increasingly focusing on the importance of parental involvement during this critical stage of growth and brain development. As such, parental responsibility is causing parents to take an increasing amount of ownership in educational standards and their child's development. Consolidation. The highly fragmented nature of the early childhood market has given way to growing consolidation. Currently, there are an estimated 3,400 distributors in the market for school supplies and furniture dominated by a preponderance of regional small businesses, usually family-owned. To remain competitive, smaller distribution companies in the sector must consolidate in order to meet customers' increasing demands for more comprehensive product offerings, higher quality service and sophisticated support, while concurrently maintaining a low fixed-cost structure. While these forces apply to the entire K-12 market, they are particularly powerful in the early childhood market because it has been recognized that effective early education for children is an essential factor in ensuring continued and accelerated learning in the higher grades. Specifically, a recent study conducted at the Frank Porter Graham Child Development Center suggests that high-quality child care programs have considerable long-term effects on such areas as school achievement, cognition skills, language ability, math skills, grade retention and social adjustment. Further driving the growth of the educational supply industry is the increase both in enrollment levels and expenditures per student. School enrollment is projected to increase steadily to more than 54 million by 2008. Further, a study conducted at the Lucille Packard Foundation found that on average, parents spend $4,000-$6,000 per year on child care, with some spending as much as $10,000 per annum. Earlychildhood believes these factors will continue to spur growth of the early childhood market. The Earlychildhood Solution Earlychildhood combines its expertise in children's education with the sale of company-developed products and a diverse selection array of third party products to help bring together educational professionals and parents to share information, ideas and products. One of Earlychildhood's advantages is its manufacturing, sale and exclusive distribution of company-developed products. Through the research, development and marketing of its own brands, Earlychildhood is able to monitor and control the quality of its products, as well as offer high quality items at competitive prices while realizing favorable profit margins. As an example, Earlychildhood has realized success with its line of BioColor products, a complete variety of paints and accessories based on Earlychildhood's company-developed children's art materials. 97 In addition to its company-manufactured and company-developed products, Earlychildhood also offers a broad assortment of carefully reviewed and selected third-party educational products. These products enhance Earlychildhood's product offerings to customers looking for a diverse range of products to fulfill their educational needs. Earlychildhood satisfies those needs by offering quality products in the following categories: . arts & crafts; . math; . active play; . music; . carpets; . puzzles; . dramatic play; . sand & water; . furniture; . science; and . infant & toddler; . teacher resources. . language; . manipulatives; Furthermore, Earlychildhood merchandises its products in an effort to maximize the educational benefit to each of its customers. For example, Earlychildhood's sales representatives are trained to understand which products are relevant to pre-kindergarten children and which products are more educationally appropriate for children in kindergarten or above. This tailored, or "contextual," merchandising has helped to foster a long-term bond between Earlychildhood's sales representatives and its customers, who view their sales representatives as knowledgeable and discerning advocates for children. Earlychildhood has created a streamlined chain of merchandising and distribution tools to make sure that customers can access Earlychildhood's offerings conveniently and effectively. To promote and sell its offerings, Earlychildhood has traditionally relied on its wide-scale distribution of the DSS catalogs, its ongoing presence at industry trade gatherings, and its dedicated sales force. Recently, to augment its traditional distribution channels, Earlychildhood created a convenient and easy-to-use website, www.earlychildhood.com, targeted at enhancing visibility and accessibility. In fact, web access to Earlychildhood is anticipated to be a critical component to the company's competitive growth strategy in the years to come. Earlychildhood's Strategy The early childhood educational community has traditionally lacked a means to adequately communicate and interact among different constituencies. Teachers, administrators and parents are conveying a desire to educate one another and to share ideas, opinions, and learning tools. To meet this demand, Earlychildhood is in the process of leveraging its existing assets and the Internet to become an end-to-end provider of educational products, services and resources to educational professionals and parents. Earlychildhood will address the needs of its educational community by leveraging the Internet to blend its product offerings with an array of information and services across multiple distribution channels and customer touch points. For example, Earlychildhood's print and online publication of informative articles in Earlychildhood NEWS, as well as its online sharing boards provide an opportunity for teachers and parents to obtain and share information about products and learning experiences critical to advancing the quality of early childhood education. As customers increasingly interact with and become aware of Earlychildhood's multiple distribution methods and customer touch points, including the catalog, direct sales force, fund-raising programs and website, Earlychildhood seeks to become synonymous with convenience, quality and value. 98 Shopping at Earlychildhood Customers may shop at Earlychildhood in four ways: . by telephone to Earlychildhood's customer service department; . by mail or fax of an order form; . online at the Earlychildhood website; and . through its sales force. Additionally, over 99% of Earlychildhood's orders ship out of the warehouse on the same day, as long as the order is placed by 2:00 p.m. in the customer's time zone. Earlychildhood uses recycled boxes and biodegradable foam to pack and ship its products. Earlychildhood's Customers Earlychildhood sells to institutions such as public and private schools, school districts, early learning centers, child care programs and PTAs as well as parents and educational professionals such as school teachers, administrators, purchasing directors, and supervisors. Earlychildhood is not dependent on any single customer or group of customers and in the year ended December 31, 2000, Earlychildhood's largest customer account amounted to approximately 1% of sales. Earlychildhood strives to strengthen customer relationships and has attained its high rate of catalog reorder by having a highly responsive customer service department and direct sales force. Earlychildhood's Marketing and Promotion Channels Earlychildhood has four primary marketing and promotion channels: Catalogs: Catalogs represent DSS's primary outreach channel. Unlike its principal competitors who send out only one catalog per year, Earlychildhood sends out three different catalogs per year (with a re-mail of the same catalog with a different cover in between new catalogs) under its Discount School Supply trade name. Mailing three different catalogs provides Earlychildhood with flexibility to change prices and calibrate pricing to its response rate. These catalogs are mailed in the months of January (edition re-mailed in March), May (edition re-mailed in July) and August (edition re-mailed in September) to coincide with the periods when school purchasing decisions are made. In the year ended December 31, 2000, over 1.9 million copies of Earlychildhood's catalogs were distributed. Direct Sales Representatives: Earlychildhood's sales force consisted of 93 sales representatives as of December 31, 2000. 57 members of the sales force acted as educational consultants focused on catalog sales through DSS, and the other 36 focused on direct sales through EPI. Sales representatives promote company-developed products such as BioColor and Colorations, and programs such as "SchoolWrapPacks" to teachers and administrators through in-school demonstrations and workshops, designed to elicit higher response and better retention rates. Within EPI, sales representatives educate PTAs and teachers about the benefits and convenience associated with the SchoolWrapPack program and other products. The sale of SchoolWrapPacks generated substantially all of EPI's consolidated sales for the year ended December 31, 2000. Web-based Sales: Earlychildhood's website has been designed to become one of the principal vehicles used by the company to reach customers and provide them with an array of information and services attendant to the sale of items from Earlychildhood's product line. Earlychildhood NEWS: Earlychildhood NEWS is a content resource published in both print and web formats. The print magazine is published six times annually and the web version is published continually at www.earlychildhoodnews.com. Earlychildhood NEWS offers a professional development program for early 99 childhood educators and provides a forum in which parents and educators can share news, ideas and information. Earlychildhood NEWS also publishes Newslink, a weekly opt-in email program that brings subscribers news, information and product specials. Earlychildhood's Products and Services. Discount School Supply: The principal component of Earlychildhood's Discount School Supply product line is the company's comprehensive arts and crafts product offerings. Anchored by Earlychildhood's company-developed and exclusively distributed children's lines of art materials, "BioColor," and "Colorations," Earlychildhood provides a wide variety of arts and crafts, art materials and accessories to children throughout the early childhood market. In addition, Earlychildhood offers products within the following categories: . active play; . math; . carpets; . music; . dramatic play; . puzzles; . furniture; . sand & water; . infant & toddlers; . science; and . language; . teacher resources. . manipulatives; Earlychildhood also distributes third-party products including brand names such as Crayola(R), Lego(R), and Elmer's(R). Regardless of origin, however, each of Earlychildhood's products has been thoroughly reviewed by its merchandisers for quality and educational value. Earlychildhood is continually updating its product line based on customer responses and sales feedback monitored by its merchandising department. Educational Products, Inc.: Through EPI, Earlychildhood sells its products to the lower elementary market. In addition to SchoolWrapPacks, EPI offers a selection of science fair supplies, including display boards, individual medals and awards. Earlychildhood Suppliers Earlychildhood purchases services, products and materials from over 650 suppliers and therefore does not experience significant supplier concentration. In addition, Earlychildhood performs significant product sourcing overseas, primarily in Southeast Asia (accounting for approximately a quarter of its sales). Earlychildhood experiences little or no supplier risk, as most of the product sources are standard and obtainable from multiple vendors. Earlychildhood's Strategic Relationships Earlychildhood has entered into a number of strategic business relationships with third parties that have enhanced its visibility and sales reach: Turn the Page Press: Earlychildhood has secured an exclusive distribution agreement for all "Turn the Page" products. These products, which include children's books and music, are chosen or created by Bev Boss, a well-known and respected educator in the early childhood field. Early Learning Centre: Earlychildhood has been chosen as the exclusive United States educational distributor of the products of Early Learning Centre, a prominent United Kingdom-based company known for its high-quality, proprietary, educational toys and school supplies. 100 The Jane Goodall Institute: Earlychildhood has partnered with the Jane Goodall Institute to create an early childhood component for Jane Goodall's successful "Roots and Shoots" program. Through this partnership, early childhood educators may join the program, and, in turn, receive information, curriculum-based activities and special product offers. University of Wisconsin-Stout: Earlychildhood NEWS offers a professional development program in cooperation with the University of Wisconsin-Stout, which has the nation's second largest early childhood education program. Registrants may earn continuing education units and certificates from the University of Wisconsin-Stout by reading articles in print or online in Earlychildhood NEWS and by taking tests which are graded by the University of Wisconsin-Stout. Operations Earlychildhood maintains manufacturing locations in Jacksonville, Florida and Salinas, California, totaling approximately 55,000 square feet of space dedicated to manufacturing non-toxic paints and other art materials. As of December 31, 2000, the manufacturing department had 21 full-time employees. Earlychildhood's innovation and quality control laboratory is located in Suwanee, Georgia. Earlychildhood is a member of the Arts & Creative Materials Institute, or ACMI, and has a representative who sits on ACMI's technical committee. All art materials produced by Earlychildhood are evaluated and certified as non-toxic by the Duke University Department of Occupational and Environmental Health. These products are packaged in accordance with federal labeling standards for art materials. Earlychildhood has warehouse and distribution centers in Salinas, California; Jacksonville, Florida; Dallas, Texas; Houston, Texas; and Harrisburg, Pennsylvania. Customer Service Earlychildhood seeks to provide a customer experience that exceeds customer expectations. Its goals include: . Prompt shipping; . Responding to all customer inquiries within the same day; . Maintaining a low return rate; and . Maintaining at least 98% of inventory items in stock at any time. Earlychildhood maintains a toll-free customer service department staffed with customer service representatives trained to assist customers with product selection, order processing, shipping and billing and any other questions or problems. Earlychildhood trains its representatives to be competent and courteous. Representatives are given wide discretion to ensure that customers are satisfied with their purchases and their purchasing experience. Competition The educational supply industry is highly fragmented. Of the estimated 3,400 school-supply distributors, the majority are small- to medium-sized companies that are regionally focused. Competition is based on price, timely service, product selection and the nature of the products. The major companies competing in the school-supply market are School Specialty, Inc., Lakeshore Learning Materials, The Kaplan Companies, ABC School Supply, Inc., U.S. Toy Company and The J.L. Hammett Early Childhood Division. Currently, School Specialty, Inc. is the only publicly owned competitor in the educational supply market. 101 Intellectual Property Earlychildhood regards the protection of its intellectual property as critical to its future success and relies on a combination of copyright, trademark, service mark and trade secret laws, license agreements and contractual restrictions to establish and protect its proprietary rights in its products, content and services. The company has entered into confidentiality and invention assignment agreements with certain employees and contractors in order to limit disclosure of our proprietary information. However, Earlychildhood cannot ensure that these contractual arrangements or the other steps taken by it to protect its intellectual property will prove sufficient to prevent misappropriation of its technology or deter independent third-party development of similar items. Earlychildhood conducts business on the Internet principally using its trademark Earlychildhood.com. There are a number of other trademarks and domain names similar to Earlychildhood's. An infringement action could be brought against Earlychildhood at any time by the holders of these marks and names. There is a risk that the owner of other marks would overcome any defenses that Earlychildhood could raise. If the owner of such marks were to prevail in such an action, Earlychildhood could lose the ability to use the Earlychildhood and Earlychildhood.com trademark and domain name and could be subject to substantial damages. Such outcomes could adversely affect Earlychildhood's business. If Earlychildhood is required to change its company or domain name, or trademarks, it could lose customers and brand equity which would have a material adverse effect on Earlychildhood's and LearningStar's business and financial condition. Although Earlychildhood may attempt to acquire or license the right to use potentially relevant third-party trademarks and domain names, it may not be successful. Regulatory Environment Earlychildhood's products are subject to the provisions of the Consumer Product Safety Act which enables the Consumer Product Safety Commission to exclude from the market consumer products that fail to comply with applicable product safety regulations or otherwise create a substantial risk of injury. The Consumer Product Safety Commission may also require the repurchase by the manufacturer of articles that are banned. Similar laws exist in some states. Earlychildhood's manufacturing operations are subject to numerous federal, state and local environmental and occupational health and safety laws and regulations, which include laws and regulations governing waste disposal, air and water emissions, workplace exposure and other matters. Earlychildhood's business, and the catalog industry in general, is subject to regulation by a variety of state and federal laws relating to, among other things, advertising and sales taxes. The Federal Trade Commission regulates Earlychildhood's advertising and trade practices and the Consumer Product Safety Commission has issued regulations governing the safety of the products which Earlychildhood sells through its catalogs. Under current law, catalog retailers are permitted to make sales in states where they do not have a physical presence without collecting sales tax. Earlychildhood believes that it collects sales taxes in states where it is required to do so. However, since 1987, legislation has been introduced periodically in the U.S. Congress which would permit states to require sales tax collection by mail order companies. To date, this proposed legislation has not been passed. Should Congress, however, pass such legislation in the future, most states could be expected to require sales tax collection by out-of-state mail order companies. This would increase the cost of purchasing Earlychildhood's products in those states and eliminate whatever competitive advantage that Earlychildhood may currently enjoy with respect to in-state competitors in terms of sales taxation, as well as increasing the administrative and overhead costs to Earlychildhood in connection with the collection of such sales tax. There can be no assurances given that these state sales tax laws will not be changed in the future to the detriment of Earlychildhood. Earlychildhood is subject to various other federal, 102 state and local laws and regulations applicable to its business. Earlychildhood believes that it is in substantial compliance with these laws and regulations. Earlychildhood has no claims or regulatory matters in process or pending as of December 31, 2000 Earlychildhood is a member in good standing of ACMI. As such, Earlychildhood's paints and other art material formulations are evaluated and to date certified non-toxic by the Department of Occupational Health at Duke University. Furthermore, Earlychildhood's paints and other art materials formulations conform to the Labeling of Hazardous Art Materials Act and ASTM Standard D-4236-88 under the auspices of the Consumer Product Safety Commission. Employees As of December 31, 2000, Earlychildhood employed 420 full-time personnel, including 93 in direct sales, 160 in warehouse operations, 33 in customer service, 21 in manufacturing and 12 merchandising, and 101 at the administrative and corporate level. Earlychildhood has not experienced any work stoppage and continues to maintain good relations with its employees. None of Earlychildhood's employees belong to a collective bargaining unit. Facilities Earlychildhood's headquarters are located at 2 Lower Ragsdale Drive, Monterey, California. The 27,000 square foot office houses customer service, finance, operations, purchasing, marketing, graphic design, merchandising and product development, as well as the magazine, Earlychildhood NEWS. Earlychildhood also maintains warehouses and sales offices in Salinas, California; Harrisburg, Pennsylvania; Jacksonville, Florida; Dallas, Texas; and Houston, Texas totaling over 589,000 square feet. Each location was selected based on customer shipping characteristics such as delivery times and shipping zones. Business-to-business orders to schools are routed to the appropriate warehouse based on the customer's destination zip code, providing the customer with fastest possible ship time while providing Earlychildhood with the lowest shipping cost available. Business-to-consumer orders to homes or individuals are shipped from Salinas, California. Earlychildhood does not own real property. Instead, it leases its facilities under non-cancelable lease agreements expiring in one to ten years. Earlychildhood believes that these facilities are adequate to meet its current requirements and that suitable additional or substitute space will be available as needed. Legal Proceedings In a demand letter dated July 13, 1999, Showboard, Inc. claimed that EPI's display boards infringed on Showboard's display board patents (U.S. Patent Nos. 4,794,712, 5,293,705, and 5,911,522). By letter dated March 6, 2000, counsel to Earlychildhood responded that Earlychildhood did not believe that such patents were infringed. No response has been received from Showboard. No complaint has been filed, nor is any litigation pending over this issue. 103 Earlychildhood Management's Discussion and Analysis of Financial Condition and Results of Operations Earlychildhood Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying financial statements for the periods specified and the associated notes. The following discussion contains forward-looking statements which involve risks and uncertainties. Earlychildhood makes such forward-looking statements under the provision of the "Safe Harbor" section of the Private Securities Litigation Reform Act of 1995. Any forward-looking statements should be considered in light of the factors described. Actual results may vary materially from those projected, anticipated or indicated in any forward-looking statements. In this section, the words "anticipates," "believes," "expects," "intends," "future," "could," and similar words or expressions (as well as other words or expressions referencing future events, conditions, or circumstances) identify forward-looking statements. The following discussion and analysis should be read in conjunction with the accompanying financial statements and related notes included elsewhere in this proxy statement-prospectus. Overview Earlychildhood LLC is a fully integrated, multi-channel supplier of educational products, services and information to schools, educational professionals and parents serving the early childhood and elementary school communities. Through a predecessor entity, Earlychildhood began operations in 1985. Earlychildhood manufactures, imports and sells company-developed products as part of its diverse mix of school supplies and educational toys, while also distributing and selling a carefully selected range of third party brands such as Crayola(R), Lego(R) and Elmer's(R). Earlychildhood utilizes multiple sales, marketing and distribution channels, including: . its catalogs issued under its tradename, Discount School Supply, or DSS; . sales programs conducted through its wholly-owned subsidiary, Educational Products, Inc., or EPI; . the Earlychildhood website; and . Earlychildhood NEWS, a professional content resource published in print and online. All of the foregoing are supported by a national sales force which, as of December 31, 2000, numbered 93 people. Earlychildhood's predecessor operating company was QTL Corporation, or QTL. As part of the recapitalization that occurred on May 5, 1999, QTL transferred significantly all of its assets and liabilities to Earlychildhood in exchange for membership interests. The transfer of assets and liabilities was considered a combination of entities under common control and accounted for on an "as if pooling" basis and accordingly, the basis of accounting did not change. The acquisition of EPI on May 5, 1999 was accounted for as a purchase and accordingly, Earlychildhood's consolidated results of operations only include the results of EPI subsequent to May 5, 1999. All results of EPI prior to May 5, 1999 are excluded from consolidated results of operations accordingly, the comparability of Earlychildhood's historical operating results is affected by the May 5, 1999 acquisition of EPI. Earlychildhood presently operates in two segments: Discount School Supply, or DSS, and EPI. DSS includes the brand names Discount School Supply, Earlychildhood NEWS and Earlychildhood.com. DSS supplies educational products and information through multiple channels to early childhood professionals and parents. EPI sells school supplies to elementary schools, teachers and other educational organizations. 104 Results Of Operations Earlychildhood's predecessor company, QTL, changed its fiscal year-end in 1998 from March 31 to December 31. The historical audited consolidated financial statements for Earlychildhood reflect the operating results of the nine months ended December 31, 1998. However, for purposes of comparability, the following discussion compares the twelve months ended December 31, 1999 operating results to the unaudited results of the twelve month period ended December 31, 1998. Information regarding the results of operations of Earlychildhood is presented below and should be read in conjunction with the following discussion and analysis.
Nine Months Twelve Months Ended Ended September December 31, 30, ------------------- --------------- 1998 1999 1999 2000 ----------- ------- ------- ------- (in thousands) (in thousands) (unaudited) (unaudited) ----------- ------- --------------- Revenues.................................. $25,149 $61,034 $49,256 $67,814 Gross profit.............................. 10,276 23,808 18,882 25,229 Selling, general and administrative expenses (includes equity based compensation)............................ 8,968 18,931 12,345 22,115 Amortization of goodwill and other intangible assets........................ 39 653 401 764 Interest expense, net..................... 257 829 513 1,040 ------- ------- ------- ------- Income (loss) before income taxes......... 1,012 3,395 5,623 1,310 Income tax expense........................ 160 982 1,449 944 ------- ------- ------- ------- Net income................................ $ 852 $ 2,413 $ 4,174 $ 366 ======= ======= ======= =======
Nine Months Ended September 30, 1999 and 2000 Revenues. Revenues increased 37.5% from $49.3 million for the nine months ended September 30, 1999 to $67.8 million for the same period in 2000. This increase was primarily due to internal growth in the existing Earlychildhood business and the inclusion of revenues from EPI for the nine months ended September 30, 2000. DSS's contribution to the $18.5 million revenue increase amounted to approximately $12.3 million and is attributed to an increase in its customer base, an increase in the number of pages per catalog, an increase in the number of catalogs sent and an increase in the number of products offered. EPI revenues accounted for $20.7 million and $26.9 million, or 42.0% and 39.7% of total revenues for the nine months ended September 30, 1999 and 2000, respectively. Gross Profit. Gross profit increased 33.6% from $18.9 million, or 38.3% of revenues, for the nine months ended September 30, 1999 to $25.2 million, or 37.2% of revenues, for the same period in 2000. The increase in gross profit was primarily related to the increase in revenues. The decrease in gross profit as a percentage of sales was driven by the inclusion of EPI, which generally generates lower gross profit percentage than DSS, for the full nine months ended September 30, 2000. EPI's gross profit margin for the nine months ended September 30, 2000 was approximately 29% of sales. EPI's lower gross profit percentage was partially offset by an increase in the gross profit percentage at DSS relating to the increased sales of company-developed, company- manufactured and imported products, which have historically maintained higher gross margins. Selling, General and Administrative Expenses. Selling, general and administrative expenses include wages and commissions, catalog costs, operations expenses (which include customer service and certain warehouse costs), administrative costs (which include information systems, accounting, and human resources), e-business costs and depreciation and amortization of property and equipment. 105 Selling, general and administrative expenses increased 79.1% from $12.3 million, or 25.1% of revenues, for the nine months ended September 30, 1999 to $22.1 million, or 32.6% of revenues, for the same period in 2000. The increase in selling, general and administrative expense was attributable to costs associated with Earlychildhood's e-business strategy which commenced in November 1999, the inclusion of EPI for the full nine months of 2000, and increased investment in personnel and facilities. For the nine months ended September 30, 2000, approximately $2.9 million of the total $9.8 million increase in selling, general and administrative expenses related to planning and executing Earlychildhood's e-business strategy. Such costs were net of $812,000 of capitalized website developments costs. Earlychildhood considers its e-business strategy to be an emerging line of business that has and will continue to require significant fixed expenditures until enough revenues can be generated to cover recurring e-business strategy start-up expenses. The inclusion of EPI in the full nine months of 2000 accounted for $2.6 million of the total increase. EPI's selling, general and administrative expenses were $3.1 million and $5.7 million for the nine months ended September 30, 1999 and 2000, respectively. The remainder of the cost increase was primarily due to the increase in personnel and facility costs related to the growth of the Earlychildhood's infrastructure. Earlychildhood's results of operations for the nine months ended September 30, 2000 also include a one-time charge for approximately $421,000 relating to equity-based compensation to Earlychildhood's management committee members. Amortization of Goodwill and Other Intangible Assets. Amortization of goodwill and other intangible assets increased 90.5% from approximately $401,000 for the nine months ended September 30, 1999 to approximately $764,000 for the nine months ended September 30, 2000. The increase in amortization of goodwill and other intangible is primarily due to the inclusion of the amortization of goodwill and other intangible assets associated with the acquisition of EPI for the full nine months ended September 2000. Interest Expense. Interest expense increased 103% from approximately $513,000 for the nine months ended September 30, 1999 to approximately $1.0 million, for the nine months ended September 30, 2000. The interest expense for both 1999 and 2000 is primarily related to the $10 million term loan, which was entered into on May 5, 1999 in conjunction with the acquisition of EPI and in order to fund general working capital needs. Income Tax Expense. Earlychildhood LLC is a limited liability company and is not subject to income taxes; however its wholly-owned subsidiary, EPI, is a C corporation, and is therefore subject to federal and state income taxes. Prior to May 5, 1999, Earlychildhood was combined with QTL. QTL was subject to federal and state income taxes as a C corporation until April 1, 1998 when it elected S corporation status. Income tax expense decreased 34.8% from $1.4 million for the nine months ended September 30, 1999 to $0.9 million for the nine months ended September 30, 2000. Offsetting the decrease was an increase in the effective tax rate from 25.8% for the nine months ended September 30, 1999 to 72.1% for the nine months ended September 30, 2000. The increase in the effective tax rate is due to the change in the composition of taxable income (losses) between DSS and EPI. DSS generated nontaxable income in the nine months ended September 30, 1999. For the nine months ended September 30, 2000, DSS generated nontaxable losses, largely due to its spending on its e-business strategy. Due to Earlychildhood LLC's limited liability company status, such losses were not available to offset taxable income generated by EPI for the nine months ended September 30, 2000. Twelve Months Ended December 31, 1999 and 1998 Revenues. Revenues increased 143% from $25.1 million for the twelve months ended December 31, 1998 to $61.0 million for 1999. This increase is primarily due to internal growth of the existing DSS business and the acquisition of EPI. EPI revenues accounted for $22.9 million, or 37.5% of total revenues in fiscal year 106 1999. DSS's contribution to the $35.9 million revenue increase amounted to $13 million and is attributed to increases in its customer base, in the number of pages per catalog, in the number of catalogs sent and in the number of products offered. Gross Profit. Gross profit increased 132% from $10.3 million, or 40.9% of revenues, for the twelve months ended December 31, 1998 to $23.8 million, or 39.0% of revenues, for 1999. The increase in gross profit was primarily related to the increase in revenues. The decrease in gross profit as a percentage of sales was driven by the inclusion of EPI in 1999. EPI's gross profit margins for 1999 were approximately 32% of sales. Selling, General and Administrative Expenses. Selling, general and administrative expenses include wages and commissions, catalog costs, operations expenses (which include customer service and certain warehouse costs), administrative costs (which include information systems, accounting and human resources), and depreciation and amortization of property and equipment. Selling, general and administrative expenses increased 109% from $9.0 million, or 35.7% of revenues, for the twelve months ended December 31, 1998 to $18.9 million, or 31.0% of revenues, for the same period in 1999. The increase in selling, general and administrative expense was partially attributable to the acquisition of EPI, which accounted for $5.3 million of the total increase in selling, general and administrative expenses. The remainder of the cost increase was primarily due to an increase in personnel and an increase in catalog production, distribution and general and administrative costs. Amortization of Goodwill and Other Intangible Assets. Amortization of goodwill and other intangible assets increased significantly from approximately $39,000 for the twelve months ended December 31, 1998 to approximately $653,000 for 1999. The increase in amortization of goodwill and other intangible assets is primarily due to the acquisition of EPI, which resulted in $0.5 million of incremental amortization expense subsequent to the May 5, 1999 acquisition. Interest Expense. Interest expense increased 223% from $257,000 for the twelve months ended December 31, 1998 to $829,000, for 1999. The increase in interest expense is primarily related to the $10 million term loan which was entered into on May 5, 1999 in conjunction with the acquisition of EPI and in order to fund general working capital needs. The interest expense in 1998 was principally related to Earlychildhood's line of credit facility which was replaced in conjunction with the May 5, 1999 recapitalization and acquisition. Income Tax Expense. As a limited liability company, Earlychildhood is not subject to income taxes; however its wholly-owned subsidiary, EPI, is a C corporation, and is therefore subject to federal and state income taxes. Prior to May 5, 1999, Earlychildhood was combined with QTL. QTL was subject to federal and state income taxes as a C corporation until April 1, 1998 when it elected S corporation status. Income tax expense increased 514% from $160,000 for the twelve months ended December 31, 1999 to $982,000 for the year ended December 31, 1999. The effective tax rate increased from 15.8% for the twelve months ended December 31, 1998 to 28.9% for 1999. The increase in the effective tax rate is due to the inclusion of EPI taxable income in 1999. The proportion of Earlychildhood's 1998 income which was related to taxable C corporation entities was lower in 1998 than in 1999. Liquidity and Capital Resources Earlychildhood's primary cash needs have been for working capital, capital expenditures and acquisitions to fund its growth. The primary sources of liquidity have been the credit facility with BNP Paribas (Paribas Credit Facility) and capital contributions from its members. As of September 30, 2000, Earlychildhood had net working capital of $16.9 million. Capitalization consisted of limited liability company membership interests of $22.3 million and long-term debt obligations of $7.8 million. The Paribas Credit Facility is a $20 million credit facility which matures on May 5, 2004. The credit facility includes a $10 million revolving credit facility which includes a $2.5 million letter of credit sublimit. 107 The revolver is subject to a cleandown provision, which requires that Earlychildhood limit the outstanding principal balance drawn on the revolver to a maximum of $3.5 million for 15 consecutive days each year. Additionally, the revolving credit facility is subject to a maximum borrowing base equal to the sum of 80% of the aggregate face amount of eligible accounts receivable plus 50% of eligible inventory. As of September 30, 2000, Earlychildhood had no amount outstanding under the revolving credit facility and $9.5 million of available borrowing capacity under the revolving credit facility. The Paribas Credit Facility also includes a $10 million term loan component with a final maturity of May 5, 2004. The term loan, which was fully drawn on May 5, 1999, is payable in 16 consecutive quarterly installments commencing March 31, 2000 and continuing until December 31, 2003, with a final payment on the maturity date. As of September 30, 2000, the outstanding balance of the term loan was $9.1 million. Interest on both the term loan and the revolving facility will accrue at a rate of either the lender's base rate plus 2% or the adjusted LIBOR rate plus 3.25% at the option of Earlychildhood. In 1999 and 2000, Earlychildhood raised $19.1 million of capital, net of issuance costs, from issuing limited liability company membership interests to, and receiving additional capital contributions from Educational Simon, L.L.C. The capital was used for investments in working capital, acquisitions and e- business operations. Earlychildhood does not anticipate the need to raise additional funding in the near future. During the nine months ended September 30, 2000, Earlychildhood's operating activities used $4.2 million in cash. The use of cash was primarily related to the increases in accounts receivable and inventories. Earlychildhood used $2.9 million of cash for investing activities in the nine months ended September 30, 2000, primarily related to capital expenditures. Earlychildhood generated $7.0 million in cash from financing activities. The cash generated from financing activities was primarily related to capital contributions by Educational Simon, L.L.C., partially offset by repayments made on long-term debt obligations. Earlychildhood used $3.3 million in cash from its operating activities during the fiscal year ended December 31, 1999. The use of cash was primarily related to reductions in accounts payable. For the year ended December 31, 1999, Earlychildhood used $9.3 million of cash in investing activities. The majority of the cash was used in the acquisition of EPI. Earlychildhood raised $12.7 million of cash from financing activities during 1999. The funds were provided through capital contributions from Educational Simon, L.L.C. and borrowings under the Paribas Credit Facility. Management believes that availability under the Paribas Credit Facility and cash flow from operations will provide adequate funds for Earlychildhood's foreseeable working capital needs, planned capital expenditures and debt service obligations. Earlychildhood's ability to fund its operations, make scheduled debt payments and make planned capital expenditures and to remain in compliance with its financial covenants under its credit facility depends on its future operating performance and cash flow, which in turn, are subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond its control. Seasonality Earlychildhood's seasonal sales trends coincide with the start of each school year. Accordingly, the majority of revenues are generated in the second and third calendar quarter, with a particular emphasis on the third quarter which generally represents 40% to 50% of Earlychildhood's annual sales. Earlychildhood's working capital needs are greatest during the second calendar quarter as inventory levels are increased to meet seasonal demands. Inflation Inflation has and is expected to have only a minor effect on Earlychildhood's results of operations and sources of liquidity. Recent Accounting Pronouncements In December 1999, the Securities and Exchange Commission staff released Staff Accounting Bulletin, or SAB, 101, "Revenue Recognition in Financial Statements," which provides guidance on the recognition, 108 presentation and disclosure of revenue in financial statements. Subsequently, SAB 101 A and B have been released which direct the application of the guidance in SAB 101 to be required in Earlychildhood's fourth quarter of 2000. Given that Earlychildhood's accounting policy for revenue recognition is in accordance with SAB 101, management does not expect the adoption of SAB 101 to have a material effect on Earlychildhood's consolidated financial statements. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" as amended by SFAS No. 137, which was issued in July 1999, delayed the adoption date for SFAS No. 133 until annual periods beginning after June 15, 2000. SFAS No. 133 established standards for recognition and measurement of derivatives and hedging activities. Earlychildhood will adopt SFAS No. 133 beginning January 1, 2001. Management does not believe the adoption of SFAS No. 133 will have a material effect on the financial position or operations of Earlychildhood. In July 2000 the Emerging Issues Task Force, or EITF, of the FASB concluded on Issue 1 of EITF issue No. 00-10 "Accounting for Shipping and Handling Fees and Costs," which provides guidance on the presentation of shipping and handling revenue and costs in the statement of operations. Earlychildhood's accounting policies are in accordance with the requirements of this EITF issue and accordingly the adoption of this new accounting pronouncement will have no effect on Earlychildhood's consolidated financial statements. In March 2000, the EITF of the FASB reached a consensus on EITF Issue 00-2, "Accounting for Web Site Development Costs." This consensus provided guidance on what types of costs incurred to develop websites should be capitalized or expensed. Earlychildhood adopted this consensus effective January 1, 2000 and capitalized $812,000 of website development costs in the nine months ended September 30, 2000. No website development costs were capitalized prior to 2000. Earlychildhood Quantitative and Qualitative Disclosure About Market Risk The following discussion of the Earlychildhood's market risk includes "forward-looking statements" that involve risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. Earlychildhood does not use derivative financial instruments for speculative or trading purposes. Interest Rate Risk Earlychildhood's financial instruments include cash and cash equivalents, accounts receivable, accounts payable, a revolving line of credit and long-term debt. Market risks relating to operations result primarily from changes in interest rates. Earlychildhood's borrowings are primarily dependent upon LIBOR rates. The estimated fair value of long-term debt approximates its carrying value at September 30, 2000. To manage interest rate risk on the variable rate long-term borrowings under Earlychildhood's credit facility, Earlychildhood entered into an interest rate cap agreement during fiscal 1999. This interest rate cap agreement effectively limits the level to which the variable rate can rise on the notional principal amount established in the cap agreement which approximates 55% of the aggregate long-term balance at September 30, 2000. As a result, this hedging arrangement is designed to reduce Earlychildhood's exposure to increases in interest rates. Credit Risk Financial instruments which potentially subject Earlychildhood to concentrations of credit risk consist primarily of cash, cash equivalents, accounts receivable, a revolving line of credit and long-term debt. Earlychildhood does not believe that it is subject to any unusual credit risk beyond the normal credit risk associated with commercial banking relationships. In addition, Earlychildhood's ability to finance future acquisition transactions may be impacted if Earlychildhood is unable to obtain appropriate financing at acceptable rates. 109 Earlychildhood Certain Relationships and Transactions In connection with the May 5, 1999 acquisition of assets from QTL Corporation, or QTL, and recapitalization of Earlychildhood, Earlychildhood leased 36,000 square feet of combined warehouse and office space located in Salinas, California from Elliott-Mair Salinas, LLC, an affiliate of QTL. The current lease agreement is effective August 9, 2000 and runs for five years. Ronald Elliott who will become LearningStar's Chairman of the Board and who is the current President, Chief Executive Officer and a member of the management committee of Earlychildhood, holds 62% of the membership interests in Elliott- Mair Salinas, LLC. Mr. Elliott is also the largest shareholder of QTL, which in turn, owns an approximate 41.1% membership interest in Earlychildhood on a fully-diluted basis. In conjunction with the May 5, 1999 recapitalization of Earlychildhood, and the transfer by QTL of significantly all of its assets and liabilities to Earlychildhood QTL retained inventory and accounts receivable having a book value of $2,168,000. Because Earlychildhood continued QTL's principal business functions, Earlychildhood subsequently collected on those accounts receivables and sold the exempted inventory and then forwarded the revenue directly to QTL. All amounts from the exempted assets were collected and forwarded to QTL by the end of the 1999 calendar year. Pursuant to a promissory note and pledge agreement between QTL and Earlychildhood effective May 5, 1999, Earlychildhood effected a loan to QTL to finance QTL's litigation expenses related to a lawsuit with Lakeshore Learning Materials. The litigation concluded in 1999, and the principal balance on the loan effective December 31, 2000 was $139,000. The note bears interest at 8% and matures no later than May 5, 2004 and earlier under certain circumstances. On May 5, 1999, Earlychildhood entered into a seven-year executive management agreement with William E. Simon & Sons, LLC. William E. Simon & Sons, LLC is an affiliate of Educational Simon, L.L.C., the largest equity holder of Earlychildhood which owns approximately 47.1% of the outstanding membership interests of Earlychildhood on a fully-diluted basis and, after the completion of the combination, will own approximately 32.7% of the capital stock of LearningStar on a fully-diluted basis. Pursuant to the terms of this executive management agreement, William E. Simon & Sons, LLC received an initial fee of $400,000, and an aggregate base fee of $300,000 per year. The base fee is subject to revision upon approval of a supermajority of the Earlychildhood management committee provided that it does not exceed $600,000 at any time. In addition, if mutually agreed upon by a supermajority of the management committee, William E. Simon & Sons, LLC is entitled to receive an acquisition fee for services provided in connection with an acquisition of Earlychildhood. William E. Simon & Sons, LLC did not receive an acquisition fee in connection with the combination. The executive management agreement will be terminated upon the closing of this combination. Pursuant to the amended and restated operating agreement of Earlychildhood, Educational Simon, L.L.C. is entitled to select three of the six members of the management committee of Earlychildhood. All three of the Educational Simon, L.L.C. designees who serve on the Earlychildhood management committee, Robert MacDonald, Scott Graves and Stephen Kaplan, will join the LearningStar board of directors as three of the four designees of Earlychildhood. Security Ownership of Certain Beneficial Owners and Management of Earlychildhood The following table sets forth certain information as of December 31, 2000 with respect to the class and percentage of the Earlychildhood membership interests held by the following persons: . each person or entity known by Earlychildhood to beneficially own 5% of more of the Earlychildhood membership interests; . each member of the management committee of Earlychildhood; . each executive officer of Earlychildhood; and . all members of the Earlychildhood management committee and Earlychildhood executive officers as a group. 110 Except as otherwise indicated, Earlychildhood believes that persons listed as the beneficial owners of the Earlychildhood membership interests have sole voting and investment power with respect to such membership interests. Unless otherwise indicated, the address of the following persons is c/o Earlychildhood 2 Lower Ragsdale Drive, Suite 200, Monterey, California 93940.
Percent of Equity Membership Percent of on a Class of Beneficial fully- Interests of Ownership diluted Name and Address of Beneficial Owner Ownership (1) basis (2) - ------------------------------------ ------------ ---------- ---------- Executive Officers Ronald Elliott(3).......................... Class B 44.0 41.1% Judith McGuinn............................. Class C -- -- Richard Phelan............................. Class B 2.7 2.5 Ronald Phelan.............................. Class B 1.4 1.3 Members of the Management Committee Randy Dean(4).............................. Class C * * Scott Graves(5)............................ Class A 50.5 47.1 Robert Healy............................... Class C * * Dr. Judith Herr............................ Class C * * Stephen Kaplan............................. Class C * * Robert MacDonald(4)........................ Class A 50.5 47.1 5% Members Educational Simon, L.L.C................... Class A 50.5 47.1 QTL Corporation............................ Class B 44.0 41.1 All members of the management committee and executive officers as a group............. 99.6 92.9
- -------- * Less than 1%. (1) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. Membership interests issuable by Earlychildhood to a person or entity named below pursuant to options which may be exercised within 60 days after December 31, 2000 are deemed to be beneficially owned by that person or entity, after giving effect to the exchange ratios set forth in the combination agreements. However, these shares are not deemed to be outstanding for purposes of computing the percentage beneficially owned by any other person or entity. (2) Beneficial ownership as shown under this column is determined by calculating the percentage interest of a person or entity owned by that person or entity, as compared to the fully-diluted total of membership interests outstanding on December 31, 2000. (3) Includes a 44.0% membership interest in Earlychildhood held by QTL Corporation computed in accordance with the formula set forth in footnote 1 (or a 41.1% membership interest in Earlychildhood computed in accordance with the formula set forth in footnote 2). Mr. Elliott, also a member of the Earlychildhood management committee, disclaims beneficial ownership of these membership interests, except to the extent of his pecuniary interest in the membership interests. (4) Mr. Dean resigned as a member of the Earlychildhood management committee in the spring of 2000. (5) Includes a 50.5% membership interest in Earlychildhood held by Educational Simon, L.L.C. computed in accordance with the formula set forth in footnote 1 (or a 47.1% membership interest in Earlychildhood computed in accordance with the formula set forth in footnote 2). Mr. Graves disclaims beneficial ownership of these membership interests, except to the extent of his pecuniary interest in the membership interests. (6) Includes a 50.5% membership interest in Earlychildhood held by Educational Simon, L.L.C. computed in accordance with the formula set forth in footnote 1 (or a 47.1% membership interest in Earlychildhood computed in accordance with the formula set forth in footnote 2). Mr. MacDonald disclaims beneficial ownership of these membership interests, except to the extent of his pecuniary interest in the membership interests. 111 LEARNINGSTAR The Board of Directors of LearningStar Following the Combination Upon completion of the combination, the board of directors of LearningStar will be comprised of nine individuals; four of whom will be designated by Earlychildhood; two of whom will be designated by SmarterKids.com; and three of whom will be independent directors jointly designated by Earlychildhood and SmarterKids.com. SmarterKids.com and Earlychildhood expect to designate the independent directors of LearningStar prior to the mailing of this proxy statement- prospectus. To date, Earlychildhood and SmarterKids.com have designated the individuals set forth below to be directors of LearningStar upon completion of the combination:
Name Age Designee of: - ---- --- ------------ Ronald Elliott.............................................. 45 Earlychildhood Al Noyes.................................................... 43 SmarterKids.com Scott Graves................................................ 30 Earlychildhood Stephen Kaplan.............................................. 42 Earlychildhood Michael Kolowich............................................ 47 SmarterKids.com Robert MacDonald............................................ 53 Earlychildhood
Ronald Elliott is the founder of Earlychildhood and has been an executive officer of Earlychildhood since 1984. Prior thereto, Mr. Elliott served as the President of QTL Corporation, the predecessor to Earlychildhood, from 1985 to 1999. Al Noyes has served as SmarterKids.com's Chief Operating Officer since November 2000 and before that served as its Executive Vice President, Sales and Marketing from February 2000 to July 2000. Mr. Noyes also served as Senior Vice President, Sales and Marketing of SmarterKids.com from September 1997 to February 2000. Prior to joining SmarterKids.com, Mr. Noyes served as Vice President of Sales and Marketing of net.Genesis, a developer and marketer of website usage and performance analysis products, from July 1996 to May 1997. From November 1995 to May 1996, Mr. Noyes served as Chief Executive Officer of The Mesa Group, a developer and marketer of messaging and groupware software, which was subsequently acquired by Microsoft. Mr. Noyes served as Venture Partner/Entrepreneur-in-Residence for Highland Capital, a venture capital firm from October 1994 to October 1995. Scott Graves has been a member of the Earlychildhood management committee since July 2000. Mr. Graves joined William E. Simon & Sons, LLC, a private investment firm and merchant bank, in 1998 and is currently a Principal of its Private Equity Group. From 1996 through 1997, Mr. Graves worked in the Mergers and Acquisitions Group of Merrill Lynch & Company, an international investment banking firm. Prior thereto, Mr. Graves worked in the Audit and Business Services Division of PricewaterhouseCoopers LLP, an international professional services firm from 1993 through 1995. Mr. Graves is a Certified Public Accountant in the State of California and serves on the board of directors of SF Interactive. Stephen Kaplan has been a Principal of Oaktree Capital Management, LLC since 1995. Oaktree provides investment management services 62 pursuant to a sub- advisory agreement with TCW Asset Management Company, the general partner of TCW Special Credits Fund V--The Principal Fund. Mr. Kaplan was a Managing Director of Trust Company of the West from 1993 to 1995. Prior to that time, Mr. Kaplan was a partner with the law firm of Gibson, Dunn & Crutcher. Mr. Kaplan is also a director of Acorn Products, Inc., GeoLogistics Corporation, KinderCare Learning Centers, Inc. and Roller Bearing Holding Co. Michael Kolowich has been a director of SmarterKids.com since January 1999. Mr. Kolowich has served as the Vice Chairman and as a Director of NewsEdge Corporation, a provider of news and information services, since February 1998. From September 1996 to February 1998, Mr. Kolowich served as the Chairman, President 112 and Chief Executive Officer of Individual, Inc., which merged with NewsEdge in February 1998. Mr. Kolowich served as the President of AT&T New Media Services, a division of AT&T that he founded, from December 1994 to July 1996. Mr. Kolowich also served as President of Ziff-Davis Interactive, a division of Ziff-Davis Interactive Publishing Company that he founded, from April 1988 to December 1994. Robert MacDonald joined the Earlychildhood management committee in May 1999. Mr. MacDonald joined William E. Simon & Sons, LLC, a private investment firm and merchant bank in 1993 and is currently Managing Director and President of its Private Equity Group. From 1988 through 1992, Mr. MacDonald provided private investment and financial services to a variety of clients, including William E. Simon & Sons, LLC, through East Rock Partners, a firm he co-founded. In 1981, Mr. MacDonald co-founded Catalyst Energy Corporation, a leading developer of independent power facilities throughout the United States. Mr. MacDonald serves on the boards of directors of PBOC Holdings, Corporate Staffing Resources, and Do+Able Products. Committees of the LearningStar Board of Directors Upon completion of the combination, the board of directors of LearningStar initially will have a compensation committee and an audit committee. The compensation committee, of which Messrs. , and are members, will determine the compensation (including stock option grants) of LearningStar's senior management. The audit committee, of which Messrs. , and are members, will oversee financial results and internal controls of LearningStar, including matters relating to the appointment and activities of LearningStar's independent auditors. Each of Messrs. , and are "independent directors" as defined by the Nasdaq Stock Market Rule 4200(a)(14). Compensation of Directors of LearningStar It is expected that neither employee nor non-employee directors will receive cash compensation for services performed in their capacity as directors of LearningStar. SmarterKids.com will reimburse directors for reasonable out-of- pocket expenses incurred in attending meetings of the board of directors and any of its committees on which they serve. Directors will be eligible to participate in the LearningStar 2001 Stock Plan. Under the LearningStar 2001 stock option and incentive plan, non-employee directors will be eligible to receive stock option grants at the discretion of the board of directors. In addition, each director who is not also an employee or officer of LearningStar will be entitled to participate in the LearningStar 2001 Non-Employee Director Stock Option Plan. Executive Officers of LearningStar Following the Combination The executive officers of LearningStar upon completion of the combination will be as follows:
Name Age Title - ---- --- ----- Ronald Elliott........................... 45 Chairman of the Board of Directors Al Noyes................................. 43 Chief Executive Officer Robert Cahill............................ 34 Chief Financial Officer Judith McGuinn........................... 51 Chief Operating Officer
Robert Cahill has served as SmarterKids.com's Vice President, Finance and Administration and Chief Financial Officer since April 2000 and served as Vice President, Finance from June 1999 and served as Controller from October 1997 to June 1999. Prior to joining SmarterKids.com, Mr. Cahill served as Accounting Manager for Gensym Corp., a developer and marketer of software products, from May 1995 to October 1997. Mr. Cahill is a Certified Public Accountant in the Commonwealth of Massachusetts and served as a Senior Accountant for Ernst & Young LLP from January 1993 to May 1995. 113 Judith McGuinn has served as Earlychildhood's Senior Vice President and Chief Operating Officer since December 1999. Prior to joining Earlychildhood Ms. McGuinn served as Vice President/Director of Time Warner Audio Books, a division of Time Warner Trade Publishing in New York, from July 1994 to December 1999. For information regarding Messrs. Elliott and Noyes, please see their biographies in the section entitled "--The Board of Directors of LearningStar Following the Combination." Compensation of Executive Officers of LearningStar LearningStar has not yet paid any compensation to the persons expected to become executive officers of LearningStar. The form and amount of compensation to be paid to each of LearningStar's executive officers in any future period will be determined by the compensation committee of the LearningStar board of directors. The following table sets forth the compensation paid by SmarterKids.com to its executive officers in fiscal year ended December 31, 2000 who will become executive officers and/or directors of LearningStar:
Annual Compensation Long-Term --------------------- Compensation on Name and Principal Fiscal Salary Bonus Securities Underlying All Other Positions Year ($) ($)(2) Options (#) Compensation ($)(1) - ------------------ ------ ------- ------ --------------------- ------------------- Al Noyes................. 1998 105,794 15,073 150,000 696 Chief Operating Officer 1999 120,000 27,200 200,000 696 2000 145,750 15,000 60,000 385 Robert Cahill............ 1998 80,278 -- 15,000 696 Vice President, Finance 1999 101,729 -- 105,000 696 and Chief Financial Officer 2000 155,750 -- 95,000 414
- -------- (1) Excludes prerequisites and other personal benefits, the aggregate annual amount of which for each officer was less than the lesser of $50,000 or 10% of the total salary and bonus reported. (2)Bonuses are reported in the year earned, even if actually paid in a subsequent year. The following table sets forth the compensation paid by Earlychildhood in fiscal year ended December 31, 2000 to the executive officers of Earlychildhood who will become executive officers of LearningStar:
Annual Compensation Long-Term ------------------------- Compensation on Name and Principal Fiscal Salary Bonus Securities Underlying All Other Positions Year ($) ($) Options (#) Compensation - ------------------ ------ ------- ------- --------------------- ------------- Ronald Elliott........... 1998 268,573 700,000 -- -- Founder, President and 1999 242,752 -- -- -- Chief Executive Officer 2000 231,341 -- -- -- Judith McGuinn(1)........ 1998 -- -- -- -- Chief Operating Officer 1999 8,750(1) -- -- -- 2000 156,923 28,854 140,182(2) --
- -------- (1) Judith McGuinn joined Earlychildhood on December 6, 1999. (2) Ms. McGuinn was granted options for 0.6% of Earlychildhood membership interests which will be exchanged for the right to purchase 140,182 shares of LearningStar common stock upon completion of the combination. 114 Option Grants in Last Fiscal Year The following table sets forth grants of stock options pursuant to SmarterKids.com's 1995 stock plan and 1999 stock option and incentive plan granted during the fiscal year ended December 31, 2000 to the SmarterKids.com executive officers and directors who will become executive officers and/or directors of LearningStar:
Option Grants In Last Fiscal Year Individual Grants ---------------------------------------------------------- Potential Realizable Value at Assumed Annual Rates of Stock Percent of Price Total Options Appreciation Number of Granted to for Option Term Securities Employees in ($)(3) Underlying Options Fiscal Exercise Price Expiration --------------- Name Granted (#)(1) Year (%)(2) Per Share ($) Date 5% 10% - ---- ------------------ ------------- -------------- ---------- ------- ------- Al Noyes................ 60,000 3.6% 1.50 9/7/10 56,601 143,437 200,000(4) -- (6) 1.50 10/1/09 188,668 478,123 Robert Cahill........... 60,000(5) 3.6% 1.50 4/1/10 56,601 143,437 10,000(5) .6% 1.50 1/12/10 9,433 23,906 25,000 1.5% 1.50 9/7/10 23,584 59,765 75,000(5) -- 1.50 10/1/09 70,751 179,296 Michael Kolowich........ -- -- -- -- -- --
- -------- (1) No stock appreciation rights ("SARs") were granted by SmarterKids.com in the fiscal year ended December 31, 2000. (2) Represents all options granted to the individual during 2000 as a percentage of all options granted to employees during 2000. (3) Amounts reported in these columns represent amounts that may be realized upon exercise of the options immediately prior to the expiration of their term assuming the specified compounded rates of appreciation (5% and 10%) on the market value of SmarterKids.com's common stock on the date of option grant over the term of the options. These numbers are calculated based on rules promulgated by the Securities and Exchange Commission and do not reflect SmarterKids.com's estimate of future stock price growth. Actual gains, if any, on stock option exercises and common stock holdings are dependent on the timing of such exercise and the future performance of SmarterKids.com's common stock. There can be no assurance that the rates of appreciation assumed in this table can be achieved or that the amounts reflected will be received by the individuals. (4) On September 7, 2000, certain of Mr. Noye's options were amended by the board of directors of SmarterKids.com to reduce the exercise price to $1.50, the current market value on that date. See the description under the caption "--Ten Year Option Repricing." (5) On September 7, 2000, certain of Mr. Cahill's options were amended by the board of directors of SmarterKids.com to reduce the exercise price to $1.50, the current market value on that date. See the description under the caption "--Ten Year Option Repricing." (6) For purposes of calculating the percentage, the repriced options described in footnotes (4) and (5) are not deemed to be options granted to employees in the fiscal year. 115 The following table sets forth grants of membership interests granted during the fiscal year ended December 31, 2000 to members of the Earlychildhood management committee and Earlychildhood executive officers will become executive officers and/or directors of LearningStar.
Option Grants In Last Fiscal Year Individual Grants ---------------------------------------------------------- Potential Realizable Value at Assumed Percent of Annual Rates of Total Options Stock Price Number of Granted to Appreciation for Securities Employees in Option Term ($)(3) Underlying Options Fiscal Exercise Price Expiration --------------------- Name Granted (#)(1) Year (%)(2) Per Share ($) Date 5% 10% - ---- ------------------ ------------- -------------- ---------- ---------- ---------- Ronald Elliott.......... -- -- -- -- -- -- Judy McGuinn............ 140,182 9% .018 9/01/10 408,492 651,950
- -------- (1) No SARs were granted by Earlychildhood in the fiscal year ended December 31, 2000. (2) Represents all options granted to the individual during 2000 as a percentage of all options granted to employees during 2000. (3) Amounts reported in these columns represent amounts that may be realized upon exercise of the options immediately prior to the expiration of their term assuming the specified compounded rates of appreciation (5% and 10%) on the market value of Earlychildhood's membership interests on the date of option grant over the term of the options. These numbers are calculated based on rules promulgated by the Securities and Exchange Commission and do not reflect Earlychildhood's estimate of future stock price growth. Actual gains, if any, on option exercises and membership interests holdings are dependent on the timing of such exercise and the future performance of Earlychildhood's membership interests. There can be no assurance that the rates of appreciation assumed in this table can be achieved or that the amounts reflected will be received by the individuals. Option Exercises and Fiscal Year-End Values The following table sets forth information with respect to options to purchase SmarterKids.com's common stock granted under SmarterKids.com's 1995 Stock Plan and 1999 Stock Option and Incentive Plan to the SmarterKids.com executive officers and directors who will become directors and/or executive officers of LearningStar, including: . the number of shares of common stock purchased upon exercise of options in the fiscal year ended December 31, 2000; . the net value realized upon such exercise; . the number of unexercised options outstanding at December 31, 2000; and . the value of such unexercised options at December 31, 2000. AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION/SAR VALUES
Number of Securities Underlying Unexercised Value of Unexercised Value Options at In-the-Money Options at Shares Acquired Realized Fiscal Year End (#) Fiscal Year End ($)(1) Name on Exercise (#) ($) (Exercisable/Unexercisable) (Exercisable/Unexercisable) - ---- --------------- -------- --------------------------- --------------------------- Al Noyes................ 160,000 653,667 220,875/218,125 60,423/11,184 Robert Cahill........... -- -- 89,375/155,625 24,978/4,847 Michael Kolowich........ 75,000 125,900 0/0 0/0
- -------- (1) Value is based on the difference between the option exercise price and the fair market value of SmarterKids.com common stock at December 31, 1999, the fiscal year-end ($.531 per share as quoted on the Nasdaq National Market, multiplied by the number of shares underlying the option). 116 The following table sets forth information with respect to options to purchase Earlychildhood membership interests granted under the Earlychildhood management incentive option plan to the Earlychildhood executive officers and members of the Earlychildhood management committee who will become directors and/or executive officers of LearningStar including: . the number of membership interests of common stock purchased upon exercise of options in the fiscal year ended December 31, 2000; . the net value realized upon such exercise; . the number of unexercised options outstanding at December 31, 2000; and . the value of such unexercised options at December 31, 2000. AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION/SAR VALUES
Number of Membership Membership Interests Underlying Value of Unexercised Interests Unexercised Options at In-the-Money Options at Acquired on Value Fiscal Year End % Fiscal Year End ($)(1) Name Exercise (#)% Realized ($) (Exercisable/Unexercisable) (Exercisable/Unexercisable) - ---- ------------- ------------ --------------------------- --------------------------- Ronald Elliott.......... -- -- -- -- Judith McGuinn.......... -- -- 0.0%/0.6% 0/71,914 Scott Graves............ -- -- -- --/-- Stephen Kaplan.......... -- -- -- --/-- Robert MacDonald........ -- -- -- --/--
- -------- (1) Value is based on the difference between the option exercise price and the fair market value of Earlychildhood membership interests at December 31, 2000, the fiscal year-end ($1,198.57 per .0001 Class C membership interest). The fair market value was determined by multiplying the number of options of LearningStar to be received in the combination using the exchange ratios set forth in the combination agreement by the closing price. Ten Year Option Repricing On September 7, 2000, SmarterKids.com completed a direct repricing of certain employee stock option grants. As part of the repricing, SmarterKids.com reduced the exercise price of all outstanding options with exercise prices of greater than $1.50 per share. The new exercise price of these repriced options was reset to $1.50 per share, which was equal to the market value of SmarterKids.com's common stock on September 7, 2000. The number of options repriced totaled 2,325,574. SmarterKids.com is accounting for the repriced options as a variable award. In the quarter ending September 30, 2000, SmarterKids.com recorded an incremental non-cash stock compensation charge of $110,000 as a result of the repricing. The following chart presents information about the consequences of the repricing for the SmarterKids.com executive officers and directors who will become directors and/or executive officers of LearningStar:
Original Exercise Option Term Price at Exercise Remaining at Date of # Mkt Price at Prior to Price Post time of Repricing Securities Repricing($) Repricing($) Repricing($) Repricing(yrs) --------- ---------- ------------ ------------ ------------ -------------- Al Noyes................ 9/7/00 200,000 1.50 11.00 1.50 3.21 Robert Cahill........... 9/7/00 10,000 1.50 6.44 1.50 3.38 9/7/00 60,000 1.50 2.50 1.50 3.58 9/7/00 75,000 1.50 11.00 1.50 3.06 Michael Kolowich........ -- -- -- -- -- --
117 Compensation Committee Report on Option Repricing On August 30, 1999, the compensation committee of SmarterKids.com board of directors (the "compensation committee") approved a reduction, effective September 7, 2000, in the exercise price of certain outstanding stock options held by executive officers and employees of SmarterKids.com to $1.50 per share, the fair market value of SmarterKids.com's common stock on September 7, 2000. These options were granted between July 1999 and April 2000 at exercise prices ranging from $1.50 to $14.00 per share. As set forth in SmarterKids.com 1995 stock plan and 1999 stock option and incentive plan, stock options are intended to provide incentives to SmarterKids.com's executive officers and employees. The SmarterKids.com compensation committee believed that such equity incentives are a significant factor in SmarterKids.com's ability to attract, retain and motivate key employees who are critical to the SmarterKids.com long-term success. The SmarterKids.com compensation committee believed that, at their original exercise prices, the disparity between the exercise price of these options and recent market prices for SmarterKids.com's common stock did not provide meaningful incentive to the executive officers and employees holding these options to perform to their maximum potential and to work towards the success of SmarterKids.com. Inquiries conducted indicated that other comparable companies in the Internet education product industry sector have been confronted with this problem and have made similar adjustments in option prices to motivate their executive officers and employees. The SmarterKids.com compensation committee approved the repricing of these options as a means of ensuring that the optionees will continue to have meaningful equity incentives to work toward the success of SmarterKids.com. The adjustment was deemed by the SmarterKids.com compensation committee to be in the best interest of SmarterKids.com and its stockholders. Respectfully submitted by the Compensation Committee: Richard D'Amore and Michael Kolowich Earlychildhood has never repriced its options to purchase membership interests in Earlychildhood. Employment and Change of Control Agreements Currently, none of the executive officers or directors of LearningStar have employment agreements or change of control agreements with LearningStar. For more information on the employment agreements and change of control agreements of the SmarterKids.com directors and executive officers, the members of the Earlychildhood management committee and the Earlychildhood executive officers, see the section entitled "The Combination--Interests of Certain Persons in the Combination." 118 Pro Forma Security Ownership of Certain Beneficial Owners and Management of LearningStar The following table sets forth certain pro forma information as to the number of shares of LearningStar common stock to be held by the following persons upon completion of the combination: . each person or entity expected by LearningStar to beneficially own 5% of more of the LearningStar common stock; . each director of LearningStar; . each executive officer of LearningStar; and . all LearningStar directors and executive officers as a group. Except as otherwise indicated, LearningStar believes that persons expected to be the beneficial owners of the LearningStar common stock listed below, based on information furnished by such owners, have sole voting and investment power with respect to such shares. Unless otherwise indicated the address of the following persons is c/o LearningStar, 15 Crawford Street, Needham, Massachusetts 02494.
Amount and Nature of Percent of Name and Address of Beneficial Owner Ownership(1) Common Stock - ------------------------------------ ------------ ------------ Executive Officers Ronald Elliott(2).................................... 19,205,598 29.3% Al Noyes(3).......................................... 461,875 * Robert Cahill(4)..................................... 91,875 * Judith McGuinn....................................... -- -- Directors Scott Graves(5)...................................... 23,537,465 35.9 Stephen Kaplan....................................... 77,882 * Michael Kolowich..................................... 155,000 * Robert MacDonald(6).................................. 23,537,465 35.9 5% Holders Educational Simon, L.L.C............................. 23,537,465 35.9 QTL Corporation...................................... 19,205,598 29.3 All executive officers and directors as group(7)..... 43,529,659 66.4
- -------- * Less than 1% (1) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. Membership interests issuable by Earlychildhood to a person or entity named below pursuant to options which may be exercised within 60 days after December 31, 2000 are deemed to be beneficially owned by that person or entity. However, these shares are not deemed to be outstanding for purposes of computing the percentage beneficially owned by any other person or entity. (2) Include 19,205,598 shares of LearningStar common stock to be held by QTL Corporation. Mr. Elliott, who will also become a director of LearningStar, disclaims beneficial ownership of these shares except to the extent of his pecuniary interest therein. (3) Includes 214,875 shares of LearningStar common stock issuable upon the exercise of options exercisable on December 31, 2000 or within 60 days thereafter. Mr. Noyes will also become a director of LearningStar. (4) Consists of 91,875 shares of LearningStar common stock issuable upon the exercise of options exercisable on December 31, 2000 or within 60 days thereafter. (5) Include 23,537,465 shares of LearningStar common stock to be held by Educational Simon, L.L.C. Mr. Graves disclaims beneficial ownership of these shares except to the extent of his pecuniary interest therein. (6) Include 23,537,465 shares of LearningStar common stock to be held by Educational Simon, L.L.C. Mr. MacDonald disclaims beneficial ownership of these shares except to the extent of his pecuniary interest therein. (7) See footnotes (1) through (6) above. Includes options to purchase an aggregate of 306,750 shares of LearningStar common stock issuable upon the exercise of options exercisable on December 31, 2000 or within 60 days thereafter. 119 DESCRIPTION OF CAPITAL STOCK OF LEARNINGSTAR Effective upon the closing of this combination and the filing of the LearningStar restated certificate of incorporation, the LearningStar authorized capital stock will consist of shares of common stock, par value $.01 per share, and shares of preferred stock, par value $.01 per share. The following summary description of the LearningStar capital stock is not intended to be complete and is qualified by reference to the provisions of applicable law and to the LearningStar restated certificate of incorporation attached as Annex D to this proxy statement-prospectus and the LearningStar amended and restated bylaws attached as Annex E to this proxy statement-prospectus. Common Stock Upon the completion of the combination, there will be shares of LearningStar common stock outstanding held by stockholders of record. In addition, upon completion of the combination, there will be stock options outstanding to purchase an aggregate of shares of LearningStar common stock due to the conversion of outstanding options to purchase SmarterKids.com common stock and the conversion of outstanding options to purchase Earlychildhood membership interests. In addition, following the completion of the combination, there will be outstanding warrants to purchase 217,292 shares of LearningStar common stock due to the conversion of warrants to purchase shares of SmarterKids.com common stock. Holders of LearningStar common stock are entitled to one vote for each share held on all matters submitted to a vote of stockholders and do not have cumulative voting rights. Directors are elected by a plurality of the votes of the shares present in person or by proxy at the meeting and entitled to vote in the election. Holders of LearningStar common stock are entitled to receive ratably dividends, if any, as may be declared by the LearningStar board of directors out of funds legally available therefor, after provision has been made for any preferential dividend rights of outstanding preferred stock, if any. Upon liquidation, dissolution or winding up of LearningStar, the holders of LearningStar common stock are entitled to receive ratably the net assets available after the payment of all of its debts and other liabilities, and after the satisfaction of the rights of any outstanding preferred stock. Holders of LearningStar common stock have no preemptive, subscription, redemption or conversion rights, nor are they entitled to the benefit of any sinking fund. The outstanding shares of LearningStar common stock will be, when validly issued, fully paid and non-assessable. The rights, powers, preferences and privileges of holders of LearningStar common stock are subordinate to, and may be adversely affected by, the rights of the holders of shares of any series of preferred stock that LearningStar may designate and issue in the future. Preferred Stock The LearningStar board of directors will be authorized, without further stockholder approval, to issue from time to time up to an aggregate of shares of preferred stock, in one or more series. Each series of preferred stock shall have the number of shares, designations, preferences, voting powers, qualifications and special or relative rights or privileges as shall be determined by the LearningStar board of directors, which may include, among others, dividend rights, voting rights, redemption and sinking fund provisions, liquidation preferences, conversion rights and preemptive rights. The rights of the holders of LearningStar common stock will be subordinate to the rights of holders of any preferred stock issued in the future. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could adversely affect the voting power or other rights of the holders of common stock, and could make it more difficult for a third party to acquire, or discourage a third party from attempting to acquire, a majority of LearningStar's outstanding voting stock. LearningStar has not, to date, issued any shares of preferred stock, and has no present plans to issue any shares of preferred stock. 120 Warrants As of the completion of the combination, the following warrants to purchase an aggregate of 217,292 shares of LearningStar common stock will be outstanding: . J.L. Hammett Co. will have a warrant to purchase 165,000 shares of LearningStar common stock at an exercise price of $1.33 per share; . Silicon Valley Bank will have a warrant to purchase 7,500 shares of LearningStar common stock at an exercise price of $1.33 per share; . TLP Leasing Programs, Inc. will have a warrant to purchase 16,667 shares of LearningStar common stock at an exercise price of $3.00 per share; and . National Computer Systems will have warrants to purchase an aggregate of 28,125 shares of LearningStar common stock at an exercise price of $1.33 per share. Registration Rights Upon the expiration of the contractual lock-up period in accordance with the lock-up agreements between LearningStar and each of the directors and executive officers and certain significant stockholders of SmarterKids.com and all of the holders of membership interests in Earlychildhood, collectively referred to herein as the "Rightsholders," will be entitled to require LearningStar to register under the Securities Act of 1933 up to an aggregate of shares of LearningStar common stock held by the Rightsholders pursuant to the registration rights agreement among LearningStar and the Rightsholders. The registration rights agreement provides that if LearningStar proposes to register in a firm commitment underwritten offering any of its securities under the Securities Act at any time or times, the Rightsholders will generally be entitled to include shares of common stock held by them in the registration. However, the managing underwriter of any offering may exclude for marketing reasons some or all of the shares from the registration. The Rightsholders also have the right to require LearningStar, on no more than two occasions 180 days after the closing date of the combination, to prepare and file a registration statement under the Securities Act registering the shares of LearningStar common stock held by them. LearningStar is generally required to bear the expenses of all these registrations, except underwriting discounts and commissions. These rights will terminate on the fifth anniversary of the closing date of the combination. In addition, holders of warrants to purchase an aggregate of 24,167 shares of LearningStar common stock will have certain registration rights. Anti-Takeover Effects of Certain Provisions of LearningStar's Charter and Bylaws and Delaware Law Upon completion of the combination, the provisions of Section 203 of the Delaware General Corporation Law will prohibit LearningStar from engaging in a "business combination" with an "interested stockholder" for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. A "business combination" includes mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. An "interested stockholder" is generally defined as a person who, together with affiliates and associates, owns, or within three years did own, 15% or more of a corporation's voting stock. The LearningStar and restated certificate of incorporation provides for the division of the LearningStar board of directors into three classes as nearly equal in size as possible with staggered three-year terms. In addition, the LearningStar amended and restated certificate of incorporation provides that directors may be removed only for cause by the affirmative vote of the holders of 75% of the shares of the LearningStar 121 capital stock entitled to vote generally in the election of directors, voting as a single class. Under the LearningStar restated certificate of incorporation, any vacancy on the LearningStar board of directors, however occurring, including a vacancy resulting from an enlargement of the board of directors, may only be filled by vote of a majority of the directors then in office. The likely effect of the classification of the LearningStar board of directors and the limitations on the removal of directors and filling of vacancies is an increase in the time required for the stockholders to change the composition of the LearningStar board of directors. For example, in general, at least two annual meetings of the stockholders will be necessary for stockholders to effect a change in a majority of the members of the LearningStar board of directors. The LearningStar restated certificate of incorporation also provides that, after the effective date of the LearningStar registration statement on Form S-4 of which this proxy statement-prospectus is a part, any action required or permitted to be taken by LearningStar stockholders at an annual meeting or special meeting of stockholders may only be taken if it is properly brought before the meeting and may not be taken by written action in lieu of a meeting. The LearningStar amended and restated bylaws provide that special meetings of the stockholders may only be called by the LearningStar board of directors, the chairman of the board or by the board of directors. The LearningStar amended and restated bylaws further provide that in order for any matter to be considered "properly brought" before a meeting, a stockholder must comply with requirements regarding timely notice to LearningStar. The foregoing provisions could have the effect of delaying until the next LearningStar stockholders meeting stockholder actions which are favored by the holders of a majority of the LearningStar outstanding voting securities. These provisions may also discourage another person or entity from making a tender offer for SmarterKids.com common stock, because such person or entity, even if it acquired a majority of SmarterKids.com outstanding voting securities, would be able to take action as a stockholder, such as electing new directors or approving a merger, only at a duly called stockholders meeting, and not by written consent. The Delaware General Corporation Law provides generally that the affirmative vote of a majority of the shares entitled to vote on any matter is required to amend a corporation's certificate of incorporation or bylaws, unless a corporation's certificate of incorporation or bylaws, as the case may be, requires a greater percentage. The LearningStar restated certificate of incorporation requires the affirmative vote of the holders of at least 75% of the shares of LearningStar capital stock that are issued and outstanding and entitled to vote to amend or repeal any of the foregoing provisions of the LearningStar restated certificate of incorporation. The LearningStar amended and restated bylaws may generally be amended or repealed by a majority vote of the LearningStar board of directors and may also be amended or repealed by the affirmative vote of the holders of at least 75% of the shares of LearningStar capital stock that are issued and outstanding and entitled to vote and voting as a single class. The 75% stockholder vote would be in addition to any separate class vote that might in the future be required in accordance with the terms of any series of preferred stock that might be outstanding at the time any such amendments are submitted to stockholders. Transfer Agent and Registrar The transfer agent and registrar for the LearningStar common stock is ChaseMellon Shareholder Services, L.L.C. 122 COMPARISON OF RIGHTS OF HOLDERS OF LEARNINGSTAR COMMON STOCK, SMARTERKIDS.COM COMMON STOCK AND EARLYCHILDHOOD MEMBERSHIP INTERESTS The following is a summary of the material differences between the rights of holders of SmarterKids.com common stock and holders of membership interests in Earlychildhood before the combination and the rights of holders of LearningStar capital stock after the combination. Because SmarterKids.com and LearningStar are both corporations organized under the laws of the State of Delaware, the differences arise solely from differences between various provisions of their respective certificates of incorporation and bylaws. However, because Earlychildhood is organized under the laws of the State of California as a limited liability company and LearningStar is organized under the laws of the State of Delaware as a corporation, the differences arise both from differences between various provisions of their respective organizational documents and California and Delaware law. The discussion of the comparative rights of the stockholders of SmarterKids.com, the members of Earlychildhood and the holders of LearningStar common stock set forth below does not purport to be complete and is subject to and qualified in its entirety by reference to the certificates of incorporation and bylaws of SmarterKids.com and LearningStar, the operating agreement of Earlychildhood and California and Delaware law. Authorized Capital Stock The total number of shares LearningStar will have the authority to issue will be consisting of shares of common stock, par value $.01 per share, and shares of LearningStar preferred stock. The total number of shares of capital stock which SmarterKids.com has authority to issue is 100,000,000, consisting of 90,000,000 shares of common stock, par value $0.01 per share, 20,668,849 shares of which are issued and outstanding as of December 31, 2000 and 10,000,000 shares of preferred stock, par value $0.01 per share, none of which are issued and outstanding as of the date hereof. Number of Directors or Members of Management Committee The Delaware General Corporation Law provides that the board of directors of a Delaware corporation will consist of one or more directors as fixed by the certificate of incorporation or bylaws. LearningStar's restated certificate of incorporation provides for a board of directors of not less than three nor more than 15 directors, as fixed by LearningStar's amended and restated bylaws. LearningStar's amended and restated bylaws and the combination agreement provide for a LearningStar board of directors consisting of nine members; two of whom will be designated by SmarterKids.com and referred to herein as the "SmarterKids.com Designated Directors" four of whom will be designated by Earlychildhood and referred to herein as the "Earlychildhood Designated Directors"; and three of whom will be jointly designated by SmarterKids.com and Earlychildhood. The LearningStar restated certificate of incorporation provides that the board of directors will be divided into three classes each consisting of three directors and designated Class I, Class II, and Class III. Class I directors will be initially elected for a term expiring at the first annual meeting of LearningStar stockholders. Class II directors will be initially elected for a term expiring at the second annual meeting of LearningStar stockholders. Class III directors will be initially elected for a term expiring at the third annual meeting of LearningStar stockholders. The LearningStar restated certificate of incorporation provides that at each annual meeting of the LearningStar stockholders, successors to the class of directors whose term expires at that annual meeting will be elected for a three-year term. The combination agreement provides that the SmarterKids.com Designated Directors and the Earlychildhood Designated Directors will be allocated as evenly as possible among LearningStar's three classes of directors. SmarterKids.com's bylaws provide for a board of directors consisting of not less than three directors as fixed by the SmarterKids.com board of directors or by the SmarterKids.com stockholders at an annual or special meeting. SmarterKids.com's bylaws provide for a classified board of directors consisting of three classes. Currently, SmarterKids.com has a board of directors consisting of six directors with two directors in each class. 123 The Beverly-Killea Limited Liability Company Act, or the California Limited Liability Company Act, provides that the business and affairs of a California limited liability company be managed by one or more managers and not by all its members if the articles of organization so provides. The number and qualifications of managers are dictated by provisions of the articles of organization or operating agreement of the limited liability company. Earlychildhood's amended articles of organization provides that Earlychildhood will be managed by more than one manager. Earlychildhood's amended and restated operating agreement provides that the business and affairs of Earlychildhood will be managed by the members acting through a management committee initially composed of five representatives and currently composed of six representatives. Committees of the Board of Directors or Management Committee LearningStar's amended and restated bylaws provide that the board of directors may by resolution designate an Executive Committee to exercise all of the powers of the LearningStar board of directors in the management of the business and affairs of LearningStar when the board is not in session and may also adopt one or more other committees. It is intended that LearningStar will designate an audit committee and a compensation committee. The audit committee will be initially comprised of and , each an Earlychildhood Designated Director, and , a SmarterKids.com Designated Director. The members of the LearningStar audit committee meet the independence and audit committee composition requirements under the rules of the Nasdaq National Market. The audit committee will assist the board of directors in fulfilling its responsibilities by reviewing: . the financial reports provided by LearningStar to the Securities and Exchange Commission; and . LearningStar's internal financial and accounting controls. The LearningStar compensation committee will be initially comprised of and , each an Earlychildhood Designated Director, and , a SmarterKids.com Designated Director, each of whom will meet the requirements of independence as established by Nasdaq National Market and required by the Securities and Exchange Commission pursuant to Section 16 of the Securities Exchange Act. The LearningStar compensation committee will have responsibility for: . reviewing the compensation and employee benefit policies of LearningStar; . recommending to the LearningStar board of directors the base salary amounts and incentive awards for all elected officers of LearningStar and setting guidelines for the administration of all salaries; . administering incentive compensation and awarding stock options to employees under any stock option or compensation plan of LearningStar and amending or modifying any provisions of such stock option or compensation plan that may be amended or modified without stockholder approval; and . supervising all administrative matters with respect to the foregoing. SmarterKids.com's bylaws provide that its board of directors by a majority vote may establish one or more committees, each committee consisting of one or more of the directors of SmarterKids.com. Any committee so established to the extent provided in the resolution of the board of directors, will have and may exercise all the powers of the board of directors in the management of the business and affairs of SmarterKids.com. SmarterKids.com has established two committees, an audit committee and a compensation committee. Neither Earlychildhood's amended articles of organization nor its amended and restated operating agreement specifically provides for the establishment of committees, although Earlychildhood's amended and restated operating agreement states that its provisions do not bar Earlychildhood's management committee from delegating responsibility for any of the management committee's management decisions to any member, officer, or other representative or agent of Earlychildhood. 124 Removal of Directors or Member of the Management Committee The Delaware General Corporation Law provides that a director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors, except that: . in the case of a corporation whose board is classified, directors may be removed only for cause unless the certificate of incorporation provides otherwise; or . if the corporation has cumulative voting, in which event if less than the entire board is to be removed, no director may be removed without cause if the votes cast against the director's removal would be sufficient to elect that director if voted cumulatively either at an election of the entire board of directors or for classes of the board. LearningStar's restated certificate of incorporation provides that directors may be removed only for cause and in addition to any other vote required by law, by the affirmative vote of the holders of at least 75% of the voting power of the shares of LearningStar capital stock entitled to vote generally in the election of directors, voting together as a single class. SmarterKids.com's bylaws allow the removal with cause of a director by the affirmative vote of the holders of at least 75% the shares entitled to vote at an election of directors. The California Limited Liability Company Act provides that any or all managers of a limited liability company may be removed, with or without cause, by the vote of a majority in interest of the members at a meeting called expressly for that purpose. Neither Earlychildhood's amended articles of organization nor its amended and restated operating agreement provide any further guidance with respect to the removal of members of Earlychildhood's management committee. Amendment to the Bylaws or Operating Agreement Under the Delaware General Corporation Law, bylaws may be altered, amended, supplemented or repealed, or new bylaws adopted, by the stockholders entitled to vote, by the board of directors, or by any other manner as may be authorized by the certificate of incorporation. LearningStar's amended and restated bylaws provide that the board of directors may amend, alter, or repeal any provision of LearningStar's amended and restated bylaws with an affirmative vote of a majority of LearningStar's board of directors, provided that notice of the proposed change is given to the board of directors not later than two days prior to the meeting of the board of directors to effect such change. In addition to any other vote required by law, LearningStar's amended and restated bylaws provide that any amendment, alteration or repeal of any provision of the LearningStar amended and restated bylaws requires the affirmative vote of 75% of the voting power of all outstanding shares of LearningStar then entitled to vote generally in the election of directors, voting together as a single class. SmarterKids.com's bylaws may be altered, amended or repealed, or new bylaws may be adopted by a majority of the board of directors. In addition to an amendment made by the board of directors, the shareholder may amend or repeal any provision of the SmarterKids.com bylaws with a vote of 75% of the shares of capital stock that are issued, outstanding and entitled to vote at any regular or special meeting of stockholders. The California Limited Liability Company Act gives the members of a California limited liability company the power to amend the limited liability company's operating agreement. The manner in which the operating agreement may be amended may be prescribed by the articles of organization or the operating agreement. Earlychildhood's amended and restated operating agreement provides that it may be amended only upon receipt of the written consent of the management committee, which may be given, withheld or made subject to such conditions as are determined by each member of the management committee in its sole and 125 absolute discretion. In addition, amendment of certain provisions of Earlychildhood's amended and restated operating agreement requires the approval of a supermajority of the representatives on Earlychildhood's management committee. Amendments to the Certificates of Incorporation or Articles of Organization Under the Delaware General Corporation Law amendment of the certificate of incorporation of a corporation will be made by a resolution of the board of directors setting forth the amendment, declaring its advisability, and either calling a special meeting of the stockholders entitled to vote or directing that the amendment proposed be considered at the next annual meeting of the stockholders. At the stockholder's meeting, a majority of the outstanding shares entitled to vote is required to approve the amendment. If an amendment would increase or decrease the number of authorized shares of such class, increase or decrease the par value of the shares of such class or alter or change the powers, preferences or other special rights of a class of outstanding shares so as to affect the class adversely, then a majority of shares of that class must approve the amendment as well. The Delaware General Corporation Law also permits a corporation to make provision in its certificate requiring a greater proportion of voting power to approve a specified amendment. LearningStar's amended and restated bylaws provide that the board of directors may amend, alter, or repeal any provision of LearningStar's restated certificate of incorporation as provided by Delaware statute. SmarterKids.com's certificate of incorporation may be altered, amended or repealed, or new bylaws may be adopted by a majority of the board of directors. In addition to a vote of the SmarterKids.com board of directors, to amend or repeal any provision of the SmarterKids.com certificate of incorporation the vote of 75% of the shares of capital stock that are issued, outstanding and entitled to vote is required. The California Limited Liability Company Act provides that the articles of organization of a limited liability company may be amended at any time and in any manner as the members may determine, as long as the articles of organization, as amended, contain only those provisions as would be lawful if inserted in the original articles of organization. In order to affect an amendment to the articles of organization, a certificate of amendment must be filed with the Secretary of State of the State of California setting forth the name and Secretary of State's file number of the limited liability company and the text of the amendment to the articles of organization. Action by Written Consent of Stockholders or Members. The Delaware General Corporation Law contains provisions permitting actions by holders of common stock without providing notice and convening a meeting of such holders if consents setting for the action to be taken are signed by holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting of stockholders unless prohibited by the corporation's bylaws. LearningStar's amended and restated bylaws do not permit any actions to be taken by written consent of its stockholders. SmarterKids.com's bylaws permit any actions to be taken by stockholders without a meeting, by written consent, provided such written consent sets forth the actions taken and is signed by the holders of the minimum number of shares required to take such actions at a meeting at which all shares entitled to vote are present and voted and the consents delivered to SmarterKids.com within 60 days of the earliest consent date. The California Limited Liability Company Act provides that any action that may be taken at any meeting of the members of a limited liability company may be taken without a meeting if a consent in writing setting forth the action is signed and delivered to the limited liability company, within 60 days of the record date for the action, by members having not less than the minimum number of votes necessary to authorize to take the 126 action at a meeting at which all members entitled to vote on the action were present and voted. Members, or their proxyholders, may revoke their consent in a writing received by the limited liability company prior to the time that written consents of members having the minimum number of votes that would be required to authorize the proposed action have been filed with the limited liability company, but may not be revoked after that time. Neither Earlychildhood's amended articles of organization nor its amended and restated operating agreement has any provisions respecting actions taken by written consent of its members. Indemnification The Delaware General Corporation Law contains provisions setting forth conditions under which a corporation may indemnify its directors, officers and employees; however, indemnification is permitted only if certain statutory standards of conduct are met. The Delaware General Corporation Law requires that the indemnified officer or director acted in good faith and in a manner that the officer or director reasonably believed to be in, or not opposed to, the best interests of the corporation and, with respect to any criminal action or proceeding, had no reasonable cause to believe the conduct was unlawful. Indemnification is not mandatory only permissible under the Delaware General Corporation Law; however, the Delaware General Corporation Law requires that a corporation indemnify an officer or director who is successful on the merits, or otherwise, in the defense of certain specified actions, suits or proceedings for expenses and attorneys' fees actually and reasonably incurred in connection therewith. Although indemnification is permissible in Delaware, the Delaware General Corporation Law allows a corporation, through its certificate of incorporation, bylaws, or other intracorporate agreements, to make indemnification mandatory. Pursuant to this authority, LearningStar's restated certificate of incorporation and amended and restated bylaws provide that LearningStar will indemnify its directors, officers and employees to the fullest extent permitted by law. LearningStar's restated certificate of incorporation specifically requires indemnification of costs, charges and expenses, judgments, fines, settlements actually or reasonably incurred in connection with a third-party actions, suit or proceeding for any person who was or is a party, or is threatened to be a party, by reason of the fact that such person is or was or agreed to be a director, officer or employee of LearningStar or because such person was serving another legal entity as a director, officer or employee at the request of LearningStar while a director, officer or employee of LearningStar. SmarterKids.com's bylaws provide similar indemnification protections and provide that SmarterKids.com shall indemnify to the fullest extent of the law any director, officer, employee or agent whom it may indemnify pursuant thereto. SmarterKids.com's amended and restated bylaws specifically require indemnification of judgments, fines, settlements and expenses of third-party actions for any director, officer, employee or agent who is or was a party, or is threatened to be a party, by reason of the fact that such person is or was a director, officer, employee or agent of SmarterKids.com or because such person was serving another legal entity as a director, officer, employee or agent at the request of SmarterKids.com. The Delaware General Corporation Law differentiates between third-party actions and claims by or in the right of the corporation (i.e., stockholder derivative suits). Indemnification under the Delaware General Corporation Law varies depending on whether the action is brought by a third party or by stockholders in a derivative suit. Unlike a third-party action, in which indemnification is permissive under the statute and mandatory under both LearningStar's restated certificate of incorporation and SmarterKids.com's amended and restated bylaws, the Delaware General Corporation Law does not permit indemnification in a stockholder derivative suit if the person is found liable to the corporation, unless and only to the extent that, the Delaware Court of Chancery or the court in which such action or suit was brought determines that the person is fairly and reasonably entitled to indemnification. Further, the corporation may indemnify such persons only for attorneys' fees and other expenses. 127 The advancement of expenses is permissible under the Delaware General Corporation Law. LearningStar's restated certificate of incorporation provides for the advancement of expenses incurred by a director or officer, subject to an undertaking that the director or officer will repay such amount if it is ultimately determined that such director or officer is not entitled to indemnification. LearningStar's restated certificate of incorporation also provides that no advance will be made if a determination is reasonably and promptly made by: . a majority vote of a quorum of disinterested directors of LearningStar; . a quorum of disinterested directors so directed by independent legal counsel in a written opinion that, based upon the facts known to the board of directors and the counsel at the time, the director, officer or employee acted in bad faith and in a manner that the persons did not believe to be in the best interests of LearningStar; or . with respect to a criminal proceeding, that such director, officer or employee believed or had reasonable cause to believe that his or her conduct was unlawful. In no event will expenses by advanced to any director, officer or employee if the board of directors or independent legal counsel reasonably determines that such person breached his or her duty to LearningStar. SmarterKids.com's bylaws provides that expenses may be advanced; however, advanced expenses must be repaid if it is ultimately determined that such person is not entitled to be indemnified. The California Limited Liability Company Act provides that, except for a breach of the fiduciary duty a manager owes to a limited liability company and to its members, the articles of organization or operating agreement of a limited liability company may provide for indemnification of any person, including, without limitation, any manager, member, officer, employee, or agent of the limited liability company, against judgments, settlements, penalties, fines or expenses of any kind incurred as a result of the person's acting within that capacity. Earlychildhood's amended and restated operating agreement provides that, to the greatest extent permitted by law, Earlychildhood will defend, indemnify and hold harmless . its members (in their capacity as members); . representatives on its management committee; . its affiliates, agents, officers, partners, employees, representatives, directors, members or shareholders of any of its members (which is not an individual); or . itself, against any liability or loss as a result of any claim or legal proceeding by any person (including by or through Earlychildhood and/or any of its members) relating to the performance or nonperformance of any act concerning the activities of Earlychildhood if: . the act or failure to act of the person to be indemnified was in good faith, within the scope of that person's authority and in a manner he or she reasonably believed to be in, or not inconsistent with, the best interest of Earlychildhood; and . the conduct of the person did not constitute fraud, willful misconduct, gross negligence or a material breach of a material provision of Earlychildhood's amended and restated operating agreement. The indemnification authorized by Earlychildhood's amended and restated operating agreement includes any judgment, award, settlement, the payment of reasonable attorneys' fees and other expenses (not limited to taxable costs) incurred in settling or defending any claims, threatened action or finally adjudicated legal proceeding. If Earlychildhood's management committee finds that the person to be indemnified has met the two standards described above, the attorneys' fees and other expenses will be advanced by Earlychildhood prior to the final disposition of such claims, actions or proceedings upon receipt by Earlychildhood of an undertaking, reasonably acceptable to the management committee, by or on behalf of the person to be indemnified to repay such amounts if it shall be determined that the person is not entitled to be indemnified as authorized under Earlychildhood's amended and restated operating agreement. 128 Liability of Directors or Members of the Management Committee Under the Delaware General Corporation Law, a corporation's certificate of incorporation may contain a provision limiting or eliminating a director's personal liability to the corporation or its stockholders for monetary damages for a director's breach of fiduciary duty subject to certain limitations. Neither LearningStar's nor SmarterKids.com's certificates of incorporation or bylaws contains a provision limiting the liability of directors. The California Limited Liability Company Act provides that no person that is a manager of a limited liability company shall be personally liable under any judgment of a court, or in any other manner, for any debt, obligation or liability of the limited liability company solely by reason of being a manager of the limited liability company. Earlychildhood's amended and restated operating agreement provides that, to the fullest extent permitted by law, none of . its members (in their capacity as members); . the representatives on its management committee; . its affiliates, agents, officers, partners, employees, representatives, directors, members or shareholders of any of its members (which is not an individual); or . itself acting in accordance with its amended and restated operating agreement will be liable, responsible or accountable, in damages or otherwise, to Earlychildhood or any of its members for doing any act or failing to do any act, the effect of which may cause or result in loss or damage to Earlychildhood or the member if: . the act or failure to act of the person or entity was in good faith, within the scope of its authority and in a manner it reasonably believed to be in, or not inconsistent with, the best interest of Earlychildhood; and . the conduct of the person or entity did not constitute fraud, willful misconduct, gross negligence or a material breach of a material provision of Earlychildhood's amended and restated operating agreement. Stockholder or Member Meetings The Delaware General Corporation Law requires that meetings of the stockholders be held in the place designated in the corporation's certificate of incorporation or bylaws or, if not designated therein, as determined by the corporation's board of directors. Special meetings of a corporation's stockholders may be called by the board of directors or such persons designated in the corporation's certificate of incorporation. In order to determine the stockholders entitled to vote in any annual or special meeting, the Delaware General Corporation Law requires a corporation's board of directors to set a record date of not more than 60 nor less than ten days from the date of the meeting. In accordance with LearningStar's amended and restated bylaws, annual and special meetings of stockholders will be held on such date as may be fixed by LearningStar's board of directors, and special meetings of stockholders may be called only by the chairman of the board or a majority of LearningStar's board of directors. LearningStar's amended and restated bylaws require notice of any meeting of stockholders to be given to each stockholder not less than ten nor more than 60 days before the date of the meeting. Pursuant to SmarterKids.com's bylaws, annual meetings of stockholders will be held March 31 of each year, or at such other date and time as designated by the board of directors or the chief executive officer of SmarterKids.com. The SmarterKids.com bylaws provide that a special meeting of stockholders may be called by the board of directors or the chief executive officer or by the chief executive officer at the request in writing of a majority of the SmarterKids.com board of directors or at the request in writing of SmarterKids.com stockholders owning a majority in amount of the entire capital stock of SmarterKids.com. 129 The Delaware General Corporation Law, SmarterKids.com's bylaws and LearningStar's bylaws require that whenever stockholders are required or permitted to take action at a meeting, a written notice stating the place, time and date of the meeting and, in the case of a special meeting, the purpose or purposes for which the meeting is called, must be sent to all stockholders of record entitled to vote thereon not less than ten nor more than 60 days before the meeting. The Delaware General Corporation Law further requires that notice of a meeting to consider an agreement of merger must be sent at least 20 days prior to the date of the meeting. The California Limited Liability Company Act code provides that meetings of members of a limited liability company may be held at any place, within or without the State of California, selected by the person(s) calling the meetings or as may be stated or fixed in accordance with the articles of organization or operating agreement. If no place is stated or fixed in these documents, the California Limited Liability Company Act provides that all meetings are to be held at the principal executive office of the limited liability company. A meeting of the members of a limited liability company may be called by any manager or by any member(s) representing more than 10% of the interests of members for the purpose of addressing any matters on which the members may vote. The California Limited Liability Company Act requires that written notice of a meeting of the members of a limited liability company be given not less than ten days nor more than 60 days before the date of the meeting to each stockholder entitled to vote at the meeting. Neither Earlychildhood's amended articles of organization nor its amended and restated operating agreement addresses meetings of Earlychildhood members. Mergers and Consolidations In order to effect a merger under the Delaware General Corporation Law, a corporation's board of directors must adopt an agreement of merger and recommend it to the stockholders. The agreement must be adopted by holders of a majority of the outstanding shares of the corporation entitled to vote thereon. The California Limited Liability Company Act Code provides that, in order to effect the merger of a limited liability company, the agreement of merger must be approved by the vote of a majority in interest of the members of the limited liability company, or such greater percentage of the voting interests of the members as may be specified in the articles of organization or the operating agreement. The amended and restated operating agreement does not address the voting rights of members of Earlychildhood.com. Business Combinations The Delaware General Corporation Law bars a corporation which has securities traded on an exchange, designated on the Nasdaq National Market or held of record by more than 2,000 stockholders from engaging in certain business combinations, including a merger, sale of substantial assets, loan or substantial issuance of stock, with an interested stockholder, or an interest stockholder's affiliates and associates, for a three-year period beginning on the date the interested stockholder acquires 15% or more of the outstanding voting stock of the corporation. The restrictions on business combinations do not apply if: . the board of directors gives prior approval to the transaction in which the 15% ownership level is exceeded; . the interested stockholder acquires at one time at least 85% of the corporation's stock (excluding those shares owned by persons who are directors and also officers as well as employee stock plans in which employees do not have a confidential right to vote); or . the business combination is approved by the board of directors and authorized at a meeting of stockholders by the holders of at least two- thirds of the outstanding voting stock, excluding shares owned by the interested stockholder. Although a Delaware corporation may elect, pursuant to its certificate or bylaws, not to be governed by this provision, none of LearningStar's restated certificate of incorporation, amended and restated bylaws, SmarterKids.com's amended and restated certificate of incorporation or amended and restated bylaws contain such an election or other limitation on the applicability of this provision. 130 The California Limited Liability Company Act does not provide any similar business combination provisions with respect to limited liability companies. Other Anti-Takeover Provisions The Delaware General Corporation Law does not contain a control share acquisition statute which restricts the voting rights of a person who acquires a controlling interest in the corporation to those voting rights which are conferred by the stockholders at a meeting. The California Limited Liability Company Act does not provide any similar control share acquisition statutes. Dissenter's Appraisal Rights Under the Delaware General Corporation Law, stockholders may exercise a right of dissent from certain corporate actions and obtain payment of the fair value of their shares. This remedy is an exclusive remedy, except where the corporate action involves fraud or illegality. Under the Delaware General Corporation Law, dissenters' rights are limited. Appraisal rights are available only in connection with certain statutory mergers or consolidations, amendments to the certificate of incorporation (if so provided in the certificate of incorporation), any merger or consolidation in which the corporation is a constituent corporation, or sales of all or substantially all of the assets of a corporation. The California Limited Liability Company Act provides that, if the approval of outstanding membership interests is required for a limited liability company to participate in certain corporate reorganizations, pursuant to the operating agreement of the limited liability company or otherwise, then each member of the limited liability company holding the membership interests may require the limited liability company to purchase for cash, at its fair market value, the interest owned by the member in the limited liability company. The fair market value of the dissenting membership interest is determined as of the day before the first announcement of the terms of the proposed corporate reorganization. In order to obtain this right, a dissenting member's interest must: . have been outstanding on the date for the determination of members entitled to vote on the reorganization; and . not have been voted in favor of the reorganization or have been voted against the reorganization; and the dissenting member must: . have demanded that the limited liability company purchase at its fair market value; and . have submitted for endorsement, if necessary. Neither Earlychildhood's amended articles of organization nor its amended and restated operating agreement addresses the rights of dissenting members, except to state that Earlychildhood's members must waive any dissenters' rights that they may have by law under certain circumstances in which the company is sold. 131 LEGAL MATTERS The validity of the shares of LearningStar common stock to be issued in connection with the combination will be passed upon by Testa, Hurwitz & Thibeault, LLP, Boston, Massachusetts. Testa, Hurwitz & Thibeault, LLP, counsel to SmarterKids.com, and Latham & Watkins, counsel to Earlychildhood, will pass upon certain U.S. federal income tax consequences of the combination for SmarterKids.com and Earlychildhood, respectively. EXPERTS The financial statements of SmarterKids.com as of December 31, 1998 and 1999 and for each of the three years in the period ended December 31, 1999 included in this proxy statement-prospectus have been so included in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. The consolidated financial statements of Earlychildhood LLC and subsidiary as of December 31, 1998 and 1999 and for the year ended March 31, 1998, the nine months ended December 31, 1998 and the year ended December 31, 1999, have been included herein in reliance on the report of KPMG LLP, independent accountants, appearing elsewhere herein, and upon authority of said firm as experts in accounting and auditing. The financial statements of Educational Products, Inc. as of March 31, 1999 and May 5, 1999 and the year ended March 31, 1999 and the 35-day period ended May 5, 1999 have been included herein in reliance on the report of KPMG LLP, independent accountants, appearing elsewhere herein, and upon authority of said firm as experts in auditing and accounting. OTHER MATTERS As of the date of this proxy statement-prospectus, the SmarterKids.com board of directors know of no matters that will be presented for consideration at the SmarterKids.com special meeting other than as described in this proxy statement-prospectus. If any other matters shall properly come before the special meeting or any adjournments or postponements of the special meeting and are to be voted upon, the enclosed proxy will be deemed to confer discretionary authority on the individuals named as proxies therein to vote the shares represented by such proxy as to any such matters, unless such authority is specifically withheld. The persons named as proxies intend to vote or not vote in accordance with the recommendation of the management of SmarterKids.com. 132 STOCKHOLDER PROPOSALS If the combination is completed, the first annual meeting of stockholders of LearningStar is expected to be held on or about , 2002. If the combination is not completed, the next annual meeting of SmarterKids.com stockholders is expected to be held on or about June , 2001. Subject to the foregoing, if any LearningStar stockholder intends to present a proposal at LearningStar's first annual meeting and wishes to have the proposal considered for inclusion in the proxy materials for that meeting, the holder must submit the proposal to the secretary of LearningStar in writing so as to be received at the executive offices of LearningStar no sooner than , 2001 and no later than , 2001. These proposals must also meet the other requirements of the rules of the Securities and Exchange Commission relating to stockholders' proposals. In addition to other applicable requirements, the amended and restated bylaws of LearningStar require that for business to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof, containing the information required by the LearningStar amended and restated bylaws and in writing to the Secretary of LearningStar. To be timely, a stockholder's notice containing the information required by the LearningStar bylaws must be delivered to or mailed and received at the principal executive offices of LearningStar not less than days nor more than days prior to the meeting; provided, however, that in the event less than days notice or prior disclosure of the date of the annual meeting is given or is made to stockholders, notice by a stockholder to be timely must be received no later than the close of business on the day following the day on which such notice of the date of the annual meeting was mailed or such public disclosure was made, whichever occurs first. In the event the combination is not completed, the only stockholder proposals eligible to be considered in the proxy materials for the next annual meeting of SmarterKids.com will be those which were duly submitted to the Secretary of SmarterKids.com by , 2001, as provided in the next annual meeting proxy statement of SmarterKids.com. 133 WHERE YOU CAN FIND MORE INFORMATION SmarterKids.com files annual, quarterly and special reports and other information with the Securities and Exchange Commission. You may read and copy any reports, statements or other information filed by SmarterKids.com at the Securities and Exchange Commission's public reference rooms in Washington, D.C., New York, New York and Chicago, Illinois. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the public reference rooms. SmarterKids.com's Securities and Exchange Commission filings are also available to the public from commercial document retrieval services and at the website maintained by the Securities and Exchange Commission at www.sec.gov. Learning Star filed with the Securities and Exchange Commission a registration statement on Form S-4 under the Securities Act of 1933, as amended, to register with the Securities and Exchange Commission the LearningStar common stock issuable pursuant to the combination agreement. This proxy statement-prospectus does not contain all the information you can find in the registration statement or the exhibits and schedules to the registration statement. For further information with respect to SmarterKids.com, Earlychildhood and the LearningStar common stock, please refer to the registration statement, including the exhibits and schedules. You may inspect and copy the registration statement, including the exhibits and schedules, as described above. Statements contained in this proxy statement-prospectus about the contents of any contract or other document are not necessarily complete, and we refer you, in each case, to the copy of such contract or other document filed as an exhibit to the registration statement. If you would like to request documents from SmarterKids.com, please do so by , 2001 to receive them before the special meeting. You should rely only on the information contained in this proxy statement- prospectus to vote on the combination. SmarterKids.com has not authorized anyone to provide you with information that is different from what is contained in this proxy statement-prospectus. This proxy statement-prospectus is dated , 2001. You should not assume that the information contained in this proxy statement-prospectus is accurate as of any date other than , 2001, and neither the mailing of this proxy statement-prospectus to SmarterKids.com stockholders nor the issuance of LearningStar common stock in the combination shall create any implication to the contrary. 134 INDEX TO FINANCIAL STATEMENTS
Page ---- SMARTERKIDS.COM, INC.: Report of Independent Accountants......................................... F-2 Balance Sheet as of December 31, 1998 and 1999............................ F-3 Statement of Operations for the years ended December 31, 1997, 1998 and 1999..................................................................... F-4 Statement of Stockholders' Equity (Deficit) for the years ended December 31, 1997, 1998 and 1999.................................................. F-5 Statement of Cash Flows for the years ended December 31, 1997, 1998 and 1999..................................................................... F-6 Notes to Financial Statements............................................. F-7 Unaudited Interim Balance Sheet as of December 31, 1999 and September 30, 2000..................................................................... F-20 Unaudited Interim Statement of Operations for the nine months ended September 30, 1999 and 2000.............................................. F-21 Unaudited Interim Statement of Cash Flows for the nine months ended September 30, 1999 and 2000.............................................. F-22 Unaudited Notes to Interim Financial Statements........................... F-23 EARLYCHILDHOOD LLC AND SUBSIDIARY Independent Auditors' Report.............................................. F-26 Consolidated Balance Sheets as of December 31, 1998, 1999 and September 30, 2000 (Unaudited)..................................................... F-27 Consolidated Statements of Operations for the year ended March 31, 1998, the nine months ended December 31, 1998, the year ended December 31, 1999 and the nine months ended September 30, 1999 (Unaudited) and 2000 (Unaudited).............................................................. F-28 Consolidated Statements of Members' Equity for the year ended March 31, 1998, the nine months ended December 31, 1998, the year ended December 31, 1999, and the nine months ended September 30, 2000 (Unaudited)....... F-29 Consolidated Statements of Cash Flows for the year ended March 31, 1998, the nine months ended December 31, 1998, the year ended December 31, 1999 and the nine months ended September 30, 1999 (Unaudited) and 2000 (Unaudited).............................................................. F-30 Notes to Consolidated Financial Statements................................ F-31 EDUCATIONAL PRODUCTS, INC. Independent Auditors' Report.............................................. F-49 Balance Sheets as of March 31, 1999 and May 5, 1999....................... F-50 Statements of Operations for the year ended March 31, 1999 and for the thirty-five-day period ended May 5, 1999................................. F-51 Statements of Stockholders' Equity for the year ended March 31, 1999 and for the thirty-five-day period ended May 5, 1999......................... F-52 Statements of Cash Flows for the year ended March 31, 1999 and for the thirty-five-day period ended May 5, 1999................................. F-53 Notes to Financial Statements............................................. F-54
REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of SmarterKids.com, Inc.: In our opinion, the accompanying balance sheet and the related statements of operations, of stockholders' equity (deficit), and of cash flows present fairly, in all material respects, the financial position of SmarterKids.com, Inc. at December 31, 1998 and 1999, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Boston, Massachusetts February 15, 2000 F-2 SMARTERKIDS.COM, INC. BALANCE SHEET (In thousands, except share data)
December 31, ----------------- 1998 1999 ------- -------- ASSETS Current assets: Cash and cash equivalents..................................... $ 4,273 $ 55,621 Short-term investments........................................ -- 11,735 Accounts receivable, net of allowance for doubtful accounts of $27 at December 31, 1998 and 1999............................ 915 132 Other receivable.............................................. -- 486 Inventories................................................... 104 8,902 Other current assets.......................................... 153 1,917 ------- -------- Total current assets........................................ 5,445 78,793 Property and equipment, net..................................... 44 2,421 Intangible assets, net.......................................... -- 621 Restricted cash................................................. -- 500 Other assets.................................................... 15 -- ------- -------- Total assets................................................ $ 5,504 $ 82,335 ======= ======== LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Current portion of long term debt and capital lease obligations.................................................. $ 41 $ 74 Accounts payable.............................................. 833 10,996 Accrued expenses.............................................. 787 6,699 Deferred revenue.............................................. -- 811 Sales returns allowances...................................... 718 87 ------- -------- Total current liabilities................................... 2,379 18,667 Long term debt and capital lease obligations, net of current portion........................................................ -- 34 ------- -------- Total liabilities........................................... 2,379 18,701 ------- -------- Commitments and contingencies (Note 12)......................... -- -- Redeemable preferred stock: Series B redeemable convertible preferred stock, $0.01 par value; 3,518 shares authorized, issued and outstanding at December 31, 1998; no shares authorized, issued and outstanding at December 31, 1999 ............................ 7,036 -- Series A convertible preferred stock, $0.01 par value; 687 shares authorized, issued and outstanding at December 31, 1998; no shares authorized, issued and outstanding at December 31, 1999............................................ 3,251 -- ------- -------- Total redeemable preferred stock............................ 10,287 -- ------- -------- Stockholders' equity (deficit): Preferred stock, $0.01 par value; no and 10,000,000 shares authorized; no shares issued or outstanding, at December 31, 1998 and 1999, respectively.................................. -- -- Common stock, $0.01 par value; 10,000,000 and 90,000,000 shares authorized; 1,628,510 and 20,301,770 shares issued and outstanding, at December 31, 1998 and 1999, respectively..... 16 203 Additional paid-in capital.................................... 2,530 112,907 Deferred stock compensation................................... (1,435) (6,286) Accumulated deficit........................................... (8,273) (43,190) ------- -------- Total stockholders' equity (deficit)........................ (7,162) 63,634 ------- -------- Total liabilities, redeemable preferred stock and stockholders' equity (deficit)............................. $ 5,504 $ 82,335 ======= ========
The accompanying notes are an integral part of these financial statements. F-3 SMARTERKIDS.COM, INC. STATEMENT OF OPERATIONS (In thousands, except share data)
Year Ended December 31, ------------------------------- 1997 1998 1999 --------- --------- --------- Net revenues: Online retail............................... $ -- $ 22 $ 5,421 Proprietary CD-ROM.......................... 1,416 2,278 -- --------- --------- --------- Total net revenues........................ 1,416 2,300 5,421 --------- --------- --------- Cost of revenues: Online retail............................... -- 20 4,005 Proprietary CD-ROM.......................... 491 908 -- --------- --------- --------- Total cost of revenues.................... 491 928 4,005 --------- --------- --------- Gross profit.................................. 925 1,372 1,416 --------- --------- --------- Operating expenses: Marketing and sales (excluding stock compensation of $15, $91 and $1,216 for 1997, 1998 and 1999, respectively)......... 756 2,678 28,916 Development (excluding stock compensation of $0, $60 and $1,143 for 1997, 1998 and 1999, respectively).............................. 721 1,378 1,721 General and administrative (excluding stock compensation of $0, $36 and $1,046 for 1997, 1998 and 1999, respectively)......... 430 490 2,854 Stock compensation.......................... 15 187 3,405 --------- --------- --------- Total operating expenses.................. 1,922 4,733 36,896 --------- --------- --------- Loss from operations.......................... (997) (3,361) (35,480) Interest income............................... 3 41 732 Interest expense.............................. (15) (18) (16) Other income (expense), net................... (5) (4) 36 --------- --------- --------- Net loss...................................... (1,014) (3,342) (34,728) Accretion of redeemable preferred stock....... (67) (254) (189) --------- --------- --------- Net loss attributable to common stockholders.. $ (1,081) $ (3,596) $ (34,917) ========= ========= ========= Basic and diluted net loss per common share... $ (0.72) $ (2.34) $ (9.20) Weighted average shares-basic and diluted..... 1,502,148 1,533,524 3,795,967
The accompanying notes are an integral part of these financial statements. F-4 SMARTERKIDS.COM, INC. STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) (In thousands, except share data)
Total Common Stock Additional Deferred Stockholders' ----------------- Paid-In Stock Accumulated Equity Shares Amount Capital Compensation Deficit (Deficit) ---------- ------ ---------- ------------ ----------- ------------- Balance at December 31, 1996....................... 1,501,875 $ 15 $ 790 $ -- $ (3,596) $ (2,791) Issuance of common stock pursuant to exercise of stock options................................... 875 -- -- -- Accretion of redeemable preferred stock related to issuance costs............................... 18 (67) (49) Issuance of stock options to consultants......... 11 11 Deferred stock compensation related to employee stock option grants............................. 62 (62) -- Amortization of deferred stock compensation...... 4 4 Net loss......................................... (1,014) (1,014) ---------- ---- -------- ------- -------- -------- Balance at December 31, 1997....................... 1,502,750 15 881 (58) (4,677) (3,839) Issuance of common stock pursuant to exercise of stock options................................... 125,760 1 9 10 Accretion of redeemable preferred stock related to issuance costs............................... 69 (254) (185) Issuance of warrants for amendment of debt agreement....................................... 7 7 Issuance and revaluation of stock options and warrants to consultants......................... 106 106 Deferred stock compensation related to employee stock option grants............................. 1,458 (1,458) -- Amortization of deferred stock compensation...... 81 81 Net loss......................................... (3,342) (3,342) ---------- ---- -------- ------- -------- -------- Balance at December 31, 1998....................... 1,628,510 16 2,530 (1,435) (8,273) (7,162) Issuance of common stock pursuant to exercise of stock options................................... 497,028 5 110 115 Issuance of common stock to acquire intangible assets.......................................... 33,000 -- 445 445 Issuance of common stock warrants in connection with issuance of Series C redeemable preferred stock........................................... 515 515 Conversion of redeemable preferred stock to common stock.................................... 12,732,887 127 35,096 35,223 Accretion of redeemable preferred stock related to issuance costs............................... (189) (189) Issuance and revaluation of stock options and warrants to consultants......................... 2,758 (1,550) 1,208 Issuance of common stock pursuant to the exercise of warrants..................................... 251,845 3 63 66 Issuance of common stock in initial public offering........................................ 5,158,500 52 65,892 65,944 Deferred stock compensation related to employee stock option grants............................. 5,734 (5,734) -- Cancellation of unvested employee stock options.. (236) 236 -- Amortization of deferred stock compensation related to employee stock options............... 2,197 2,197 Net loss......................................... (34,728) (34,728) ---------- ---- -------- ------- -------- -------- Balance at December 31, 1999....................... 20,301,770 $203 $112,907 $(6,286) $(43,190) $ 63,634 ========== ==== ======== ======= ======== ========
The accompanying notes are an integral part of these financial statements. F-5 SMARTERKIDS.COM, INC. STATEMENT OF CASH FLOWS (In thousands)
Year Ended December 31, -------------------------- 1997 1998 1999 ------- ------- -------- Increase (Decrease) in Cash and Cash Equivalents Cash flows from operating activities: Net loss......................................... $(1,014) $(3,342) $(34,728) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization.................. 60 66 296 Compensation expense related to stock option and warrant grants............................ 15 187 3,405 Debt issue costs............................... -- 7 -- Changes in assets and liabilities: Accounts receivable............................ (22) (348) 783 Other receivable............................... -- -- (486) Inventories.................................... (1) 50 (8,798) Other assets................................... (31) (114) (1,749) Accounts payable............................... (16) 521 10,163 Accrued expenses............................... 54 482 5,912 Deferred revenue............................... -- -- 811 Sales return allowance......................... 8 477 (631) ------- ------- -------- Net cash used in operating activities.............. (947) (2,014) (25,022) ------- ------- -------- Cash flows from investing activities: Purchase of short-term investments............... -- -- (11,735) Purchases of property and equipment.............. (18) (33) (2,451) Purchase of intangible assets.................... -- -- (250) (Deposit) release of restricted cash............. 199 -- (500) ------- ------- -------- Net cash provided by (used in) investing activities........................................ 181 (33) (14,936) ------- ------- -------- Cash flows from financing activities: Net proceeds from issuance of common stock....... -- -- 65,944 Net proceeds from issuance of Series C redeemable preferred stock................................. -- -- 25,262 Net proceeds from issuance of Series B redeemable preferred stock................................. 710 6,091 -- Net proceeds from sale-leaseback of property and equipment....................................... 112 -- Repayments of long-term debt and capital lease obligations..................................... (196) (74) (81) Proceeds from exercise of common stock options... -- 10 115 Proceeds from exercise of common stock warrants.. -- -- 66 ------- ------- -------- Net cash provided by financing activities.......... 626 6,027 91,306 ------- ------- -------- Net increase (decrease) in cash and cash equivalents....................................... (140) 3,980 51,348 Cash and cash equivalents at beginning of year..... 433 293 4,273 ------- ------- -------- Cash and cash equivalents at end of year........... $ 293 $ 4,273 $ 55,621 ======= ======= ======== Supplemental disclosure of cash flow information: Cash paid during the year for interest........... $ 15 $ 11 $ 28 Supplemental disclosure of noncash investing and financing activities: Capital lease obligations incurred for property and equipment................................... $ 112 $ -- $ 148 Issuance of warrants to purchase common stock in exchange for services related to Series B redeemable preferred stock offerings............ $ 18 $ 69 $ 515 Issuance of common stock in exchange for purchase of intangible assets............................ $ -- $ -- $ 445
The accompanying notes are an integral part of these financial statements. F-6 SMARTERKIDS.COM, INC. NOTES TO FINANCIAL STATEMENTS 1. Formation and Operations of the Company: SmarterKids.com, Inc. (the "Company") is an online retailer focused on children's educational books, toys and games, and software. Prior to 1999, the Company was engaged in developing, marketing and selling proprietary educational and entertainment software. The Company primarily sold its products to national distributors and its principal market was the domestic consumer market. In March 1998, the Company commenced development of the SmarterKids.com website. In November 1998, the Company began transitioning its business model to online sales of third-party educational products. In November 1998, the Company launched its website, ceased the sale of proprietary CD-ROM products through traditional retail channels, and now uses its proprietary CD-ROM products on a limited basis for promotional events. The Company was incorporated in Delaware on March 28, 1994 and changed its name to Virtual Knowledge, Inc. effective August 4, 1997. Effective September 1998, the Company changed its name to SmarterKids.com, Inc. 2. Summary of Significant Accounting Policies: Cash and Cash Equivalents The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The Company invested its excess cash primarily in money market funds at major financial institutions and fixed income notes secured by U.S. Government-backed securities in 1998 and 1999. These investments are subject to minimal credit and market risks. At December 31, 1998 and 1999, total cash and cash equivalents were $4,273,000 and $55,621,000, respectively. The cash equivalent investments were stated at amortized cost plus accrued interest, which approximates market value. Financial Instruments The Company's financial instruments consist of cash and cash equivalents, short-term investments, accounts receivable, accounts payable, long-term debt and capital lease obligations. The carrying amounts of these instruments at December 31, 1998 and 1999 approximate their fair values. The Company's short-term investments consist of short-term debt securities, which are classified at the date of purchase as held to maturity. Investments with remaining maturities of less than twelve months from the balance sheet date are classified as short-term. At December 31, 1999, these investments were stated at amortized cost plus accrued interest, which approximates market value. Inventories Inventories are stated at the lower of cost or market value, cost being determined on a first-in, first-out basis. All inventory consists of finished goods. Property and Equipment Property and equipment assets are recorded at cost and depreciated using the straight-line method over their estimated useful lives, generally three years. Intangible Assets Costs incurred for acquiring trademarks and domain names are capitalized as intangible assets and amortized over their estimated useful lives, generally two years, using the straight-line method. Amortization expense related to intangibles assets for the year ended December 31, 1999 was $74,000. F-7 SMARTERKIDS.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) Long-Lived Assets The Company evaluates the recoverability of its property and equipment and intangible assets in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets to be Disposed of" ("SFAS 121"). SFAS 121 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the estimated future undiscounted cash flows attributable to such assets or the business to which such intangible assets relate. No impairments were required to be recognized during the years ended December 31, 1997, 1998 or 1999. Concentrations of Credit Risk and Significant Customers Management believes its credit policies are prudent and reflect normal industry terms and business risk. The Company does not anticipate non- performance by counter parties and, accordingly, does not require collateral. At December 31, 1998, the Company's three largest customers, all of which were distributors of the Company's proprietary CD-ROM products, accounted for 96% of total amounts due to the Company. At December 31, 1999 no customer accounted for more than 10% of total amounts due to the Company. Sales to four customers accounted for 16%, 14%, 16% and 25% of the Company's total net revenue in 1997. Sales to two customers accounted for 40% and 35% of the Company's total net revenue in 1998. No customers accounted for more than 10% of the Company's total net revenue during in 1999. Concentrations of Vendor and Distributor Risk The Company outsources all of its receiving, handling and warehousing of inventory as well as its fulfillment of customer orders to one distributor. Although this creates a concentration in sources of distribution, management believes that other distributors are available to provide similar services on comparable terms. A failure of or a change in the Company's distributor who provides these services could cause a delay in the receiving and movement of inventory, as well as the fulfillment of orders. Such delays could result in the possible loss of sales, which would adversely affect operating results. Purchases of inventory from the Company's two largest vendors accounted for approximately 15% and 13% of total inventory purchases in 1999. Although this creates a concentration in sources of supply, management believes that other vendors are available to provide similar products on comparable terms. A failure of or change in the Company's vendor, however, could cause a delay in the fulfillment of orders and a possible loss of sales, which would adversely affect operating results. Revenue Recognition The Company recognizes revenue from product sales, net of any discounts and allowances made for estimated product returns, when the products are shipped to customers, provided that no significant Company obligations remain and collection of the receivable is probable. Outbound shipping and handling charges billed to customers are included in net revenues. Cost of Revenues Cost of revenues consist of the cost of merchandise sold to customers and the Company's shipping costs. Marketing and Sales Expenses Marketing and sales expenses consist primarily of advertising and promotional expenditures, as well as payroll and related costs for personnel engaged in marketing and sales. Fulfillment costs related to online retail F-8 SMARTERKIDS.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) products, including the outsourced cost of operating and staffing warehousing and distribution centers as well as customer service, are also included in marketing and sales expenses. Advertising costs are charged to operations as incurred. Advertising expenses for 1997, 1998 and 1999 were $276,000, $1,154,000 and $21,314,000, respectively. Stock Compensation Stock options issued to employees and members of the Company's Board of Directors are accounted for in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations; accordingly, compensation expense is recorded for options awarded to employees and directors to the extent that the exercise prices are less than the common stock's fair market value on the date of grant, where the number of options and exercise price are fixed. The difference between the fair value of the Company's common stock and the exercise price of the stock option is recorded as deferred stock compensation. Deferred stock compensation is amortized to compensation expense over the vesting period of the underlying stock option. The Company follows the disclosure requirements of Statement of Financial Accounting Standards No. 123, "Accounting for Stock- Based Compensation" ("SFAS 123") (Note 9). All stock-based awards to non- employees are accounted for at their fair value in accordance with SFAS 123. Net loss per common share The Company computes net loss per common share in accordance with SFAS No. 128, "Earnings Per Share," and SEC Staff Accounting Bulletin No. 98. Under the provisions of SFAS 128 and SAB 98, basic net loss per common share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding. The calculation of diluted net loss per common share for the years ended December 31, 1997, 1998 and 1999 does not include 1,547,351, 2,775,141 and 3,017,400 potential shares of common stock equivalents, respectively, as their inclusion would be antidilutive. Segment Reporting In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"). This statement requires companies to report information about operating segments consistent with management's internal view of the Company. The Company adopted SFAS 131 effective for its fiscal year ended December 31, 1998. The Company operates in a single segment: retail domestic software and other product sales. The Company has no organizational structure dictated by product lines, geography or customer type. Comprehensive Income In June 1997, the FASB issued SFAS No. 130, "Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. Adoption of SFAS 130 did not impact the Company's financial statements as the Company had no items of other comprehensive income during the three-year period ended December 31, 1999. 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 F-9 SMARTERKIDS.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) liabilities and the disclosures of contingent liabilities at the period end, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Recent Accounting Pronouncements In December 1999, the SEC staff released Staff Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements", which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. Subsequently, SAB 101 A and B have been released which direct the application of the guidance in SAB 101 to be required in the Company's fourth quarter of 2000. The effects of applying this guidance, if any, will be reported as a cumulative effect adjustment resulting from a change in accounting principle. The Company is evaluating the impact of SAB 101 adoption on its financial statements. In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" as amended by SFAS No. 138, which was issued in June 2000. The Company will adopt SFAS No. 133 on January 1, 2001. SFAS No. 133 requires that all derivative instruments be reported on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. The Company has not yet determined the impact of the adoption of SFAS No. 133 on its financial condition, results of operations, or business practices. 3. Allowances for Doubtful Accounts and Sales Returns: Allowances for doubtful accounts and sales returns consist of the following (in thousands):
December 31, ------------------- 1997 1998 1999 ----- ----- ----- Balance at beginning of year............................... $ 262 $ 269 $ 745 Additions: Charged against revenues or expense...................... 237 601 360 Deductions: Write-offs and returns................................... (230) (125) (991) ----- ----- ----- Balance at end of year..................................... $ 269 $ 745 $ 114 ===== ===== =====
4. Property and Equipment: Property and equipment consist of the following (in thousands):
December 31, ----------- 1998 1999 ---- ------ Software........................................................ $ 28 $ 377 Furniture and fixtures.......................................... 5 207 Computer and office equipment................................... 233 1,774 Leasehold improvements.......................................... -- 507 ---- ------ 266 2,865 Less--Accumulated depreciation and amortization................. 222 444 ---- ------ $ 44 $2,421 ==== ======
F-10 SMARTERKIDS.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) Furniture and fixtures and computer and office equipment includes $214,000 at December 31, 1998 and $362,000 at December 31, 1999 related to assets held under capital leases. Accumulated depreciation related to assets held under these leases was $214,000 and $265,000 at December 31, 1998 and 1999, respectively. Depreciation and amortization expense for the years ended December 31, 1997, 1998 and 1999 was $60,000, $66,000 and $222,000, respectively. 5. Accrued Expenses: Accrued expenses consist of the following (in thousands):
December 31, ------------- 1998 1999 ------------- Marketing...................................................... $ 268 $ 261 Commissions.................................................... 94 171 Professional fees.............................................. 172 105 Advertising.................................................... 159 5,724 Other.......................................................... 94 438 ----- ------- $ 787 $ 6,699 ===== =======
6. Preferred Stock: In October 1995, the Company authorized 10,000 shares of preferred stock and designated 687 preferred shares as Series A convertible preferred stock (the "Series A preferred"). The Company sold 634 shares of Series A preferred to an entity affiliated with a common stockholder and member of the Board of Directors of the Company for net proceeds of $3,000,000. In addition, 53 shares of Series A preferred were issued in connection with the conversion of a $240,000 note payable, plus accrued interest of $11,000, due to the same common stockholder. In 1997, the Company designated and sold 380 shares of Series B redeemable convertible preferred stock (the "Series B preferred") for net proceeds of $710,000. Included in this offering, the Company sold 125 shares of the Series B preferred for net proceeds of $234,000 to an entity with which the Company subsequently entered a marketing and licensing agreement. The Company also entered into a stock purchase agreement with this entity allowing for the purchase of preferred stock having a conversion value of 250,000 common shares, at the same terms as the Series B preferred. The option expired unexercised in July 1998. As payment for certain costs associated with the issuance of the Series B preferred, the Company issued warrants to purchase 66,000 shares of common stock (Note 8). In 1998, the Company issued an additional 3,138 shares of the Series B preferred for net proceeds of $6,091,000. As payment for certain costs associated with the issuance of the Series B preferred, the Company issued warrants to purchase 55,050 shares of common stock (Note 8). In July 1999, the Company designated and sold 4,284,091 shares of Series C redeemable convertible preferred stock (the "Series C preferred") for net proceeds of $25.3 million. As payment for certain costs associated with the issuance of the Series C preferred, the Company issued warrants to purchase 113,027 shares of the Series C preferred (Note 8). The Series C preferred was recorded upon issuance based on the net proceeds less the $515,000 value of the warrants related to the issuance. The difference between the total net proceeds at issuance and the total redemption value was being charged to accumulated deficit over the period from issuance until redemption first became available. F-11 SMARTERKIDS.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) In November 1999, each Series A and Series B preferred share automatically converted into 1,500 shares of common stock and each Series C preferred share automatically converted into 1.5 shares of common stock upon the closing of the Company's initial public offering of common stock (Note 7). 7. Common Stock: On September 7, 1999, the Board of Directors authorized a 3-for-2 stock split of the Company's common stock, which was effective upon the filing of the Company's Amended and Restated Certificate of Incorporation in connection with the Company's initial public offering of common stock. As a result, all common stock share data included in the accompanying financial statements and notes were retroactively restated for this split. In September 1999, the Company issued 25,500 shares of common stock valued at $340,000 in connection with the acquisition of intangible assets. In November 1999, the Company issued 7,500 shares of common stock valued at $105,000 in connection with the acquisition of intangible assets. On November 23, 1999, the Company completed its initial public offering of 5,158,500 shares of common stock resulting in net proceeds of $65,944,000. In connection with the closing of the offering, all outstanding convertible preferred stock was converted into an aggregate 12,732,887 shares of common stock. Additionally, all warrants for the purchase of preferred stock were converted into warrants for the purchase of shares of common stock. The redemption rights of the 25,500 shares of redeemable common stock were automatically eliminated upon the Company's initial public offering of common stock. 8. Warrants: In 1997 and 1998, in connection with issuance of the Series B preferred (Note 6), the Company issued warrants to purchase a total of 66,000 and 55,050 shares, respectively, of the Company's common stock with an exercise price of $0.13 per share. These warrants were exercisable immediately and expire at the earlier of a change in control of the Company, completion of an initial public offering, or five years from the date of grant. The fair values ascribed to these warrants at the time of issuance were estimated by management to be $18,000 and $69,000 for 1997 and 1998, respectively. The values of these warrants were recorded as an increase to accumulated deficit and an increase to additional paid-in capital. In October 1999, these warrants were exercised for 121,050 shares of common stock at $0.13 per share. In March 1998, in connection with an amended debt agreement, the Company granted warrants to purchase 5 shares of Series B preferred stock with an exercise price of $2,000 per share. These warrants were exercisable immediately and expire in five years. The fair value ascribed to these warrants was $7,000 and was recorded as interest expense in 1998. Upon completion of the Company's initial public offering in November 1999, these warrants converted into warrants to purchase 7,500 shares of common stock at an exercise price of $1.33 per share. In September 1998, in connection with a warehousing and fulfillment services agreement, the Company issued warrants to its distribution partner to purchase 57,000 shares of the Company's common stock with an exercise price of $1.33 per share. Of these warrants, 15,000 shares vested immediately. Warrants for an additional 42,000 shares vested in increments of 10,500 every six months, commencing on March 1, 1999. These warrants expire in five years and were remeasured at each reporting period until they vested. The fair value ascribed to these warrants initially was $51,000, which was recorded as compensation expense in 1998. In September 1999, in connection with amending and further formalizing the warehouse and fulfillment services agreement, the Company granted additional warrants to purchase 108,000 shares of the Company's F-12 SMARTERKIDS.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) common stock with an exercise price of $1.33 per share. These warrants expire in five years and were exercisable immediately. Also, the previously granted warrants for 57,000 shares were amended to be fully exercisable immediately. Accordingly, the fair market value of these previously unvested warrants was determined final upon the amendment. The fair value of the newly issued warrants was determined final when granted. The final value of all of these warrants was determined to be $1,448,000. As of December 31, 1999, deferred stock compensation related to all of the warrants held by the fulfillment service provider was $1,207,000, which is being amortized to compensation expense over the term of the service agreement as the services are performed. Amortization expense related to these warrants of $241,000 was recorded during the year ended December 31, 1999. In December 1998, in connection with a management consulting services agreement, the Company granted warrants to a consultant to purchase 22,500 shares of the Company's common stock with an exercise price of $1.33 per share. These warrants were exercisable immediately and were set to expire at the earlier of a change in control of the Company, completion of an initial public offering, or five years from the date of grant. The fair value ascribed to these warrants at the time of issuance was $22,000 and was recorded as compensation expense in 1998 as this was the period in which the services were provided. In October 1999, these warrants were exercised for 22,500 shares of common stock. In March 1999, in connection with a promotional services program, the Company issued warrants to an affiliated party to purchase 112,500 shares of the Company's common stock with an exercise price of $1.33 per share. These warrants vest upon the attainment of certain performance targets and expire in five years. The final value of these warrants will be determined upon the attainment of these performance targets based on their then-current fair value. As of December 31, 1999, the fair value of this grant was $741,000. Related compensation expense of $520,000 was recorded in the year ended December 31, 1999. The remaining deferred stock compensation is to be recognized over the period that the services are provided. In July 1999, in connection with the issuance of the Series C redeemable convertible preferred stock (Note 7), the Company issued warrants to purchase 113,027 shares of the Company's Series C preferred stock at an exercise price of $6.27 per share. These warrants were convertible into warrants to purchase shares of the Company's common stock based on an exchange ratio of 1.5 shares of common stock for each share of Series C preferred. These warrants were exercisable immediately and were set to expire at the earlier of a change in control of the Company, completion of an initial public offering, or four years from the date of grant. The value ascribed to these warrants was $515,000, based on the fair value on the date of issuance. The value ascribed to these warrants was recorded as a discount to the Series C preferred stock upon issuance. The discount was being accreted to the Series C preferred stock balance over the period from the date of issuance through the expected mandatory redemption date until the conversion of the preferred stock into common stock at the initial public offering date. On November 22, 1999, a portion of these warrants were exercised for 93,295 shares of common stock. Consideration for the exercise price of these warrants was not cash, but the forfeiture of the warrants for the remaining 76,246 shares, which had an aggregate value on the exercise date equal to the exercise price for the warrants. In September 1999, in connection with a management consulting services agreement, the Company granted warrants to a consultant to purchase 15,000 shares of the Company's common stock with an exercise price of $1.33 per share. These warrants were exercisable immediately and expire at the earlier of a change in control of the Company, completion of an initial public offering, or five years from the date of grant. The fair value ascribed to these warrants at the time of issuance was $213,000 and was recorded as compensation expense during 1999, the period in which the services were provided. In October 1999, these warrants were exercised for 15,000 shares of common stock. F-13 SMARTERKIDS.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) A summary of the status of stock warrants for the three years ended December 31, 1999 is presented below:
Number of Weighted- Shares Average of Common Exercise Stock Price --------- --------- Outstanding--December 31, 1996.......................... -- $ -- Granted (weighted average fair value of $0.28)........ 66,000 0.13 Exercised............................................. -- -- Forfeited............................................. -- -- -------- Outstanding--December 31, 1997.......................... 66,000 0.13 Granted (weighted average fair value of $0.97)........ 142,050 0.87 Exercised............................................. -- -- Forfeited............................................. -- -- -------- Outstanding--December 31, 1998.......................... 208,050 0.64 Granted (weighted average fair value of $3.14)........ 405,041 2.52 Exercised............................................. (251,845) 1.81 Forfeited............................................. (76,246) 4.18 -------- Outstanding--December 31, 1999.......................... 285,000 1.33 ======== =====
The fair value of each warrant during 1999, 1998 and 1997 was estimated on the applicable measurement dates using the Black-Scholes option pricing model with the following assumptions:
1997 1998 1999 ---- ---- ----- Dividend yield............................................ 0.0% 0.0% 0.0% Expected volatility....................................... 90.0% 90.0% 90.0% Risk-free interest rate................................... 6.1% 5.0% 5.4% Expected life (years)..................................... 5 5 4 to 5
9. Stock Option Plan: In 1995, the Company adopted the 1995 Stock Plan (the "Plan"). The Plan provides for issuance of incentive stock options to employees of the Company and nonqualified stock options, awards of stock, and direct stock purchase opportunities to directors, officers, employees and consultants of the Company. The Board of Directors determines the term of each option, option price, number of shares for which each option is granted and the rate at which each option is exercisable. The total number of shares of common stock that may be issued under the Plan is 3,822,000. For holders of 10% or more of the Company's outstanding common stock, options may not be granted at less than 110% of the fair market value of the common stock at the date of grant, and the option term may not exceed five years. The option term for nonqualified stock options may not exceed ten years from the date of grant. During the years ended December 31, 1998 and 1999, 1,238,251 and 1,207,501 options were granted under the 1995 Plan, respectively. 1999 Stock Option and Incentive Plan In September 1999, the Board of Directors voted to terminate the 1995 Stock Option Plan effective on November 23, 1999, the date of the consummation of the Company's initial public offering and approved the adoption of the 1999 Stock Option and Incentive Plan (the "1999 Plan"). The 1999 Plan provides for the grant of stock-based awards to employees, officers and directors, and consultants or advisors, including incentive F-14 SMARTERKIDS.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) stock options and non-qualified stock options and other equity-based awards. A total of 2,000,000 shares of common stock may be issued upon the exercise of options or other awards granted under the 1999 Plan. As of December 31, 1999, 994,348 options were granted under the 1999 Plan. 1999 Non-Employee Director Stock Option Plan The 1999 Non-Employee Director Stock Option Plan (the "Director Plan") was adopted by the Board of Directors and approved by stockholders in September 1999 and became effective on November 23, 1999. The Director Plan provides for the grant of options to purchase a maximum of 200,000 shares of common stock of the Company to non-employee directors of the Company. A committee appointed by the Board of Directors will administer the Director Plan. Under the Director Plan, each director who is not an employee or officer of the Company and who was not a director at the time of the Company's initial public offering will be automatically granted on the date such person is first elected to the Board of Directors an option to purchase 45,000 shares of common stock. Each time a non- employee director is re-elected to the Board, such non-employee director will automatically receive an option to purchase 2,000 shares of common stock. Provided that the director continues to serve as a member of the Board of Directors, one-third of the shares included in each grant will become exercisable on each of the first, second and third anniversaries of the date of grant. All options granted under the Director Plan will have an exercise price equal to the fair market value of the common stock on the date of grant. As of December 31, 1999, no options have been granted under the Director Plan. 1999 Employee Stock Purchase Plan The 1999 Employee Stock Purchase Plan (the "Stock Purchase Plan") was adopted by the Board of Directors and approved by stockholders in September 1999, and became effective upon completion of the Company's initial public offering in November 1999. The Stock Purchase Plan provides for the issuance of a maximum of 400,000 shares of common stock. The Board of Directors and the Compensation Committee administer the Stock Purchase Plan. All employees whose customary employment is for more than 20 hours per week and for more than three months in any calendar year and who have completed more than 1 day of employment on or before the first day of any six-month payment period are eligible to participate in the Stock Purchase Plan. Outside directors and employees who would own 5% or more of the total combined voting power or value of the Company's common stock immediately after the grant may not participate in the Stock Purchase Plan. As of December 31, 1999, no shares have been issued under the Stock Purchase Plan. The Company recorded deferred stock compensation of $62,000, $1,458,000 and $5,734,000 in 1997, 1998 and 1999, respectively, related to employee stock option grants. The Company recognized $4,000, $81,000 and $2,197,000 in non- cash stock compensation expense related to amortization of deferred stock compensation on employee stock option grants during 1997, 1998 and 1999, respectively. During 1997, 1998 and 1999, the Company granted nonqualified stock options under the Plan to non-employees, for services performed, to purchase 30,000, 5,250 and 44,250 shares of common stock, respectively. Accordingly, the Company recorded stock compensation expense of $11,000, $33,000 and $234,000 in 1997, 1998 and 1999, respectively. Such amounts were determined under the Black- Scholes model based on the fair value of the options granted, including adjustments for revaluation at each period-end for unvested options. F-15 SMARTERKIDS.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) A summary of the activity under the Company's Plan for the three years ended December 31, 1999 is presented below:
Weighted- Average Number of Exercise Shares Price --------- --------- Outstanding--December 31, 1996.......................... 1,223,100 $0.37 Granted (weighted average fair value of $0.15)........ 562,500 0.13 Exercised............................................. (875) 0.10 Forfeited............................................. (303,375) 1.35 --------- Outstanding--December 31, 1997.......................... 1,481,350 0.07 Granted (weighted average fair value of $1.22)........ 1,238,251 0.14 Exercised............................................. (125,760) 0.08 Forfeited............................................. (26,750) 0.13 --------- Outstanding--December 31, 1998.......................... 2,567,091 0.07 Granted (weighted average fair value of $7.96)........ 2,201,849 7.72 Exercised............................................. (497,028) 0.23 Forfeited............................................. (97,713) 0.85 --------- Outstanding--December 31, 1999.......................... 4,174,199 4.09 =========
At December 31, 1997, 1998, and 1999, the Company maintained options available for future grants of 87,900, 1,126,400, and 1,082,263, respectively. The following table summarizes information about stock options outstanding at December 31, 1999:
Weighted- Average Weighted - Remaining Weighted- Average Contractual Average Number Exercise Price Exercise Number Life Exercise of Shares for Exercisable Price of Shares (years) Price Exercisable Options - -------- --------- ----------- --------- ----------- --------------- $ 0.02 315,000 5.7 $ 0.02 315,000 $0.02 0.06- 0.13 1,744,500 8.4 0.13 1,228,470 0.13 0.15- 0.33 546,000 8.8 0.15 546,000 0.15 1.33- 4.18 126,900 9.6 3.25 -- -- 11.00- 14.00 1,441,799 9.8 11.34 -- -- --------- --------- 4,174,199 2,089,470 ========= =========
At December 31, 1997 and 1998, of the options outstanding, 771,606 and 988,515, respectively, were exercisable. The fair value of each option grant during 1997, 1998 and 1999 is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:
1997 1998 1999 ---- ---- ---- Dividend yield............................................. 0.0% 0.0% 0.0% Expected volatility........................................ 0.0% 0.0% 90.0% Risk-free interest rate.................................... 6.1% 5.0% 5.4% Expected life (years)...................................... 5 5 5
In March 1997, the Company's Board of Directors determined that because certain options held by an employee of the Company had an exercise price significantly higher than the fair value of the Company's F-16 SMARTERKIDS.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) common stock, such options were not providing the incentive intended. Accordingly, options to purchase 201,000 shares of common stock with an exercise price of $2.00 per share were cancelled and reissued at a price of $0.13 per share. The exercise price of the reissued options equaled the fair market value of the Company's common stock on the date of repricing. Stock compensation expense has been recognized for options granted to employees pursuant to APB 25. Had stock compensation cost been determined based on the fair value of the options at the grant date consistent with the provisions of SFAS 123, the Company's net loss attributable to common stockholders would have been increased to the pro forma amounts indicated below. Because options vest over several years and additional option grants are expected to be made in future years, the pro forma results for 1997, 1998 and 1999 are not representative of pro forma results for future years.
Year Ended December 31, -------------------------- 1997 1998 1999 ------- ------- -------- Net loss attributable to common stockholders (in thousands): As reported................................. $(1,081) $(3,596) $(34,917) Pro forma................................... (1,086) (3,621) (36,639) Net loss per common share: As reported................................. $ (0.72) $ (2.34) $ (9.20) Pro forma................................... (0.72) (2.63) (9.65)
10. Income Taxes: Deferred tax assets consist of the following (in thousands):
December 31, ----------------- 1998 1999 ------- -------- Net operating loss carryforwards.......................... $ 2,261 $ 15,322 Research and development credit carryforwards............. 90 136 Stock compensation expense................................ 81 495 Other..................................................... 404 64 ------- -------- Deferred tax assets..................................... 2,836 16,017 Deferred tax asset valuation allowance.................... (2,836) (16,017) ------- -------- Net deferred tax assets................................. $ -- $ -- ======= ========
At December 31, 1999, available net operating loss carryforwards for federal and state tax purposes were approximately $38,000,000, which expire through 2019. At December 31, 1999, the Company has research and development tax credit carryforwards of approximately $99,000 and $37,000 available to reduce future federal and state tax liabilities, respectively, which expire through 2019. Under the provisions of the Internal Revenue Code, certain substantial changes in the Company's ownership could result in an annual limitation of the amount of net operating loss carryforwards and research and development credit carryforwards which can be utilized in future years. F-17 SMARTERKIDS.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) Income taxes computed using the federal statutory income tax rate differ from the Company's effective tax rate primarily due to the following (in thousands):
Year Ended December 31, ------------------------ 1997 1998 1999 ----- ------- -------- Income tax expense (benefit) at US federal statutory tax rate............................. $(345) $(1,136) $(11,807) State income taxes, net of federal tax effect... (59) (221) (2,050) Permanent items................................. 1 1 751 Other........................................... 13 (24) 75 Change in deferred tax asset valuation allowance...................................... 390 1,380 13,031 ----- ------- -------- Provision for income taxes...................... $ -- $ -- $ -- ===== ======= ========
11. Defined Contribution Plan: In January 1996, the Company adopted a defined contribution plan under Section 401(k) of the Internal Revenue Code covering substantially all employees. Under the plan, employees may contribute the lower of up to 15% of their salaries or a dollar amount prescribed by the Internal Revenue Code. The Board of Directors may elect to make a discretionary contribution to the plan. The Company made no contributions during the years ended December 31, 1997, 1998 and 1999. 12. Commitments and Contingencies: Leases The Company leases its facilities and certain computer equipment under noncancelable operating leases. Rental expense under operating leases for the years ended December 31, 1997, 1998 and 1999 was $101,000, $121,000 and $499,000, respectively. In April 1997, the Company entered into an agreement for the sale and capital leaseback of substantially all of the Company's fixed assets. Proceeds from the sale were $112,000 and the sale did not result in a gain or loss. During 1999, the Company entered into capital leases for the acquisition of certain assets. Future minimum lease obligations as of December 31, 1999 are as follows (in thousands):
Operating Capital Leases Leases --------- ------- Year Ending December 31, 2000..................................................... $1,498 $ 87 2001..................................................... 1,171 36 2002..................................................... 1,111 -- 2003..................................................... 1,017 -- 2004..................................................... 848 -- ------ ---- Total minimum lease payments........................... $5,645 123 ====== Less--amount representing interest..................... 15 ---- Total.................................................. $108 ====
F-18 SMARTERKIDS.COM, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) Restricted Time Deposit In connection with a facility lease entered into in 1999, the Company is required to maintain, on behalf of the landlord, a certificate of deposit in the amount of $500,000, which is restricted as to its use. License Agreements The Company has entered into agreements with various third parties whereby the Company is obligated to pay a royalty ranging from 3% to 11% of the revenues on certain of its software products. Royalty expenses in the years ended December 31, 1997, 1998 and 1999 were not significant. Legal Matters On July 15, 1999, a patent infringement suit was filed against the Company. Specifically, the suit alleged that the SmartPicks technology developed by the Company in connection with its web-based product line infringes on a patent held by the plaintiff. This patent purports to disclose and claim a computer system for matching appropriate educational products with a child's developmental profile comprising so-called "static and dynamic data." In November 1999, the Company settled the patent infringement lawsuit, and the lawsuit was dismissed. The settlement agreement granted the Company a non- exclusive license to the plaintiff's patent. Through December 31, 1999, the Company incurred legal expenses and settlement costs of $861,000 pursuant to the above referenced patent litigation. These expenses have been included in general and administrative expenses in the Company's statement of operations for the year ended December 31, 1999. The Company is party from time to time to certain other litigation matters and claims which are normal in the course of its operations and, while the results of litigation and claims cannot be predicted with certainty, management believes that the final outcome of such matters will not have a materially adverse effect on the Company's financial position or results from operations. 13. Events Subsequent to Independent Accountant's Report Date--Unaudited Proposed Combination On November 14, 2000, the Company entered into an agreement to combine with Earlychildhood LLC. In the proposed transaction, the Company's stockholders will convert their outstanding shares of common stock and Earlychildhood's members will exchange their membership interests for shares of common stock of LearningStar Corp., a newly-formed company. Also, the Company's outstanding stock options and warrants will be converted to options and warrants to receive common stock of LearningStar. After the conversion, holders of the Company's common stock, stock options and warrants will own approximately one-third of LearningStar's shares on a diluted basis. The completion of the combination is subject to certain conditions, including approval by the Company's stockholders. Option Repricing On September 7, 2000, the Company completed a direct repricing of certain employee stock option grants. As part of the repricing, the Company reduced the exercise price of all outstanding options with exercise prices of greater than $1.50 per share. The new exercise price of these repriced options was reset to $1.50 per share, which was equal to the market value of the Company's common stock on September 7, 2000. Options to purchase 2,325,574 shares of the Company's common stock were repriced. The Company is accounting for the repriced options as variable awards. In the nine months ended September 30, 2000, the Company recorded an incremental non-cash stock compensation charge of $110,000 as a result of the repricing. F-19 SMARTERKIDS.COM, INC. UNAUDITED INTERIM BALANCE SHEET
December 31, September 30, 1999 2000 ------------ ------------- (in thousands, except share data) ASSETS Current assets: Cash and cash equivalents......................... $ 55,621 $ 17,754 Short-term investments............................ 11,735 15,201 Accounts receivable, net of allowance for doubtful accounts of $27 and $22 at December 31, 1999 and September 30, 2000, respectively................. 132 175 Inventories....................................... 8,902 4,161 Other current assets.............................. 2,403 2,573 -------- -------- Total current assets............................ 78,793 39,864 Property and equipment, net......................... 2,421 5,469 Other assets........................................ -- 1,761 Intangible assets, net.............................. 621 362 Restricted cash..................................... 500 1,028 -------- -------- Total assets.................................... $ 82,335 $ 48,484 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long term debt and capital lease obligations................................ $ 74 $ 541 Accounts payable.................................. 10,996 2,123 Accrued expenses.................................. 6,699 2,983 Deferred revenue.................................. 811 533 Other current liabilities......................... 87 72 -------- -------- Total current liabilities....................... 18,667 6,252 Long term debt and capital lease obligations, net of current portion.................................... 34 806 -------- -------- Total liabilities............................... 18,701 7,058 -------- -------- Commitments and contingencies (Note 4).............. -- -- Stockholders' equity: Common stock, $0.01 par value; 90,000,000 shares authorized; 20,301,770 and 20,641,040 shares issued and outstanding at December 31, 1999 and September 30, 2000, respectively................. 203 206 Additional paid-in capital........................ 112,907 112,374 Deferred stock compensation....................... (6,286) (4,494) Accumulated deficit............................... (43,190) (66,660) -------- -------- Total stockholders' equity...................... 63,634 41,426 -------- -------- Total liabilities and stockholders' equity...... $ 82,335 $ 48,484 ======== ========
The accompanying notes are an integral part of these financial statements. F-20 SMARTERKIDS.COM, INC. UNAUDITED INTERIM STATEMENT OF OPERATIONS
For the Nine Months Ended September 30, ------------------ 1999 2000 -------- -------- (in thousands, except per share data) Net revenues............................................... $ 1,108 $ 4,504 Cost of revenues........................................... 795 3,386 -------- -------- Gross profit............................................... 313 1,118 -------- -------- Operating expenses: Marketing and sales (excluding stock compensation of $327 and $1,157 for 1999 and 2000, respectively)............. 10,726 20,215 Development (excluding stock compensation of $1,141 and $(238) for 1999 and 2000, respectively)................. 1,149 2,546 General and administrative (excluding stock compensation of $321 and $455 for 1999 and 2000, respectively)....... 1,091 2,490 Stock compensation....................................... 1,789 1,374 -------- -------- Total operating expenses............................... 14,755 26,625 -------- -------- Loss from operations....................................... (14,442) (25,507) Interest and other income (expense), net................... 300 2,037 -------- -------- Net loss................................................... (14,142) (23,470) Accretion of redeemable preferred stock.................... (119) -- -------- -------- Net loss attributable to common stockholders............... $(14,261) $(23,470) ======== ======== Basic and diluted net loss per common share................ $ (8.10) $ (1.15) Weighted average shares outstanding--basic and diluted..... 1,760 20,476
The accompanying notes are an integral part of these financial statements. F-21 SMARTERKIDS.COM, INC. UNAUDITED INTERIM STATEMENT OF CASH FLOWS
For the Nine Months Ended September 30, ------------------ 1999 2000 -------- -------- (in thousands) Cash flows from operating activities: Net loss................................................. $(14,142) $(23,470) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization............................ 49 1,368 Stock compensation expense............................... 1,789 1,374 Changes in assets and liabilities: Accounts receivable.................................... 708 (43) Inventories............................................ 104 4,741 Other assets........................................... (2,986) (170) Other long-term assets................................. -- (1,761) Accounts payable....................................... 4,186 (8,873) Accrued expenses....................................... 1,143 (3,716) Other current liabilities.............................. (386) (293) -------- -------- Net cash used in operating activities...................... (9,535) (30,843) -------- -------- Cash flows from investing activities: Purchase of short-term investments....................... (5,000) (3,466) Purchases of property and equipment...................... (1,041) (4,157) Purchase of intangible assets............................ (150) -- Deposit of restricted cash............................... (500) (528) -------- -------- Net cash used in investing activities...................... (6,691) (8,151) -------- -------- Cash flows from financing activities: Proceeds from long-term borrowings....................... -- 1,601 Repayments of long-term borrowings....................... (59) (362) Proceeds from issuance of Series C redeemable preferred stock, net of issuance costs............................ 25,260 -- Proceeds from exercise of common stock options........... 113 25 Proceeds from exercise of common stock warrants.......... -- 15 Proceeds from the purchase of common stock under the Employee Stock Purchase Plan............................ -- 52 Increase from estimated IPO costs........................ -- (204) -------- -------- Net cash provided by financing activities.................. 25,314 1,127 -------- -------- Net decrease in cash and cash equivalents.................. 9,088 (37,867) Cash and cash equivalents at beginning of period........... 4,273 55,621 -------- -------- Cash and cash equivalents at end of period................. $ 13,361 $ 17,754 ======== ========
The accompanying notes are an integral part of these financial statements. F-22 SMARTERKIDS.COM, INC. UNAUDITED NOTES TO INTERIM FINANCIAL STATEMENTS 1. Basis of Presentation: The interim financial statements as of September 30, 2000 and for the nine months ended September 30, 1999 and 2000 have been prepared by SmarterKids.com, Inc. ("SmarterKids.com" or the "Company") pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC") for interim financial reporting. These statements are unaudited and, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments and accruals) necessary to present fairly the balance sheet and the statement of operations and cash flows for the periods presented. Operating results for the nine months ended September 30, 2000 may not be indicative of the results for the year ending December 31, 2000. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted in accordance with the rules and regulations of the SEC. These financial statements should be read in conjunction with the audited financial statements and accompanying notes of SmarterKids.com for the year ended December 31, 1999 included elsewhere in this proxy statement-prospectus. 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 disclosures of contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from the estimates. Marketing and Sales Expenses Marketing and sales expenses consist primarily of the cost of advertising and promotional activities, fulfillment costs including service fees to J.L. Hammett Co., commissions to online marketing companies and expenses for personnel engaged in marketing and merchandising. Fulfillment costs represent costs incurred in operating and staffing the distribution center and the customer service department, picking and packing customers' orders for shipment, responding to inquires from customers, credit card fees, as well as fees paid to J.L. Hammett Co., a fulfillment partner during the first six months of 2000. As of July 1, 2000, the Company discontinued using J.L. Hammett Co. as a third party fulfillment partner due to the opening of its own distribution facility. Fulfillment costs were $340,000 and $1,538,000 for the nine months ended September 30, 1999 and 2000, respectively. Advertising costs are charged to operations as incurred. Advertising expenses were $8,040,000 and $10,610,000 for the nine months ended September 30, 1999 and 2000, respectively. Recent Accounting Pronouncements In December 1999, the SEC staff released Staff Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements", which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. Subsequently, SAB 101 A and B have been released which direct the application of the guidance in SAB 101 to be required in the Company's fourth quarter of 2000. The effects of applying this guidance, if any, will be reported as a cumulative effect adjustment resulting from a change in accounting principle. The Company is evaluating the impact of SAB 101 adoption on its financial statements. In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities"as amended by SFAS No. 138, which was issued in June 2000. The Company will adopt SFAS No. 133 on January 1, 2001. SFAS No. 133 requires that all derivative instruments be reported on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other F-23 SMARTERKIDS.COM, INC. UNAUDITED NOTES TO INTERIM FINANCIAL STATEMENTS--(Continued) comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. The Company has not yet determined the impact of the adoption of SFAS No. 133 on its financial condition, results of operations, or business practices. In March 2000, the Emerging Issues Task Force ("EITF") of the FASB reached a consensus on EITF Issue 00-2, "Accounting for Web Site Development Costs." This consensus provided guidance on what types of costs incurred to develop web sites should be capitalized or expensed. The Company adopted this consensus on July 1, 2000. The adoption of this consensus had no material impact on the Company's financial statements. 2. Property and Equipment: Property and equipment consist of the following (in thousands):
December 31, September 30, 1999 2000 ------------ ------------- Software................ $ 377 $1,769 Furniture and fixtures.. 207 230 Computer and office equipment.............. 1,774 3,928 Leasehold improvements.. 507 1,095 ------ ------ 2,865 7,022 Less--Accumulated depreciation and amortization........... 444 1,553 ------ ------ $2,421 $5,469 ====== ======
During April 2000, the Company entered into a lease agreement for a new distribution facility. As of September 30, 2000, there were $3,114,000 of capital costs associated with the opening of the new distribution facility held in fixed assets. The five-year lease requires minimum annual payments of approximately $900,000. 3. Equipment Line of Credit: During the quarter ended March 31, 2000, the Company secured a three-year equipment line of credit facility. Through September 30, 2000, borrowings and equipment collateralized under this agreement were $1.5 million. The interest on the agreement is the three-year U.S. Treasury rate plus 3.5%. In accordance with the agreement, the balance under the line of credit was converted to a 36- month term loan at the time of funding. Accordingly, the Company is making payments of approximately $45,000 per month over the term of the loan. At September 30, 2000, a total balance of $1.2 million remains outstanding and no additional amounts are available under the line. During the quarter ended June 30, 2000, the Company secured additional borrowing capacity of $1.0 million under another three-year equipment line of credit facility. Through September 30, 2000, borrowings and equipment collateralized under this agreement were $149,000. The interest on the borrowings is 9% per annum. The Company issued warrants for the purchase of 16,667 shares of common stock with an exercise price of $3.00 per share in connection with obtaining the facility. The warrants have been valued and a discount of $8,645 has been recorded on the lease obligation. The discount is being amortized to interest expense over the life of the line of credit. At September 30, 2000, a balance of $131,000 remains outstanding. F-24 SMARTERKIDS.COM, INC. UNAUDITED NOTES TO INTERIM FINANCIAL STATEMENTS--(Continued) 4. Commitments and Contingencies: Restricted Time Deposit In connection with a facility lease entered into in 1999, the Company is required to maintain, on behalf of the landlord, a certificate of deposit in the amount of $500,000, which is restricted as to its use. In connection with the warehouse facility lease entered into in the second quarter of 2000, the Company was required to maintain, on behalf of the landlord, $500,000 in an interest-bearing account, which will be restricted as to its use. 5. Stockholders' Equity: In March 2000, the Financial Accounting Standard Board ("FASB") issued FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation--an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44 clarifies the application of Accounting Policy Bulletin ("APB") Opinion No. 25 and among other issues clarifies the following: the definition of an employee for purposes of applying APB Opinion No. 25, the criteria for determining whether a plan qualifies as a noncompensatory plan, the accounting consequence of various modifications to the terms of previously issued fixed stock options or awards, and the accounting for an exchange of stock compensation awards in a business combination. FIN 44 was effective July 1, 2000, but certain conclusions in FIN 44 cover specific events that occurred after either December 15, 1998 or January 12, 2000. On September 7, 2000, the Company completed a direct repricing of certain employee stock option grants. As part of the repricing, the Company reduced the exercise price of all outstanding options with exercise prices of greater than $1.50 per share. The new exercise price of these repriced options was reset to $1.50 per share, which was equal to the market value of the Company's common stock on September 7, 2000. Options to purchase 2,325,574 shares of the Company's common stock were repriced. The Company is accounting for the repriced options as variable awards. In the nine months ended September 30, 2000, the Company recorded an incremental non-cash stock compensation charge of $110,000 as a result of the repricing. 6. Subsequent Events: Proposed Combination On November 14, 2000, the Company entered into an agreement to combine with Earlychildhood LLC. In the proposed transaction, the Company's stockholders will convert their outstanding shares of common stock and Earlychildhood's members will exchange their membership interests for shares of common stock of LearningStar, Corp., a newly-formed company. Also, the Company's outstanding stock options and warrants will be converted to options and warrants to receive common stock of LearningStar. After the conversion, holders of the Company's common stock, stock options and warrants will own approximately one-third of LearningStar's shares on a diluted basis. The completion of the combination is subject to certain condition, including approval by the Company's stockholders. F-25 Independent Auditors' Report The Board of Directors Earlychildhood LLC: We have audited the accompanying consolidated balance sheets of Earlychildhood LLC and subsidiary (the "Company") as of December 31, 1998 and 1999, and the related consolidated statements of operations, members' equity and cash flows for the year ended March 31, 1998, the nine months ended December 31, 1998 and the year ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Earlychildhood LLC and subsidiary as of December 31, 1998 and 1999, and the results of their operations and their cash flows for the year ended March 31, 1998, the nine months ended December 31, 1998 and the year ended December 31, 1999 in conformity with generally accepted accounting principles. KPMG LLP San Francisco, California December 22, 2000, except for Note 1, which is as of January 8, 2001 F-26 EARLYCHILDHOOD LLC Consolidated Balance Sheets (In thousands)
December 31, December 31, September 30, 1998 1999 2000 ------------ ------------ ------------- (Unaudited) Assets Current assets: Cash and cash equivalents............ $ 29 $ 151 $ -- Accounts receivable, net............. 1,421 4,188 10,032 Inventories.......................... 3,324 11,227 14,023 Prepaid expenses and other current assets.............................. 383 1,679 2,153 ------ ------- ------- Total current assets............... 5,157 17,245 26,208 Receivable from member................. 405 137 139 Property and equipment, net............ 1,898 2,169 4,495 Deferred income taxes.................. 47 -- -- Other assets........................... 40 1,233 1,086 Goodwill, net.......................... -- 5,772 5,306 Other intangible assets, net........... 896 2,359 2,109 ------ ------- ------- Total assets....................... $8,443 $28,915 $39,343 ====== ======= ======= Liabilities and Members' Equity Current liabilities: Bank overdraft....................... $ -- $ 407 $ 8 Short-term debt...................... 2,203 3,608 1,375 Accounts payable..................... 1,497 2,238 4,991 Accrued expenses..................... 403 1,128 1,240 Income taxes payable................. -- 920 1,015 Deferred income taxes................ 33 577 475 Other liabilities.................... 137 408 163 ------ ------- ------- Total current liabilities.......... 4,273 9,286 9,267 Deferred income taxes.................. -- 48 61 Notes payable to member................ 591 -- -- Notes payable.......................... 1,525 9,087 7,750 ------ ------- ------- Total liabilities.................. 6,389 18,421 17,078 ------ ------- ------- Members' equity........................ 2,054 10,494 24,980 Deferred compensation.................. -- -- (2,715) ------ ------- ------- Total members' equity.............. 2,054 10,494 22,265 ------ ------- ------- Total liabilities and members' equity............................ $8,443 $28,915 $39,343 ====== ======= =======
See accompanying notes to consolidated financial statements. F-27 EARLYCHILDHOOD LLC Consolidated Statements of Operations (In thousands, except per share data)
Nine Months Fiscal Year Nine Months Nine Months Fiscal Year Ended Ended Ended Ended Ended March December 31, December 31, September 30, September 30, 31, 1998 1998 1999 1999 2000 ----------- ------------ ------------ ------------- ------------- (Unaudited) (Unaudited) Revenues................ $18,597 $20,786 $ 61,034 $49,256 $ 67,814 Cost of goods sold...... 10,789 12,154 37,226 30,374 42,585 ------- ------- ----------- ------- ----------- Gross profit........ 7,808 8,632 23,808 18,882 25,229 ------- ------- ----------- ------- ----------- Operating expenses: Selling, general and administrative (includes equity based compensation of $467 for nine months ended September 30, 2000)................ 7,774 6,574 18,931 12,345 22,115 Amortization of goodwill and other intangible assets.... 12 36 653 401 764 ------- ------- ----------- ------- ----------- 7,786 6,610 19,584 12,746 22,879 ------- ------- ----------- ------- ----------- Operating income.... 22 2,022 4,224 6,136 2,350 ------- ------- ----------- ------- ----------- Other (income) expense: Interest expense...... 265 194 875 536 1,075 Interest income....... -- (3) (46) (23) (35) ------- ------- ----------- ------- ----------- 265 191 829 513 1,040 ------- ------- ----------- ------- ----------- Income (loss) before income taxes....... (243) 1,831 3,395 5,623 1,310 Income tax (benefit) expense................ (103) 182 982 1,449 944 ------- ------- ----------- ------- ----------- Net income (loss)... $ (140) $ 1,649 $ 2,413 $ 4,174 $ 366 ======= ======= =========== ======= =========== Pro forma income tax expense (unaudited).... $ 1,493 $ 723 ----------- ----------- Pro forma net income (unaudited)............ $ 1,902 $ 587 =========== =========== Pro forma net income per share--basic (unaudited)............ $ 0.05 $ 0.01 =========== =========== Pro forma net income per share--diluted (unaudited)............ $ 0.05 $ 0.01 =========== =========== Shares used in pro forma per share calculation-- basic (unaudited)...... 35,908,666 44,737,985 =========== =========== Shares used in pro forma per share calculation-- diluted (unaudited).... 35,908,666 44,738,777 =========== ===========
See accompanying notes to consolidated financial statements. F-28 EARLYCHILDHOOD LLC Consolidated Statements of Members' Equity (In thousands)
Earlychildhood LLC Membership Interest Elliott Mair LLC ----------------------- Membership Class Class Deferred Interest Class A B C Compensation Total ---------------- ------- ------ ------ ------------ ------- Balance at April 1, 1997................... $ 736 $ -- $ -- $ -- $ -- $ 736 Net loss................ (140) -- -- -- -- (140) Distributions to members................ (5) -- -- -- -- (5) ------- ------- ------ ------ ------- ------- Balance at March 31, 1998................... $ 591 $ -- $ -- $ -- $ -- $ 591 Net income.............. 1,649 -- -- -- -- 1,649 Distributions to members................ (186) -- -- -- -- (186) ------- ------- ------ ------ ------- ------- Balance at December 31, 1998................... $ 2,054 $ -- $ -- $ -- $ -- $ 2,054 Net income January 1, 1999 through May 5, 1999................... 505 -- -- -- -- 505 Distribution to members................ (1,150) -- -- -- -- (1,150) Recapitalization: Transfer of net assets to Elliott Mair Salinas LLC.......... (160) -- -- -- -- (160) Distributions to members.............. (2,168) -- -- -- -- (2,168) Recapitalization of existing membership interests............ 919 -- (919) -- -- -- Issuance of new membership interests, net of fees.......... -- 7,240 -- 165 -- 7,405 Acquisition of Educational Products, Inc.................... -- -- 1,600 -- -- 1,600 Capital contribution.... -- 500 -- -- -- 500 Net income May 6, 1999 to December 31, 1999... -- 1,277 625 6 -- 1,908 ------- ------- ------ ------ ------- ------- Balance at December 31, 1999................... $ -- $ 9,017 $1,306 $ 171 $ -- $10,494 Capital contributions (unaudited)............ -- 11,328 -- -- -- 11,328 Net income (unaudited).. -- 366 -- -- -- 366 Issuance of new membership interests (unaudited)............ -- -- -- 421 -- 421 Issuance of options to purchase membership interests (unaudited).. -- -- -- 2,761 (2,761) -- Amortization of deferred compensation (unaudited)............ -- 46 46 Distributions to members (unaudited)............ -- (314) (76) -- -- (390) ------- ------- ------ ------ ------- ------- Balance at September 30, 2000 (unaudited)....... $ -- $20,397 $1,230 $3,353 $(2,715) $22,265 ======= ======= ====== ====== ======= =======
See accompanying notes to consolidated financial statements. F-29 EARLYCHILDHOOD LLC Consolidated Statements of Cash Flows (In thousands)
Fiscal Nine Fiscal Nine Nine Year Ended Months Ended Year Ended Months Ended Months Ended March 31, December 31, December 31, September September 30, 1998 1998 1999 30, 1999 2000 ---------- ------------ ------------ ------------ ------------- (unaudited) (unaudited) Cash flows from operating activities: Net income (loss)................................... $ (140) $1,649 $2,413 $4,174 $ 366 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization....................... 222 234 963 631 1,263 Equity based compensation........................... -- -- -- -- 467 Deferred income taxes............................... (16) 50 (207) (137) (89) Changes in operating assets and liabilities, net of acquisitions: Accounts receivable................................. 95 (282) (3,870) (7,028) (5,844) Inventories......................................... (1,424) (743) 2,225 3,139 (2,796) Prepaid expenses and other current assets........... 155 (202) (1,296) (821) (474) Other assets........................................ 72 (16) 254 205 147 Accounts payable.................................... 802 54 (5,393) 448 2,753 Accrued expenses.................................... 311 (42) 355 370 112 Income taxes payable................................ (227) 68 1,123 1,483 95 Other liabilities................................... 84 60 153 33 (245) ------- ------ ------ ------ ------ Net cash provided by (used in) operating activities........................................ (66) 830 (3,280) 2,497 (4,245) ------- ------ ------ ------ ------ Cash flows from investing activities: Purchase of plant and equipment..................... (191) (285) (1,581) (1,156) (2,825) Purchase of other intangible assets................. -- (216) (327) (282) (48) Acquisitions, net of cash acquired.................. -- (638) (7,372) (6,872) -- ------- ------ ------ ------ ------ Net cash used in investing activities.............. (191) (1,139) (9,280) (8,310) (2,873) ------- ------ ------ ------ ------ Cash flows from financing activities: Bank overdraft...................................... 9 (9) 407 -- (399) Net borrowings (principal payments) on line of credit............................................. 95 746 (1,639) (3,160) (2,233) Net borrowings on long-term liabilities............. 75 130 7,482 7,696 (1,337) Issuance of membership interests, net of fees....... -- -- 7,905 7,405 11,328 Member distributions................................ (5) (186) (1,150) (1,150) (390) Member loans........................................ -- -- (591) (591) (2) Member (advances) payments.......................... (9) (343) 268 105 -- ------- ------ ------ ------ ------ Net cash provided by financing activities.......... 165 338 12,682 10,305 6,967 ------- ------ ------ ------ ------ Net increase (decrease) in cash and cash equivalents......................................... (92) 29 122 4,492 (151) Cash and cash equivalents at beginning of period..... 92 -- 29 29 151 ------- ------ ------ ------ ------ Cash and cash equivalents at end of period........... $ -- $ 29 $ 151 $4,521 $ -- ======= ====== ====== ====== ====== Supplemental disclosures of cash flow information: Cash payments during the period: Cash paid for interest.............................. $ 265 $ 194 $ 875 $ 536 $1,075 Cash paid for taxes................................. $ 333 $ -- $1,506 $ 271 $ 938 Non-cash investing and financing activities: Membership interests issued in acquisition of business........................................... $ -- $ -- $1,600 $1,600 $ -- Transfer of net assets to Elliott Mair Salinas LLC.. $ -- $ -- $ 160 $ 160 $ -- Distribution of assets to members................... $ -- $ -- $2,168 $2,168 $ -- Issuance of membership interests.................... $ -- $ -- $ -- $ -- $ 421
See accompanying notes to consolidated financial statements. F-30 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements (1) The Business Earlychildhood LLC ("Earlychildhood") and its wholly-owned subsidiary, Educational Products, Inc. (collectively, the "Company") is a fully integrated, multi-channel supplier of educational products, services and information to schools, educational professionals and parents serving the early childhood and elementary school communities. A predecessor company, QTL Corporation ("QTL"), commenced operations in 1985 and was incorporated in 1986. Earlychildhood itself was formed in 1995, and was originally named Elliott-Mair LLC. QTL and Elliott-Mair LLC had the same ownership. On May 5, 1999, Elliott-Mair LLC changed its name to Earlychildhood.com LLC. On January 8, 2001 Earlychildhood.com LLC changed its name to Earlychildhood LLC. On May 5, 1999, QTL transferred significantly all of its assets and liabilities to Earlychildhood in exchange for membership interests. The acquisition constituted a combination of entities under common control for financial accounting purposes and a tax-free reorganization for tax purposes. The transaction was accounted for as an "as if pooling of interests" under Accounting Principles Board Opinion 16 and related AICPA Accounting Interpretations. Accordingly, the consolidated financial statements present the combined results of operations, financial position and cash flows of the Company as if QTL had been part of Earlychildhood LLC prior to May 5, 1999. (2) Summary of Significant Accounting Policies (a) Principles of Consolidation The consolidated financial statements include the accounts of Earlychildhood and its wholly-owned subsidiary. All material intercompany transactions have been eliminated in consolidation. (b) Fiscal Year On April 1, 1998, QTL changed their fiscal year to end on December 31. Prior to April 1, 1998, Earlychildhood and QTL's fiscal year ended on March 31. Accordingly, the fiscal year ended December 31, 1998 consists of nine months. (c) Cash and Cash Equivalents The Company considers all highly liquid investments with a remaining maturity of three months or less at the date of the acquisition to be cash equivalents. (d) Concentration of Credit Risk The Company has no customer comprising greater than 10% of their revenues. However, receivables arising from sales to customers are not collateralized and management continually monitors the financial condition of its customers to reduce the risk of loss. (e) Inventories The Company values inventories at the lower of cost or market, using the first-in, first-out method. (f) Deferred Catalog Costs Deferred catalog costs are considered direct response advertising and are capitalized and amortized in amounts proportionate to revenues over the lives of each catalog, generally five to six months. Such costs are included in prepaid expenses and other current assets. Amortization expense related to deferred catalog costs is F-31 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued included in the statements of operations as a component of selling, general and administrative expenses. Such amortization expense was $887,000 for the year ended March 31, 1998, $749,000 for the nine months ended December 31, 1998, $2,083,000 for the year ended December 31, 1999 and $1,537,000 and $2,235,000 for the nine months ended September 30, 1999 and 2000, respectively. (g) Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Leasehold improvements are capitalized and amortized over the lesser of the remaining life of the asset or the remaining term of the lease. Maintenance and repairs are expensed as incurred. Depreciation of property and equipment is calculated using the straight-line method over the estimated useful lives of the respective assets. The estimated useful lives range from five to thirteen years for leasehold improvements and three to seven years for furniture, fixtures and equipment. Depreciation of property and equipment amounted to $210,000 for the year ended March 31, 1998, $198,000 for the nine months ended December 31, 1998, $310,000 for the year ended December 31, 1999 and $230,000 and $499,000 for the nine months ended September 30, 1999 and 2000, respectively. (h) Web Site Development The Company does not produce software to be sold or marketed. However, in connection with building its new web site, the Company has capitalized certain web site development costs during the nine months ended September 30, 2000. Capitalized costs of $812,000 are included in property and equipment on the Company's balance sheet at September 30, 2000. No depreciation of capitalized website development costs was recognized during the nine months ended September 30, 2000 as the Company's new website was not launched as of September 30, 2000. (i) Goodwill and Other Intangible Assets Trademarks and other intangible assets are stated at cost, and are being amortized on the straight-line basis over their estimated useful lives, which range from five to ten years. Goodwill, which represents the excess of cost over fair market value of net assets acquired, is being amortized on the straight-line basis over an estimated useful life of ten years. Amortization expense amounted to $12,000 for the year ended March 31, 1998, $36,000 for the nine months ended December 31, 1998, $653,000 for the year ended December 31, 1999 and $401,000 and $764,000 for the nine months ended September 30, 1999 and 2000, respectively. (j) Accounting for Impairment of Long-Lived Assets The Company assesses the need to record impairment losses on long-lived assets used in operations when indicators of impairment are present. On an on- going basis, management reviews the value and period of amortization or depreciation of long-lived assets. Additionally, in accordance with Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," the Company's policy is to review the estimated undiscounted future cash flows for its operations on an annual basis and to compare it to the remaining net book value to ascertain if a provision for impairment is necessary. (k) Income Taxes The Company has elected to be taxed as a limited liability company (a partnership) for federal and state income tax purposes. As a partnership, the Company's income and deductions are reported by its members who are taxed on such income or loss. Educational Products, Inc. ("EPI"), a wholly-owned subsidiary of Earlychildhood, is a C corporation and therefore is subject to federal and state income taxes. F-32 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued QTL was a C corporation until April 1, 1998, when it elected S corporation status. As an S corporation, QTL's income and deductions were reported by the Company's shareholders who were taxed on such income or loss. While QTL's income generally was not subject to federal income tax, it was subject to certain state income taxes. The consolidated financial statements reflect actual income taxes based on the income tax status of the Company and its subsidiary combined with QTL for the respective periods. In addition, the statement of operations for the year ended December 31, 1999 and the nine months ended September 30, 2000 reflect pro forma income taxes as if the Company had elected to be taxed as a C corporation for federal and state income tax purposes during those periods. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (l) Revenue Recognition The Company recognizes revenue from product sales upon the delivery of products. Provisions for estimated returns and allowances are recorded as a reduction to sales and cost of sales. The Company records revenue related to these arrangements once the products are sold through to the end user. Shipping and handling revenues and costs are included in revenues and cost of goods sold, respectively. (m) Equity--Based Compensation The Company has adopted SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). As permitted by SFAS 123, the Company measures compensation cost in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations. Accordingly, no accounting recognition is given to stock options granted at fair market value until they are exercised. Upon exercise, net proceeds, including income tax benefits realized, are credited to equity. Compensation cost for stock options granted with exercise prices below estimated fair market value is recognized over the period which certain Company repurchase provisions lapse (see Note 16). The pro forma impact on earnings has been disclosed in the notes to the financial statements as allowed by SFAS 123 (see Note 16). (n) Comprehensive Income SFAS No. 130, "Reporting Comprehensive Income", requires that the Company report comprehensive income, which includes net income as well as other changes in assets and liabilities recorded in members' equity (deficit) in the financial statements. There were no components of comprehensive income other than net income for all periods presented. (o) Unaudited Pro Forma Basic and Diluted Net Income per Share The unaudited pro forma basic and diluted net income per share information included in the accompanying statements of operations for the year ended December 31, 1999 and the nine months ended September 30, 2000 F-33 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued reflects the impact of the conversion of all membership interests into common shares of LearningStar Corp. ("LearningStar") in conjunction with the proposed combination transaction with SmarterKids.com (see Note 22) as of the beginning of each period or date of issuance, if later. Common equivalent shares of 792 have been included in the computation of diluted net income per share for the nine months ended September 30, 2000. Common equivalent shares consist of membership interests issuable upon the exercise of options. Historical basic and diluted net income per share have not been presented because they are irrelevant due to the significant change in the Company's capital structure and resultant basic and diluted net income per share that will result upon conversion of all membership interests into common shares of LearningStar (see Note 22). The following table sets forth the computation of pro forma basic and diluted net income per share:
Nine Months Year Ended Ended December 31, September 30, 1999 2000 ------------ ------------- Pro forma net income............................ $ 1,902,000 $ 587,000 =========== ========== Weighted average shares outstanding assuming conversion of membership interests to LearningStar common stock: Class A membership interests.................. 15,476,689 23,537,465 Class B membership interests.................. 20,365,158 20,969,096 Class C membership interests.................. 66,819 231,424 ----------- ---------- Shares used in pro forma per share calculation basic.......................................... 35,908,666 44,737,985 ----------- ---------- Options to purchase membership interests assuming conversion to LearningStar stock options...................................... -- 792 ----------- ---------- Shares used in pro forma per share calculation-- diluted........................................ 35,908,666 44,738,777 =========== ========== Pro forma net income per share--basic........... $ 0.05 $ 0.01 =========== ========== Pro forma net income per share--diluted......... $ 0.05 $ 0.01 =========== ==========
(p) Fair Value of Financial Instruments The carrying value for cash and cash equivalents, accounts receivable, short-term debt, accounts payable and notes payable approximates fair value because of the short term nature of these instruments. The carrying value of notes payable approximates their fair values due to variable interest rates. (q) Use of Estimates in Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (r) Unaudited Interim Financial Information The consolidated financial statements, including footnote disclosures as of September 30, 2000 and for the nine months ended September 30, 1999 and 2000 are unaudited; however, in the opinion of management, all F-34 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial statements for the interim periods have been included. Results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the full fiscal year or any future periods. (s) Recent Accounting Pronouncements In December 1999, the SEC staff released Staff Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements", which provides guidance on the recognition, presentation and disclosure of revenue in financial statements. Subsequently, SAB 101 A and B have been released which direct the application of the guidance in SAB 101 to be required in our fourth quarter of 2000. Given that the Company's accounting policy for revenue recognition is in accordance with SAB 101, the management does not expect the adoption of SAB 101 to have a material effect on the Company's financial statements. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" as amended by SFAS No. 137, which was issued in July 1999, delayed the adoption date for SFAS No. 133 until annual periods beginning after June 15, 2000. SFAS No. 133 established standards for recognition and measurement of derivatives and hedging activities. The Company will adopt SFAS No. 133 beginning January 1, 2001. Management does not believe the adoption of SFAS No. 133 will have a material effect on the financial position or operations of the Company. In July 2000 the Emerging Issues Task Force ("EITF") of the FASB concluded on Issue 1 of EITF issue No. 00-10 "Accounting for Shipping and Handling Fees and Costs," which provides guidance on the presentation of shipping and handling revenue and costs in the statement of operations. The Company's accounting policies are in accordance with the requirements of this EITF issue and accordingly the adoption of this new accounting pronouncement will have no effect on the Company's consolidated financial statements. In March 2000, the EITF of the FASB reached a consensus on EITF Issue 00-2, "Accounting for Web Site Development Costs." This consensus provided guidance on what types of costs incurred to develop web sites should be capitalized or expensed. The Company adopted this consensus effective January 1, 2000 and capitalized $812,000 of web site development costs in the nine months ended September 30, 2000. No significant web site development costs were incurred prior to 2000. (3) Recapitalization The recapitalization of Earlychildhood took effect on May 5, 1999. The net assets of the former Elliott Mair LLC in the amount of $160,000, which consisted primarily of property and notes payable, were initially transferred out of Earlychildhood into an affiliated company, Elliott-Mair Salinas LLC. Thereafter, the following events occurred: . QTL transferred significantly all of its assets and liabilities to Earlychildhood in exchange for Class B membership interests in Earlychildhood. The net book value of the assets transferred by QTL was $1,409,000. As a result of the transfer, QTL received a 43.7% Class B membership interest in Earlychildhood. . In conjunction with the transaction, a portion of QTL's assets consisting of inventory and receivables having a book value of $2,168,000 were retained by QTL. . Educational Simon, L.L.C. contributed $8,172,000 in cash. As a result of its capital contribution, Educational Simon, L.L.C. received a 51.7% Class A membership interest in Earlychildhood (Note 15). . The Company incurred $932,000 in professional fees associated with the issuance of Class A membership interests; $767,000 of the fees were paid in cash of which $165,000 were paid in the form of a 0.4% Class C membership interest in Earlychildhood. F-35 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued . The Company borrowed $10,000,000 in the form of a term loan with BNP Paribas. The proceeds were used to pay down existing debt, fund acquisitions and provide for future working capital needs of the Company. (4) Acquisitions On May 5, 1999, after the recapitalization, Earlychildhood acquired all of the stock of EPI, a company which sells school supplies to elementary schools, teachers and other educational organizations, for $6,800,000 in cash and 4.1% in Class B membership interests in Earlychildhood, valued at $1,600,000. In conjunction with the acquisition, EPI's existing notes payable of $1,193,000 and amounts outstanding under the existing line of credit of $1,500,000 were repaid. Transaction fees amounted to $217,000. The EPI acquisition was accounted for as a purchase with the excess of the purchase price over the estimated fair value of the net assets recorded as goodwill. The purchase price was allocated based on the fair values of the assets and liabilities acquired as follows (in thousands): Cash............................................................... $ 131 Other current assets............................................... 11,193 Property and equipment............................................. 277 Other intangible assets............................................ 1,410 Goodwill........................................................... 5,545 Other assets....................................................... 250 Current liabilities................................................ (10,191) -------- $ 8,615 ========
The unaudited pro forma financial information in the following table illustrates the combined results of the Company's operations and the operations of EPI for the nine months ended December 31, 1998 and year ended December 31, 1999 and as if the acquisition of EPI had occurred as of April 1, 1998 and January 1, 1999, respectively. The pro forma financial information is presented for informational purposes and is not necessarily indicative of the results of operations which would have occurred had the Company constituted a single entity as of April 1, 1998 and January 1, 1999, respectively. The pro forma information also is not necessarily indicative of the future results of operations of the combined Company.
Nine months Year ended ended December 31, December 1998 31, 1999 ------------ -------- (in thousands) Net sales............................................ $40,034 $63,741 Operating income..................................... $ 3,149 $ 2,687 Pro forma net income................................. $ 1,655 $ 1,097 Pro forma basic and diluted net income per share..... $ 0.03 Shares used in pro forma basic and diluted net income per share calculation............................... 36,513
The Company also concluded two less significant acquisitions. In December 1998 the Company acquired the stock of Colorations, Inc. a manufacturer and distributor of non-toxic arts materials for $638,000. The net fair value of the tangible assets acquired was insignificant and the majority of the purchase price was allocated to trademarks, tradenames and formulas and amortized over five years. In November 1999, the Company acquired certain assets and liabilities relating to the Earlychildhood NEWS magazine for $500,000. The net fair value of the tangible assets and liabilities acquired was insignificant and the majority of the purchase price for the acquisition was allocated to goodwill and amortized over ten years. F-36 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued The results of each acquired operation have been included in the consolidated financial results of the Company from the date of acquisition. (5) Accounts Receivable Accounts receivable consists of the following amounts (in thousands):
December 31, December 31, September 30, 1998 1999 2000 ------------ ------------ ------------- Accounts receivable................ $1,490 $4,331 $10,273 Less: allowance for doubtful accounts.......................... (69) (143) (241) ------ ------ ------- $1,421 $4,188 $10,032 ====== ====== =======
(6) Inventories Inventories, stated at lower of cost or market, consist of the following amounts (in thousands):
December 31, December 31, September 30, 1998 1999 2000 ------------ ------------ ------------- Raw materials and work in progress......................... $ 155 $ 658 $ 997 Finished goods.................... 3,169 10,569 13,026 ------ ------- ------- $3,324 $11,227 $14,023 ====== ======= ======= (7) Prepaid Expenses and Other Current Assets Prepaid expenses and other current assets consist of the following amounts (in thousands): December 31, December 31, September 30, 1998 1999 2000 ------------ ------------ ------------- Prepaid catalog costs............. $ 224 $ 353 $ 565 Prepaid inventory................. 75 555 861 Non trade receivables............. 84 207 -- Other prepaid expenses............ -- 329 554 Other............................. -- 235 173 ------ ------- ------- $ 383 $ 1,679 $ 2,153 ====== ======= =======
F-37 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued (8) Property and Equipment A summary of property and equipment is as follows (in thousands):
December 31, December 31, September 30, 1998 1999 2000 ------------ ------------ ------------- Land................................. $ 250 $ -- $ -- Building............................. 1,127 -- -- Furniture & fixtures................. 64 248 372 Leasehold improvements............... 97 819 1,472 Machinery & equipment................ 1,109 2,571 3,807 Website development costs............ -- -- 812 ------ ------ ------ 2,647 3,638 6,463 Accumulated depreciation............. (749) (1,469) (1,968) ------ ------ ------ $1,898 $2,169 $4,495 ====== ====== ======
(9) Goodwill and Other Intangible Assets Goodwill is presented net of accumulated amortization of $0, $379,000 and $844,000 as of December 31, 1998, December 31, 1999 and September 30, 2000, respectively. Other intangible assets consist of the following amounts (in thousands):
December 31, December 31, September 30, 1998 1999 2000 ------------ ------------ ------------- Trademarks, tradenames and formulas......................... $964 $1,292 $1,340 Customer lists.................... -- 1,410 1,410 ---- ------ ------ 964 2,702 2,750 Less accumulated amortization..... (68) (343) (641) ---- ------ ------ $896 $2,359 $2,109 ==== ====== ======
(10) Accrued Expenses Accrued expenses consist of the following amounts (in thousands):
December 31, December 31, September 30, 1998 1999 2000 ------------ ------------ ------------- Payroll and commissions.............. $ 3 $ 282 $ 338 Vacation............................. 84 367 167 Professional services................ 40 107 327 Sales tax............................ 78 151 235 Other................................ 198 221 173 ---- ------ ------ $403 $1,128 $1,240 ==== ====== ======
(11) Related Party Transactions The Company has a note receivable from QTL amounting to $137,000 and $139,000 as of December 31, 1999 and September 30, 2000, respectively. The note bears interest at 8% and matures no later than May 5, 2004 or earlier under certain circumstances. The note agreement was entered into effective May 5, 1999 to finance QTL's expenses related to a litigation matter which was settled later in 1999. F-38 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued As of December 31, 1998, the Company had accounts receivable from a shareholder of QTL in the amount of $405,000. The accounts receivable were unsecured and bore no interest. In addition, as of December 31, 1998, Earlychildhood had an unsecured note payable from a shareholder of QTL of $591,000. The interest rate on this borrowing was 7.0% per annum. The note was subsequently paid in full on May 5, 1999 as part of the recapitalization. On May 5, 1999, Earlychildhood entered into a seven-year executive management agreement with William E. Simon & Sons, LLC, an affiliate of Educational Simon, L.L.C. Pursuant to the agreement, Earlychildhood paid William E. Simon & Sons, LLC an initial fee of $400,000 and it pays a quarterly fee of $75,000. The initial fee was allocated between costs of the recapitalization and the EPI acquisition, whereas the quarterly fee is included in selling, general and administrative expenses in the consolidated statement of operations. Beginning on May 5, 1999, Earlychildhood leased its distribution center from Elliott Mair-Salinas LLC, a related company. Monthly payments are $13,000. The lease term is indefinite and is renewed on a monthly basis. Earlychildhood also utilizes a distribution center, which is owned by a related party for storage and distribution of certain inventory. Earlychildhood recorded expenses of $1,300 for the year ended March 31, 1998, $24,000 for the nine months ended December 31, 1998, $96,000 for the year ended December 31, 1999 and $80,000 and $14,000 for the nine months ended September 30, 1999 and September 30, 2000, respectively. (12) Credit Facilities (a) Short-Term Debt Short-term debt consists of the following (in thousands):
December 31, December 31, September 30, 1998 1999 2000 ------------ ------------ ------------- Outstanding revolver line under: Paribas Credit Facility............. $ -- $2,800 $ -- Bank of Salinas Credit Facility..... 1,918 -- -- Current portion of long-term debt..... 285 808 1,375 ------ ------ ------ Total short-term debt............. $2,203 $3,608 $1,375 ====== ====== ====== (b) Notes Payable Less Current Installments Notes payable less current installments consist of the following (in thousands): December 31, December 31, September 30, 1998 1999 2000 ------------ ------------ ------------- Term loan under the Paribas Credit Fa- cility............................... $ -- $9,625 $9,125 Notes payable secured by land and building............................. 1,228 -- -- Other obligations..................... 582 270 -- ------ ------ ------ 1,810 9,895 9,125 Less current portion of long-term debt................................. 285 808 1,375 ------ ------ ------ Total long-term debt................ $1,525 $9,087 $7,750 ====== ====== ======
On May 5, 1999, the Company entered into a Senior Secured Credit Facility with BNP Paribas, hereinafter, the Paribas Credit Facility. The Paribas Credit Facility consisted of the following components: Revolving Line of Credit--The Paribas Credit Facility included a $10 million Senior Secured Revolving Credit Facility, hereinafter, the Revolver, maturing on May 5, 2004. The Revolver is subject to F-39 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued a clean-down provision, which requires that the Company limit the outstanding principal balance drawn on the Revolver to a maximum of $3.5 million for 15 consecutive days each year. Additionally, the terms of the Revolver include a $2.5 million letter of credit sublimit. At the option of the Company, interest on principal borrowings outstanding on the Revolver will accrue at a rate of either lender's base rate plus 2.0% per annum or the adjusted LIBOR rate plus 3.25% per annum. The average annual interest rate charged to the Company on the outstanding principal balance drawn on the Revolver, as of December 31, 1999 was 8.94%. Indebtedness is secured by substantially all of the assets of the Company. The credit facility is available for working capital and general corporate purposes in the ordinary course of business. Term Loan--The Paribas Credit Facility included a $10 million term loan component with a final maturity of May 5, 2004. The term loan, which was fully drawn on May 5, 1999, is payable in 16 consecutive quarterly installments commencing March 31, 2000 and continuing until December 31, 2003, with a final payment due on the maturity date. At the option of the Company, interest on principal borrowings outstanding on the term loan will accrue at a rate of either lender's base rate plus 2.0% per annum or the adjusted LIBOR rate plus 3.25% per annum. The average annual interest rate charged to the Company on the outstanding principal balance drawn on the term loan, as of December 31, 1999 was 9.0%. Acquisition Line--The Paribas Credit Facility included a $20 million acquisition line with a maturity date of May 5, 2004. Principal balances drawn on the acquisition line are governed by a defined set of covenants. As of January 31, 2000, the Senior Secured Credit Facility was amended and restated as follows: Revolving Line of Credit--The terms of the Revolver were amended to include the calculation of a collateralized borrowing base. The borrowing base equals the sum of 80% of the aggregate face amount of eligible accounts receivables due and owing; plus 50% of eligible inventory (calculated at the lower of cost or market, on a first in, first out basis). Term Loan--Unchanged. Acquisition Line--Terminated and removed. As of September 30, 2000 the Company has $9,450,000 in borrowing capacity under the Paribas Credit Facility. The Company's credit facilities include certain restrictive covenants, which require maintenance of minimum amounts of tangible net worth and EBITDA. The Company was in compliance with such covenants at September 30, 2000. From 1998 through May 5, 1999 the Company had a revolving line of credit agreement with Bank of Salinas which allowed for borrowings of up to $2.5 million at an interest rate based on the bank's prime rate plus 0.75%. Notes payable which were secured by land and building were transferred, along with the related land and building and other assets and liabilities to Elliott Mair Salinas LLC in conjunction with the recapitalization. Other obligations consist of various notes in relation to the equipment of the Company. Their interest rates range from 8.5% to 15.0% as of December 31, 1999. Certain assets of the Company were pledged as collateral for the notes. Maturities as of September 30, 2000 are as follows (in thousands): 2001................................................................. $1,375 2002................................................................. 2,500 2003................................................................. 3,375 2004................................................................. 1,875 Thereafter........................................................... -- ------ Total maturities of debt........................................... $9,125 ======
F-40 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued (13) Income Taxes As a limited liability company, the Company is not subject to income taxes; however its wholly-owned subsidiary, EPI, is a C corporation and therefore is subject to federal and state income taxes. QTL was a C corporation until April 1, 1998 when it elected S corporation status. As an S corporation, QTL's income and deductions were reported by the Company's shareholders who are taxed on such income or loss. While QTL's income generally was not subject to federal income tax, it was subject to certain state income taxes. The following table reflects actual income taxes based on the income tax status of the Company and its subsidiary combined with QTL for the respective periods (in thousands):
Nine Months Nine Months Nine Months Year ended Ended Year ended Ended Ended March 31, December 31, December 31, September 30, September 30, 1998 1998 1999 1999 2000 ---------- ------------ ------------ ------------- ------------- Federal: Current............... $ (71) $ 46 $1,068 $1,431 $ 937 Deferred.............. (10) 14 (192) (129) (80) ----- ---- ------ ------ ------ Total................. $ (81) $ 60 $ 876 $1,302 $ 858 ===== ==== ====== ====== ====== State: Current............... $ (16) $ 86 $ 121 $ 155 $ 96 Deferred.............. (6) 36 (15) (8) (9) ----- ---- ------ ------ ------ Total................. $ (22) $122 $ 106 $ 147 $ 87 ===== ==== ====== ====== ====== Total income tax expense (benefit): Current............... $ (87) $132 $1,189 $1,586 $1,033 Deferred.............. (16) 50 (207) (137) (89) ----- ---- ------ ------ ------ Total................. $(103) $182 $ 982 $1,449 $ 945 ===== ==== ====== ====== ======
The Company's actual tax expense (benefit) differs from the statutory federal income tax rate of 34% as shown in the following schedule (in thousands):
Nine months Nine months Nine months Year ended Ended Year ended Ended Ended March 31, December 31, December 31, September 30, September 30, 1998 1998 1999 1999 2000 ---------- ------------ ------------ ------------- ------------- Income tax expense (benefit) at statutory rate................... $ (83) $623 $1,154 $1,912 $445 Effect of (income) loss not subject to federal taxes.................. (5) (623) (389) (626) 257 State income taxes...... (15) 108 50 81 57 Nondeductible amortization of goodwill............... -- -- 173 108 185 Effect of change in tax status................. -- 74 9 9 -- Other................... (15) (35) -- ----- ---- ------ ------ ---- Actual tax expense (benefit).............. $(103) $182 $ 982 $1,449 $944 ===== ==== ====== ====== ====
F-41 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued The following table displays the tax effects of temporary differences, which, except for 1998, are primarily related to EPI and give rise to significant portions of the deferred tax liabilities (in thousands):
December 31, December 31, September 30, 1998 1999 2000 ------------ ------------ ------------- Deferred tax assets: Inventory............................ $ 9 $ -- $ -- Allowance for bad debts.............. 3 13 39 Accrued expenses..................... 11 60 -- State taxes.......................... -- 62 50 ---- ----- ----- 23 135 89 Deferred tax liabilities: Property and equipment............... (9) (37) (61) Inventory............................ -- (723) (564) ---- ----- ----- Net deferred tax asset (liability)..... $ 14 $(625) $(536) ==== ===== =====
Due to the nontaxable status of Earlychildhood, no deferred tax assets or liabilities have been established relating to the differences between book and tax basis of LLC assets and liabilities. As of September 30, 2000 the net tax basis of Earlychildhood's assets and liabilities exceeded the net book basis by $3,375,000. The Company has presented unaudited pro forma income tax expense for the year ended December 31, 1999 and the nine months ended September 30, 2000, on the consolidated statements of operations as if Earlychildhood was subject to federal and state income taxes as a C corporation. Such pro forma income tax expense differs from the statutory rate primarily due to the effect of state income taxes and the amortization of goodwill and certain intangible assets, which are not deductible for tax purposes and the effect of state income taxes. (14) Retirement Savings Plans Employees of the Company are eligible to participate in the Earlychildhood Retirement Savings Plan ("the Plan") amended and restated as of September 9, 1999. The Plan is a defined contribution plan operating under section 401(k) of the Internal Revenue Service Code. Under the Plan, employees are eligible to participate after completing one year of service. Participants may defer up to 15% of their compensation to a maximum of $10,500 as a contribution to the Plan. The Company matches 50% of the employee contributions to the Plan up to a maximum of 6% of participant contributions. Participant contributions are 100% vested immediately. Employer contributions are subject to the following vesting schedule: Year 3 of service....................................................... 20% Year 4 of service....................................................... 40% Year 5 of service....................................................... 60% Year 6 of service....................................................... 80% Year 7 of service....................................................... 100%
The Company's expense was $13,000 for the year ended March 31, 1998, $25,000 for the nine months ended December 31, 1998, $48,000 for the year ending December 31, 1999 and $9,000 and $94,000 for the nine months ended September 30, 1999 and 2000, respectively. F-42 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued (15) Members' Equity Upon formation of Earlychildhood under its former name Elliott Mair LLC in 1995, membership interests were established at 62% and 38% between the two then existing members, based upon their respective capital contributions. These two members were also the owners of QTL. Net income of Earlychildhood was allocated based upon each member's percentage interest. Per the amended and restated Operating Agreement of Earlychildhood (the "Operating Agreement") entered into as of May 5, 1999 and as a result of the Company's recapitalization, four classes of membership interests were established: Classes A, B, C, and D. No Class D interests have ever been issued. The following table sets forth the relative membership interests for each outstanding class of interests as of December 31, 1999 and September 30, 2000:
Membership Interests --------------------------------- December 31, Class 1999 September 30, 2000 ----- ------------- ------------------ A 51.7% 50.5% B 47.9% 48.1% C 0.4% 1.4%
Upon execution of the Operating Agreement, Educational Simon, L.L.C. made a capital contribution of $8,172,000. To the extent that Educational Simon, L.L.C. did not make a cumulative capital contribution of $20,000,000, gross of transaction fees by July 31, 2000, the Operating Agreement provided that a proportionate share of membership interests would be reallocated as Class B membership interests to the Class B members. Educational Simon, L.L.C. made such $11,828,000 additional capital contributions during the period from May 5, 1999 through July 31, 2000. In addition, the Operating Agreement provides that if Earlychildhood met certain targeted operating results for the twelve month period ended March 31, 2000, QTL Corporation would receive additional Class B membership interests. Based on those provisions, after meeting certain of the targets, QTL received additional Class B membership interests of 0.67% in April 2000, which ratably diluted certain of the other members. Such reallocations of membership interests were not contingent on the continued employment of any QTL employees and have been reflected as a reallocation between the respective classes of members' equity. Net income is allocated to the members as follows: . First, to the Class A member in an amount equal to their preferred return amount. The preferred return is calculated as a 10% annual return on the amount of its unreturned capital contributions taking into account the amount and timing of the capital contributions. . Second, to the Class A, B and C members, pro rata in accordance with their relative percentage interests until the Class A member receives at least a 25% internal rate of return, as defined by the Operating Agreement. . Thereafter, to the members, pro rata in accordance with their relative percentage interest. The management committee is comprised of six members, three of whom are designated by Educational Simon, L.L.C., two of whom are designated by QTL and one who is appointed upon the mutual agreement of Educational Simon, L.L.C. and QTL. F-43 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued In May 2000, the Company issued Class C membership interests of 1% to certain members of its management committee. Such members were not employees of the Company or affiliates of Educational Simon, L.L.C. or QTL. The membership interests were fully vested upon issuance. The fair value of the Class C membership interests of $421,000 has been recorded in selling, general and administrative expense during the nine months ended September 30, 2000. (16) Options to Purchase Membership Interests Effective June 20, 2000, the Company adopted the 2000 Management Equity Incentive Option Plan (the "2000 Plan"), pursuant to which the Company's management committee may grant options to eligible employees and consultants to purchase Class C membership interests. A total of approximately 9% of Earlychildhood's membership interests were available for issue under the 2000 Plan. The interests issued under the 2000 Plan will dilute the Class A and B members on a pro-rata basis. Options issued in 2000 become exercisable at a rate of 33.3% per year on the anniversary date of grant and expire ten years from the date of grant. The membership interests which are acquired by virtue of exercise of the options, are subject to repurchase by the Company at cost in the event of employee termination for any reason other than for cause. Such repurchase provisions lapse at an annual rate of 20% each year, measured from the grant date. On September 1, 2000 the initial option grant under the 2000 Plan was made to Company employees. The grant represented 6.6% of the Company's membership interests at an exercise price of $42.50 per .01% interest. The Company recorded deferred compensation of $2,761,000 as of September 30, 2000, representing the difference between the exercise price and the implied fair value of the related membership interests at the date of grant. The implied fair value was calculated upon conversion to shares of LearningStar in conjunction with the proposed combination of the Company with SmarterKids.com, Inc. ("SmarterKids.com") (see Note 22). Such implied fair value was based upon the fair market value of SmarterKids.com at the announcement date of the proposed combination. The deferred compensation reflected in membership interests is being amortized over five years, which represents the period over which the repurchase provisions ratably lapse. Of the total deferred compensation amount, $46,000 has been amortized as of September 30, 2000. As of September 30, 2000, all of the options issued, representing 6.6% of Earlychildhood's membership interests, are outstanding. None of the options are exercisable at September 30, 2000. The fair value of each option grant is established on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for grants for the nine months ended September 30, 2000: volatility of 60%, risk-free rate of 5.75%, expected life of options of ten years and no dividend yield. The weighted average fair value of options granted during the nine months ended September 30, 2000 was approximately $420,000 per 1% Class C membership interest. Had compensation expense for these awards been determined based on the fair value at the date of grant consistent with the method prescribed by SFAS No. 123, the Company's pro forma net income would have been $365,000 for the nine months ended September 30, 2000. F-44 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued (17) Lease Commitments The Company leases its facilities and certain equipment under noncancelable lease agreements, which expire at various dates. Future minimum lease payments as of September 30, 2000 under operating leases are as follows (in thousands):
Operating Leases --------- 2000............................................................... $ 679 2001............................................................... 2,767 2002............................................................... 2,727 2003............................................................... 2,687 2004............................................................... 2,233 2005............................................................... 1,893 Thereafter......................................................... 3,847 ------- $16,833 =======
Total rental expense under operating leases was $227,000 for the nine months ended December 31, 1998, $685,000 for the year ended December 31, 1999 and $389,000 and $902,000 for the nine months ended September 30, 1999 and 2000, respectively. As stated in Note 11, the Company leases one of its warehouse facilities from an affiliate of one of its members. (18) Segment Information The Company has adopted the provisions of SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for the reporting by public business enterprises of information about operating segments, products and services, geographic areas and major customers. The method for determining the Company's operating segments is based on the internal organization that is used by management for making operating decisions and assessing performance. The Company's chief operating decision maker is considered to be the Company's Chief Executive Officer ("CEO"). The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information by operating segment for purposes of making operating decisions and assessing financial performance. The Company presently operates in two segments, DSS and EPI. DSS includes the brand names Discount School Supply, Earlychildhood NEWS and Earlychildhood.com. DSS supplies educational products and information through multiple channels to early childhood professionals and parents. EPI sells school supplies to elementary schools, teachers and other educational organizations. F-45 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. There were no intersegment sales. Segment identifiable assets are those which are directly used in or identified to segment operations. The Company's profit measure of EBITDA represents net income adding back depreciation and amortization, interest and income taxes. Information regarding DSS and EPI is as follows:
DSS EPI Total ------- ------- ------- (in thousands) Year ended December 31, 1999: Revenues............................................ $38,111 $22,923 $61,034 EBITDA.............................................. 2,387 2,800 5,187 Amortization and depreciation....................... 424 539 963 Interest expense.................................... 864 11 875 Net income.......................................... 986 1,427 2,413 Assets.............................................. 13,537 15,378 28,915 Capital expenditures................................ $ 1,387 $ 194 $ 1,581 Nine months ended September 30, 1999: Revenues............................................ $28,514 $20,742 $49,256 EBITDA.............................................. 2,641 4,126 6,767 Amortization and depreciation....................... 298 333 631 Interest expense.................................... 525 11 536 Net income.......................................... 2,097 2,077 4,174 Assets.............................................. 14,599 19,912 34,511 Capital expenditures................................ $ 1,010 $ 146 $ 1,156 Nine months ended September 30, 2000: Revenues............................................ $40,890 $26,924 $67,814 EBITDA.............................................. 935 2,678 3,613 Amortization and depreciation....................... 650 613 1,263 Interest expense.................................... 1,075 -- 1,075 Net income (loss)................................... (1,698) 2,064 366 Assets.............................................. 22,333 17,010 39,343 Capital expenditures................................ $ 2,469 $ 356 $ 2,825
Prior to the May 5, 1999 acquisition of EPI, the Company operated in only one segment, DSS. DSS performs limited administrative activities, including certain accounting and information system functions on behalf of EPI. DSS charges EPI based on estimates of its actual costs for such activities. Intersegment charges amounted to $108,000, $68,000 and $81,000 for the year ended December 31, 1999, the nine months ended September 30, 1999 and the nine months ended September 30, 2000, respectively. F-46 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued (19) Quarterly Financial Information (Unaudited)
Quarter Ended (in thousands) ------------------------------------------- March 31 June 30 September 30 December 31 -------- ------- ------------ ----------- 1998: Revenues................ $ 5,670 $ 9,128 $ 5,988 Gross profit............ 2,407 3,803 2,422 Operating income........ 746 1,428 (152) Income (loss) before income taxes........... 693 1,383 (245) Net income (loss)....... $ 578 $ 1,301 $ (230) 1999: Revenues................ $ 7,049 $12,557 $29,650 $11,778 Gross profit............ 3,037 4,961 10,884 4,926 Operating income........ 469 1,073 4,594 (1,912) Income (loss) before income taxes........... 406 898 4,319 (2,228) Net income (loss)....... $ 399 $ 605 $ 3,170 $(1,761) 2000: Revenues................ $ 12,503 $18,459 $36,852 Gross profit............ 4,577 7,211 13,441 Operating income........ (2,152) (545) 5,047 Income (loss) before income taxes........... (2,454) (990) 4,754 Net income (loss)....... $ (1,941) $ (793) $ 3,100
(20) Legal Proceedings The Company is involved in litigation arising in the ordinary course of business. While the ultimate results of such proceedings cannot be predicted with certainty, management expects that these matters will not have a material adverse effect on the Company's financial position or results of operations. (21) Combining Financial Information The recapitalization of Earlychildhood has been accounted for as an "as-if- pooling" and accordingly, the historical consolidated financial statements have been restated to include the accounts and results of operations of Earlychildhood and QTL back to the beginning of the fiscal year ended March 31, 1998. The results of operations previously reported by the separate businesses and the combined amounts presented in the accompanying consolidated financial statements are presented below.
Nine Months Nine Months Nine Months Year Ended Ended Year Ended Ended Ended March 31, December 31, December 31, September 30, September 30, 1998 1998 1999 1999 2000 ---------- ------------ ------------ ------------- ------------- Revenue Earlychildhood.......... $ 203 $ 148 $51,871 $40,093 $67,814 QTL..................... 18,586 20,782 9,163 9,163 -- Eliminations............ (192) (144) -- -- -- ------- ------- ------- ------- ------- $18,597 $20,786 $61,034 $49,256 $67,814 ======= ======= ======= ======= ======= Net income Earlychildhood.......... $ 16 $ 11 $ 1,908 $ 3,669 $ 366 QTL..................... (156) 1,638 505 505 -- ------- ------- ------- ------- ------- $ (140) $ 1,649 $ 2,413 $ 4,174 $ 366 ======= ======= ======= ======= =======
F-47 EARLYCHILDHOOD LLC Notes to the Consolidated Financial Statements--Continued Rental income from the Earlychildhood's distribution center lease to QTL, which ended on May 5, 1999 has been eliminated in the consolidated financial statements. There were no other transactions between Earlychildhood and QTL prior to the recapitalization. (22) Proposed Combination On November 14, 2000, the Company entered into an agreement to combine with SmarterKids.com. In the proposed transaction, the Company's members will exchange their membership interests and SmarterKids.com's shareholders will convert their shares for shares of common stock of LearningStar, a newly- formed company. In addition, holders of options to purchase Earlychildhood membership interests will exchange their Earlychildhood options for options to purchase common stock of LearningStar. After the exchange, the Company's members and option holders will own approximately two-thirds of LearningStar's shares on a diluted basis. The combination agreement provides that each of the outstanding classes of LLC members will receive shares of LearningStar at the following exchange ratios:
LearningStar shares received per .00001% Membership interest ---------------- Class A Members............................................. 4.9951 Class B Members............................................. 4.6781 Class C Members............................................. 2.3365
The Company is required to obtain the consent of the lenders under the Paribas Credit Facility to complete the combination. If the Company is unable to obtain the lenders' consent, the credit facility could be declared in default and any borrowings under the credit facility would become due and payable. In addition, the completion of the combination is subject to certain conditions including approval by the SmarterKids.com stockholders. F-48 Independent Auditors' Report The Board of Directors Educational Products, Inc.: We have audited the accompanying balance sheets of Educational Products, Inc. ("the Company") as of March 31, 1999 and May 5, 1999 and the related statements of operations, stockholders' equity and cash flows for the year ended March 31, 1999 and the 35-day period ended May 5, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Educational Products, Inc. as of March 31, 1999 and May 5, 1999, and the results of its operations and its cash flows for the year ended March 31, 1999 and the 35-day period ended May 5, 1999 in conformity with generally accepted accounting principles. KPMG LLP San Francisco, California December 3, 1999 F-49 EDUCATIONAL PRODUCTS, INC. Balance Sheets (In thousands)
March 31, May 5, 1999 1999 --------- ------- ASSETS Current assets: Cash and cash equivalents.................................. $ -- $ 1,631 Accounts receivable, less allowance for doubtful accounts of $50,000 as of March 31, 1999 and May 5, 1999........... 944 629 Inventories................................................ 8,820 10,565 Prepaid income taxes....................................... 14 10 Other current assets....................................... 164 157 ------- ------- Total current assets..................................... 9,942 12,992 Property and equipment, net................................ 276 277 Other assets............................................... 51 84 ------- ------- Total assets............................................. $10,269 13,353 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Bank overdraft............................................. $ 379 $ -- Line of credit............................................. 270 1,500 Note payable to stockholders............................... 1,125 1,125 Note payable Earlychildhood................................ -- 1,850 Accounts payable........................................... 5,173 6,134 Accrued expenses........................................... 660 439 Deferred income taxes...................................... 744 594 ------- ------- Total current liabilities................................ 8,351 11,642 Deferred income taxes...................................... 51 49 ------- ------- Total liabilities........................................ 8,402 11,691 ------- ------- Stockholders' equity: Common stock, no par value, 10,000 shares authorized; 1,000 shares issued and outstanding............................. 1 1 Retained earnings.......................................... 1,866 1,661 ------- ------- Total stockholders' equity............................... 1,867 1,662 ------- ------- $10,269 $13,353 ======= =======
See accompanying notes to financial statements. F-50 EDUCATIONAL PRODUCTS, INC. Statements of Operations (In thousands)
Year ended Thirty-five-day March 31, period ended 1999 May 5, 1999 ---------- --------------- Net sales............................................ $21,304 $ 422 Cost of goods sold................................... 14,011 296 ------- ----- Gross profit..................................... 7,293 126 ------- ----- Operating expenses: Selling............................................ 228 12 General and administrative......................... 6,523 452 ------- ----- 6,751 464 ------- ----- Operating income (loss).......................... 542 (338) ------- ----- Other income (expense): Interest income.................................... 49 -- Interest expense................................... (112) (15) ------- ----- Total other expense.............................. (63) (15) ------- ----- Income (loss) before income taxes.................... 479 (353) Income tax expense (benefit)......................... 184 (148) ------- ----- Net income (loss)................................ $ 295 $(205) ======= =====
See accompanying notes to financial statements. F-51 EDUCATIONAL PRODUCTS, INC. Statements of Stockholders' Equity Year ended March 31, 1999 and thirty-five-day period ended May 5, 1999 (In thousands, except per share data)
Total Number Retained stockholders' of shares Amount earnings equity --------- ------ -------- ------------- Balances, April 1, 1998................. 1,000 $ 1 $1,571 $1,572 Net income.............................. -- -- 295 295 ----- --- ------ ------ Balances, March 31, 1999................ 1,000 1 1,866 1,867 Net loss................................ -- -- (205) (205) ----- --- ------ ------ Balances, May 5, 1999................... 1,000 $ 1 $1,661 $1,662 ===== === ====== ======
See accompanying notes to financial statements. F-52 EDUCATIONAL PRODUCTS, INC. Statements of Cash Flows (In thousands)
Year ended Thirty-five-day March 31, period ended 1999 May 5, 1999 ---------- --------------- Cash flows from operating activities: Net income (loss)................................. $ 295 $ (205) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization................... 100 8 Deferred income taxes........................... 245 (152) Gain on disposal of property and equipment...... (4) -- Changes in operating assets and liabilities: Accounts receivable........................... (272) 315 Inventories................................... (1,992) (1,745) Other current assets.......................... (200) 7 Prepaid income taxes.......................... -- 4 Other assets.................................. 21 (33) Accounts payable.............................. 1,858 962 Accrued expenses.............................. 76 (222) ------- ------- Net cash provided by (used in) operating activities................................. 127 (1,061) ------- ------- Cash flows from investing activities: Proceeds from sale of property and equipment...... 4 -- Purchase of property and equipment................ (106) (9) ------- ------- Net cash used in investing activities....... (102) (9) ------- ------- Cash flows from financing activities: Drawdowns on line of credit....................... 20 1,230 Repayments on notes payable to stockholders....... (1,275) -- Proceeds from notes payable to stockholders....... 1,250 -- Proceeds from note payable to Earlychildhood...... -- 1,850 ------- ------- Net cash (used in) provided by financing activities................................. (5) 3,080 ------- ------- Net increase in cash and cash equivalents........... 20 2,010 Cash and cash (overdraft) equivalents beginning of period............................................. (399) (379) ------- ------- Cash and cash (overdraft) equivalents end of period............................................. $ (379) $ 1,631 ======= ======= Supplemental disclosures of cash flow information: Cash paid during the period for: Interest........................................ $ 112 $ 6 ======= ======= Income taxes.................................... $ 28 $ -- ======= =======
See accompanying notes to financial statements. F-53 EDUCATIONAL PRODUCTS, INC. Notes to Financial Statements (1) Organization of the Company Educational Products, Inc. (the "Company"), a Texas corporation, was incorporated on February 13, 1980. The Company sells school supplies to elementary schools, teachers and other educational organizations. The Company's business cycle is highly seasonal. Substantially all sales activity occurs during the period from May through August, with a need to draw upon financial resources to fund working capital in advance of the peak of the Company's business cycle. On May 5, 1999, 100% of the common stock of the Company was acquired by Earlychildhood LLC, or Earlychildhood, a fully integrated, multi-channel supplier of educational products, services and information to parents, as well as educational professionals and schools serving the early childhood and elementary age communities. The consideration for the acquisition was $6.8 million in cash and membership interests in Earlychildhood valued at $1.6 million. In conjunction with the acquisition, the notes payable to stockholders and amounts outstanding under the line of credit were repaid. Financial statements reflect the financial position and the operating results on a historical cost basis immediately prior to the acquisition of EPI by Earlychildhood. (2) Summary of Significant Accounting Policies (a) Cash and Cash Equivalents The Company considers all highly liquid investments with a remaining maturity of three months or less at the date of the acquisition to be cash equivalents. (b) Inventories The Company values inventories at the lower of cost or market, using the average cost method. (c) Deferred Catalog Costs Deferred catalog costs reflected with other current assets, which include paper, production, printing and postage, are reflected with other current assets and are amortized in amounts proportionate to revenues over the life of the catalog, which is approximately one year. Amortization expense related to deferred catalog costs is included in the statements of income as a component of selling expenses. Such amortization expense for the year ended March 31, 1999 and the 35-day period ended May 5, 1999 was $25,000 and $1,000, respectively. (d) Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Maintenance and repairs are expensed as incurred. Depreciation of property and equipment is calculated using the straight-line method over the estimated useful lives of the respective assets. The estimated useful lives range from five to seven years for furniture, fixtures and equipment. (e) Other Current Assets and Other Assets Other assets consist of security deposits and prepaid expenses. (f) Income Taxes Income taxes are accounted for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying F-54 EDUCATIONAL PRODUCTS, INC. Notes to Financial Statements--(Continued) amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (g) Revenue Recognition The Company recognizes revenue from product sales upon the delivery of products. Provisions for estimated returns and allowances are recorded as a reduction to sales and cost of sales. The Company has arrangements with certain customers under which it delivers products on a consignment basis. The Company records revenue related to these arrangements once the products are sold through to the end user. (h) Fair Value of Financial Instruments The carrying value for cash and cash equivalents, accounts receivable, short-term debt, accounts payable and notes payable approximate fair value because of the short-term nature of these instruments. The carrying value of notes payable approximates their fair values due to variable interest rates. (i) Use of Estimates in Preparation of Financial Statements The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (3) Other Current Assets Other current assets consist of the following as of March 31, 1999 and May 5, 1999 (in thousands):
March 31, May 5, 1999 1999 --------- ------ Deferred catalog costs.................................... $135 $134 Other..................................................... 29 23 ---- ---- $164 $157 ==== ====
(4) Property and Equipment A summary of property and equipment as of March 31, 1999 and May 5, 1999 is as follows (in thousands):
March 31, May 5, 1999 1999 --------- ------ Machinery and equipment..................................... $ 726 $735 Furniture and fixtures...................................... 87 87 ----- ---- 813 822 Less accumulated depreciation............................... (537) (545) ----- ---- $ 276 $277 ===== ====
F-55 EDUCATIONAL PRODUCTS, INC. Notes to Financial Statements--(Continued) (5) Accrued Expenses Accrued expenses consist of the following as of March 31, 1999 and May 5, 1999 (in thousands):
March 31, May 5, 1999 1999 --------- ------ Employee stock ownership plan payable....................... $310 $-- Employee related accruals................................... 290 274 Other....................................................... 60 165 ---- ---- $660 $439 ==== ====
As of May 5, 1999, the Company had established an employee stock ownership plan ("ESOP"), but it did not own any of the Company's stock. The ESOP was terminated in conjunction with the acquisition by Earlychildhood. (6) Line of Credit The Company has an available a revolving line of credit of $1.5 million. Borrowings under the line of credit bear interest at the bank's index rate (currently 8%) plus 0.75%. Borrowings outstanding were $270,000 and $1,500,000 as of March 31, 1999 and May 5, 1999, respectively. The credit facility is secured by certain assets of the Company. All outstanding borrowings were repaid on May 5, 1999 in conjunction with the acquisition by Earlychildhood (Note 1). (7) Notes Payable Notes payable consist of the following as of March 31, 1999 and May 5, 1999 (in thousands):
March 31, May 5, 1999 1999 --------- ------ Note payable to stockholders at prime rate plus 1% (8.75% at May 5, 1999)......................................... $1,125 $1,125 Note payable to Earlychildhood........................... -- 1,850 ------ ------ $1,125 $2,975 ====== ======
The notes to stockholders are considered current as of March 31, 1999 and May 5, 1999 as they were repaid subsequent to year end (Note 1). The fair value of the notes approximates the carrying value as of March 31, 1999 and May 5, 1999. The note payable to Earlychildhood represents amounts advanced to the Company to be used to pay off the note payable to stockholders (Note 1). (8) Employee Stock Ownership Plan The Company has an employee stock ownership program ("ESOP") in which eligible employees are allowed to participate. Contributions are determined at the Company's discretion. Contributions during the year ended March 31, 1999 and the 35-day period ended May 5, 1999 amounted to $290,000 and $310,000, respectively. As of March 31, 1999, no shares were held by the ESOP. The value of the assets held by the plan amounted to $947,000 and $214,000 as of March 31, 1999 and May 5, 1999, respectively. F-56 EDUCATIONAL PRODUCTS, INC. Notes to Financial Statements--(Continued) (9) Income Taxes Income tax expense (benefit) consisted of the following for the year ended March 31, 1999 and the period ended May 5, 1999 (in thousands):
Current Deferred Total ------- -------- ----- Year ended March 31, 1999: Federal.......................................... $(68) $ 217 $ 149 State............................................ 7 29 35 ---- ----- ----- $(61) $ 246 $ 184 ==== ===== ===== Period ended May 5, 1999: Federal.......................................... $-- $(142) $(142) State............................................ 4 (10) (6) ---- ----- ----- $ 4 $(152) $(148) ==== ===== =====
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of March 31, 1999 and May 5, 1999 are presented below (in thousands):
Year ended Thirty-five-day March 31, period ended 1999 May 5, 1999 ---------- --------------- Deferred income tax assets: Net operating loss............................ $ 45 $ 222 Allowance for doubtful accounts............... 19 18 Accrued vacation.............................. 31 34 State taxes................................... 32 -- Other......................................... 15 6 ----- ----- Deferred tax assets......................... 142 280 Deferred income tax liabilities: Property and equipment, principally due to differences in depreciation.................. (51) (49) Inventory..................................... (886) (874) ----- ----- Net deferred tax asset (liability).......... $(795) $(643) ===== =====
The Company's management believes that it is more likely than not that its deferred tax amount will be realized. Accordingly, no valuation allowance has been established. The actual income tax expense differs from the "expected" income tax expense, computed by applying the U.S. federal income statutory tax rate of 34% to income before income taxes as follows (in thousands):
Year ended Thirty-five-day March 31, period ended 1999 May 5, 1999 ---------- --------------- Computed "expected" tax (benefit) expense....... $163 $(120) Increase resulting from: State income tax, net of federal income tax benefit...................................... 23 (4) Other permanent differences................... (2) (24) ---- ----- $184 $(148) ==== =====
F-57 EDUCATIONAL PRODUCTS, INC. Notes to Financial Statements The net operating loss represents an interim period loss which will be offset against taxable income generated by the Company subsequent to the acquisition by Earlychildhood. The utilization of such interim net operating losses will not be impacted by the aquisition due to the acquirer's limited liability company status. (10) Lease Commitments The Company leases its facilities and certain equipment under noncancelable lease agreements which expire at various dates. Future minimum lease payments under noncancelable operating leases are as follows (in thousands):
Year ended Thirty-five-day March 31, period ended 1999 May 5, 1999 ---------- --------------- 2000............................................. $ 586 $ 529 2001............................................. 242 242 2002............................................. 242 242 2003............................................. 230 230 2004............................................. 164 164 Thereafter....................................... -- -- ------ ------ Total future minimum lease payments under operating leases.............................. $1,464 $1,407 ====== ======
Total rental expense under operating leases was $605,000 and $39,000 for the year ended March 31, 1999 and the 35-day period ended May 5, 1999, respectively. (11) Legal Proceedings The Company is involved in litigation arising in the ordinary course of its business. While the ultimate results of such proceedings cannot be predicted with certainty, management expects that these matters will not have a material adverse effect on the Company's financial position or results of operations. F-58 ANNEX A EXECUTION COPY CONTRIBUTION AGREEMENT AND PLAN OF REORGANIZATION AND MERGER BY AND AMONG EARLYCHILDHOOD.COM, LLC, SMARTERKIDS.COM, INC., S-E EDUCATIONAL HOLDINGS CORP. AND S-E EDUCATIONAL MERGER CORP. ---------------- DATED AS OF NOVEMBER 14, 2000 ---------------- TABLE OF CONTENTS
Page ---- ARTICLE I. THE CONTRIBUTION AND THE MERGER.............................. A-2 Section 1.1 Certificate of Incorporation and Bylaws of Holdings.... A-2 Section 1.2 The Contribution....................................... A-2 Section 1.3 The SmarterKids Merger................................. A-3 Section 1.4 Effective Time......................................... A-3 Section 1.5 Closing................................................ A-3 Section 1.6 Effect of the Contribution............................. A-3 Section 1.7 Effect of the SmarterKids Merger....................... A-3 Section 1.8 Organizational Documents of Earlychildhood............. A-3 Section 1.9 Certificate of Incorporation and Bylaws of the Surviving Corporation.................................. A-3 Section 1.10 Management of Earlychildhood Following the Contribution; Directors and Officers of the Surviving Corporation............................................ A-4 Section 1.11 Earlychildhood Employees............................... A-4 ARTICLE II. EXCHANGE AND CONVERSION OF SECURITIES....................... A-4 Section 2.1 Exchange of LLC Interests of Earlychildhood............ A-4 Section 2.2 Conversion of SmarterKids Capital Stock................ A-4 Section 2.3 Treatment of Outstanding Options, SmarterKids Warrants, and SmarterKids Employee Stock Purchase Plan........... A-5 Section 2.4 Cancellation of Holdings Common Stock.................. A-6 Section 2.5 Exchange of Certificates............................... A-6 ARTICLE III. REPRESENTATIONS AND WARRANTIES OF EARLYCHILDHOOD........... A-9 Section 3.1 Organization of Earlychildhood......................... A-9 Section 3.2 Earlychildhood Capital Structure....................... A-10 Section 3.3 Authority; No Conflict; Required Filings and Consents.. A-11 Section 3.4 Books and Records...................................... A-12 Section 3.5 Financial Information.................................. A-12 Section 3.6 No Undisclosed Liabilities............................. A-12 Section 3.7 Absence of Certain Changes or Events................... A-12 Section 3.8 Taxes.................................................. A-14 Section 3.9 Properties............................................. A-15 Section 3.10 Intellectual Property.................................. A-15 Section 3.11 Product Warranty and Liability......................... A-17 Section 3.12 Material Contracts..................................... A-17 Section 3.13 Litigation............................................. A-18 Section 3.14 Environmental Matters.................................. A-18 Section 3.15 Employee Benefit Plans................................. A-19 Section 3.16 Compliance With Laws................................... A-21 Section 3.17 Tax Matters............................................ A-21 Section 3.18 Registration Statement; Proxy Statement/Prospectus..... A-21 Section 3.19 Labor Matters.......................................... A-22 Section 3.20 Insurance.............................................. A-22 Section 3.21 No Existing Discussions................................ A-22 Section 3.22 Consent................................................ A-22 Section 3.23 Management Committee Approval.......................... A-22
Page ---- ARTICLE IV. REPRESENTATIONS AND WARRANTIES OF SMARTERKIDS................ A-23 Section 4.1 Organization of SmarterKids............................. A-23 Section 4.2 SmarterKids Capital Structure........................... A-23 Section 4.3 Authority; No Conflict; Required Filings and Consents... A-24 Section 4.4 SEC Filings; Financial Statements....................... A-25 Section 4.5 No Undisclosed Liabilities.............................. A-25 Section 4.6 Absence of Certain Changes or Events.................... A-26 Section 4.7 Taxes................................................... A-27 Section 4.8 Properties.............................................. A-28 Section 4.9 Intellectual Property................................... A-28 Section 4.10 Product Warranties and Liability........................ A-29 Section 4.11 Agreements, Contracts and Commitments................... A-30 Section 4.12 Litigation.............................................. A-31 Section 4.13 Environmental Matters................................... A-31 Section 4.14 Employee Benefit Plans.................................. A-31 Section 4.15 Compliance With Laws.................................... A-33 Section 4.16 Tax Matters............................................. A-33 Section 4.17 Registration Statement; Proxy Statement/Prospectus...... A-34 Section 4.18 Labor Matters........................................... A-34 Section 4.19 Insurance............................................... A-34 Section 4.20 Opinion of Financial Advisor............................ A-34 Section 4.21 No Existing Discussions................................. A-34 Section 4.22 Board Recommendation.................................... A-34 Section 4.23 Voting Requirements..................................... A-34 Section 4.24 Section 203 of the DGCL Not Applicable.................. A-35 ARTICLE V. COVENANTS..................................................... A-35 Section 5.1 Conduct of Business..................................... A-35 Section 5.2 Cooperation; Notice; Cure............................... A-37 Section 5.3 No Solicitation......................................... A-37 Section 5.4 No Negotiation.......................................... A-39 Section 5.5 Proxy Statement/Prospectus; Registration Statement...... A-40 Section 5.6 Nasdaq Quotation........................................ A-40 Section 5.7 Access to Information................................... A-40 Section 5.8 SmarterKids Stockholders' Meeting....................... A-41 Section 5.9 Legal Conditions to Merger.............................. A-41 Section 5.10 Earlychildhood Financial Statements..................... A-42 Section 5.11 Public Disclosure....................................... A-42 Section 5.12 Non-recognition Exchange................................ A-42 Section 5.13 Affiliate Agreements.................................... A-42 Section 5.14 Nasdaq Quotation........................................ A-42 Section 5.15 Stock Plans............................................. A-42 Section 5.16 Employee Stock Purchase Plan............................ A-44 Section 5.17 Non-Employee Director Plan.............................. A-44 Section 5.18 Brokers or Finders...................................... A-44 Section 5.19 Indemnification......................................... A-44 Section 5.20 Letter of SmarterKids' Accountants...................... A-45 Section 5.21 Letter of Earlychildhood's Accountants.................. A-45 Section 5.22 Post-Transaction Corporate Governance of Holdings....... A-45 Section 5.23 Name of Holdings........................................ A-46 Section 5.24 Conveyance Taxes........................................ A-46 Section 5.25 SmarterKids Minimum Closing Cash........................ A-46 Section 5.26 Blohm Consulting Agreement.............................. A-46
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Page ---- ARTICLE VI. CONDITIONS TO THE TRANSACTIONS.............................. A-46 Section 6.1 Conditions to Each Party's Obligation to Effect the Transactions............................................ A-46 Section 6.2 Additional Conditions to Obligations of Earlychildhood.. A-47 Section 6.3 Additional Conditions to Obligations of SmarterKids..... A-48 ARTICLE VII. TERMINATION AND AMENDMENT.................................. A-49 Section 7.1 Termination............................................. A-49 Section 7.2 Effect of Termination................................... A-50 Section 7.3 Fees and Expenses....................................... A-50 Section 7.4 Amendment............................................... A-51 Section 7.5 Extension; Waiver....................................... A-51 ARTICLE VIII. MISCELLANEOUS A-52 Section 8.1 Nonsurvival of Representations, Warranties and Agreements.............................................. A-52 Section 8.2 Notices................................................. A-52 Section 8.3 Interpretation.......................................... A-53 Section 8.4 Counterparts............................................ A-53 Section 8.5 Entire Agreement; No Third Party Beneficiaries. A-53 Section 8.6 Governing Law........................................... A-53 Section 8.7 Assignment.............................................. A-53
- iii - EXHIBITS Exhibit A Form of Stockholder Support Agreement Exhibit B Form of Consent and Non-Contravention Agreement Exhibit C Form of Lockup Agreement Exhibit D Form of Registration Rights Agreement Exhibit E Form of Restated Certificate of Incorporation of Holdings Exhibit F Form of Amended and Restated Bylaws of Holdings Exhibit G Form of Second Amended and Restated Operating Agreement Form of Restated Certificate of Incorporation of Surviving Exhibit H Corporation Exhibit I Form of Amended and Restated Bylaws of Surviving Corporation Exhibit J Form of Affiliate Agreement Exhibit K Form of Holdings Stock Plan Exhibit L Form of Holdings Employee Stock Purchase Plan Exhibit M Form of Holdings Director Plan Exhibit N Form of Blohm Consulting Agreement
- iv - TABLE OF DEFINED TERMS
Cross Reference in Terms Agreement - ----- ------------------ Acquisition Proposal......................................... Section 5.3(a) Affiliate.................................................... Section 5.13 Affiliate Agreement.......................................... Section 5.13 Agreement.................................................... Preamble Bankruptcy and Equity Exception.............................. Section 3.3(a) Benefit Arrangements......................................... Section 3.15(a) Breaching Party.............................................. Section 7.3(b) Certificates................................................. Section 2.5(b)(ii) Class A Exchange Ratio....................................... Section 2.1 Class B Exchange Ratio....................................... Section 2.1 Class C Exchange Ratio....................................... Section 2.1 Closing...................................................... Section 1.5 Closing Date................................................. Section 1.5 Code......................................................... Recitals Confidentiality Agreements................................... Section 5.7 Consent Agreement............................................ Recitals Contribution................................................. Recitals Conveyance Taxes............................................. Section 5.24 Costs........................................................ Section 5.19(a) Current Premium.............................................. Section 5.19(b) DGCL......................................................... Recitals Earlychildhood............................................... Preamble Earlychildhood Acquisition Proposal.......................... Section 5.4(a) Earlychildhood Balance Sheet................................. Section 3.5 Earlychildhood Change of Control Arrangements................ Section 3.15(f) Earlychildhood Confidentiality Agreement..................... Section 5.3(b) Earlychildhood Director...................................... Section 5.22(a) Earlychildhood Disclosure Schedule........................... ARTICLE III Earlychildhood Employee Plans................................ Section 3.15(a) Earlychildhood ERISA Affiliate............................... Section 3.15(c)(i) Earlychildhood Exchange Ratio................................ Section 2.1 Earlychildhood Financial Information......................... Section 3.5 Earlychildhood Intellectual Property......................... Section 3.10(a) Earlychildhood Lease Agreements.............................. Section 3.9(a) Earlychildhood Material Adverse Change....................... Section 3.7 Earlychildhood Material Adverse Effect....................... Section 3.1 Earlychildhood Material Contracts............................ Section 3.12(b) Earlychildhood Option........................................ Section 2.3(a) Earlychildhood Option Plans.................................. Section 2.3(a) Earlychildhood Organizational Documents...................... Section 3.3(b) Earlychildhood Owned Real Property........................... Section 3.9(a) Earlychildhood Permitted Encumbrances........................ Section 3.9(a) Earlychildhood Third Party Rights............................ Section 3.10(e) Effective Time............................................... Section 1.4 Employee Benefit Plans....................................... Section 3.15(a) Encumbrance ................................................. Section 3.2(a) Environmental Law ........................................... Section 3.14(b) ERISA ....................................................... Section 3.15(a)
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Cross Reference in Terms Agreement - ----- ------------------ ESPP Termiation Date ........................................ Section 2.3(d) Exchange Act ................................................ Section 4.3(c) Exchange Agent .............................................. Section 2.5(a) Exchange Fund ............................................... Section 2.5(a) Executive Management Agreement .............................. Section 3.12(e) Expenses .................................................... Section 7.3(b) Final SmarterKids Purchase Date ............................. Section 2.3(d) Fund ........................................................ Section 3.3(c) GAAP ........................................................ Section 3.5 Governmental Entity ......................................... Section 3.3(c) Hazardous Substance ......................................... Section 3.14(c) Holdings..................................................... Preamble Holdings Common Stock........................................ Recitals Holdings Director Plan....................................... Section 5.17 Holdings Employee Stock Purchase Plan........................ Section 5.16(a) Holdings Material Adverse Effect............................. Section 6.1(f) Holdings Stock Plan.......................................... Section 5.15(f) HSR Act...................................................... Section 3.3(c) Indemnified Parties.......................................... Section 5.19(a) Independent Director......................................... Section 5.22(a) IRS.......................................................... Section 3.8(b) LLC Certificates............................................. Section 2.5(b)(i) LLC Interests................................................ Section 1.2 Lockup Agreement............................................. Recitals Members...................................................... Section 3.2(a) Merger Sub................................................... Preamble Minimum Closing Cash......................................... Section 5.25 Operating Agreement.......................................... Section 1.2 Order........................................................ Section 5.9(b) Other Party.................................................. Section 5.4(a) Outside Date................................................. Section 7.1(b) Proxy Statement/Prospectus................................... Section 3.18 Registration Rights Agreement................................ Recitals Registration Statement....................................... Section 3.18 Rule 145..................................................... Section 5.13 SEC.......................................................... Section 3.18 Second Amended and Restated Operating Agreement.............. Section 1.8 Stockholder Support Agreement................................ Recitals Subsidiary................................................... Section 3.1 Superior Proposal............................................ Section 5.3(b) Surviving Corporation........................................ Section 1.7 SmarterKids.................................................. Preamble SmarterKids Balance Sheet.................................... Section 4.4(c) SmarterKids Certificate of Merger............................ Section 1.4 SmarterKids Certificates..................................... Section 2.5(b)(ii) SmarterKids Change of Control Agreements..................... Section 4.14(f) SmarterKids Common Stock..................................... Section 1.3 SmarterKids Confidentiality Agreement........................ Section 5.7 SmarterKids Director......................................... Section 5.22(a) SmarterKids Disclosure Schedule.............................. ARTICLE IV
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Cross Reference in Terms Agreement - ----- ------------------ SmarterKids Employee Plans................................... Section 4.14(a) SmarterKids Employee Stock Purchase Plan..................... Section 2.3(d) SmarterKids ERISA Affiliate.................................. Section 4.14(c)(i) SmarterKids Exchange Ratio................................... Section 2.2(c) SmarterKids Intellectual Property............................ Section 4.9(a) SmarterKids Lease Agreements................................. Section 4.8(a) SmarterKids Material Adverse Change.......................... Section 4.6 SmarterKids Material Adverse Effect.......................... Section 4.1 SmarterKids Material Contracts............................... Section 4.11(b) SmarterKids Merger........................................... Recitals SmarterKids Organizational Documents......................... Section 4.3(b) SmarterKids Permitted Encumbrances........................... Section 4.8(a) SmarterKids Preferred Stock.................................. Section 4.2(a) SmarterKids SEC Reports...................................... Section 4.4(a) SmarterKids Stock Option..................................... Section 2.3(b) SmarterKids Stock Plans...................................... Section 4.2(a) SmarterKids Stockholders' Meeting............................ Section 3.18 SmarterKids Third Party Rights............................... Section 4.9(e) SmarterKids Warrants......................................... Section 4.2(a) Tax.......................................................... Section 3.8(a) Taxes........................................................ Section 3.8(a) Termination Fee.............................................. Section 7.3(c) Third Party.................................................. Section 5.3(a) Transaction Documents........................................ Section 3.3(a) Transactions................................................. Section 1.3 Transfer Documents........................................... Section 2.5(b)(i)
- vii - CONTRIBUTION AGREEMENT AND PLAN OF REORGANIZATION AND MERGER CONTRIBUTION AGREEMENT AND PLAN OF REORGANIZATION AND MERGER (the "Agreement"), dated as of November 14, 2000 by and among EARLYCHILDHOOD.COM, LLC, a California limited liability corporation ("Earlychildhood"), SMARTERKIDS.COM, INC., a Delaware corporation ("SmarterKids"), S-E EDUCATIONAL HOLDINGS CORP., a newly-formed Delaware corporation, one-half of the issued and outstanding capital stock of which is owned by each of Earlychildhood and SmarterKids ("Holdings") and S-E EDUCATIONAL MERGER CORP., a newly-formed Delaware corporation and a wholly-owned subsidiary of Holdings ("Merger Sub"). WHEREAS, the Management Committee of Earlychildhood and the Board of Directors of SmarterKids deem it advisable and in the best interests of each corporation and its members or stockholders, as the case may be, in order to advance the long-term business interests of Earlychildhood and SmarterKids, that Earlychildhood and SmarterKids combine; WHEREAS, the combination of Earlychildhood and SmarterKids shall be effected through (i) the contribution to Holdings by the holders of all outstanding LLC Interests (as defined in Section 1.2) of all of the right, title and interest in and to their entire ownership interest in Earlychildhood (the "Contribution") such that Earlychildhood will become a wholly-owned subsidiary of Holdings and the holders of LLC Interests in Earlychildhood will become stockholders of Holdings, and (ii) the merger of Merger Sub with and into SmarterKids (the "SmarterKids Merger") such that SmarterKids becomes a wholly- owned subsidiary of Holdings and the holders of capital stock of SmarterKids become stockholders of Holdings; WHEREAS, concurrently with the execution and delivery of this Agreement and as a condition and inducement to Earlychildhood's willingness to enter into this Agreement, certain stockholders of SmarterKids have entered into a Stockholder Support Agreement with Earlychildhood, dated as of the date hereof, substantially in the form attached hereto as Exhibit A (the "Stockholder Support Agreement"), pursuant to which such stockholders have agreed, among other things, to vote all voting securities of SmarterKids beneficially owned by them in favor of approval and adoption of this Agreement and the SmarterKids Merger; WHEREAS, concurrently with the execution and delivery of this Agreement and as a condition and inducement to SmarterKids' willingness to enter into this Agreement, the holders of all outstanding LLC Interests in Earlychildhood have entered into a Consent and Non-Contravention Agreement, dated as of the date hereof, substantially in the form attached hereto as Exhibit B (the "Consent Agreement"), pursuant to which such persons have agreed, among other things, to (i) effect the Contribution upon the terms and subject to the conditions set forth herein and (ii) take no action, directly or indirectly, to contravene, supersede or modify their consent in favor of this Agreement and the Contribution or to cause Earlychildhood to take any action in contravention of this Agreement or the transactions contemplated hereby; WHEREAS, concurrently with the execution and delivery of this Agreement and as a condition and inducement to Earlychildhood's and SmarterKids' willingness to enter into this Agreement, certain holders of LLC Interests in Earlychildhood and certain stockholders of SmarterKids have entered into a Lockup Agreement, dated as of the date hereof, substantially in the form attached hereto as Exhibit C (the "Lockup Agreement"), pursuant to which such persons have agreed, among other things, not to sell the shares of Holdings Common Stock (as defined below) such persons receive in connection with the Transactions (as defined in Section 1.3) until the earlier to occur of (i) 180 days from the Effective Time (as defined in Section 1.4) and (ii) the date upon which a secondary offering of Holdings Common Stock for the purposes of effecting the orderly sale of such shares has been consummated; WHEREAS, concurrently with the execution and delivery of this Agreement and as a condition and inducement to Earlychildhood's and SmarterKids' willingness to enter into this Agreement, Holdings has entered into a Registration Rights Agreement, dated as of the date hereof, substantially in the form attached hereto as Exhibit D (the "Registration Rights Agreement") with certain Holders (as defined in the Registration A-1 Rights Agreement) of common stock, par value $0.01 per share of Holdings (the "Holdings Common Stock"), which Registration Rights Agreement will govern the resale registration by Holdings, for the benefit of the Holders, of shares of Holdings Common Stock received by such Holders in the Transactions; WHEREAS, for Federal income tax purposes, it is intended that (i) the Contribution shall qualify as a transfer of property to Holdings by holders of LLC Interests described in Section 351 of the Internal Revenue Code of 1986, as amended (the "Code"), and (ii) the SmarterKids Merger shall qualify as a reorganization described in Section 368(a) of the Code and, taken together with the Contribution, as a transfer of property to Holdings by holders of SmarterKids capital stock described in Section 351 of the Code; and WHEREAS, the Management Committee of Earlychildhood and the Board of Directors of SmarterKids have approved this Agreement and each of the Transaction Documents (as defined in Section 3.3(a)) to which its company is a party; WHEREAS, no further action on the part of the Management Committee of Earlychildhood is required to effect the transactions contemplated hereby; WHEREAS, the holders of LLC Interests have approved this Agreement and the Contribution and no further action on the part of the holders of LLC Interests is required to effect the transactions contemplated hereby; WHEREAS, under the Delaware General Corporation Law (the "DGCL"), in order to effect the SmarterKids Merger, SmarterKids is required to obtain the vote of the holders of a majority of the outstanding shares of SmarterKids capital stock to approve this Agreement; and WHEREAS, Earlychildhood, SmarterKids and Holdings desire to make certain representations, warranties, covenants and agreements in connection with the combination and also to prescribe various conditions to the combination. NOW, THEREFORE, in consideration of the foregoing and the respective representations, warranties, covenants and agreements set forth below, the parties agree as follows: ARTICLE I. THE CONTRIBUTION AND THE MERGER Section 1.1 Certificate of Incorporation and Bylaws of Holdings. The Certificate of Incorporation and Bylaws of Holdings shall be amended prior to the Effective Time to be substantially in the form of Exhibit E and Exhibit F attached hereto, respectively. From the date hereof until the Effective Time, Earlychildhood and SmarterKids shall consult with each other prior to causing or permitting Holdings to take any action and neither shall cause or permit Holdings to take any action inconsistent with the provisions of this Agreement without the written consent of the other. Section 1.2 The Contribution. Upon the terms and subject to the provisions of this Agreement, at the Effective Time, each holder of an outstanding membership interest in Earlychildhood (such membership interests (other than Earlychildhood Options (as defined below) and membership interests issuable upon conversion of Earlychildhood Options) being collectively referred to herein as the "LLC Interests") shall contribute to Holdings all of the right, title and interest in and to such holder's entire ownership interest in Earlychildhood, which ownership interest, in each case, is set forth next to the name of such person in the Earlychildhood Disclosure Schedule (as defined in Article III), and in exchange therefor (as described in Section 2.1), (i) each holder of LLC Interests which is a Class A Member (as defined in that certain Amended and Restated Operating Agreement of Earlychildhood dated as of May 5, 1999 (the "Operating Agreement")) shall be entitled to receive 4.9951 shares of Holdings Common Stock for each .00001% of an LLC Interest A-2 held in such capacity, (ii) each holder of an LLC Interest which is a Class B Member (as defined in the Operating Agreement) shall be entitled to receive 4.6781 shares of Holdings Common Stock for each .00001% of an LLC Interest held in such capacity, and (iii) each holder of an LLC Interest which is a Class C Member (as defined in the Operating Agreement) shall be entitled to receive 2.3365 shares of Holdings Common Stock for each .00001% of an LLC Interest held in such capacity. At the Effective Time, the Operating Agreement shall be amended and restated to provide that Holdings shall be the sole member of Earlychildhood, holding a single class of membership interests. Section 1.3 The SmarterKids Merger. Earlychildhood and SmarterKids shall cause Holdings to form Merger Sub under the laws of the State of Delaware. Earlychildhood and SmarterKids shall cause Holdings to cause Merger Sub to execute and deliver this Agreement. Upon the terms and subject to the provisions of this Agreement, and in accordance with the DGCL, Merger Sub shall merge with and into SmarterKids at the Effective Time, and each outstanding share of common stock, par value $.01 per share, of SmarterKids ("SmarterKids Common Stock") shall be converted into the right to receive one (1) share of Holdings Common Stock (as described in Section 2.2(c)). Merger Sub will be formed solely to facilitate the SmarterKids Merger and will conduct no business or activity other than in connection with the SmarterKids Merger. The SmarterKids Merger, together with the Contribution, collectively constitute the "Transactions." Section 1.4 Effective Time. Subject to, and consistent with, the provisions of this Agreement, a certificate of merger (the "SmarterKids Certificate of Merger") with respect to the SmarterKids Merger in such form as is required by the relevant provisions of the DGCL shall be duly prepared, executed and acknowledged and thereafter delivered to the Secretary of State of the State of Delaware for filing, as provided in the DGCL, as early as practicable on the Closing Date. The SmarterKids Merger shall become effective upon the filing of the SmarterKids Certificate of Merger with the Secretary of State of the State of Delaware or such later time as may be specified therein. The time at which the Contribution has been consummated and the SmarterKids Merger has become fully effective is hereinafter referred to as the "Effective Time." Section 1.5 Closing. The closing of the Transactions (the "Closing") will take place at 10:00 a.m., Eastern Standard Time, on a date to be specified by SmarterKids and Earlychildhood, which shall be no later than the third business day after satisfaction or, if permissible, waiver of the conditions set forth in Article VI (the "Closing Date"), at the offices of Latham & Watkins, 633 West Fifth Street, Suite 4000 Los Angeles, California 90071, unless another date, place or time is agreed to in writing by SmarterKids and Earlychildhood. Section 1.6 Effect of the Contribution. As a result of the Contribution, (i) Holdings shall become the sole member of Earlychildhood and shall have all of the rights, benefits and obligations set forth in the Second Amended and Restated Operating Agreement (as defined in Section 1.8) and (ii) Earlychildhood will become a wholly-owned subsidiary of Holdings. Section 1.7 Effect of the SmarterKids Merger. As a result of the SmarterKids Merger, the separate corporate existence of Merger Sub shall cease and SmarterKids shall continue as the surviving corporation (the "Surviving Corporation"). Upon becoming effective, the SmarterKids Merger shall have the effects set forth in the DGCL. Without limiting the generality of the foregoing, and subject thereto, at the Effective Time, all properties, rights, privileges, powers and franchises of SmarterKids and Merger Sub shall vest in the Surviving Corporation, and all debts, liabilities and duties of SmarterKids and Merger Sub shall become the debts, liabilities and duties of the Surviving Corporation. Section 1.8 Organizational Documents of Earlychildhood. At the Effective Time, the Operating Agreement shall be amended and restated in substantially the form attached hereto as Exhibit G to provide that Holdings shall be the sole member of Earlychildhood upon consummation of the Contribution holding a single class of membership interests (as so amended and restated, the "Second Amended and Restated Operating Agreement"). Section 1.9 Certificate of Incorporation and Bylaws of the Surviving Corporation. At the Effective Time, the Certificate of Incorporation and Bylaws of the Surviving Corporation shall be amended and restated A-3 as set forth in Exhibit H and Exhibit I attached hereto, respectively, in each case until duly amended in accordance with applicable law. Section 1.10 Management of Earlychildhood Following the Contribution; Directors and Officers of the Surviving Corporation. (a) Management of Earlychildhood. At the Effective Time (after giving effect to the Contribution), Earlychildhood shall be managed in accordance with the provisions of the Second Amended and Restated Operating Agreement. (b) Directors and Officers of the Surviving Corporation. The directors and officers of SmarterKids immediately prior to the Effective Time shall be the initial directors and officers of the Surviving Corporation, each to hold office in accordance with the Certificate of Incorporation and Bylaws of the Surviving Corporation. Section 1.11 Earlychildhood Employees. At the Effective Time, all of the employees of Earlychildhood shall be transferred to Holdings and, from and after the Effective Time, shall be employees of Holdings. Such transferred employees shall serve Holdings in the same capacity or capacities as they served Earlychildhood prior to the Effective Time. Each of the parties hereto shall take all actions necessary to effect the provisions of this Section 1.11. ARTICLE II. EXCHANGE AND CONVERSION OF SECURITIES Section 2.1 Exchange of LLC Interests of Earlychildhood. At the Effective Time, subject to Section 2.5(e), (i) each .00001% of an LLC Interest then outstanding and owned by a holder of LLC Interests which is a Class A Member in such capacity shall, by virtue of the Contribution, be exchanged for 4.9951 shares of Holdings Common Stock (the "Class A Exchange Ratio"), (ii) each .00001% of an LLC Interest then outstanding and owned by a holder of LLC Interests which is a Class B Member in such capacity shall, by virtue of the Contribution, be exchanged for 4.6781 shares of Holdings Common Stock (the "Class B Exchange Ratio"), and (iii) each .00001% of an LLC Interest then outstanding and owned by a holder of LLC Interests which is a Class C Member in such capacity shall, by virtue of the Contribution, be exchanged for 2.3365 shares of Holdings Common Stock (the "Class C Exchange Ratio" and, collectively with the Class A Exchange Ratio and the Class B Exchange Ratio, the "Earlychildhood Exchange Ratio"). Upon such Contribution, all such LLC Interests shall be transferred in full, together with all right, title and interest in and to such LLC Interests, to Holdings and each person who was formerly a holder of an LLC Interest shall cease to have any rights with respect thereto, except the right to receive the shares of Holdings Common Stock and any cash in lieu of fractional shares of Holdings Common Stock to be issued or paid in consideration therefor, without interest thereon. Section 2.2 Conversion of SmarterKids Capital Stock. At the Effective Time, by virtue of the SmarterKids Merger and without any action on the part of any of the parties hereto or the holders of any shares of SmarterKids Common Stock or capital stock of Merger Sub: (a) Capital Stock of Merger Sub. Each issued and outstanding share of the capital stock of Merger Sub shall be converted into and become one fully paid and nonassessable share of common stock, par value $.01 per share, of the Surviving Corporation. (b) Cancellation of Treasury Stock. All shares of SmarterKids Common Stock that are owned by SmarterKids (including treasury stock) shall be canceled and retired and shall cease to exist and no shares of Holdings Common Stock or other consideration shall be delivered in exchange therefor. (c) Exchange Ratio for SmarterKids Common Stock. Subject to Section 2.5(e), each issued and outstanding share of SmarterKids Common Stock (other than shares to be canceled in accordance with A-4 Section 2.2(b)) shall be converted into the right to receive one (1) share of Holdings Common Stock (the "SmarterKids Exchange Ratio"). All such shares of SmarterKids Common Stock, when so converted, shall no longer be outstanding and shall automatically be cancelled and retired and shall cease to exist, and each holder of a certificate representing any such shares shall cease to have any rights with respect thereto, except the right to receive the shares of Holdings Common Stock and any cash in lieu of fractional shares of Holdings Common Stock to be issued or paid in consideration therefor, in each case upon the surrender of such certificate in accordance with Section 2.5 and without interest thereon. Section 2.3 Treatment of Outstanding Options, SmarterKids Warrants, and SmarterKids Employee Stock Purchase Plan. (a) Earlychildhood Options. At the Effective Time, each outstanding option to purchase LLC Interests (an "Earlychildhood Option") under any option plans of Earlychildhood in effect on the date hereof (the "Earlychildhood Option Plans"), whether vested or unvested, shall be deemed to constitute an option to acquire, on substantially the same terms and conditions as were applicable under such Earlychildhood Option the same number of shares of Holdings Common Stock as the holder of such Earlychildhood Option would have been entitled to receive pursuant to the Contribution had such holder exercised such option in full immediately prior to the Effective Time (rounded down to the nearest whole number), at a price per share (rounded up to the nearest whole cent) equal to (x) the aggregate exercise price for the LLC Interests purchasable pursuant to such Earlychildhood Option immediately prior to the Effective Time divided by (y) the number of full shares of Holdings Common Stock deemed purchasable pursuant to such Earlychildhood Option in accordance with the foregoing. Prior to the Effective Time, Earlychildhood shall make any such amendments to the terms of the Earlychildhood Option Plans that are necessary to give effect to the transactions contemplated by this Section 2.3(a) and to make such Earlychildhood Option Plans and the provisions thereof consistent with option plans customary for public companies. (b) SmarterKids Stock Options. At the Effective Time, each outstanding option to purchase shares of SmarterKids Common Stock (a "SmarterKids Stock Option") under the SmarterKids Stock Plans (as defined in Section 4.2(a)), whether vested or unvested, shall be deemed to constitute an option to acquire, on the same terms and conditions as were applicable under such SmarterKids Stock Option the same number of shares of Holdings Common Stock as the holder of such SmarterKids Stock Option would have been entitled to receive pursuant to the SmarterKids Merger had such holder exercised such option in full immediately prior to the Effective Time (rounded down to the nearest whole number), at a price per share (rounded up to the nearest whole cent) equal to (x) the aggregate exercise price for the shares of SmarterKids Common Stock purchasable pursuant to such SmarterKids Stock Option immediately prior to the Effective Time divided by (y) the number of full shares of Holdings Common Stock deemed purchasable pursuant to such SmarterKids Stock Option in accordance with the foregoing. Prior to the Effective Time, SmarterKids shall make any such amendments to the terms of the SmarterKids Stock Plans that are necessary to give effect to the transactions contemplated by this Section 2.3(b). It is the intention of the parties that any SmarterKids Stock Options that are "incentive stock options" within the meaning of Section 422 of the Code and which are converted into options to acquire Holdings Common Stock pursuant to this Section 2.3(b) qualify following the Effective Time as incentive stock options. Such adjustments pursuant to this Section 2.3(b) are intended to be effective in a manner which is consistent with Section 424(a) of the Code. (c) SmarterKids Warrants. At the Effective Time, each SmarterKids Warrant (as defined in Section 4.2(a)) shall thereafter represent solely the right to acquire, on substantially the terms and conditions as are currently applicable under the SmarterKids Warrants, the same number of shares of Holdings Common Stock as a holder of the SmarterKids Warrants would have been entitled to receive pursuant to the SmarterKids Merger had such holder exercised such SmarterKids Warrants in full immediately prior to the Effective Time (rounded down to the nearest whole number), at the price per share (rounded up to the nearest whole cent) equal to (x) the aggregate exercise price for the shares of SmarterKids Common Stock purchasable pursuant to the SmarterKids Warrants immediately prior to the Effective Time divided by (y) the number of full shares of Holdings Common Stock deemed purchasable pursuant to the SmarterKids Warrants in accordance with the A-5 foregoing. Prior to the Effective Time, SmarterKids shall make any such amendments to the terms of the SmarterKids Warrants that are necessary to give effect to the transactions contemplated by this Section 2.3(c). (d) SmarterKids Employee Stock Purchase Plan. (i) In the event that the current "payment period" (as such term is used in the 1999 Employee Stock Purchase Plan of SmarterKids (the "SmarterKids Employee Stock Purchase Plan")), in effect as of the date of this Agreement, ends prior to the Effective Time, SmarterKids shall use its reasonable best efforts to terminate the SmarterKids Employee Stock Purchase Plan, subject to Section 2.3(d)(iii) below, as of the date that the current payment period ends (the "ESPP Termination Date"). (ii) In the event that the Effective Time occurs on or prior to the end of the current payment period in effect as of the date of this Agreement, SmarterKids shall use its reasonable best efforts, to the extent permitted by law and the provisions of the SmarterKids Employee Stock Purchase Plan, including any amendment provisions thereof, to cause the exercise date applicable to the current payment period to be the last trading day on which the shares of SmarterKids Common Stock are traded on Nasdaq immediately prior to the Effective Time (the "Final SmarterKids Purchase Date"); provided, that, such change in the Final SmarterKids Purchase Date will be conditioned upon the consummation of the SmarterKids Merger. Subject to Section 2.3(d)(iii) below, SmarterKids shall use its reasonable best efforts to terminate the SmarterKids Employee Stock Purchase Plan immediately after the Final SmarterKids Purchase Date and prior to the Effective Time. (iii) On the occurrence of either the ESPP Termination Date or the Final SmarterKids Purchase Date, as the case may be, SmarterKids shall apply the funds credited as of such date under the SmarterKids Employee Stock Purchase Plan within each participant's payroll withholdings account to the purchase of whole shares of SmarterKids Common Stock in accordance with the terms of the SmarterKids Employee Stock Purchase Plan. The cost to each participant in the SmarterKids Employee Stock Purchase Plan for shares of SmarterKids Common Stock will be the lower of 85% of the average market price of SmarterKids Common Stock on Nasdaq on (A) the first day of the then current offering period or (B) the ESPP Termination Date or the Final SmarterKids Purchase Date, as the case may be. No fractional shares of SmarterKids Common Stock shall be issued and any payroll withholdings not used to purchase fractional shares of SmarterKids Common Stock will be refunded, without interest to the participant. (iv) It is the intention of the parties that notwithstanding anything contained in this Agreement, the exercise price, the number of shares purchasable and the terms and conditions applicable to any adjustments to the SmarterKids Employee Stock Purchase Plan and any employee stock purchase plan maintained by Holdings will be determined so as to comply with Sections 423 and 424 of the Code and the regulations promulgated thereunder such that the arrangement implemented under the SmarterKids Employee Stock Purchase Plan by reason of the SmarterKids Merger not constitute a "modification." Section 2.4 Cancellation of Holdings Common Stock. At the Effective Time, by virtue of the Transactions and without any action on the part of any holder of any LLC Interest or any holder of capital stock of SmarterKids or Holdings, each share of Holdings Common Stock issued and outstanding immediately prior to the Effective Time shall be canceled, and no consideration shall be delivered in exchange therefor. Section 2.5 Exchange of Certificates. The procedures for exchanging LLC Interests and shares of SmarterKids Common Stock outstanding immediately prior to the Effective Time for shares of Holdings Common Stock in the Transactions are as follows: (a) Exchange Agent. As of the Effective Time, Holdings shall deposit with a bank or trust company designated by SmarterKids and Earlychildhood (the "Exchange Agent"), for the benefit of the holders of LLC Interests outstanding immediately prior to the Effective Time and the holders of shares of SmarterKids Common Stock outstanding immediately prior to the Effective Time, for exchange in accordance with this Section 2.5, through the Exchange Agent, certificates representing the shares of Holdings Common Stock issuable pursuant to Sections 2.1 and 2.2 in exchange for outstanding LLC A-6 Interests and outstanding shares of SmarterKids Common Stock, respectively (such shares of Holdings Common Stock, together with any dividends or distributions with respect thereto, and any cash in lieu of fractional shares of Holdings Common Stock being hereinafter referred to as the "Exchange Fund"). (b) Exchange Procedures. (i) At the Effective Time, each holder of an LLC Interest shall deliver to the Exchange Agent, or to such other agent or agents (including Holdings) as may be appointed by Holdings, (A) documentation reasonably satisfactory to the Exchange Agent or Holdings evidencing the transfer of the LLC Interests to Holdings (the "Transfer Documents"), which Transfer Documents shall include, to the extent previously issued by Earlychildhood, certificates evidencing the LLC Interests (the "LLC Certificates") and (B) instructions for effecting the exchange of such LLC Interests for certificates evidencing shares of Holdings Common Stock (plus cash in lieu of fractional shares, if any, of Holdings Common Stock as provided below) in accordance with Section 2.1. Upon delivery of the Transfer Documents, duly endorsed, to the Exchange Agent or to such other agent or agents (including Holdings) as may be appointed by Holdings, such holders of LLC Interests shall be entitled to receive in exchange therefor, certificates representing the number of whole shares of Holdings Common Stock which such holder has the right to receive pursuant to the provisions of this Article II and any cash in lieu of fractional shares, if any, of Holdings Common Stock. (ii) As soon as reasonably practicable after the Effective Time, the Exchange Agent shall mail to each holder of record of a certificate or certificates which immediately prior to the Effective Time represented outstanding shares of SmarterKids Common Stock (the "SmarterKids Certificates" and, together with the LLC Certificates, the "Certificates") whose shares were converted pursuant to Section 2.2 into the right to receive shares of Holdings Common Stock, (A) a letter of transmittal (which shall specify that delivery shall be effected, and risk of loss and title to the SmarterKids Certificates shall pass, only upon delivery of the SmarterKids Certificates to the Exchange Agent and shall be in such form and have such other provisions as Earlychildhood and SmarterKids may reasonably specify), and (B) instructions for effecting the surrender of the SmarterKids Certificates in exchange for certificates representing shares of Holdings Common Stock (plus cash in lieu of fractional shares, if any, of Holdings Common Stock as provided below). Upon surrender of a SmarterKids Certificate for cancellation to the Exchange Agent or to such other agent or agents (including Holdings) as may be appointed by Holdings, together with such letter of transmittal, duly executed, the holder of such SmarterKids Certificate shall be entitled to receive in exchange therefor a certificate representing that number of whole shares of Holdings Common Stock which such holder has the right to receive pursuant to the provisions of this Article II, and any cash in lieu of fractional shares, if any, of Holdings Common Stock, and the SmarterKids Certificate so surrendered shall immediately be canceled. (iii) In the event of a transfer of ownership of LLC Interests or SmarterKids Common Stock prior to the Effective Time which is not registered in the transfer records of Earlychildhood or SmarterKids, respectively, a certificate representing the proper number of shares of Holdings Common Stock may be issued to a transferee if the Transfer Documents for such LLC Interests or the SmarterKids Certificate representing such SmarterKids Common Stock, as applicable, is presented to the Exchange Agent, or such other agent or agents as may be appointed by Holdings (including Holdings), accompanied by all documents required to evidence and effect such transfer and by evidence that any applicable stock transfer taxes have been paid. (iv) Immediately after the Effective Time, (A) all LLC Interests shall have been delivered (or, in the absence of certificated LLC Interests, shall be deemed to have been delivered) to the Exchange Agent (or to such other agent or agents (including Holdings) as may be appointed by Holdings, and exchanged for shares of Holdings Common Stock in accordance with the provisions set forth in subsection (i) above and (B) each outstanding SmarterKids Certificate which theretofore represented shares of SmarterKids Common Stock shall represent only the right to receive shares of Holdings Common Stock pursuant to the terms hereof and shall not be deemed to evidence ownership of the number of shares of Holdings A-7 Common Stock into which such shares of SmarterKids Common Stock would be or were, as the case may be, converted until the SmarterKids Certificate therefor shall have been surrendered in accordance with this Section 2.5. (c) Distributions With Respect to Unexchanged Interests or Shares. No dividends or other distributions declared or made after the Effective Time with respect to Holdings Common Stock with a record date after the Effective Time shall be paid to the holder of any uncontributed LLC Interest or unsurrendered SmarterKids Certificate with respect to the shares of Holdings Common Stock the holder thereof is entitled to receive in respect thereof and no cash payment in lieu of fractional shares shall be paid to any such holder pursuant to subsection (e) below until the holder of record of such LLC Interests or SmarterKids Certificate shall contribute such LLC Interest as described in subsection (b)(i) above or surrender such SmarterKids Certificate as described in subsection (b)(ii) above, as applicable. Subject to the effect of applicable laws, following the contribution of any such LLC Interest or surrender of any such SmarterKids Certificate, there shall be paid to the record holder of the certificates representing whole shares of Holdings Common Stock issued in exchange therefor, without interest, (i) at the time of such contribution or surrender, as applicable, the amount of any cash payable in lieu of a fractional share of Holdings Common Stock to which such holder is entitled pursuant to subsection (e) below and the amount of dividends or other distributions with a record date after the Effective Time previously paid with respect to such whole shares of Holdings Common Stock, and (ii) at the appropriate payment date, the amount of dividends or other distributions with a record date after the Effective Time but prior to surrender and a payment date subsequent to surrender payable with respect to such whole shares of Holdings Common Stock. (d) No Further Ownership Rights in LLC Interests and SmarterKids Common Stock. All shares of Holdings Common Stock issued upon the delivery of the Transfer Documents and/or surrender for exchange of the SmarterKids Certificates, as applicable, in accordance with the terms hereof (including any cash paid pursuant to subsection (c) or (e) of this Section 2.5) shall be deemed to have been issued in full satisfaction of all rights pertaining to the LLC Interests so contributed or to the shares of SmarterKids Common Stock theretofore represented by such SmarterKids Certificates, as applicable, and from and after the Effective Time there shall be no further registration of transfers on the stock transfer books of the Surviving Corporation of the shares of SmarterKids Common Stock which were outstanding immediately prior to the Effective Time or registration of transfers on the ownership records of Earlychildhood of LLC Interests held by holders thereof immediately prior to the Effective Time. If, after the Effective Time, SmarterKids Certificates are presented to the Surviving Corporation or Holdings for any reason, such SmarterKids Certificates shall be canceled and exchanged as provided in this Section 2.5. If, after the Effective Time, Transfer Documents with respect to valid LLC Interests are presented to Holdings for any reason, such LLC Interests shall be deemed contributed to Holdings in accordance with the provisions of this Agreement, effective as of the Effective Time and the holders thereof, in exchange therefor, shall receive such number of shares of Holdings Common Stock as may be calculated pursuant to the applicable Earlychildhood Exchange Ratio, together, without interest, with cash in lieu of fractional shares as described in Section 2.5(e). (e) No Fractional Shares. No certificate or scrip representing fractional shares of Holdings Common Stock shall be issued upon the contribution or surrender for exchange, as applicable, of LLC Interests or SmarterKids Certificates, and such fractional share interests will not entitle the owner thereof to vote or to any other rights of a stockholder of Holdings. Notwithstanding any other provision of this Agreement, each holder of LLC Interests or shares of SmarterKids Common Stock outstanding immediately prior to the Effective Time exchanged pursuant to the Contribution or the SmarterKids Merger who would otherwise have been entitled to receive a fraction of a share of Holdings Common Stock (after taking into account the entire LLC Interest exchanged by such holder or all SmarterKids Certificates delivered by such holder, as applicable) shall receive, in lieu thereof, cash (without interest) in an amount equal to such fractional part of a share of Holdings Common Stock multiplied by the per share opening sales price of Holdings Common Stock (as reported by the national securities exchange or market on which such Holdings Common Stock is traded or quoted) on the first day of trading of Holdings Common Stock on such exchange or market after the Effective Time. A-8 (f) Termination of Exchange Fund. Any portion of the Exchange Fund which remains undistributed to the former holders of LLC Interests or the former stockholders of SmarterKids on the 180th day after the Effective Time shall be delivered to Holdings upon demand, and any former holder or stockholder, as the case may be, who has not previously complied with Section 1.2 or this Section 2.5 shall thereafter look only to Holdings for payment of such holder's or stockholder's claim for Holdings Common Stock, any cash in lieu of fractional shares of Holdings Common Stock and any dividends or distributions with respect to Holdings Common Stock. (g) No Liability. None of Earlychildhood, SmarterKids or Holdings shall be liable to any holder of LLC Interests or shares of SmarterKids Common Stock, as the case may be, for any shares of Holdings Common Stock (or cash in lieu of fractional shares of Holdings Common Stock or any dividends or distributions with respect thereto) delivered to a public official pursuant to any applicable abandoned property, escheat or similar law. (h) Withholding Rights. Holdings and the Surviving Corporation shall be entitled to deduct and withhold from the consideration otherwise payable pursuant to this Agreement to any holder of LLC Interests or shares of SmarterKids Common Stock such amounts as it is required to deduct and withhold with respect to the making of such payment under the Code, or any provision of state, local or foreign tax law. To the extent that amounts are so withheld by Holdings or the Surviving Corporation, as the case may be, such withheld amounts shall be treated for all purposes of this Agreement as having been paid to the holder of LLC Interests or shares of SmarterKids Common Stock, as the case may be, in respect of which such deduction and withholding was made. (i) Lost Certificates. If any Certificate shall have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming such Certificate to be lost, stolen or destroyed and, if required by Holdings or the Surviving Corporation, the posting by such person of a bond in such reasonable amount as Holdings or the Surviving Corporation may direct as indemnity against any claim that may be made against it with respect to such Certificate, the Exchange Agent will issue in exchange for such lost, stolen or destroyed Certificate, the shares of Holdings Common Stock, any cash in lieu of fractional shares, and any unpaid dividends and distributions on shares of Holdings Common Stock deliverable in respect thereof pursuant to this Agreement. (j) Affiliates. Notwithstanding anything herein to the contrary, neither LLC Interests nor SmarterKids Certificates surrendered for exchange by any Affiliate (as defined in Section 5.13) of Earlychildhood or SmarterKids shall be exchanged until Holdings has received an Affiliate Agreement (as defined in Section 5.13) substantially in the form of Exhibit J attached hereto from such Affiliate. ARTICLE III. REPRESENTATIONS AND WARRANTIES OF EARLYCHILDHOOD Earlychildhood represents and warrants to SmarterKids that the statements contained in this Article III are true and correct, except as set forth herein and in the disclosure schedules delivered by Earlychildhood to SmarterKids on or before the date of this Agreement (the "Earlychildhood Disclosure Schedule"). The Earlychildhood Disclosure Schedule shall be arranged in paragraphs corresponding to the numbered and lettered paragraphs contained in this Article III and the disclosure in any paragraph shall qualify other paragraphs in this Article III only to the extent that it is reasonably apparent from a reading of such disclosure that it also qualifies or applies to such other paragraphs. Section 3.1 Organization of Earlychildhood. Each of Earlychildhood and its Subsidiaries (as defined below) is duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization, has all requisite corporate power to own, lease and operate its property and to carry on its business as now being conducted and as proposed to be conducted, and is duly qualified to do business and is in good standing as a foreign limited liability company or corporation, as the case may be, in each jurisdiction A-9 in which the failure to be so qualified would have a material adverse effect on the business, assets, properties, financial condition or results of operations of Earlychildhood and its Subsidiaries, taken as a whole (an "Earlychildhood Material Adverse Effect"). Except as set forth on the Earlychildhood Disclosure Schedule, neither Earlychildhood nor any of its Subsidiaries, directly or indirectly owns (other than ownership interests in Earlychildhood or in one or more of its Subsidiaries) any equity or similar interest in, or any interest that is mandatorily convertible into or exchangeable or exercisable for, any corporation, partnership, joint venture or other business association or entity. A true, correct and complete copy of the organizational documents of Earlychildhood and each of its Subsidiaries has been delivered to SmarterKids. As used in this Agreement, the word "Subsidiary" means, with respect to any party, any corporation or other organization, whether incorporated or unincorporated, of which (i) such party or any other Subsidiary of such party is a general partner (excluding partnerships the general partnership interests of which held by such party or any Subsidiary of such party do not have a majority of the voting interest in such partnership) or (ii) at least a majority of the securities or other interests having by their terms ordinary voting power to elect a majority of the board of directors or others performing similar functions with respect to such corporation or other organization is directly or indirectly owned or controlled by such party or by any one or more of its Subsidiaries, or by such party and one or more of its Subsidiaries. Section 3.2 Earlychildhood Capital Structure. (a) The outstanding LLC Interests currently consist, and will consist on the Closing Date, of the LLC Interests set forth in the Earlychildhood Disclosure Schedule, which LLC Interests, subject to LLC Interests represented by options granted under the Earlychildhood Option Plans, represent one hundred percent (100%) of the membership and other equity interests in Earlychildhood. Other than the persons set forth in the Earlychildhood Disclosure Schedule (the "Members"), no other person owns or holds any LLC Interest or portion of an LLC Interest, including, without limitation, an economic interest in Earlychildhood, an interest in the profits or losses of Earlychildhood, an interest in the right to affect the management of Earlychildhood or an interest in the right to receive distributions from Earlychildhood. With respect to each Member, the Earlychildhood Disclosure Schedule sets forth such Member's designation as a Class A Member, Class B Member or Class C Member, as applicable. Set forth on the Earlychildhood Disclosure Schedule is the aggregate amount of LLC Interests issuable pursuant to options granted and outstanding under the Earlychildhood Option Plans as of the date hereof, and the entities or persons to whom such options were granted. Except as may exist under the Earlychildhood Option Plan or as otherwise set forth on the Earlychildhood Disclosure Schedule, there are no outstanding subscriptions, calls, commitments, warrants or options for the purchase of LLC Interests, or any securities convertible into or exchangeable for LLC Interests, or any other commitments of any kind for the granting of additional LLC Interests or other equity interests or securities issued by Earlychildhood. All of the outstanding LLC Interests are duly authorized, fully paid and nonassessable securities of Earlychildhood, free and clear of all Encumbrances (as defined below). Except as set forth on the Earlychildhood Disclosure Schedule, there are no contracts relating to the issuance, sale, or transfer of any LLC Interests, or any portions of any LLC Interests. To the knowledge of Earlychildhood, there are no voting trusts, proxies or other voting agreements or understandings with respect to the outstanding LLC Interests. For purposes of this Agreement, "Encumbrance" shall mean any charge, claim, condition, equitable interest, lien, option, pledge, security interest, right of first refusal or restriction of any kind, including any restriction on use, voting, transfer, receipt of income or exercise of any other attribute of ownership. (b) All of the outstanding shares of capital stock or other equity interests of each of Earlychildhood's Subsidiaries are duly authorized, validly issued, fully paid and nonassessable and all such shares are owned by Earlychildhood or another Subsidiary free and clear of all Encumbrances. There are no outstanding subscriptions, calls, commitments, warrants or options for the purchase of shares of capital stock or equity interests, as the case may be, or any securities convertible into or exchangeable for shares of capital stock or equity interests, as the case may be, or any other commitments of any kind for the granting of additional shares of capital stock, other equity interests or securities issued by any of Earlychildhood's Subsidiaries. There are no contracts relating to the issuance, sale, or transfer of any shares of capital stock or equity interests, as the case may be, of any of Earlychildhood's Subsidiaries. A-10 Section 3.3 Authority; No Conflict; Required Filings and Consents. (a) Earlychildhood has all requisite corporate power and authority to enter into this Agreement and each of the Transaction Documents (as defined below) to which it is a party and to consummate the Transactions contemplated by this Agreement and each of the Transaction Documents to which it is a party. The execution and delivery of this Agreement and each of the Transaction Documents to which it is a party and the consummation of the transactions contemplated by this Agreement and each of the Transaction Documents to which it is a party by Earlychildhood have been duly authorized by all necessary action on the part of Earlychildhood, its Management Committee and its Members. Each holder of an LLC Interest outstanding on the date hereof has executed and delivered a Consent Agreement in the form of Exhibit B attached hereto and, assuming the due authorization and execution of the Consent Agreement by each such Member, the Consent Agreements constitute the valid and binding obligations of such Members, enforceable in accordance with their terms, subject to the Bankruptcy and Equity Exception (as hereafter defined). This Agreement and each of the Transaction Documents to which it is a party have been duly executed and delivered by Earlychildhood and constitute the valid and binding obligations of Earlychildhood, enforceable in accordance with their terms, subject to bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium and similar laws of general applicability relating to or affecting creditors' rights and to general equitable principles (the "Bankruptcy and Equity Exception"). "Transaction Documents" means the Stockholder Support Agreement, the Registration Rights Agreement, the Consent Agreement, the Affiliate Agreement and the Lockup Agreement. (b) Except as set forth on the Earlychildhood Disclosure Schedule, the execution and delivery of this Agreement and each of the Transaction Documents to which it is a party by Earlychildhood does not, and the consummation of the Transactions contemplated by this Agreement, and each of the Transaction Documents to which Earlychildhood is a party will not, (i) conflict with, or result in any violation or breach of, any provision of the organizational documents of Earlychildhood (including the Operating Agreement) or any of the organizational documents of any of Earlychildhood's Subsidiaries (collectively, the "Earlychildhood Organizational Documents"), (ii) result in any violation or breach of, or constitute (with or without notice or lapse of time, or both) a default (or give rise to a right of termination, cancellation or acceleration of any obligation or loss of any material benefit) under, or require a consent or waiver under, any of the terms, conditions or provisions of any note, bond, mortgage, indenture, lease, contract or other agreement, instrument or obligation to which Earlychildhood or any of its Subsidiaries is a party or by which any of them or any of their respective properties or assets may be bound, or (iii) conflict with or violate any permit, concession, franchise, license, judgment, order, decree, statute, law, ordinance, rule or regulation applicable to Earlychildhood or any of its Subsidiaries or any of its or their properties or assets, except in the case of (ii) and (iii) for any such conflicts, violations, defaults, terminations, cancellations or accelerations which are not, individually or in the aggregate, reasonably likely to have an Earlychildhood Material Adverse Effect. The execution and delivery of each Consent Agreement by the holders of all outstanding LLC Interests does not conflict with, and will not result in any violation or breach of any provision of, the Earlychildhood Organizational Documents. (c) No consent, approval, order or authorization of, or registration, declaration or filing with, any court, administrative agency or commission or other governmental authority or instrumentality ("Governmental Entity") is required by or with respect to Earlychildhood or any of its Subsidiaries in connection with the execution and delivery of this Agreement and each of the Transaction Documents to which it is a party or the consummation of the transactions contemplated hereby or thereby, except for (i) the filing of the pre-merger notification report under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act"), if applicable, (ii) such consents, approvals, orders, authorizations, registrations, declarations and filings as may be required under applicable state securities laws, and (iii) such other consents, authorizations, filings, approvals and registrations which, if not obtained or made, would not be reasonably likely to have an Earlychildhood Material Adverse Effect. Earlychildhood is not a "$100 Million Person" within the meaning of the HSR Act (and the Regulations thereunder) and William E. Simon & Sons Private Equity Fund, L.P. (the "Fund"), to the extent the Fund is the "ultimate parent entity" of Earlychildhood (as such term is used in the HSR Act and the Regulations thereunder), is not, together, with all the entities that it controls, directly and indirectly, a "$100 million Person" within the meaning of the HSR Act (and the Regulations thereunder). A-11 Section 3.4 Books and Records. The books of account, minute books (or any other books containing records of member or manager action) and record books and other records which are material to the business of Earlychildhood and its Subsidiaries, all of which have been made available to SmarterKids, are complete and correct in all material respects and have been maintained in accordance with sound business practices. The minute books (or any other books containing records of member or manager action) of Earlychildhood and its Subsidiaries contain, in all material respects, accurate records of all meetings held of, and corporate or other action taken by, the Members, or the Management Committee of Earlychildhood, or the stockholders or owners or board of directors or other similar bodies of any of its Subsidiaries and no meeting has been held for which minutes have not been prepared and are not contained in such minute books. At the Closing, all of the books and records of Earlychildhood and its Subsidiaries will be in the possession of Earlychildhood. Section 3.5 Financial Information. Earlychildhood has delivered to SmarterKids: (i) an audited consolidated balance sheet of Earlychildhood and its Subsidiaries as of December 31, 1999 and the related audited consolidated statements of income, changes in members' equity and cash flows of Earlychildhood and its Subsidiaries for the fiscal year then ended, together with the report thereon of KPMG, LLP, its independent certified public accountants; (ii) an audited consolidated balance sheet of QTL Corporation and its Subsidiaries as of December 31, 1998 and the related audited consolidated statements of income, stockholders' equity and cash flows of QTL Corporation for the nine months then ended, together with the report thereon of KPMG LLP, its independent certified public accountants; (iii) an audited balance sheet of Educational Products, Inc. as of March 31, 1999 and the related audited statements of income, stockholders' equity and cash flows of Educational Products, Inc. for the fiscal year then ended, together with the report thereon of KPMG LLP, its independent certified public accountants and (iv) an unaudited consolidated balance sheet of Earlychildhood and its Subsidiaries as of September 30, 2000 (the "Earlychildhood Balance Sheet") and the related unaudited consolidated statements of income, changes in members' equity, and cash flows, including, in each case, the notes thereto (together with the Earlychildhood Balance Sheet, the "Earlychildhood Financial Information"). The Earlychildhood Financial Information has been prepared in accordance with generally accepted accounting principles ("GAAP") applied on a consistent basis (except as may be noted therein), and presents fairly, in all material respects, the financial position of Earlychildhood and its Subsidiaries on a consolidated basis as of the respective dates and for the periods referred to in such Earlychildhood Financial Information, except that the Earlychildhood Financial Information is subject to normal and recurring year-end adjustments and subject, in each case, to the notes regarding the matters reflected therein. Except set forth on the Earlychildhood Disclosure Schedule, no financial information of any entity are required to be included in the financial statements of Earlychildhood under GAAP. Section 3.6 No Undisclosed Liabilities. Except as set forth on the Earlychildhood Disclosure Schedule or the Earlychildhood Balance Sheet and except for normal or recurring liabilities incurred since the date of the Earlychildhood Balance Sheet in the ordinary course of business consistent with past practices, Earlychildhood and its Subsidiaries do not have any liabilities, either accrued, contingent or otherwise (whether or not required to be reflected in the Earlychildhood Financial Information in accordance with GAAP), and whether due or to become due, which, individually or in the aggregate, are reasonably likely to have an Earlychildhood Material Adverse Effect. Section 3.7 Absence of Certain Changes or Events. Except as expressly contemplated by this Agreement and the Transaction Documents or as set forth on the Earlychildhood Disclosure Schedule, since the date of the Earlychildhood Balance Sheet, Earlychildhood has conducted its businesses only in the ordinary course and in a manner consistent with past practice, and, since such date, there has been no material adverse change in the financial condition, results of operations, business, assets or properties of Earlychildhood or any of its Subsidiaries, taken as a whole (an "Earlychildhood Material Adverse Change") or any development or combination of developments of which the management of Earlychildhood is aware that, individually or in the aggregate, has had, or is reasonably likely to have, an Earlychildhood Material Adverse Effect, and, since such date, there has not been any: (a) (i) issuance of LLC Interests, or options or rights therefor, other than pursuant to the Earlychildhood Option Plans through the date hereof; (ii) purchase, redemption, retirement or other A-12 acquisition by Earlychildhood of any LLC Interest, parts of any LLC Interest or other rights or equity interests in Earlychildhood or any of its Subsidiaries; or (iii) declaration or payment of any dividend or other distribution or payment in respect of any LLC Interest, parts of any LLC Interest or other rights or equity interests in Earlychildhood or any of its Subsidiaries, other than tax distributions made in the ordinary course of business; (b) amendment to the organizational documents of Earlychildhood or any of its Subsidiaries (including the Operating Agreement); (c) payment by Earlychildhood or any of its Subsidiaries of any bonuses, salaries or other compensation (including management or other similar fees but excluding tax distributions) to any shareholder or member, as applicable, managing member, member of the Management Committee or executive officer (except for payments of salary, bonuses and other compensation payable for employment services rendered in the ordinary course of business (in which case there has been no increase in such payments)) or entry into any employment, severance or similar contract with any such person; (d) adoption of any new Employee Benefit Plan or Benefit Arrangement (each as defined below) for or with any employees of Earlychildhood or any Earlychildhood ERISA Affiliate or any increase in the payment to or benefits under any Earlychildhood Plan or other benefit obligations for or with any employees of Earlychildhood or any Earlychildhood ERISA Affiliate or change any actuarial or other assumption used to calculate funding obligations with respect to any Earlychildhood Employee Benefit Plans or Benefit Arrangements, or any change in the manner in which contributions to any Earlychildhood Employee Benefit Plans or Benefit Arrangements are made or the basis on which such contributions are determined; (e) damage to or destruction or loss of any asset or property of Earlychildhood or any of its Subsidiaries, whether or not covered by insurance, that would have an Earlychildhood Material Adverse Effect; (f) sale, lease or other disposition of any material asset or property of Earlychildhood or any of its Subsidiaries (other than sales of inventory in the ordinary course of business); (g) accrual of any expenses except for such accruals in the ordinary course of business; (h) cancellation or waiver of any claims or rights by Earlychildhood or any of its Subsidiaries that would have an Earlychildhood Material Adverse Effect; (i) assumption, guarantee or endorsement or other agreement to become responsible for the obligations of any other individual, firm or corporation (other than intercompany obligations) or making of any loans or advances to, any employee of Earlychildhood or any of its Subsidiaries, other than in the ordinary course of business; (j) material change by Earlychildhood or its Subsidiaries in their respective accounting methods, principles or practices to which SmarterKids has not previously consented in writing, except insofar as may be appropriate for changes required by applicable law or GAAP; (k) revaluations by Earlychildhood or its Subsidiaries of any of their respective assets having an Earlychildhood Material Adverse Effect; (l) agreement, whether oral or written, by Earlychildhood or any of its Subsidiaries, with respect to or to do any of the foregoing; or (m) other action or event that would have required the consent of SmarterKids pursuant to Section 5.1 of this Agreement had such action or event occurred after the date of this Agreement, and that, individually or in the aggregate, has had, or is reasonably likely to have, an Earlychildhood Material Adverse Effect. A-13 Section 3.8 Taxes. (a) For the purposes of this Agreement, a "Tax" or, collectively, "Taxes," means any and all federal, state, local and foreign taxes, assessments and other governmental charges, duties, impositions and liabilities, including taxes based upon or measured by gross receipts, income, profits, sales, use and occupation, and value added, ad valorem, transfer, gains, franchise, withholding, payroll, recapture, employment, excise, unemployment insurance, social security, business license, occupation, business organization, stamp, environmental and property taxes, together with all interest, penalties and additions imposed with respect to such amounts. For purposes of this Agreement, "Taxes" also includes any obligations under any agreements or arrangements with any other person or any provision of law with respect to Taxes of such other person (including pursuant to Treas. Reg. (S) 1.1502-6 or comparable provisions of state, local or foreign tax law) and including any liability for Taxes of any predecessor entity. (b) Except as set forth on the Earlychildhood Disclosure Schedule, Earlychildhood and each of its Subsidiaries have (i) timely filed all federal, state, local and foreign Tax returns and reports required to be filed by them prior to the date of this Agreement (taking into account all applicable extensions) and such Tax returns are accurate and complete in all material respects, (ii) timely paid or accrued all Taxes owed (whether or not shown on any Tax return), and (iii) paid all Taxes for which a notice of assessment or collection has been received (other than amounts being contested in good faith by appropriate proceedings). None of the Tax returns filed or Taxes payable by either Earlychildhood or any of its Subsidiaries (or, to the knowledge of Earlychildhood, by the holders of the LLC Interests as they relate to the items of income, deductions, etc. of Earlychildhood) have been the subject of an audit, action, suit, proceeding, claim, examination, deficiency or assessment by the Internal Revenue Service (the "IRS") or any other governmental authority, and no such audit, action, suit, proceeding, claim, examination, deficiency or assessment is currently pending or, to the knowledge of Earlychildhood or any of its Subsidiaries, contemplated or threatened. The unpaid Taxes of Earlychildhood and each of its Subsidiaries (whether or not yet payable) attributable to any period (or portion thereof) ending on or before the Closing Date did not, as of September 30, 2000, exceed the reserve for actual Taxes (as opposed to any reserve for deferred Taxes established to reflect timing differences between book and Tax income) as shown on the Earlychildhood Balance Sheet, and will not exceed such reserve as adjusted for the passage of time through the Closing Date in accordance with the reasonable past custom and practice of Earlychildhood and its Subsidiaries in filing their Tax returns. Earlychildhood and each of its Subsidiaries will not incur any liability for Taxes from September 30, 2000 through the Closing Date other than in the ordinary course of business and consistent with reasonable past practice, and will not incur any Tax liability in connection with the transactions contemplated by this Agreement. Except as set forth on the Earlychildhood Disclosure Schedule, neither Earlychildhood nor any of its Subsidiaries has agreed to make any adjustment under Section 481(a) of the Code (or any corresponding provision of state, local or foreign Tax law) by reason of a change in accounting method or otherwise, and neither Earlychildhood nor any of its Subsidiaries will be required to make any such adjustment as a result of the transactions contemplated by this Agreement. Earlychildhood and each of its Subsidiaries have timely withheld or collected and paid over to the appropriate governmental authorities (or are properly holding for such timely payment) all Taxes required by law to be withheld or collected. None of the Subsidiaries of Earlychildhood which is a corporation has made an election under Section 341(f) of the Code. There are no liens for Taxes upon the assets of Earlychildhood or any of its Subsidiaries (other than liens for Taxes that are not yet due or that are being contested in good faith by appropriate proceedings). No extension of a statute of limitations relating to any Taxes is in effect with respect to Earlychildhood and its Subsidiaries. (c) Earlychildhood and any non-corporate Subsidiaries of Earlychildhood have at all times during their existence been properly treated as a partnership or a disregarded entity for U.S. federal, state and local income tax purposes. No Subsidiary of Earlychildhood which is a corporation has been a member of an affiliated group of corporations filing a consolidated federal income tax return (or a group of corporations filing a consolidated, combined or unitary income tax return under comparable provisions of state, local or foreign tax law) for any taxable period. Neither Earlychildhood nor any of its Subsidiaries has been or is a party to or member of any joint venture, partnership, limited liability company, or other arrangement or contract which could be treated as A-14 a partnership for federal income tax purposes. None of the LLC Interests nor any assets transferred from Earlychildhood to Holdings, whether an actual transfer or a deemed transfer of assets, pursuant to the Contribution is a U.S. real property interest (as that term is defined in Section 897(c)(1) of the Code). (d) Neither Earlychildhood nor any of its Subsidiaries has any obligation under any agreement or arrangement with any other person or any provision of law with respect to Taxes of such other person (including pursuant to Treas. Reg. (S) 1.1502-6 or comparable provisions of state, local or foreign tax law) and including any liability for Taxes of any predecessor entity. Section 3.9 Properties. (a) The Earlychildhood Disclosure Schedule sets forth a list of (i) all material leases to which Earlychildhood or any of its Subsidiaries is a party as a lessee as of the date hereof (the "Earlychildhood Lease Agreements"), setting forth in the case of any such lease covering real property, the location of such real property, and (ii) all material real properties owned by Earlychildhood or any of its Subsidiaries as of the date hereof (the "Earlychildhood Owned Real Property"). To the knowledge of Earlychildhood, each of Earlychildhood and its Subsidiaries has good and marketable titled to the Earlychildhood Owned Real Property and a valid and binding leasehold interest in each of the properties that is the subject of an Earlychildhood Lease Agreement, free and clear of all Encumbrances, except for (i) any Encumbrances reflected in the Earlychildhood Financial Information and the Earlychildhood Disclosure Schedule; (ii) any Encumbrances which, individually or in the aggregate, are not reasonably likely to have an Earlychildhood Material Adverse Effect; (iii) zoning laws and other land use restrictions that do not impair the present or anticipated use or occupancy of the property subject thereto, (iv) any Encumbrances for taxes, assessments and other governmental charges not yet due and payable or due but not delinquent or due and being contested in good faith; (v) any mechanics' workmen's, repairmen's, warehousemen's, carrier's or other similar liens and encumbrances arising in the ordinary course of business consistent with past practice or being contested in good faith and (vi) any Encumbrances which are matters of public record or are shown by a current title report and reflected on the Earlychildhood Disclosure Schedule (clauses (i) through (vi) above collectively referred to herein as "Earlychildhood Permitted Encumbrances"). (b) None of Earlychildhood and its Subsidiaries is in default under any of the Earlychildhood Lease Agreements, except for such defaults which have not had and are not reasonably likely to have an Earlychildhood Material Adverse Effect. Section 3.10 Intellectual Property. (a) Each of Earlychildhood and its Subsidiaries owns free and clear of all Encumbrances or is licensed or otherwise possesses legally enforceable rights to use all patents, trademarks, trade names, service marks, copyrights, and any applications for such patents, trademarks, trade names, service marks, copyrights, know-how, computer software programs or applications and tangible or intangible proprietary information or material that are necessary to conduct the business of each of Earlychildhood and its Subsidiaries as currently conducted (the "Earlychildhood Intellectual Property"), subject to such exceptions that would not be reasonably likely to have an Earlychildhood Material Adverse Effect. The Earlychildhood Disclosure Schedule contains a list of all of the following that are material within the Earlychildhood Intellectual Property: (i) patents and patent applications; (ii) trademarks, trade names and service marks and registrations thereof and applications therefor; and (iii) registered copyrights and applications therefor. The Earlychildhood Disclosure Schedule identifies the owner of each item listed thereon and, in the case of registrations and applications, the application or registration number and date. (b) To the knowledge of Earlychildhood, Earlychildhood or a Subsidiary thereof is the sole and exclusive owner or a licensee of all of the material Earlychildhood Intellectual Property. All of the material Earlychildhood Intellectual Property will be owned or available for use by Earlychildhood or its Subsidiaries on terms and conditions immediately following the Effective Time identical to the terms and conditions pertaining to Earlychildhood or a Subsidiary thereof immediately prior to the Effective Time. Earlychildhood or a A-15 Subsidiary thereof has taken reasonable measures to protect the proprietary nature of the Earlychildhood Intellectual Property and to maintain in confidence the trade secrets and confidential information that they own or use. No other person has any rights to any material item of the Earlychildhood Intellectual Property or has any rights to any of the material Earlychildhood Intellectual Property, except that the items of the Earlychildhood Intellectual Property identified on the Earlychildhood Disclosure Schedule as licensed to Earlychildhood or a Subsidiary thereof are owned by the respective owners identified on the Earlychildhood Disclosure Schedule, and, to the knowledge of Earlychildhood, no person is infringing, violating or misappropriating any of the material Earlychildhood Intellectual Property. (c) To the knowledge of Earlychildhood, none of the activities or business presently conducted by Earlychildhood or any of its Subsidiaries infringes or violates, or constitutes a misappropriation of, any intellectual property of any other person, and, if without the knowledge of Earlychildhood, such activities or business presently conducted by Earlychildhood or any of its Subsidiaries does infringe, violate or constitute a misappropriation of any intellectual property of any other person, no such infringement, violation or misappropriation, individually or in the aggregate, is reasonably likely to have an Earlychildhood Material Adverse Effect. None of Earlychildhood, any Subsidiary or any Affiliate of Earlychildhood has received any complaint, claim or notice alleging any such infringement, violation or misappropriation. (d) With respect to each item of the Earlychildhood Intellectual Property: (i) Earlychildhood or a Subsidiary thereof possesses all right, title and interest in and to such item, except for any Earlychildhood Third Party Rights (as defined below); (ii) such item is not subject to any outstanding judgment, order, decree, stipulation or injunction; and (iii) neither Earlychildhood nor any of its Subsidiaries has agreed, except in the ordinary course of business consistent with past practice or in conjunction with product or service sales or licenses, to indemnify any person for or against any infringement, misappropriation or other conflict with respect to such item. (e) The Earlychildhood Disclosure Schedule identifies each item of the intellectual property used by Earlychildhood or any Subsidiary that is owned by a party other than Earlychildhood ("Earlychildhood Third Party Rights"), and all licenses or other agreements pursuant to which Earlychildhood or any Subsidiary uses such items are listed on the Earlychildhood Disclosure Schedule. With respect to each such item: (i) the license or other agreement covering any such material item is valid, binding, enforceable and in full force and effect with respect to Earlychildhood or a Subsidiary thereof and, to the knowledge of Earlychildhood, with respect to every other party thereto; (ii) each such license or other agreement, including licenses to all third-party software listed in the Earlychildhood Disclosure Schedule other than generally commercially available software, to which Earlychildhood or a Subsidiary thereof is a party, is assignable by Earlychildhood or such Subsidiary without the consent or approval of, or any payment to, any party except as set forth on the Earlychildhood Disclosure Schedule, and, except as set forth on the Earlychildhood Disclosure Schedule, all such licenses and other agreements will continue to be valid, binding, enforceable and in full force and effect immediately following the Effective Time in accordance with the terms thereof as in effect immediately prior to the Effective Time, and the consummation of the transactions will not conflict with, result in a violation or breach of or constitute a default under (with notice or lapse of time or both) any such license or other agreement; and (iii) neither Earlychildhood, any Subsidiary thereof nor, to the knowledge of Earlychildhood, any other party to any such license or other agreement, is in breach or default under any such license or other agreement and, to the knowledge of Earlychildhood, no event has occurred that, with notice or lapse of time or both, would constitute such a breach or default or permit termination, modification or acceleration thereunder. A-16 Section 3.11 Product Warranty and Liability. (a) No reserves have been provided for by Earlychildhood to cover potential claims under existing customer indemnification agreements. (b) Except as to claims, actions, proceedings or investigations which have been asserted but as to which no notice has been given to Earlychildhood or any of its Subsidiaries, and except as set forth on the Earlychildhood Disclosure Schedule, there are no product liability claims, actions, proceedings or investigations pending or, to the knowledge of Earlychildhood, threatened against Earlychildhood or any of its Subsidiaries or their respective assets, or, to the knowledge of Earlychildhood, any state of facts existing which could give rise to any such product liability claim, action, proceeding or investigation. (c) To the knowledge of Earlychildhood, no claims have been made that the products sold by Earlychildhood or any of its Subsidiaries are not effective for the uses such products purport to serve. To the knowledge of Earlychildhood, neither Earlychildhood nor any of its Subsidiary has received any written notice that any product manufactured or distributed by Earlychildhood or any of its Subsidiaries has not been manufactured in accordance with "current Good Manufacturing Practices" (as such term is commonly understood within Earlychildhood's industry) or has not been properly labeled for its approved use. Section 3.12 Material Contracts. (a) The Earlychildhood Disclosure Schedule sets forth a complete and accurate list, and Earlychildhood has made available to SmarterKids, true and complete copies of: (i) each contract that provides for annual payments to or by Earlychildhood or any of its Subsidiaries in excess of $150,000; (ii) each contract of Earlychildhood or any of its Subsidiaries that was not entered into in the ordinary course of business; (iii) any contract under which Earlychildhood or any of its Subsidiaries has or may, except by way of endorsement of negotiable instruments for collection in the ordinary course of business and consistent with past practice, become absolutely or contingently or otherwise liable for (x) the performance under any contract of any other person, firm or corporation or (y) the whole or any part of the indebtedness or liabilities of any other person, firm or corporation, in all cases, individually in excess of $1,000,000 and in the aggregate in excess of $5,000,000; (iv) all employment agreements, consulting agreements, contracts or commitments with any employee or member of Earlychildhood's Management Committee, other than those which are terminable by Earlychildhood or any of its Subsidiaries on not more than thirty days notice without liability or financial obligation, and within each such category of agreements, contracts or commitments, which are individually in excess of $150,000; (v) any agreements or plans, including, without limitation, any stock option, stock or equity appreciation right or stock or equity purchase plans or agreements, any of the benefits of which will be increased, or the vesting of benefits of which will be accelerated, by the occurrence of any of the transactions contemplated by this Agreement or the value of any of the benefits of which will be calculated on the basis of any of the transactions contemplated by this Agreement; (vi) any contract with any Member, managing member or member of the Management Committee of Earlychildhood, other than in such person's capacity as a Member, managing member or member of the Management Committee, or any contract with any entity in which, to the knowledge of Earlychildhood, any Member, managing member or member of the Management Committee or any family member of any such person has a material economic interest; (vii) any contract that limits or restricts in any material respect where Earlychildhood or any of its Subsidiaries may conduct its or their business or the type or line of business that Earlychildhood or any of its Subsidiaries may engage in; A-17 (viii) any powers of attorney outstanding (other than those issued in the ordinary course of business with respect to Tax matters), or material obligations or liabilities (absolute or contingent) as guarantor, surety, cosigner, endorser, co-maker, indemnitor, or otherwise respecting the obligations or liabilities of any person. (ix) any material contract containing any agreement with respect to any change of control; and (x) each material amendment, supplement, and modification (whether oral or written) in respect of any of the foregoing. (b) Neither Earlychildhood nor any of its Subsidiaries have breached, or received in writing any claim or notice that it has breached, any of the terms or conditions of any material agreement, contract or commitment set forth or required to be set forth in Section 3.12 of the Earlychildhood Disclosure Schedule ("Earlychildhood Material Contracts") in such a manner as, individually or in the aggregate, is reasonably likely to have an Earlychildhood Material Adverse Effect. Except as set forth in the Earlychildhood Disclosure Schedule, each Earlychildhood Material Contract that has not expired by its terms is in full force and effect, except for those contracts, the ineffectiveness of which would not reasonably be likely to have an Earlychildhood Material Adverse Effect and, if all of the consents, approvals, authorizations, filings, notifications and other actions listed with respect to such contract in the Earlychildhood Disclosure Schedule are obtained, taken or made, as applicable, such contract will continue, after the Effective Time, to be in full force and effect on identical terms. (c) To the knowledge of Earlychildhood or its Subsidiaries, none of the parties to any Earlychildhood Material Contract have terminated, or notified Earlychildhood or any of its Subsidiaries in writing of its intent to materially reduce or terminate its business relationship with Earlychildhood or any of its Subsidiaries in the future. (d) Neither of Earlychildhood nor any of its Subsidiaries have received written notice from any customer, or group of customers, that are under common ownership or control, and that accounted for a material percentage of the aggregate products and services furnished by Earlychildhood or any of its Subsidiaries since January 1, 1999 that such customer or group of customers has stopped or intends to stop purchasing Earlychildhood's or any of its Subsidiaries' products or services, nor has Earlychildhood or any of its Subsidiaries lost any supplier, or group of suppliers that are under common ownership or control, that accounted for a material percentage of the aggregate supplies purchased by Earlychildhood or any of its Subsidiaries since January 1, 1999. (e) As of the Effective Time, Earlychildhood will have terminated the Executive Management Agreement, dated as of May 5, 1999 by and between Earlychildhood and William E. Simon and Sons, L.L.C., a Delaware limited liability company (the "Executive Management Agreement"), and, from and after the Effective Time, there will be no further obligations or liabilities, including payment obligations, outstanding or due thereunder. The fees payable to William E. Simon and Sons, L.L.C. between the date hereof and the Effective Time pursuant to the Executive Management Agreement shall not exceed $25,000 per month. Section 3.13 Litigation. Except as disclosed in the Earlychildhood Financial Information or in the Earlychildhood Disclosure Schedule, there is no (i) action, suit or proceeding, claim, arbitration or investigation against Earlychildhood or any of its Subsidiaries pending or, to the knowledge of Earlychildhood, threatened, against Earlychildhood or any of its Subsidiaries or (ii) outstanding order, judgment, writ, injunction or decree of any court, governmental agency or arbitration tribunal in a proceeding to which Earlychildhood or any of its Subsidiaries is a party, except, in the case of each of clauses (i) and (ii) above, those that, individually or in the aggregate, are not reasonably likely to have an Earlychildhood Material Adverse Effect or a material adverse effect on the ability of Earlychildhood to consummate the transactions contemplated by this Agreement. Section 3.14 Environmental Matters. (a) To the knowledge of Earlychildhood, except as disclosed on the Earlychildhood Disclosure Schedule and except, with or without the knowledge of Earlychildhood, for such matters that, individually or in the aggregate, are not reasonably likely to have an Earlychildhood Material A-18 Adverse Effect: (i) Earlychildhood and its Subsidiaries are in material compliance with all applicable Environmental Laws (as defined in Section 3.14(b)); (ii) the properties currently owned or operated by Earlychildhood and its Subsidiaries (including soils, groundwater, surface water, buildings or other structures) are not contaminated with any Hazardous Substances (as defined in Section 3.14(c)); (iii) the properties formerly owned or operated by Earlychildhood or any of its Subsidiaries were not contaminated with Hazardous Substances during the period of ownership or operation by Earlychildhood or any of its Subsidiaries; (iv) neither Earlychildhood nor its Subsidiaries are subject to liability for any Hazardous Substance disposal or contamination on any third party property; (v) neither Earlychildhood nor any of its Subsidiaries has been associated with any release or threat of release of any Hazardous Substance; (vi) neither Earlychildhood nor any of its Subsidiaries has received any written notice, demand, letter, claim or request for information alleging that Earlychildhood or any of its Subsidiaries may be in violation of or liable under any Environmental Law; and (vii) neither Earlychildhood nor any of its Subsidiaries is subject to any orders, decrees, injunctions or other arrangements with any Governmental Entity or is subject to any indemnity or other agreement with any third party relating to liability under any Environmental Law or relating to Hazardous Substances. (b) As used in this Agreement, the term "Environmental Law" means any federal, state, local or foreign law, regulation, order, decree, permit, authorization, common law or agency requirement relating to: (A) the protection, investigation or restoration of the environment, health and safety, or natural resources, (B) the handling, use, presence, disposal, release or threatened release of any Hazardous Substance or (C) noise, odor, wetlands, pollution, contamination or any injury or threat of injury to persons or property. (c) As used in this Agreement, the term "Hazardous Substance" means any substance that is: (A) listed, classified or regulated pursuant to any Environmental Law; (B) any petroleum product or by-product, asbestos-containing material, lead-containing paint or plumbing, polychlorinated biphenyls, radioactive materials or radon; or (C) any other substance which is the subject of regulatory action by any Governmental Entity pursuant to any Environmental Law. Section 3.15 Employee Benefit Plans. (a) The Earlychildhood Disclosure Schedule sets forth all employee benefit plans ("Employee Benefit Plans"), as defined in Section 3(3) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and all other material employee benefit arrangements that are not Employee Benefit Plans, including, but not limited to any employment or consulting agreement, any arrangement providing insurance benefits, any incentive bonus or deferred bonus arrangement, any arrangement providing termination allowance, severance or similar benefits, any equity compensation plan, any deferred compensation plan, and any compensation policy or practice (collectively "Benefit Arrangements"), which are maintained, contributed to or required to be contributed to by Earlychildhood or any of its Subsidiaries ("Earlychildhood Employee Plans"). (b) A true and complete copy of each written Earlychildhood Employee Plan, including, if applicable, each amendment thereto and any trust agreement, insurance contract, collective bargaining agreement, or other funding or investment arrangements for the benefits under such Earlychildhood Employee Plan, has been made available to SmarterKids. In addition, with respect to each such Earlychildhood Employee Plan to the extent applicable, Earlychildhood has made available to SmarterKids the most recently filed Federal Forms 5500, the most recent summary plan description (including any summaries of material modifications), the most recent IRS determination letter, if applicable, the most recent actuarial report or valuation, if applicable, and all material employee communications with respect to each such Earlychildhood Employee Plan. (c) Except as set forth on the Earlychildhood Disclosure Schedule: (i) neither Earlychildhood nor any entity that, together with Earlychildhood is required to be treated as a single employer under Section 414 of the Code ("Earlychildhood ERISA Affiliate"), sponsors or has previously sponsored, maintained, contributed to or incurred an obligation to contribute to any Employee Benefit Plan regulated under Title IV of ERISA, including any "multiemployer plan," as defined in Sections 3(37) and 4001(a)(3) of ERISA and neither Earlychildhood nor any Earlychildhood ERISA A-19 Affiliate has incurred nor reasonably expects to incur any liability under Title IV of ERISA arising in connection with the termination of any plan covered or previously covered by Title IV of ERISA. Neither Earlychildhood nor any ERISA Affiliate participates in or has employees covered by an Employee Plan sponsored by a professional employer organization or similar entity; (ii) neither Earlychildhood nor any of its Subsidiaries sponsors or has previously sponsored, maintained, contributed to or incurred an obligation to contribute to any Employee Benefit Plan that provides or will provide benefits described in Section 3(1) of ERISA to any former employee or retiree of Earlychildhood or any of its Subsidiaries, except as required under Part 6 of Title I of ERISA and Section 4980B of the Code or applicable state law; (iii) all Earlychildhood Employee Plans and Benefit Arrangements have been maintained and operated, and currently are, in compliance in all material respects with their terms, the requirements prescribed by any and all applicable laws (including ERISA and the Code), orders, or governmental rules and regulations in effect with respect thereto, and Earlychildhood and its Subsidiaries have performed all material obligations required to be performed by them under, are not in any material respect in default under or in violation of, and have no knowledge of any default or violation by any other party to, any of the Earlychildhood Employee Plans; (iv) each Earlychildhood Employee Plan that is intended to qualify under Section 401(a) of the Code and each trust established pursuant to each such Earlychildhood Employee Plan that is intended to qualify under Section 501(a) of the Code is the subject of a favorable determination letter from the IRS, a copy of which has been made available to SmarterKids, and, to Earlychildhood's knowledge, nothing has occurred which may reasonably be expected to impair such determination or otherwise adversely affect the tax-qualified status of such Earlychildhood Employee Plan; (v) Earlychildhood and its Subsidiaries have made full and timely payment of all amounts required to be contributed under the terms of each Earlychildhood Employee Plan and applicable law or required to be paid as expenses under such Earlychildhood Employee Plan and there has been no amendment to, written interpretation of or announcement (whether or not written) by Earlychildhood or any Earlychildhood ERISA Affiliates relating to, or change in employee participation or coverage under, any Employee Benefit Plan or Benefit Arrangement that would increase materially the expense of maintaining such Employee Benefit Plan or Benefit Arrangement above the level of the expense incurred in respect thereof for the fiscal year ended prior to the date hereof; and (vi) other than claims for benefits in the ordinary course, there is no claim, suit, action, dispute, arbitration or legal, administrative or other proceeding or governmental investigation or audit pending, or, to the knowledge of Earlychildhood, threatened, alleging any breach of the terms of any Earlychildhood Employee Plan or of any fiduciary duty thereunder or violation of any applicable law with respect to any such Earlychildhood Employee Plan. (d) With respect to the Earlychildhood Employee Plans, individually and in the aggregate, no event has occurred, and to the knowledge of Earlychildhood, there exists no condition or set of circumstances in connection with which Earlychildhood could be subject to any liability that is reasonably likely to have an Earlychildhood Material Adverse Effect under ERISA, the Code or any other applicable law. (e) Earlychildhood is not a party to any written or oral contract, agreement, plan or arrangement pursuant to which Earlychildhood has any obligation to "gross up," indemnify or otherwise compensate or hold harmless any person with respect to any portion of any excise tax (or interest or penalties with respect thereto) which such person may become subject to under Section 4999 of the Code or any similar state tax law, and there is no contract, agreement, plan or arrangement covering any person that, individually or collectively, would constitute compensation in excess of the limitation set forth in Section 162(m) of the Code. (f) Except as set forth on the Earlychildhood Disclosure Schedule, and except as provided for in this Agreement, neither Earlychildhood nor any of its Subsidiaries is a party to any oral or written (i) agreement with any officer or other key employee of Earlychildhood or any of its Subsidiaries, the benefits of which are contingent, or the terms of which are materially altered, upon the occurrence of a transaction involving A-20 Earlychildhood of the nature contemplated by this Agreement, (ii) agreement with any officer of Earlychildhood providing any term of employment or compensation guarantee extending for a period longer than one year from the date hereof and for the payment of compensation in excess of $100,000 per annum, or (iii) agreement or plan, including any stock option plan, stock appreciation right plan, restricted stock plan or stock purchase plan, any of the benefits of which will be increased, or the vesting of the benefits of which will be accelerated, by the occurrence of any of the transactions contemplated by this Agreement or the value of any of the benefits of which will be calculated on the basis of any of the transactions contemplated by this Agreement. None of the execution and delivery of this Agreement or any of the Transaction Documents or the consummation of the transactions contemplated hereunder or thereunder will trigger any "change of control" or similar provisions resulting in the acceleration of benefits or compensation with respect to any agreements with any officer or other key employee of Earlychildhood or any of its Subsidiaries except for such applicable agreements as set forth on the Earlychildhood Disclosure Schedule (the "Earlychildhood Change of Control Agreements"). Section 3.16 Compliance With Laws. (a) Neither Earlychildhood nor any of its Subsidiaries has violated or failed to comply with any statute, law, ordinance, regulation, rule or order of any Governmental Entity, or any judgment, decree or order of any court, applicable to it, its business or operations or by which it, its business or operations are bound, except for any such violations or failures to comply that, individually or in the aggregate have not had and are not reasonably likely to have an Earlychildhood Material Adverse Effect; (b) No investigation or review by any Governmental Entity is pending or, to the knowledge of Earlychildhood, has been threatened against Earlychildhood or any of its Subsidiaries, nor, to the knowledge of Earlychildhood, has any Governmental Entity indicated by written notice or otherwise, an intention to conduct an investigation of Earlychildhood or any of its Subsidiaries; and (c) There is no agreement, judgment, injunction, order or decree binding upon Earlychildhood or any of its Subsidiaries which has had or is reasonably likely to have the effect of prohibiting or materially impairing the conduct of Earlychildhood's business as currently conducted or the transactions contemplated by this Agreement. Section 3.17 Tax Matters. (a) To the knowledge of Earlychildhood, none of Earlychildhood, any of its Subsidiaries or other Affiliates (as defined in Section 5.13) and any holders of LLC Interests have taken or agreed to take any action (or failed to take or agreed not to take any action) which such action or inaction, as the case may be, would prevent (i) the Contribution from constituting a transaction qualifying as a transfer of property to Holdings by the holders of LLC Interests under Section 351 of the Code or (ii) the SmarterKids Merger as qualifying as a reorganization described in Section 368(a) of the Code. (b) To the knowledge of Earlychildhood, the holders of LLC Interests have no present plan, intention or arrangement to sell or otherwise dispose of any of the Holdings Common Stock received in the Contribution that would cause the Contribution and the SmarterKids Merger to fail to qualify as transfers under Section 351 of the Code. Section 3.18 Registration Statement; Proxy Statement/Prospectus. The information to be supplied by Earlychildhood or its Subsidiaries or about Earlychildhood or its Subsidiaries by Earlychildhood's agents for inclusion in the registration statement on Form S-4 pursuant to which shares of Holdings Common Stock issued in the Transactions will be registered under the Securities Act (the "Registration Statement"), shall not at the time the Registration Statement is declared effective by the Securities and Exchange Commission (the "SEC") contain any untrue statement of a material fact or omit to state any material fact required to be stated in the Registration Statement or necessary in order to make the statements in the Registration Statement, in light of the circumstances under which they were made, not misleading. The information supplied by Earlychildhood or A-21 its Subsidiaries for inclusion in the proxy statement/prospectus to be sent to the stockholders of SmarterKids in connection with the meeting of SmarterKids' stockholders (the "SmarterKids Stockholders' Meeting") to consider this Agreement and the SmarterKids Merger (the "Proxy Statement/Prospectus") shall not, on the date the Proxy Statement/Prospectus is first mailed to the stockholders of SmarterKids, at the time of the SmarterKids Stockholders' Meeting and at the Effective Time, contain any statement which, at such time and in light of the circumstances under which it shall be made, is false or misleading with respect to any material fact, omit to state any material fact necessary in order to make the statements made in the Proxy Statement/Prospectus not false or misleading, or omit to state any material fact necessary to correct any statement in any earlier communication with respect to the solicitation of proxies for the SmarterKids Stockholders' Meeting which has become false or misleading. If at any time prior to the Effective Time any event relating to Earlychildhood or any of its Affiliates, should be discovered by Earlychildhood which should be set forth in an amendment to the Registration Statement or a supplement to the Proxy Statement/Prospectus, Earlychildhood shall promptly inform SmarterKids. Section 3.19 Labor Matters. Neither Earlychildhood nor any of its Subsidiaries is a party to or otherwise bound by any collective bargaining agreement, contract or other agreement or understanding with a labor union or labor organization, nor, as of the date hereof, is Earlychildhood or any of its Subsidiaries the subject of any material proceeding asserting that Earlychildhood or any of its Subsidiaries has committed an unfair labor practice or seeking to compel it to bargain with any labor union or labor organization nor, as of the date of this Agreement, is there pending or, to the knowledge of Earlychildhood, threatened, any material labor strike, dispute, walkout, work stoppage, slow-down or lockout involving Earlychildhood or any of its Subsidiaries. Section 3.20 Insurance. All material fire and casualty, general liability, business interruption, product liability, and sprinkler and water damage insurance policies maintained by Earlychildhood or any of its Subsidiaries are with reputable insurance carriers, provide full and adequate coverage for all normal risks incident to the business of Earlychildhood and its Subsidiaries and their respective properties and assets, and are in character and amount at least equivalent to that carried by persons engaged in similar businesses and subject to the same or similar perils or hazards, except for any such failures to maintain insurance policies that, individually or in the aggregate, are not reasonably likely to have an Earlychildhood Material Adverse Effect. All premiums and other payments due from Earlychildhood or any Subsidiary with respect to any such contracts of insurance or indemnity have been paid. Neither Earlychildhood nor any of its Subsidiaries have received written notice of any threatened termination of, or premium increase with respect to, any of such policies or bonds. Section 3.21 No Existing Discussions. As of the date hereof, other than the Transactions, neither Earlychildhood nor any of its Affiliates is engaged, directly or indirectly, in any discussions or negotiations with any other party with respect to any Earlychildhood Acquisition Proposal (as defined in Section 5.4). Section 3.22 Consent. The Contribution has been approved by the unanimous consent of all holders of LLC Interests and such holders have taken all actions necessary under the California Limited Liability Company Act required for the approval of the Transactions. No separate approval by the holders of any class or series of LLC Interests or other equity interests in Earlychildhood is necessary to approve this Agreement, the Contribution, the Transaction Documents to which Earlychildhood is a party or any of the other transactions contemplated hereby. Section 3.23 Management Committee Approval. The Management Committee of Earlychildhood has taken all actions necessary under the California Limited Liability Company Act required for the approval of the Transactions and no other approval under any California anti-takeover statute or regulation applicable to Earlychildhood is required in connection with the consummation of the Transactions. No "fair price," "moratorium," "control share acquisitions" or other similar anti-takeover statute or regulation is applicable to Earlychildhood or (by reason of Earlychildhood's participation therein) this Agreement, the Contribution or the Transactions. A-22 ARTICLE IV. REPRESENTATIONS AND WARRANTIES OF SMARTERKIDS SmarterKids represents and warrants to Earlychildhood that the statements contained in this Article IV are true and correct, except as set forth herein and in the disclosure schedules delivered by SmarterKids to Earlychildhood on or before the date of this Agreement (the "SmarterKids Disclosure Schedule"). The SmarterKids Disclosure Schedule shall be arranged in paragraphs corresponding to the numbered and lettered paragraphs contained in this Article IV and the disclosure in any paragraph shall qualify other paragraphs in this Article IV only to the extent that it is reasonably apparent from a reading of such disclosure that it also qualifies or applies to such other paragraphs. Section 4.1 Organization of SmarterKids. SmarterKids is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware, has all requisite corporate power to own, lease and operate its property and to carry on its business as now being conducted and as proposed to be conducted, and is duly qualified to do business and is in good standing as a foreign corporation in each jurisdiction in which the failure to be so qualified would have a SmarterKids Material Adverse Effect (as defined below). SmarterKids does not have, and, since the date of its incorporation, has not had any Subsidiaries. Except as set forth on the SmarterKids Disclosure Schedule or in the SmarterKids SEC Reports (as defined in Section 4.4) filed prior to the date hereof, SmarterKids does not directly or indirectly own any equity or similar interest in, or any interest that is mandatorily convertible into or exchangeable or exercisable for, any corporation, partnership, joint venture or other business association or entity. A true, correct and complete copy of the Certificate of Incorporation and other similar organizational documents of SmarterKids has been delivered to Earlychildhood. For purposes of this Agreement "SmarterKids Material Adverse Effect" shall mean a material adverse effect on the business, assets, properties, financial condition or results of operations of SmarterKids, provided, that a decrease or successive decreases in the market price of the SmarterKids Common Stock prior to the Effective Time shall not, in and of itself, constitute a SmarterKids Material Adverse Effect (it being understood that any decrease or successive decreases in market price may be indicative of other factors which, in and of themselves (without giving effect to such decrease(s) in market price), would and, to the extent applicable, shall constitute a SmarterKids Material Adverse Effect). Section 4.2 SmarterKids Capital Structure. (a) The authorized capital stock of SmarterKids consists of 90,000,000 shares of SmarterKids Common Stock and 10,000,000 shares of Preferred Stock, $.01 par value ("SmarterKids Preferred Stock"). As of the date hereof, (i) 20,651,115 shares of SmarterKids Common Stock were issued and outstanding, all of which are validly issued, fully paid and nonassessable, (ii) no shares of SmarterKids Common Stock were held in the treasury of SmarterKids and (iii) no shares of SmarterKids Preferred Stock were issued and outstanding. The SmarterKids Disclosure Schedule shows the number of shares of SmarterKids Common Stock reserved for future issuance pursuant to stock options granted and outstanding as of the date hereof, the plans under which such options were granted and award agreements pursuant to which "non-plan" options were granted (collectively, the "SmarterKids Stock Plans"), and the entities or persons to whom such options were granted. As of the date hereof, warrants to purchase an aggregate of 217,292 shares of SmarterKids Common Stock were issued and outstanding the ("SmarterKids Warrants"). The SmarterKids Disclosure Schedule sets forth the SmarterKids agreements under which the SmarterKids Warrants were issued and to whom such warrants were granted. Except as set forth on the SmarterKids Disclosure Schedule, there are no obligations, contingent or otherwise, of SmarterKids to repurchase, redeem or otherwise acquire any shares of SmarterKids Common Stock or make any material investment (in the form of a loan, capital contribution or otherwise) in any other entity. A maximum of 400,000 shares of SmarterKids Common Stock is authorized for issuance under the SmarterKids Employee Stock Purchase Plan, of which 40,666 shares have been purchased pursuant thereto as of the date hereof. A-23 (b) Except as set forth in this Section 4.2 or as reserved for future grants of options under the SmarterKids Stock Plans or as disclosed on the SmarterKids Disclosure Schedule, (i) there are no equity securities of any class of SmarterKids, or any security exchangeable into or exercisable for such equity securities, issued, reserved for issuance or outstanding; (ii) there are no options, warrants, equity securities, calls, rights, commitments or agreements of any character to which SmarterKids is a party or by which it is bound obligating SmarterKids to issue, deliver or sell, or cause to be issued, delivered or sold, additional shares of capital stock of SmarterKids or obligating SmarterKids to grant, extend, accelerate the vesting of or enter into any such option, warrant, equity security, call, right, commitment or agreement; and (iii) to the knowledge of SmarterKids, there are no voting trusts, proxies or other voting agreements or understandings with respect to the shares of capital stock of SmarterKids. Section 4.3 Authority; No Conflict; Required Filings and Consents. (a) SmarterKids has all requisite corporate power and authority to enter into this Agreement and each of the Transaction Documents to which it is a party and to consummate the Transactions contemplated by this Agreement and each of the Transaction Documents to which it is a party. The execution and delivery of this Agreement and each of the Transactions Documents to which it is a party and the consummation of the transactions contemplated by this Agreement and each of the Transaction Documents to which it is a party by SmarterKids have been duly authorized by all necessary corporate action on the part of SmarterKids, subject only to the approval and adoption of this Agreement by SmarterKids' stockholders under the DGCL. The stockholders of SmarterKids identified on the SmarterKids Disclosure Schedule have each executed and delivered the Stockholder Support Agreement in the form of Exhibit A attached hereto and assuming the due authorization and execution of the Stockholder Support Agreement by each such stockholder, the Stockholder Support Agreement constitutes a valid and binding obligation of such stockholders, enforceable in accordance with its terms, subject to the Bankruptcy and Equity Exception. This Agreement and each of the Transaction Documents to which SmarterKids is a party have been duly executed and delivered by SmarterKids and constitute the valid and binding obligations of SmarterKids, enforceable in accordance with their terms, subject to the Bankruptcy and Equity Exception. (b) Except as set forth on the SmarterKids Disclosure Schedule, the execution and delivery of this Agreement and each of the Transaction Documents to which it is a party by SmarterKids does not, and the consummation of the Transactions contemplated by this Agreement and each of the Transaction Documents to which it is a party will not, (i) conflict with, or result in any violation or breach of, any provision of the Certificate of Incorporation or Bylaws of SmarterKids (the "SmarterKids Organizational Documents"), (ii) result in any violation or breach of, or constitute (with or without notice or lapse of time, or both) a default (or give rise to a right of termination, cancellation or acceleration of any obligation or loss of any material benefit) under, or require a consent or waiver under, any of the terms, conditions or provisions of any note, bond, mortgage, indenture, lease, contract or other agreement, instrument or obligation to which SmarterKids is a party or by which it or any of its properties or assets may be bound, or (iii) conflict with or violate any permit, concession, franchise, license, judgment, order, decree, statute, law, ordinance, rule or regulation applicable to SmarterKids or any of its properties or assets, except in the case of (ii) and (iii) for any such conflicts, violations, defaults, terminations, cancellations or accelerations which are not, individually or in the aggregate, reasonably likely to have a SmarterKids Material Adverse Effect. The execution and delivery of the Stockholder Support Agreement by the stockholders of SmarterKids party thereto does not conflict with, and will not result in any violation or breach of, any provision of SmarterKids Organizational Documents. (c) No consent, approval, order or authorization of, or registration, declaration or filing with, any Governmental Entity is required by or with respect to SmarterKids in connection with the execution and delivery of this Agreement and each of the Transaction Documents to which it is a party or the consummation of the Transactions contemplated hereby or thereby, except for (i) the filing of the pre-merger notification report under the HSR Act, if applicable, (ii) the filing of a Certificate of Merger with respect to the SmarterKids Merger with the Delaware Secretary of State, (iii) the filing of the Proxy Statement/Prospectus with the SEC in accordance with the Securities Exchange Act of 1934, as amended (the "Exchange Act"), (iv) such consents, A-24 approvals, orders, authorizations, registrations, declarations and filings as may be required under applicable state or foreign securities laws, and (v) such other consents, authorizations, filings, approvals and registrations which, if not obtained or made, would not be reasonably likely to have a SmarterKids Material Adverse Effect. SmarterKids is its own "ultimate parent entity" (as such term is used in the HSR Act and the Regulations thereunder) and is not a "$100 million Person" within the meaning of the HSR Act and the Regulations thereunder. Section 4.4 SEC Filings; Financial Statements. (a) SmarterKids has timely filed and made available to Earlychildhood all forms, reports and documents filed or required to be filed by SmarterKids with the SEC since the date of its initial public offering (collectively, the "SmarterKids SEC Reports"). The SmarterKids SEC Reports (including all exhibits and schedules thereto and documents incorporated by reference therein) (i) at the time filed, complied in all material respects with the applicable requirements of the Securities Act and the Exchange Act, as the case may be, and (ii) did not at the time they were filed (or if amended or superseded by a filing prior to the date of this Agreement, then on the date of such filing) contain any untrue statement of a material fact or omit to state a material fact required to be stated in such SmarterKids SEC Reports or necessary in order to make the statements in such SmarterKids SEC Reports, in the light of the circumstances under which they were made, not misleading. (b) SmarterKids will deliver to Earlychildhood as soon as they become available true and complete copies of any report or statement mailed by SmarterKids to its security holders generally or filed by it with the SEC, in each case subsequent to the date hereof and prior to the Effective Time. As of their respective dates, such reports and statements (excluding any information therein provided by Earlychildhood, as to which SmarterKids makes no representation) will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they are made, not misleading and will comply in all material respects with all applicable requirements of law. The audited financial statements and unaudited interim financial statements of SmarterKids to be included or incorporated by reference in such reports and statements will be prepared in accordance with GAAP and regulations of the SEC applicable to public companies and will fairly present the financial position of SmarterKids as of the dates thereof and the results of operations and consolidated cash flows for the periods then ended (subject, in the case of any unaudited interim financial statements, to normal year-end adjustments and to the extent they may not include footnotes or may be condensed or summary statements). (c) Each of the financial statements (including, in each case, any related notes) contained in the SmarterKids SEC Reports complied as to form in all material respects with the applicable published rules and regulations of the SEC with respect thereto, was prepared in accordance with GAAP and regulations of the SEC applicable to public companies applied on a consistent basis throughout the periods involved (except as may be indicated in the notes to such financial statements or, in the case of unaudited statements, in conformity with the requirements of Form 10-Q under the Exchange Act) and fairly presented in all material respects the financial position of SmarterKids as of the respective dates and the results of its operations and cash flows for the periods indicated, except that the unaudited interim financial statements were or are subject to normal and recurring year-end adjustments which were not or are not expected to be material in amount. The unaudited balance sheet of SmarterKids as of September 30, 2000 is referred to herein as the "SmarterKids Balance Sheet." No financial statements of any other entity are required to be included in the financial statements of SmarterKids under GAAP. Section 4.5 No Undisclosed Liabilities. Except as disclosed in the SmarterKids SEC Reports filed prior to the date hereof or on the SmarterKids Disclosure Schedule, and except for normal or recurring liabilities incurred since the date of the SmarterKids Balance Sheet in the ordinary course of business consistent with past practices, SmarterKids does not have any liabilities, either accrued, contingent or otherwise (whether A-25 or not required to be reflected in financial statements in accordance with GAAP), and whether due or to become due, which individually or in the aggregate, are reasonably likely to have a SmarterKids Material Adverse Effect. Section 4.6 Absence of Certain Changes or Events. Except as expressly contemplated by this Agreement and the Transaction Documents or as disclosed in the SmarterKids SEC Reports filed prior to the date hereof or as set forth on the SmarterKids Disclosure Schedule, since the date of the SmarterKids Balance Sheet, SmarterKids has conducted its businesses only in the ordinary course and in a manner consistent with past practice and, since such date, there has been no material adverse change in the financial condition, results of operations, business, assets or properties of SmarterKids (a "SmarterKids Material Adverse Change") or any development or combination of developments of which the management of SmarterKids is aware that, individually or in the aggregate, has had, or is reasonably likely to have, a SmarterKids Material Adverse Effect, and since such date, there has not been any: (a) issuances of any capital stock, other than pursuant to the SmarterKids Stock Plans through the date hereof, or purchases, redemptions or other acquisitions, or agreements to purchase, redeem or otherwise acquire, any shares of capital stock of SmarterKids, or issuances or purchases of any options, warrants or other equity securities, debt securities or evidence of indebtedness of SmarterKids, or declarations or payments of any dividends or any distributions (whether in cash, stock or property or any combination thereof) in respect of SmarterKids' capital stock; (b) amendment to the organizational documents of SmarterKids; (c) payment by SmarterKids of any bonuses, salaries or other compensation to any director or executive officer (except for payments of salary, bonuses and other compensation payable for employment services rendered in the ordinary course of business (in which case there has been no increase in such payments)) or entry into any employment, severance or similar contract with any such person; (d) adoption of any Employee Benefit Plan or Benefit Arrangement for or with any employees of SmarterKids or any SmarterKids ERISA Affiliate or any increase in the payment to or benefits under any SmarterKids Plan or other benefit obligations for or with any employees of SmarterKids or any SmarterKids ERISA Affiliate or change in any actuarial or other assumption used to calculate funding obligations with respect to any SmarterKids Employee Benefit Plan or Benefit Arrangements, or any change in the manner in which contributions to any SmarterKids Employee Benefit Plan or Benefit Arrangements are made or the basis on which such contributions are determined; (e) damage to or destruction or loss of any asset or property of SmarterKids, whether or not covered by insurance, that would have a SmarterKids Material Adverse Effect; (f) sale, lease or other disposition of any material asset or property of SmarterKids (other than sales of inventory in the ordinary course of business); (g) accrual of any expenses except for such accruals in the ordinary course of business; (h) cancellation or waiver of any claims or rights by SmarterKids that would have a SmarterKids Material Adverse Effect; (i) assumption, guarantee or endorsement or other agreement to become responsible for the obligations of any other individual, firm or corporation (other than intercompany obligations) or making of any loans or advances to, any employee of SmarterKids, other than in the ordinary course of business; (j) material change by SmarterKids in its accounting methods, principles or practices to which Earlychildhood has not previously consented in writing, except insofar as may be appropriate for changes required by applicable law or GAAP; A-26 (k) revaluation by SmarterKids of any of its assets having a SmarterKids Material Adverse Effect; (l) agreement, whether oral or written, by SmarterKids with respect to or to do any of the foregoing; (m) other action or event that would have required the consent of Earlychildhood pursuant to Section 5.1 of this Agreement had such action or event occurred after the date of this Agreement and that, individually or in the aggregate, has had or is reasonably likely to have a SmarterKids Material Adverse Effect. Section 4.7 Taxes. (a) SmarterKids has (i) timely filed all federal, state, local and foreign Tax returns and reports required to be filed by it prior to the date of this Agreement (taking into account all applicable extensions) and such Tax returns are accurate and complete in all material respects, (ii) timely paid or accrued all Taxes owed (whether or not shown on any Tax returns), and (iii) paid or accrued all Taxes for which a notice of assessment or collection has been received (other than amounts being contested in good faith by appropriate proceedings). None of the Tax returns filed or Taxes payable by SmarterKids have been the subject of an audit, action, suit, proceeding, claim, examination, deficiency or assessment by the IRS or any other governmental authority, and no such audit, action, suit, proceeding, claim, examination, deficiency or assessment is currently pending or, to the knowledge of SmarterKids, contemplated or threatened. The unpaid Taxes of SmarterKids (whether or not yet payable) attributable to any period (or portion thereof) ending on or before the Closing Date did not, as of September 30, 2000, exceed the reserve for actual Taxes (as opposed to any reserve for deferred Taxes established to reflect timing differences between book and Tax income) as shown on the SmarterKids Balance Sheet, and will not exceed such reserve as adjusted for the passage of time through the Closing Date in accordance with the reasonable past custom and practice of SmarterKids in filing its Tax returns. SmarterKids will not incur any liability for Taxes from September 30, 2000 through the Closing Date other than in the ordinary course of business and consistent with reasonable past practice, and will not incur any Tax liability in connection with the transactions contemplated by this Agreement. SmarterKids has not agreed to make any adjustment under Section 481(a) of the Code (or any corresponding provision of state, local or foreign Tax law) by reason of a change in accounting method or otherwise, and SmarterKids will not be required to make any such adjustment as a result of the transactions contemplated by this Agreement. SmarterKids has timely withheld or collected and paid over to the appropriate governmental authorities (or is properly holding for such timely payment) all Taxes required by law to be withheld or collected. SmarterKids has not made an election under Section 341(f) of the Code. There are no liens for Taxes upon the assets of SmarterKids (other than liens for Taxes that are not yet due or that are being contested in good faith by appropriate proceedings). No extension of a statute of limitations relating to any Taxes is in effect with respect to SmarterKids. (b) SmarterKids has not been a member of an affiliated group of corporations filing a consolidated federal income tax return (or a group of corporations filing a consolidated, combined or unitary income tax return under comparable provisions of state, local or foreign tax law) for any taxable period, other than a group the common parent of which is or was SmarterKids. SmarterKids has not been and is not a party to or member of any joint venture, partnership, limited liability company, or other arrangement or contract which could be treated as a partnership for federal income tax purposes. SmarterKids is not, and has not been, a U.S. real property holding corporation (as defined in Section 897(c)(2) of the Code) during the applicable period specified in Section 897(c)(1)(A)(ii) of the Code. (c) SmarterKids has no obligation under any agreement or arrangement with any other person or any provision of law with respect to Taxes of such other person (including pursuant to Treas. Reg. (S) 1.1502-6 or comparable provisions of state, local or foreign tax law) and including any liability for Taxes of any predecessor entity. A-27 Section 4.8 Properties. (a) The SmarterKids Disclosure Schedule sets forth a list of all material leases to which SmarterKids is a party as a lessee as of the date hereof (the "SmarterKids Lease Agreements"), setting forth in the case of any such lease covering real property, the location of such real property. To the knowledge of SmarterKids, SmarterKids has a valid and binding leasehold interest in each of the properties that is the subject of a SmarterKids Lease Agreement free and clear of all Encumbrances except for (i) any Encumbrances reflected in the financial statements included in the SmarterKids SEC Reports and the SmarterKids Disclosure Schedule; (ii) any Encumbrances which, individually or in the aggregate, are not reasonably likely to have a SmarterKids Material Adverse Effect; (iii) zoning laws and other land use restrictions that do not impair the present or anticipated use or occupancy of the property subject thereto, (iv) any Encumbrances for taxes, assessments and other governmental charges not yet due and payable or due but not delinquent or due and being contested in good faith; (v) any mechanics' workmen's, repairmen's, warehousemen's, carrier's or other similar liens and encumbrances arising in the ordinary course of business consistent with past practice or being contested in good faith and (vi) any Encumbrances which are matters of public record or are shown by a current title report and reflected on the SmarterKids Disclosure Schedule (clauses (i) through (vi) above collectively referred to herein as "SmarterKids Permitted Encumbrances"). (b) SmarterKids is not in default under any SmarterKids Lease Agreement except where the existence of such defaults, individually or in the aggregate, has not had and is not reasonably likely to have a SmarterKids Material Adverse Effect. (c) SmarterKids does not own any real property. Section 4.9 Intellectual Property. (a) SmarterKids owns free and clear of all Encumbrances or is licensed or otherwise possesses legally enforceable rights to use all patents, trademarks, trade names, service marks, copyrights, and any applications for such patents, trademarks, trade names, service marks, copyrights, know-how, computer software programs or applications and tangible or intangible proprietary information or material that are necessary to conduct the business of SmarterKids as currently conducted (the "SmarterKids Intellectual Property"), subject to such exceptions that would not be reasonably likely to have an SmarterKids Material Adverse Effect. The SmarterKids Disclosure Schedule contains a list of all of the following that are included in the material within the SmarterKids Intellectual Property: (i) patents and patent applications; (ii) trademarks, trade names and service marks and registrations thereof and applications therefor; and (iii) registered copyrights and applications therefor. The SmarterKids Disclosure Schedule identifies the owner of each item listed thereon and, in the case of registrations and applications, the application or registration number and date. (b) To the knowledge of SmarterKids, SmarterKids is the sole and exclusive owner or a licensee of all of the material SmarterKids Intellectual Property. All of the material SmarterKids Intellectual Property will be owned or available for use by SmarterKids on terms and conditions immediately following the Effective Time identical to the terms and conditions pertaining to SmarterKids immediately prior to the Effective Time. SmarterKids has taken reasonable measures to protect the proprietary nature of the SmarterKids Intellectual Property and to maintain in confidence the trade secrets and confidential information that they own or use. No other person has any rights to any material item of the SmarterKids Intellectual Property or has any rights to any of the material SmarterKids Intellectual Property, except that the items of the SmarterKids Intellectual Property identified on the SmarterKids Disclosure Schedule as licensed to SmarterKids are owned by the respective owners identified on the SmarterKids Disclosure Schedule, and, to the knowledge of SmarterKids, no person is infringing, violating or misappropriating any of the material SmarterKids Intellectual Property. (c) To the knowledge of SmarterKids, none of the activities or business presently conducted by SmarterKids infringes or violates, or constitutes a misappropriation of, any intellectual property of any other person, and, if without the knowledge of SmarterKids, such activities or business presently conducted by A-28 SmarterKids does infringe, violate or constitute a misappropriation of any intellectual property of any other person, no such infringement, violation or misappropriation, individually or in the aggregate, is reasonably likely to have a SmarterKids Material Adverse Effect. Neither SmarterKids nor any Affiliate of SmarterKids has received any complaint, claim or notice alleging any such infringement, violation or misappropriation. (d) With respect to each item of the SmarterKids Intellectual Property: (i) SmarterKids possesses all right, title and interest in and to such item, except for any SmarterKids Third Party Rights (as defined below;) (ii) such item is not subject to any outstanding judgment, order, decree, stipulation or injunction; and (iii) SmarterKids has not agreed, except in the ordinary course of business consistent with past practice or in conjunction with product or service sales or licenses, to indemnify any person for or against any infringement, misappropriation or other conflict with respect to such item. (e) The SmarterKids Disclosure Schedule identifies each item of the intellectual property used by SmarterKids that is owned by a party other than SmarterKids ("SmarterKids Third Party Rights"), and all licenses or other agreements pursuant to which SmarterKids uses such items are listed on the SmarterKids Disclosure Schedule. With respect to each such item: (i) the license or other agreement covering any such material item is valid, binding, enforceable and in full force and effect with respect to SmarterKids and, to the knowledge of SmarterKids, with respect to every other party thereto; (ii) each such license or other agreement, including licenses to all third-party software listed in the SmarterKids Disclosure Schedule other than generally commercially available software, to which SmarterKids is a party, is assignable by SmarterKids without the consent or approval of, or any payment to, any party except as set forth on the SmarterKids Disclosure Schedule, and, except as set forth on the SmarterKids Disclosure Schedule, all such licenses and other agreements will continue to be valid, binding, enforceable and in full force and effect immediately following the Effective Time in accordance with the terms thereof as in effect immediately prior to the Effective Time, and the consummation of the transactions will not conflict with, result in a violation or breach of or constitute a default under (with notice or lapse of time or both) any such license or other agreement; and (iii) neither SmarterKids nor, to the knowledge of SmarterKids, any other party to any such license or other agreement, is in breach or default under any such license or other agreement and, to the knowledge of SmarterKids, no event has occurred that, with notice or lapse of time or both, would constitute such a breach or default or permit termination, modification or acceleration thereunder. (g) The systems and web architecture currently associated with SmarterKids' web site are capable of supporting revenue of $40 million on an annual basis at present performance standards and consistent with the seasonality of SmarterKids' business. Section 4.10 Product Warranties and Liability. (a) No reserves have been provided for by SmarterKids to cover potential claims under existing customer indemnification agreements. (b) Except as to claims, actions, proceedings or investigations which have been asserted but as to which no notice has been given to SmarterKids and except as set forth on SmarterKids Disclosure Schedule, there are no product liability claims, actions, proceedings or investigations pending or, to the knowledge of SmarterKids, threatened against SmarterKids or its assets or, to the knowledge of SmarterKids, any state of facts existing which could give rise to any such product liability claim, action, proceeding or investigation. A-29 (c) To the knowledge of SmarterKids, no claims have been made that the products sold by SmarterKids are not effective for the uses such products purport to serve. To its knowledge, SmarterKids has not received any written notice that any product manufactured by it has not been manufactured in accordance with "current Good Manufacturing Practices" (as such term is commonly understood within SmarterKids' industry) or has not been properly labeled for its approved use. Section 4.11 Agreements, Contracts and Commitments. (a) As of the date hereof, SmarterKids is not a party to any existing contract, obligation or commitment (including amendments, supplements or modifications thereof (whether orally or in writing)) of any type in any of the following categories except for contracts filed as exhibits to the SmarterKids SEC Reports or set forth in the SmarterKids Disclosure Schedule (true and complete copies of which contracts have been delivered to or made available to Earlychildhood): (i) contracts that provide for annual payments to or by SmarterKids aggregating in excess of $150,000; (ii) each contract of SmarterKids that was not entered into in the ordinary course of business; (iii) contracts under which SmarterKids has or may, except by way of endorsement of negotiable instruments for collection in the ordinary course of business and consistent with past practice, become absolutely or contingently or otherwise liable for (x) the performance under a contract of any other person, firm or corporation or (y) the whole or any part of the indebtedness or liabilities of any other person, firm or corporation, in all cases, individually in excess of $1,000,000 and in the aggregate in excess of $5,000,000; (iv) employment agreements, consulting agreements, contracts or commitments with any employee or member of SmarterKids' Board of Directors, other than those which are terminable by SmarterKids on not more than thirty days notice without liability or financial obligation, and within each such category of agreements, contracts or commitments, which are individually in excess of $150,000; (v) any agreements or plans, including, without limitation, any stock option, stock appreciation right or stock purchase plans or agreements, any of the benefits of which will be increased, or the vesting of benefits of which will be accelerated, by the occurrence of any of the transactions contemplated by this Agreement or the value of any of the benefits of which will be calculated on the basis of any of the transactions contemplated by this Agreement; (vi) any contract with any director, officer or more than 5% stockholder of SmarterKids, other than in such person's capacity as a director or officer of SmarterKids, or any contract with any entity in which, to the knowledge of SmarterKids, any director, officer or more than 5% stockholder or any family member of any director, officer or stockholder has a material economic interest; (vii) any contract that limits or restricts in any material respect where SmarterKids may conduct its business or the type or line of business that Earlychildhood may engage in; (viii) any powers of attorney outstanding (other than those issued in the ordinary course of business with respect to Tax matters), or material obligations or liabilities (absolute or contingent) as guarantor, surety, cosigner, endorser, co-maker, indemnitor, or otherwise respecting the obligations or liabilities of any person; (ix) any material contract containing any agreement with respect to any change of control; and (x) each material amendment, supplement and modification (whether oral or written) in respect of any of the foregoing. (b) SmarterKids has not breached, or received in writing any claim or notice that it has breached, any of the terms or conditions of any material agreement, contract or commitment filed or required to be filed as an exhibit to the SmarterKids SEC Reports or set forth or required to be set forth in Section 4.11 of the A-30 SmarterKids Disclosure Schedule ("SmarterKids Material Contracts") in such a manner as, individually or in the aggregate, is reasonably likely to have a SmarterKids Material Adverse Effect. Each SmarterKids Material Contract that has not expired by its terms is in full force and effect, except for those contracts the ineffectiveness of which would not reasonably be likely to have a SmarterKids Material Adverse Effect, and, if all of the consents, approvals, authorizations, filings, notifications and other actions listed with respect to such contract in the SmarterKids Disclosure Schedule are obtained, taken or made, as applicable, such contract will continue, after the Effective Time, to be in full force and effect on identical terms. (c) To SmarterKids' knowledge, none of the parties to any SmarterKids Material Contract have terminated, or notified SmarterKids in writing of its intent to materially reduce or terminate its business relationship with SmarterKids in the future. (d) SmarterKids has not received written notice from any customer, or group of customers, that are under common ownership or control, and that accounted for a material percentage of the aggregate products and services furnished by SmarterKids since January 1, 1999 that such customer or group of customers has stopped or intends to stop purchasing SmarterKids' products or services, nor has SmarterKids lost any supplier, or group of suppliers that are under common ownership or control, that accounted for a material percentage of the aggregate supplies purchased by SmarterKids since January 1, 1999. Section 4.12 Litigation. Except as disclosed in the SmarterKids SEC Reports or in the SmarterKids Disclosure Schedule, there is no (i) action, suit or proceeding, claim, arbitration or investigation against SmarterKids pending or, to the knowledge of SmarterKids, threatened, against SmarterKids or (ii) outstanding order, judgment, writ, injunction or decree of any court, governmental agency or arbitration tribunal in a proceeding to which SmarterKids is a party, except, in the case of each of clauses (i) and (ii) above, those that, individually or in the aggregate, are not reasonably likely to have a SmarterKids Material Adverse Effect or a material adverse effect on the ability of SmarterKids to consummate the transactions contemplated by this Agreement. Section 4.13 Environmental Matters. To the knowledge of SmarterKids, except as disclosed in the SmarterKids SEC Reports filed prior to the date hereof and except, with or without the knowledge of SmarterKids, for such matters that, individually or in the aggregate, are not reasonably likely to have a SmarterKids Material Adverse Effect: (i) SmarterKids is in material compliance with all applicable Environmental Laws; (ii) the properties currently owned or operated by SmarterKids (including soils, groundwater, surface water, buildings or other structures) are not contaminated with any Hazardous Substances; (iii) the properties formerly owned or operated by SmarterKids were not contaminated with Hazardous Substances during the period of ownership or operation by SmarterKids; (iv) SmarterKids is not subject to liability for any Hazardous Substance disposal or contamination on any third party property; (v) SmarterKids has not been associated with any release or threat of release of any Hazardous Substance; (vi) SmarterKids has not received any written notice, demand, letter, claim or request for information alleging that SmarterKids may be in violation of or liable under any Environmental Law; and (vii) SmarterKids is not subject to any orders, decrees, injunctions or other arrangements with any Governmental Entity or subject to any indemnity or other agreement with any third party relating to liability under any Environmental Law or relating to Hazardous Substances. Section 4.14 Employee Benefit Plans. (a) The SmarterKids Disclosure Schedule sets forth all Employee Benefit Plans, as defined in Section 3(3) of ERISA, and all other material Benefit Arrangements, (i) which are maintained, contributed to or required to be contributed to by SmarterKids ("SmarterKids Employee Plans"). (b) A true and complete copy of each written SmarterKids Employee Plan, including, if applicable, each amendment thereto and any trust agreement, insurance contract, collective bargaining agreement, or other funding or investment arrangements for the benefits under such SmarterKids Employee Plan, has been made A-31 available to Earlychildhood. In addition, with respect to each such SmarterKids Employee Plan to the extent applicable, SmarterKids has made available to Earlychildhood the most recently filed Federal Forms 5500, the most recent summary plan description (including any summaries of material modifications), the most recent IRS determination letter, if applicable, the most recent actuarial report or valuation, if applicable, and all material employee communications with respect to each such SmarterKids Employee Plan. (c) Except as set forth on the SmarterKids Disclosure Schedule: (i) neither SmarterKids nor any entity that, together with SmarterKids is required to be treated as a single employer under Section 414 of the Code ("SmarterKids ERISA Affiliate") sponsors or has previously sponsored, maintained, contributed to or incurred an obligation to contribute to any Employee Benefit Plan regulated under Title IV of ERISA, including any "multiemployer plan," as defined in Sections 3(37) and 4001(a)(3) of ERISA and neither SmarterKids nor any SmarterKids ERISA Affiliate has incurred nor reasonably expects to incur any liability under Title IV of ERISA arising in connection with the termination of any plan covered or previously covered by Title IV or ERISA. Neither SmarterKids nor any ERISA Affiliate participates in or has employees covered by an Employee Plan sponsored by a professional employer organization or similar entity; (ii) SmarterKids does not and has not previously sponsored, maintained, contributed to or incurred an obligation to contribute to any Employee Benefit Plan that provides or will provide benefits described in Section 3(1) of ERISA to any former employee or retiree of SmarterKids, except as required under Part 6 of Title I of ERISA and Section 4980B of the Code or applicable state law; (iii) all SmarterKids Employee Plans and Benefit Arrangements have been maintained and operated, and currently are, in compliance in all material respects with their terms, the requirements prescribed by any and all applicable laws (including ERISA and the Code), orders, or governmental rules and regulations in effect with respect thereto, and SmarterKids has performed all material obligations required to be performed by it under, is not in any material respect in default under or in violation of, and has no knowledge of any default or violation by any other party to, any of the SmarterKids Employee Plans; (iv) each SmarterKids Employee Plan that is intended to qualify under Section 401(a) of the Code and each trust established pursuant to each such SmarterKids Employee Plan that is intended to qualify under Section 501(a) of the Code is the subject of a favorable determination letter from the IRS, a copy of which has been made available to Earlychildhood, and, to SmarterKids' knowledge, nothing has occurred which may reasonably be expected to impair such determination or otherwise adversely affect the tax-qualified status of such SmarterKids Employee Plan; (v) SmarterKids has made full and timely payment of all amounts required to be contributed under the terms of each SmarterKids Employee Plan and applicable law or required to be paid as expenses under such SmarterKids Employee Plan and there has been no amendment to, written interpretation of or announcement (whether or not written) by SmarterKids or any SmarterKids ERISA Affiliates relating to, or change in employee participation or coverage under, any Employee Benefit Plan or Benefit Arrangement that would increase materially the expense of maintaining such Employee Benefit Plan or Benefit Arrangement above the level of the expense incurred in respect thereof for the fiscal year ended prior to the date hereof; and (vi) other than claims for benefits in the ordinary course, there is no claim, suit, action, dispute, arbitration or legal, administrative or other proceeding or governmental investigation or audit pending, or, to the knowledge of SmarterKids, threatened, alleging any breach of the terms of any SmarterKids Employee Plan or of any fiduciary duty thereunder or violation of any applicable law with respect to any such SmarterKids Employee Plan. (d) With respect to the SmarterKids Employee Plans, individually and in the aggregate, no event has occurred, and to the knowledge of SmarterKids, there exists no condition or set of circumstances in connection with which SmarterKids could be subject to any liability that is reasonably likely to have a SmarterKids Material Adverse Effect under ERISA, the Code or any other applicable law. A-32 (e) SmarterKids is not a party to any written or oral contract, agreement, plan or arrangement pursuant to which SmarterKids has any obligation to "gross up," indemnify or otherwise compensate or hold harmless any person with respect to any portion of any excise tax (or interest or penalties with respect thereto) which such person may become subject to under Section 4999 of the Code or any similar state tax law, and there is no contract, agreement, plan or arrangement covering any person that, individually or collectively, would constitute compensation in excess of the limitation set forth in Section 162(m) of the Code. (f) Except as set forth on the SmarterKids Disclosure Schedule, and except as provided for in this Agreement, SmarterKids is not a party to any oral or written (i) agreement with any officer or other key employee of SmarterKids, the benefits of which are contingent, or the terms of which are materially altered, upon the occurrence of a transaction involving SmarterKids of the nature contemplated by this Agreement, (ii) agreement with any officer of SmarterKids providing any term of employment or compensation guarantee extending for a period longer than one year from the date hereof and for the payment of compensation in excess of $100,000 per annum, or (iii) agreement or plan, including any stock option plan, stock appreciation right plan, restricted stock plan or stock purchase plan, any of the benefits of which will be increased, or the vesting of the benefits of which will be accelerated, by the occurrence of any of the transactions contemplated by this Agreement or the value of any of the benefits of which will be calculated on the basis of any of the transactions contemplated by this Agreement. None of the execution and delivery of this Agreement or any of the Transaction Documents or the consummation of the transactions contemplated hereunder or thereunder will trigger any "change of control" or similar provisions resulting in the acceleration of benefits or compensation with respect to any agreements with any officer or other key employee of SmarterKids except for such applicable agreements as set forth on the SmarterKids Disclosure Schedule (the "SmarterKids Change of Control Agreements"). Section 4.15 Compliance With Laws. (a) SmarterKids has not violated or failed to comply with any statute, law, ordinance, regulation, rule or order of any Governmental Entity, or any judgment, decree or order of any court, applicable to it, its business or operations or by which it, its business or operations are bound, except for any such violations or failures to comply that, individually or in the aggregate have not had and are not reasonably likely to have a SmarterKids Material Adverse Effect; (b) No investigation or review by any Governmental Entity is pending or, to the knowledge of SmarterKids, has been threatened against SmarterKids, nor, to the knowledge of SmarterKids, has any Governmental Entity indicated by written notice or otherwise, an intention to conduct an investigation of SmarterKids; and (c) There is no agreement, judgment, injunction, order or decree binding upon SmarterKids which has had or is reasonably likely to have the effect of prohibiting or materially impairing the conduct of SmarterKids' business as currently conducted or the transactions contemplated by this Agreement. Section 4.16 Tax Matters. (a) To the knowledge of SmarterKids, none of SmarterKids, its Affiliates (as defined in Section 5.13) and any of SmarterKids' stockholders have taken or agreed to take any action (or failed to take or agreed not to take any action) which such action or inaction, as the case may be, would prevent the SmarterKids Merger from (i) qualifying as a reorganization described in Section 368(a) of the Code and, (ii) taken together with the Contribution, as a transfer of property to Holdings qualifying under Section 351 of the Code. (b) To the knowledge of SmarterKids, the stockholders of SmarterKids have no present plan, intention or arrangement to sell or otherwise dispose of any of the Holdings Common Stock received in the SmarterKids Merger that would cause the Contribution and the SmarterKids Merger to fail to qualify as transfers under Section 351 of the Code. A-33 Section 4.17 Registration Statement; Proxy Statement/Prospectus. The information to be supplied by SmarterKids or about SmarterKids to be supplied by SmarterKids' agents for inclusion in the Registration Statement shall not at the time the Registration Statement is declared effective by the SEC contain any untrue statement of a material fact or omit to state any material fact required to be stated in the Registration Statement or necessary in order to make the statements in the Registration Statement, in light of the circumstances under which they were made, not misleading. The information to be supplied by SmarterKids or about SmarterKids by SmarterKids' agents for inclusion in the Proxy Statement/Prospectus shall not, on the date the Proxy Statement/Prospectus is first mailed to stockholders of SmarterKids, at the time of the SmarterKids Stockholders' Meeting and at the Effective Time, contain any statement which, at such time and in light of the circumstances under which it shall be made, is false or misleading with respect to any material fact, omit to state any material fact necessary in order to make the statements made in the Proxy Statement/Prospectus not false or misleading, or omit to state any material fact necessary to correct any statement in any earlier communication with respect to the solicitation of proxies for the SmarterKids Stockholders' Meeting which has become false or misleading. If at any time prior to the Effective Time any event relating to SmarterKids or any of its Affiliates, officers or directors should be discovered by SmarterKids which should be set forth in an amendment to the Registration Statement or a supplement to the Proxy Statement/Prospectus, SmarterKids shall promptly inform Earlychildhood. Section 4.18 Labor Matters. SmarterKids is not a party to or otherwise bound by any collective bargaining agreement, contract or other agreement or understanding with a labor union or labor organization, nor, as of the date hereof, is SmarterKids the subject of any material proceeding asserting that SmarterKids has committed an unfair labor practice or seeking to compel it to bargain with any labor union or labor organization nor, as of the date of this Agreement, is there pending or, to the knowledge of SmarterKids, threatened, any material labor strike, dispute, walkout, work stoppage, slow-down or lockout involving SmarterKids. Section 4.19 Insurance. All material fire and casualty, general liability, business interruption, product liability, and sprinkler and water damage insurance policies maintained by SmarterKids are with reputable insurance carriers, provide full and adequate coverage for all normal risks incident to the business of SmarterKids and its respective properties and assets, and are in character and amount at least equivalent to that carried by persons engaged in similar businesses and subject to the same or similar perils or hazards, except for any such failures to maintain insurance policies that, individually or in the aggregate, are not reasonably likely to have a SmarterKids Material Adverse Effect. All premiums and other payments due from SmarterKids with respect to any such contracts of insurance or indemnity have been paid. SmarterKids has not received written notice of any threatened termination of, or premium increase with respect to, any of such policies or bonds. Section 4.20 Opinion of Financial Advisor. The financial advisor of SmarterKids, Chase H&Q, has delivered to SmarterKids an opinion dated the date of this Agreement to the effect that the SmarterKids Exchange Ratio is fair to the holders of SmarterKids Common Stock from a financial point of view. Section 4.21 No Existing Discussions. As of the date hereof, neither SmarterKids nor any of its Affiliates is engaged, directly or indirectly, in any discussions or negotiations with any other party with respect to a SmarterKids Alternative Transaction or any proposal therefor. Section 4.22 Board Recommendation. The Board of Directors of SmarterKids has, by a unanimous vote at a meeting of such board duly held on November 8, 2000, approved and adopted this Agreement, the SmarterKids Merger and the other transactions contemplated hereby and thereby, and determined that this Agreement, the SmarterKids Merger, and the other transactions contemplated hereby and thereby, taken together, are in the best interest of the stockholders of SmarterKids, and prior to the date hereof resolved to recommend that the holders of SmarterKids Common Stock approve and adopt this Agreement, the SmarterKids Merger and the other transactions contemplated hereby. Section 4.23 Voting Requirements. The approval by a majority of the voting power represented by the outstanding shares of SmarterKids Common Stock entitled to vote thereon is the only vote of the holders of A-34 any class of SmarterKids' capital stock necessary to approve this Agreement, the SmarterKids Merger and the other transactions contemplated hereby. No separate approval by the holders of any other class or series of capital stock of SmarterKids is necessary to approve this Agreement, the SmarterKids Merger or any of the other transactions contemplated hereby. Section 4.24 Section 203 of the DGCL Not Applicable. The Board of Directors of SmarterKids has taken all actions necessary under the DGCL, including approving the transactions contemplated by this Agreement and each of the Transaction Documents to which it is a party, to ensure that Section 203 of the DGCL applicable to a "business combination" (as defined in Section 203 of the DGCL) do not, and will not, apply to the transactions contemplated hereunder and thereunder. No other "fair price," "moratorium," "control share acquisition" or other similar anti-takeover statute or regulation is applicable to SmarterKids or (by reason of SmarterKids' participation therein) the SmarterKids Merger or the other transactions contemplated by this Agreement or the other Transaction Documents to which it is a party. ARTICLE V. COVENANTS Section 5.1 Conduct of Business. Except as set forth in the Earlychildhood Disclosure Schedule or the SmarterKids Disclosure Schedule, during the period from the date of this Agreement and continuing until the earlier of the termination of this Agreement or the Effective Time, Earlychildhood and SmarterKids each agrees as to itself and, in the case of Earlychildhood, its Subsidiaries (except to the extent that the other party shall otherwise consent in writing) to carry on its business in the usual, regular and ordinary course in substantially the same manner as previously conducted, to pay its debts and taxes when due subject to good faith disputes over such debts or taxes, to pay or perform its other obligations when due, and, to the extent consistent with such business, use all reasonable efforts consistent with past practices and policies to (i) preserve intact its present business organization, (ii) keep available the services of its present officers, key employees and/or managers and (iii) preserve its relationships with customers, suppliers, distributors, and others having business dealings with it. Except as expressly contemplated by this Agreement (including the Exhibits attached hereto) or as set forth in the Earlychildhood Disclosure Schedule or the SmarterKids Disclosure Schedule, during the period from the date of this Agreement and continuing until the earlier of the termination of this Agreement or the Effective Time, Earlychildhood and SmarterKids each shall not (and Earlychildhood shall not permit its Subsidiaries to), without the written consent of the other party: (a) Split, combine or reclassify any shares of its capital stock or equity interests, as applicable, declare, set aside or pay any dividend or other distribution (whether in cash, stock or property or any combination thereof) in respect of its capital stock, LLC Interests or other equity interests (as applicable) or, except pursuant to agreements in effect on the date of execution of this Agreement which have been disclosed in the Earlychildhood Disclosure Schedule or the SmarterKids Disclosure Schedule, as the case may be, purchase, prepay, redeem or otherwise acquire any shares of its own capital stock, LLC Interests or any other equity interests (as applicable) or any indebtedness or debt security; provided, however, that Earlychildhood (and to the extent necessary, its Subsidiaries) may effect tax distributions to its equity holders in the ordinary course of business up to the maximum amounts permitted under the Operating Agreement; (b) Accelerate, amend or change the period of exercisability of options or restricted stock granted under any employee stock or equity plan of such party or authorize cash payments in exchange for any options granted under any of such plans, except as required by the terms of such plans or any related agreements in effect as of the date of this Agreement; (c) Issue, deliver or sell, or authorize or propose the issuance, delivery or sale of, any shares of its capital stock or other equity interests (as applicable) or securities convertible into or exchangeable for shares of its capital stock or other equity interests (as applicable) or subscriptions, rights, warrants or A-35 options to acquire, or other agreements or commitments of any character obligating it to issue any such shares or equity interests, as applicable, or other convertible securities, other than the issuance of LLC Interests or SmarterKids Common Stock, as the case may be, pursuant to the exercise of options or the SmarterKids Warrants outstanding on the date of this Agreement; (d) Acquire or agree to acquire by merging or consolidating with, or by purchasing an equity interest in or portion of the assets of, or by any other manner, any business or any corporation, partnership or other business organization or division, or otherwise acquire or agree to acquire any assets (other than inventory and other items in the ordinary course of business), except for any such acquisitions involving aggregate consideration of not more than $250,000; (e) Consolidate, merge or amalgamate with or into any other person, or sell, lease, license or otherwise dispose of (in one or more transactions) any of its material properties or assets; (f) (i) Increase or agree to increase the compensation payable or to become payable to its directors or management committee members (as applicable), officers, managers, employees or consultants, except for increases in salary or wages of employees (other than officers) in accordance with past practices, (ii) grant any additional severance or termination pay to, or enter into any employment or severance agreements with, any consultants, employees, officers, directors or management committee members (as applicable), (iii) terminate any officers, employees or consultants, (iv) enter into any collective bargaining agreement (other than as required by law), or (v) establish, adopt, enter into or amend any Employee Benefit Plan or Benefit Arrangement or other plan, trust, fund, policy or arrangement for the benefit of any directors, officers, employees or consultants; provided, however, that SmarterKids may make bonus payments to its senior officers, up to an aggregate maximum of $200,000, after the date of this Agreement and prior to January 31, 2001, so long as such payments are made in the ordinary course of business consistent with past practice and approved by the compensation committee of SmarterKids' Board of Directors. (g) Amend or propose to amend its organizational documents (including, in the case of Earlychildhood, the Operating Agreement), except as contemplated by this Agreement and in any event pursuant to draft amendments sent for review and comment to the other party; (h) (A) Incur any indebtedness for borrowed money other than in the ordinary course of business, (B) assume, guarantee, endorse or otherwise become liable or responsible for the obligations of any other individual, firm or corporation or make any loans or advances, except advances to employees for expense reimbursement made in the ordinary course of business consistent with past practice, (C) enter into any commitment or transaction material to SmarterKids or material to Earlychildhood and its Subsidiaries, taken as a whole (as applicable) outside of product sales in the ordinary course of business, or (D) incur any liabilities, except for liabilities that, individually or in the aggregate, would not have an Earlychildhood Material Adverse Effect or a SmarterKids Material Adverse Effect, as the case may be; (i) Take any action that would or is reasonably likely to result in (A) a material breach of any provision of this Agreement or any of the Transaction Documents to which it is a party or (B) any of its representations and warranties set forth in this Agreement or any of the Transaction Documents to which it is a party being untrue on and as of the Closing Date; (j) Institute any significant change in accounting methods, principles or practices affecting its assets, liabilities, reserve or expense recognition, reserves, amortization or accruals, except insofar as may be appropriate to conform to changes in law or GAAP; (k) Revalue any of its respective assets, including without limitation, writing down the value of inventory or notes or accounts receivables, in each case, except in the ordinary course of business consistent with past practice and except insofar as may be appropriate to conform to changes in law or GAAP; (l) Make or rescind any material express or deemed election relating to Taxes, settle or compromise any material claim, action, suit, litigation, proceeding, arbitration, investigation, audit or controversy A-36 relating to Taxes, or change any of its methods of reporting income or deductions for federal income Tax purposes from those employed in the preparation of its federal income tax return for the taxable year ending December 31, 1999, except as may be required by applicable law; (m) Settle any litigation relating to the transactions contemplated hereby or any other litigation if the cost of the settlement would exceed $250,000; (n) Permit any material insurance policy naming it as a beneficiary or a loss payee to be cancelled, terminated or materially altered, unless such policy is replaced with a comparable policy for comparable cost; (o) Take, or agree in writing or otherwise to take, any of the actions described in Sections (a) through (n) above. Section 5.2 Cooperation; Notice; Cure. Each of Earlychildhood, SmarterKids and Holdings will use commercially reasonable efforts to effectuate the transactions contemplated hereby and to fulfill and cause to be fulfilled the conditions to Closing under this Agreement. Subject to compliance with applicable law, from the date hereof until the Effective Time, each of Earlychildhood and SmarterKids shall confer on a regular and frequent basis with one or more representatives of the other party to report on the general status of ongoing operations and shall promptly provide the other party or its counsel with copies of all filings made by such party with any Governmental Entity and, in the case of SmarterKids, with the SEC, in connection with this Agreement, the Transactions and the transactions contemplated hereby and thereby. Each of Earlychildhood and SmarterKids shall notify the other of, and will use all commercially reasonable efforts to cure before the Closing Date, any event, transaction or circumstance, as soon as practical after it becomes known to such party, that causes or will cause any covenant or agreement of Earlychildhood or SmarterKids under this Agreement to be breached or that renders or will render untrue any representation or warranty of Earlychildhood or SmarterKids contained in this Agreement. Each of Earlychildhood and SmarterKids shall notify the other in writing of, and will use all commercially reasonable efforts to cure, before the Closing Date, any violation or breach, as soon as practical after it becomes known to such party, of any representation, warranty, covenant or agreement made by Earlychildhood or SmarterKids. No notice given pursuant to this paragraph shall have any effect on the representations, warranties, covenants or agreements contained in this Agreement for purposes of determining satisfaction of any condition contained herein. Section 5.3 No Solicitation. (a) Subject to Section 5.3(b), unless and until this Agreement shall have been terminated by SmarterKids or Earlychildhood pursuant to and in compliance with Article VII hereof, SmarterKids shall not, nor will it authorize or permit any of its officers, directors, employees, financial advisors, attorneys, accountants, or other representatives or agents to, directly or indirectly through another person (i) solicit, initiate, facilitate or encourage any inquiries, offers or proposals by or from any Third Party (as defined below) that constitute, or could reasonably be expected to lead to, any Acquisition Proposal (as defined below), (ii) enter into or execute any agreement with respect to an Acquisition Proposal, (iii) engage in or continue negotiations or discussions with any Third Party concerning, or, except pursuant to a governmental request for information, otherwise communicate or provide any non- public information to any Third Party relating to any Acquisition Proposal, (iv) make or authorize any public statement, recommendation or solicitation in support of any Acquisition Proposal, or (v) take any other action inconsistent with its obligations or commitments under this Section 5.3. As used in this Agreement, "Acquisition Proposal" means any (i) transaction pursuant to which any corporation, partnership, trust, person or other entity or group other than Earlychildhood or its Affiliates (a "Third Party"), acquires more than 20% of the outstanding shares of SmarterKids Common Stock pursuant to a tender offer or exchange offer or otherwise, (ii) merger or other business combination, recapitalization, restructuring or similar transaction involving SmarterKids, (iii) other transaction pursuant to which any Third Party acquires control of assets of SmarterKids having a fair market value equal to more than 20% of the fair market value of all the assets of SmarterKids immediately prior to such transaction, or (iv) any public announcement of a proposal, plan or intention to do any of the foregoing or any agreement to engage in any of the foregoing. A-37 (b) Notwithstanding the foregoing, SmarterKids may, and may authorize and permit its officers, directors, employees, financial advisors, attorneys, accountants and other representatives or agents, in response to a bona fide, written, unsolicited Acquisition Proposal from a Third Party which did not otherwise result from a breach of this Section 5.3, to (i) furnish non-public information to such Third Party; (ii) otherwise facilitate any effort or attempt by such Third Party to make or implement an Acquisition Proposal; (iii) agree to or recommend or endorse any such Acquisition Proposal with or by any Third Party; (iv) withdraw or modify, or propose publicly to withdraw or modify, in a manner adverse to Earlychildhood, its approval and recommendation of the SmarterKids Merger and this Agreement; (v) participate in discussions and negotiations with such Third Party relating to such Acquisition Proposal; and (vi) cause SmarterKids to enter into an agreement implementing an Acquisition Proposal, provided that SmarterKids simultaneously terminates this Agreement pursuant to Section 7.1(f) and pays the Termination Fee (as defined in Section 7.3); provided, however, that SmarterKids shall be permitted to take any one or more of the actions enumerated in clauses (i)-(vi) above if and only to the extent that (A) the Board of Directors of SmarterKids reasonably determines in good faith (after consultation with a financial advisor of nationally recognized reputation) that (X) the Acquisition Proposal is more favorable or is reasonably likely to lead to an Acquisition Proposal that is more favorable to the SmarterKids stockholders from a financial point of view than the Transactions, and (Y) is made by a Third Party reasonably believed by the SmarterKids Board of Directors to be financially capable of completing such Acquisition Proposal, (B) the SmarterKids Board of Directors reasonably determines in good faith (after having consulted with and considered the advice of its outside legal counsel) that the failure to take such actions would cause the members of the SmarterKids Board of Directors to breach their fiduciary duties to the SmarterKids stockholders under applicable law, and (C) prior to furnishing or disclosing any non-public information to, or entering into discussions or negotiations with, such Third Party, it receives from such Third Party an executed confidentiality agreement with respect to the information to be furnished with terms no less favorable in the aggregate to it than those contained in the Confidentiality Agreement dated as of January 19, 2000 by and between Earlychildhood and SmarterKids (the "Earlychildhood Confidentiality Agreement"), but which confidentiality agreement shall not (nor shall any other agreement or arrangement between SmarterKids, on the one hand, and such Third Party, on the other hand, or any of their respective representatives or agents) provide for any exclusive right to negotiate with SmarterKids or any payments by SmarterKids. Without limiting the foregoing, it is understood that any violation of the restrictions set forth in this Section 5.3(b) by any officer, director or employee of SmarterKids or any investment banker, attorney, accountant or other advisor, representative or agent of SmarterKids shall be deemed to be a breach of this Section 5.3 by SmarterKids. (c) SmarterKids shall (i) immediately cease and cause to be terminated any existing activities, discussions or negotiations with any parties conducted heretofore with respect to any Acquisition Proposal or similar transaction, and take all necessary steps to inform such individuals or entities of the obligations undertaken in this Section 5.3, (ii) as promptly as practicable (and in any event within twenty-four (24) hours) notify Earlychildhood in writing of any Acquisition Proposal or receipt of any inquiries, proposals or offers with respect to an Acquisition Proposal or any request for non-public information relating to it in connection with an Acquisition Proposal or for access to its properties, books or records by any Third Party that informs SmarterKids' Board of Directors or any representative thereof that it is considering making, or has made (or which SmarterKids' Board of Directors reasonably believes may be considering making or has made) a proposal or offer with respect to an Acquisition Proposal, (iii) in such written notice, indicate in reasonable detail the identity of such Third Party (including the name of such Third Party and a copy of any offer or proposal and any supporting documentation) and the terms and conditions of such proposal or offer, all of which information shall be held in confidence by Earlychildhood, and (iv) as promptly as practicable (and in any event within twenty-four (24) hours) notify Earlychildhood in writing of any determination by its Board of Directors to furnish information or engage in discussions or negotiations with any Third Party. SmarterKids shall promptly furnish to Earlychildhood copies of any written information (and advise it orally of any non-written information) provided to or by any Third Party relating to an Acquisition Proposal to the extent such information has not previously been provided to Earlychildhood. If any notice is given or required to be given in accordance with the second preceding sentence, then SmarterKids shall thereafter continue to keep Earlychildhood informed, on a current basis, of the status of any such discussions or negotiations and the terms A-38 being discussed or negotiated. Notwithstanding the foregoing, SmarterKids shall not accept or enter into any agreement concerning an Acquisition Proposal for a period of at least three business days after Earlychildhood's receipt of the notification of the terms thereof pursuant to the third preceding sentence (and only in compliance with the terms of Article VII hereof). (d) Nothing contained in this Section 5.3 shall prohibit SmarterKids from taking and disclosing to its stockholders a position contemplated by Rule 14e-2 promulgated under the Exchange Act or from making any disclosure to its stockholders if the SmarterKids Board of Directors reasonably determines in good faith after receiving the advice of its outside legal counsel (who may be its regularly engaged outside counsel) that the failure to do so would cause the members of the SmarterKids Board of Directors to breach of their fiduciary duties to the SmarterKids stockholders under any applicable law, provided, however, that neither SmarterKids nor the SmarterKids Board of Directors nor any committee thereof may, except as expressly permitted by Section 5.3(b) or required by Rule 14e-2 promulgated under the Exchange Act, withdraw or modify, or propose publicly to withdraw or modify, its position with respect to this Agreement or the SmarterKids Merger or approve or recommend, or propose publicly to approve or recommend, an Acquisition Proposal. Section 5.4 No Negotiation. (a) From the date hereof until the Effective Time, or unless this Agreement is earlier terminated by SmarterKids or Earlychildhood pursuant to and in compliance with Article VII, Earlychildhood shall not and shall not permit its Subsidiaries nor any of its Members or any of their respective Affiliates, nor will Earlychildhood authorize or permit any of its employees, financial advisors, attorneys, accountants, or other representatives or agents to, directly or indirectly through another person, (i) solicit, initiate, facilitate or encourage any inquiries, offers or proposals by or from any Other Party (as defined below) that constitute, or could reasonably be expected to lead to, any Earlychildhood Acquisition Proposal (as defined below), (ii) enter into or execute any agreement with respect to an Earlychildhood Acquisition Proposal, (iii) engage in or continue negotiations or discussions with any Other Party concerning, or, except pursuant to a governmental request for information, otherwise communicate or provide any non-public information to any Other Party relating to, any Earlychildhood Acquisition Proposal, (iv) make or authorize any public statement, recommendation or solicitation in support of any Earlychildhood Acquisition Proposal, or (v) take any other action inconsistent with its obligations or commitments under this Section 5.4. As used in this Agreement, "Earlychildhood Acquisition Proposal" means any (i) transaction pursuant to which any corporation, partnership, trust, person or other entity or group other than SmarterKids or its Affiliates (an "Other Party"), acquires more than 20% of the outstanding LLC Interests, (ii) merger or other business combination, recapitalization, restructuring or similar transaction involving Earlychildhood, (iii) other transaction pursuant to which any Other Party acquires control of assets of Earlychildhood having a fair market value equal to more than 20% of the fair market value of all the assets of Earlychildhood immediately prior to such transaction, or (iv) any public announcement of a proposal, plan or intention to do any of the foregoing or any agreement to engage in any of the foregoing. (b) Earlychildhood shall (i) immediately cease and cause to be terminated any existing activities, discussions or negotiations with any parties conducted heretofore with respect to any Earlychildhood Acquisition Proposal or similar transaction, and take all necessary steps to inform such individuals or entities of the obligations undertaken in this Section 5.4, (ii) as promptly as practicable (and in any event within twenty-four (24) hours) notify SmarterKids in writing of receipt of any Earlychildhood Acquisition Proposal or any inquiries, proposals or offers with respect to an Earlychildhood Acquisition Proposal or any request for nonpublic information relating to it in connection with an Earlychildhood Acquisition Proposal or for access to its properties, books or records by any Other Party that informs Earlychildhood's Management Committee or any officer of Earlychildhood that is its considering making, or has made (or which Earlychildhood's Management Committee reasonably believes may be considering making or has made) a proposal or offer with respect to an Earlychildhood Acquisition Proposal, (iii) in such written notice indicate in reasonable detail the identity of such Other Party (including the name of such Other Party and a copy of any offer or proposal and any supporting documentation) and the terms and conditions of such proposal or offer, all of which information A-39 shall be held in confidence by SmarterKids, and (iv) as promptly as practicable (and in any event within twenty-four (24) hours) notify SmarterKids in writing of any determination by Earlychildhood's Management Committee or its officers or Affiliates to furnish information or engage in discussions or negotiations with any Other Party, it being understood that if Earlychildhood furnishes such information or engages in discussions or negotiations without SmarterKids' prior written consent, it shall constitute a breach of this Agreement. During such period, neither the Earlychildhood Management Committee nor any subcommittee thereof will approve or enter into any agreement to initiate, facilitate, encourage or implement an Earlychildhood Acquisition Proposal, or take any other action to contravene, supersede or modify their approval of this Agreement, the Transaction Documents, the Contribution or the other transactions contemplated hereby. Section 5.5 Proxy Statement/Prospectus; Registration Statement. (a) As promptly as practicable after the execution of this Agreement, SmarterKids shall prepare and file with the SEC the Proxy Statement/Prospectus and Earlychildhood and SmarterKids will cause Holdings to prepare and file with the SEC the Registration Statement on Form S-4 in which the Proxy Statement/Prospectus will be included as a prospectus. Holdings shall use all reasonable efforts to cause the Registration Statement to become effective as soon after such filing as practical and to keep such Registration Statement effective for so long as is necessary to consummate the Contribution and the SmarterKids Merger. The Proxy Statement/Prospectus shall include the recommendation of the Board of Directors of SmarterKids in favor of this Agreement and the SmarterKids Merger; provided that the Board of Directors of SmarterKids may modify or withdraw such recommendation in accordance with the terms of Section 5.3. (b) SmarterKids and Earlychildhood shall make all necessary filings with respect to the SmarterKids Merger and the Contribution, respectively, under the Securities Act, the Exchange Act, applicable state blue sky laws and the rules and regulations thereunder. (c) Earlychildhood and SmarterKids shall use their best efforts to furnish to each other all information required for any application or other filing to be made pursuant to the rules and regulations of any applicable law (including all information required to be included in the Proxy Statement/Prospectus and the Registration Statement) in connection with the transactions contemplated by this Agreement. Section 5.6 Nasdaq Quotation. SmarterKids agrees to use its reasonable best efforts to continue the quotation and listing of SmarterKids Common Stock on Nasdaq during the term of this Agreement. Section 5.7 Access to Information. Upon reasonable notice, Earlychildhood and SmarterKids shall each (and Earlychildhood shall cause its Subsidiaries to) afford to the officers, managers, employees, accountants, counsel and other authorized representatives of the other, access, during normal business hours during the period prior to the Effective Time, to all its personnel, properties, books, contracts, commitments and records and, during such period, each of Earlychildhood and SmarterKids shall (and Earlychildhood shall cause its Subsidiaries to) furnish promptly to the other (a) a copy of each report, schedule, registration statement and other document filed or received by it during such period pursuant to the requirements of federal securities laws and (b) all other information concerning its business, properties and personnel as such other party may reasonably request. The parties will hold any such information which is nonpublic in confidence in accordance with the Earlychildhood Confidentiality Agreement and the Confidentiality Agreement dated as of January 19, 2000 between SmarterKids, Earlychildhood and Thomas Weisel Partners (the "SmarterKids Confidentiality Agreement", and together with the Earlychildhood Confidentiality Agreement, the "Confidentiality Agreements"). No information or knowledge obtained in any investigation pursuant to this Section 5.7 shall affect or be deemed to modify any representation or warranty contained in this Agreement or the conditions to the obligations of the parties to consummate the Contribution or the SmarterKids Merger. A-40 Section 5.8 SmarterKids Stockholders' Meeting. SmarterKids shall call a meeting of its stockholders to be held as promptly as practicable for the purpose of voting upon this Agreement and the SmarterKids Merger. Subject to Section 5.3, SmarterKids shall, through its Board of Directors, recommend to its stockholders approval of such matters and shall coordinate and cooperate with Earlychildhood with respect to the timing of such meeting and shall use its best efforts to hold such meeting as soon as practicable after the date hereof. The only matters SmarterKids shall propose to be acted on by its stockholders at the stockholders' meeting shall be the approval of this Agreement and the SmarterKids Merger and related matters incidental to the consummation of the SmarterKids Merger. Unless otherwise required to comply with the fiduciary duties of SmarterKids' Board of Directors, as determined by such directors in good faith after consultation with outside legal counsel, SmarterKids shall use commercially reasonable efforts to solicit from its stockholders proxies in favor of such matters including the retention of a proxy solicitation firm. SmarterKids shall not require any vote greater than a majority of the votes entitled to be cast by the holders of the issued and outstanding shares of SmarterKids Common Stock for approval of this Agreement and the SmarterKids Merger. Section 5.9 Legal Conditions to Merger. (a) Earlychildhood and SmarterKids shall each use all reasonable efforts to (i) take, or cause to be taken, all appropriate action, and do, or cause to be done, all things necessary and proper under applicable law to consummate and make effective the transactions contemplated hereby as promptly as practicable, (ii) obtain from any Governmental Entity or any other third party any consents, licenses, permits, waivers, approvals, authorizations, or orders required to be obtained or made by Earlychildhood or SmarterKids (and in the case of Earlychildhood, its Subsidiaries) in connection with the authorization, execution and delivery of this Agreement and the consummation of the transactions contemplated hereby including, without limitation, the Contribution and the SmarterKids Merger, (iii) as promptly as practicable, make all necessary filings, and thereafter make any other required submissions, with respect to this Agreement, the Contribution and the SmarterKids Merger required under (A) the Securities Act and the Exchange Act, and any other applicable federal or state securities laws, (B) the HSR Act, if applicable, and (C) any other applicable law, and (iv) refrain from taking any actions (other than as expressly permitted under Sections 5.3 or 5.4) which would reasonably be likely to delay, hinder or interfere with the transactions contemplated hereby. Earlychildhood and SmarterKids shall cooperate with each other in connection with the making of all such filings, including providing copies of all such documents to the non-filing party and its advisors prior to filing and, if requested, to accept all reasonable additions, deletions or changes suggested in connection therewith. (b) Earlychildhood and SmarterKids agree, and Earlychildhood shall cause each of its Subsidiaries, to cooperate and to use their respective best efforts to obtain any government clearances required for Closing (including through compliance with the HSR Act), to respond to any government requests for information, and to contest and resist any action, including any legislative, administrative or judicial action, and to have vacated, lifted, reversed or overturned any decree, judgment, injunction or other order (whether temporary, preliminary or permanent) (an "Order") that restricts, prevents or prohibits the consummation of the Transactions or any other transactions contemplated by this Agreement. The parties hereto will consult and cooperate with one another, and consider in good faith the views of one another, in connection with any analyses, appearances, presentations, memoranda, briefs, arguments, opinions and proposals made or submitted by or on behalf of any party hereto in connection with proceedings under or relating to the HSR Act or any other federal, state or foreign antitrust or fair trade law. Earlychildhood and SmarterKids shall cooperate and work together in any proceedings or negotiations with any Governmental Entity relating to any of the foregoing. Notwithstanding anything to the contrary in this Section 5.9, neither Earlychildhood nor SmarterKids shall be required to take any action that would reasonably be expected to substantially impair the overall benefits expected, as of the date hereof, to be realized from the consummation of the Transactions. (c) Each of Earlychildhood and SmarterKids shall give any notices to third parties, and shall use all reasonable efforts to obtain any third party consents related to or required in connection with the Transactions. A-41 (d) Prior to the Effective Time, unless the parties hereto otherwise agree in writing, SmarterKids and Earlychildhood shall take all action necessary to terminate, as of immediately prior to the Effective Time, the respective Employee Benefit Plan subject to Section 401(k) of the Code maintained by Earlychildhood and each ERISA Affiliate. Section 5.10 Earlychildhood Financial Statements. Earlychildhood shall provide both audited and unaudited financial statements required to be included in the Proxy Statement/Prospectus in compliance with applicable SEC reporting requirements. Section 5.11 Public Disclosure. Earlychildhood and SmarterKids shall agree on the form and content of the initial press release regarding the transactions contemplated hereby and thereafter shall consult with each other before issuing, and use all reasonable efforts to agree upon, any press release or other public statement with respect to any of the transactions contemplated hereby and shall not issue any such press release or make any such public statement prior to such consultation, except as may be required by law. Section 5.12 Non-recognition Exchange. Whether before or after the Effective Time, none of Earlychildhood, SmarterKids, their respective Subsidiaries or Affiliates and Holdings shall knowingly take any action, or knowingly fail to take any action, that is reasonably likely to jeopardize the treatment of the SmarterKids Merger and the Contribution as transfers of property described in Section 351 of the Code or the SmarterKids Merger as a reorganization described in Section 368(a) of the Code. Section 5.13 Affiliate Agreements. Upon the execution of this Agreement, Earlychildhood and SmarterKids will provide each other with a list of those persons who are, in Earlychildhood's or SmarterKids' respective reasonable judgment, "affiliates" of Earlychildhood or SmarterKids, as the case may be, within the meaning of Rule 145 (each such person who is an "affiliate" of Earlychildhood or SmarterKids within the meaning of Rule 145 is referred to as an "Affiliate") promulgated under the Securities Act ("Rule 145"). Earlychildhood and SmarterKids shall provide each other such information and documents as the other party shall reasonably request for purposes of reviewing such list and shall notify the other party in writing regarding any change in the identity of its Affiliates prior to the Closing Date. Earlychildhood and SmarterKids shall each use all reasonable efforts to deliver or cause to be delivered to each other by November 30, 2000 (and in any case prior to the Effective Time) from each of its Affiliates, an executed Affiliate Agreement, substantially similar to the form attached hereto as Exhibit J, by which each Affiliate of Earlychildhood and each Affiliate of SmarterKids agrees to comply with the applicable requirements of Rule 145 (an "Affiliate Agreement"). Holdings shall be entitled to place appropriate legends on the certificates evidencing any Holdings Common Stock to be received by such Affiliates of Earlychildhood or SmarterKids pursuant to the terms of this Agreement, and to issue appropriate stop transfer instructions to the transfer agent for Holdings Common Stock, consistent with the terms of the Affiliate Agreements (provided that such legends or stop transfer instructions shall be removed, when such shares of Holdings Common Stock are generally transferable without any restrictions imposed by Rule 145, upon the request of any stockholder that is not then an Affiliate of Holdings). Section 5.14 Nasdaq Quotation. Earlychildhood and SmarterKids shall cause Holdings to promptly prepare and submit an application to Nasdaq to quote the shares of Holdings Common Stock to be issued in the Transactions and upon exercise or conversion of the Earlychildhood Options, the SmarterKids Stock Options and the SmarterKids Warrants, and shall use all reasonable efforts to cause such shares to be approved for quotation on Nasdaq, prior to the Effective Time, subject to official notice of issuance. Section 5.15 Stock Plans. (a) At the Effective Time, each outstanding Earlychildhood Option under the Earlychildhood Option Plans and each outstanding SmarterKids Stock Option under the SmarterKids Stock Plans, in each case whether vested or unvested, shall be deemed to constitute an option to acquire, in the case of Earlychildhood, on substantially the same terms and conditions as were applicable under such Earlychildhood Option and, in the A-42 case of SmarterKids, on the same terms and conditions as were applicable under such SmarterKids Stock Option, the same number of shares of Holdings Common Stock as the holder of such Earlychildhood Option or SmarterKids Stock Option, as the case may be, would have been entitled to receive pursuant to the Contribution or the SmarterKids Merger, respectively, had such holder exercised such option in full immediately prior to the Effective Time (rounded down to the nearest whole number), at a price per share (rounded up to the nearest whole cent) equal to (y) the aggregate exercise price for the LLC Interests or shares of SmarterKids Common Stock, as the case may be, purchasable pursuant to such Earlychildhood Option or such SmarterKids Stock Option immediately prior to the Effective Time divided by (z) the number of full shares of Holdings Common Stock deemed purchasable pursuant to such Earlychildhood Option or SmarterKids Stock Option, as the case may be, in accordance with the foregoing. Prior to the Effective Time, each of Earlychildhood and SmarterKids shall make any such adjustments to the terms of the Earlychildhood Option Plans or SmarterKids Stock Plans as may be necessary to give effect to the provisions of this Section 5.15. (b) As soon as practicable after the Effective Time, Holdings shall deliver to the participants in the Earlychildhood Option Plans and the SmarterKids Stock Plans appropriate notice setting forth such participants' rights pursuant thereto and the grants pursuant to Earlychildhood Option Plans or SmarterKids Stock Plans, as the case may be, shall continue in effect on the same terms and conditions (subject to the adjustments required by this Section 5.15 after giving effect to the Transactions). (c) Holdings shall take all corporate action necessary to reserve for issuance a sufficient number of shares of Holdings Common Stock for delivery under Earlychildhood Option Plans and SmarterKids Stock Plans in accordance with this Section 5.15. As soon as practicable after the Effective Time, Holdings shall file a registration statement on Form S-8 (or any successor or other appropriate forms), or another appropriate form with respect to the shares of Holdings Common Stock subject to such options and shall use its best efforts to maintain the effectiveness of such registration statement or registration statements (and maintain the current status of the prospectus or prospectuses contained therein) for so long as such options remain outstanding. (d) The Management Committee or Board of Directors, as the case may be, of Earlychildhood and SmarterKids shall, prior to or as of the Effective Time, take all necessary actions, pursuant to and in accordance with the terms of the Earlychildhood Option Plans and the instruments evidencing the Earlychildhood Options, or the SmarterKids Stock Plans and the instruments evidencing the SmarterKids Stock Options, as the case may be, to provide for the conversion of the Earlychildhood Options and the SmarterKids Stock Options into options to acquire Holdings Common Stock in accordance with this Section 5.14, and to the extent required, obtain the consent of the holders of the Earlychildhood Options or SmarterKids Stock Options in connection with such conversion. (e) The Board of Directors of SmarterKids shall, prior to or as of the Effective Time, take appropriate action to approve the deemed disposition of the SmarterKids Stock Options, as the case may be, for purposes of excepting such disposition under Rule 16b-3(e) promulgated under the Exchange Act. The Board of Directors of Holdings shall, prior to or as of the Effective Time, take appropriate action to approve the deemed grant of options to purchase Holdings Common Stock under the Earlychildhood Options and the SmarterKids Stock Options (as converted pursuant to this Section 5.14) for purposes of excepting such grant under Rule 16b-3(d) promulgated under the Exchange Act. (f) Prior to the Effective Time, Holdings shall adopt the stock plan (the "Holdings Stock Plan") substantially in the form attached hereto as Exhibit K, which Holdings Stock Plan shall become effective as of the Effective Time. A-43 Section 5.16 Employee Stock Purchase Plan. (a) Prior to the Effective Time, Holdings shall adopt an Employee Stock Purchase Plan (the "Holdings Employee Stock Purchase Plan") substantially in the form attached hereto as Exhibit L, which Holdings Employee Stock Purchase Plan shall be effective as of the Effective Time, so that employees of Earlychildhood and SmarterKids as of the Effective Time will be permitted to participate in Holdings' Employee Stock Purchase Plan commencing on the first enrollment date following the Effective Time, subject to compliance with the eligibility provisions of such plan (with employees receiving credit, to the extent permissible, for purposes of such eligibility provisions, for service with SmarterKids). (b) Holdings shall take all corporate action necessary to reserve for issuance a sufficient number of shares of Holdings Common Stock for purchase under the Holdings Employee Stock Purchase Plan assumed in accordance with this Section 5.16. Section 5.17 Non-Employee Director Plan. Prior to the Effective Time, Holdings shall adopt a Non-Employee Director Plan (the "Holdings Director Plan") substantially in the form attached hereto as Exhibit M, which Holdings Director Plan shall become effective as of the Effective Time. Section 5.18 Brokers or Finders. Each of SmarterKids and Earlychildhood represents, as to itself, its Subsidiaries and its Affiliates, that no agent, broker, investment banker, financial advisor or other firm or person is or will be entitled to any broker's or finder's fee or any other commission or similar fee in connection with any of the transactions contemplated by this Agreement, except Thomas Weisel Partners, whose fees and expenses will be paid by Earlychildhood in accordance with Earlychildhood's agreement with such firm (a copy of which has been delivered by Earlychildhood to SmarterKids prior to the date of this Agreement), and Chase H&Q, whose fees and expenses will be paid by SmarterKids in accordance with SmarterKids' agreement with such firm (a copy of which has been delivered by SmarterKids to Earlychildhood prior to the date of this Agreement). Each of SmarterKids and Earlychildhood agrees to indemnify and hold the other harmless from and against any and all claims, liabilities or obligations with respect to any such fees, commissions or expenses asserted by any person on the basis of any act or statement alleged to have been made by such party or any of its Affiliates. Section 5.19 Indemnification. (a) From and after the Effective Time, Holdings agrees that it will, and will cause Earlychildhood and the Surviving Corporation to, indemnify and hold harmless each present and former director, Management Committee member and officer of Earlychildhood and SmarterKids (the "Indemnified Parties"), against any costs or expenses (including attorneys' fees), judgments, fines, losses, claims, damages, liabilities or amounts paid in settlement (collectively, "Costs") incurred in connection with any claim, action, suit, proceeding or investigation, whether civil, criminal, administrative or investigative, arising out of or pertaining to matters existing or occurring at or prior to the Effective Time, whether asserted or claimed prior to, at or after the Effective Time, to the fullest extent that Earlychildhood or SmarterKids, as the case may be, would have been permitted under applicable law and its organizational documents (including, in the case of Earlychildhood, the Operating Agreement) in effect on the date hereof to indemnify such Indemnified Party (and Holdings, Earlychildhood and the Surviving Corporation, as applicable, shall also advance expenses as incurred to the fullest extent permitted under applicable law; provided the Indemnified Party to whom expenses are advanced provides an undertaking to repay such advances if it is ultimately determined that such Indemnified Party is not entitled to indemnification). (b) For a period of six years after the Effective Time, Holdings shall maintain (to the extent available in the market) in effect a directors' and officers' liability insurance policy covering those persons who are currently covered by Earlychildhood's and SmarterKids' directors' and officers' liability insurance policies (copies of which have been heretofore delivered by SmarterKids to Earlychildhood and vice versa) with coverage in amount and scope at least as favorable as Earlychildhood's and SmarterKids' existing coverage; A-44 provided that in no event shall Holdings be required to expend in excess of 200% of the higher annual premium currently paid by Earlychildhood or SmarterKids, as applicable, for such coverage (in either case, the "Current Premium"); and if such premium would at any time exceed 200% of the Current Premium, then Holdings shall maintain insurance policies which provide the maximum and best coverage available at an annual premium equal to 200% of the Current Premium. (c) The provisions of this Section 5.19 are intended to be in addition to the rights otherwise available to the current officers, directors or members of the Management Committee of Earlychildhood and SmarterKids, as applicable, by law, charter, statute, bylaw or agreement, and shall operate for the benefit of, and shall be enforceable by, each of the Indemnified Parties, their heirs and their representatives. Section 5.20 Letter of SmarterKids' Accountants. SmarterKids shall use all reasonable efforts to cause to be delivered to Earlychildhood and SmarterKids a comfort letter of PricewaterhouseCoopers LLP, SmarterKids' independent accountants, dated a date within two business days before the date on which the Registration Statement shall become effective and addressed to Holdings, in form reasonably satisfactory to Earlychildhood and customary in scope and substance for letters delivered by independent public accountants in connection with registration statements similar to the Registration Statement. Section 5.21 Letter of Earlychildhood's Accountants. Earlychildhood shall use all reasonable efforts to cause to be delivered to SmarterKids and Earlychildhood a comfort letter of KPMG, LLP, Earlychildhood's independent accountants, dated a date within two business days before the date on which the Registration Statement shall become effective and addressed to Holdings, in form reasonably satisfactory to SmarterKids and customary in scope and substance for letters delivered by independent public accountants in connection with registration statements similar to the Registration Statement. Section 5.22 Post-Transaction Corporate Governance of Holdings. At the Effective Time, the total number of persons serving on the Board of Directors of Holdings shall be nine (9) (unless otherwise agreed in writing by Earlychildhood and SmarterKids prior to the Effective Time), four (4) of whom shall be Earlychildhood Directors, two (2) of whom shall be SmarterKids Directors and three (3) of whom shall be Independent Directors (as such terms are defined below), all of which Earlychildhood Directors, SmarterKids Directors and Independent Directors shall be spread proportionately among Holdings' three classes of Directors; provided, however, that one SmarterKids Director shall be required to stand for election at the first annual meeting of stockholders of Holdings after the Effective Time and one SmarterKids Director shall be required to stand for election at the third annual meeting of stockholders of Holdings after the Effective Time; the persons to serve initially on the Board of Directors of Holdings at the Effective Time who are Earlychildhood Directors shall be selected solely by and at the absolute discretion of Earlychildhood's Management Committee prior to the Effective Time; the persons to serve initially on the Board of Directors of Holdings at the Effective Time who are SmarterKids Directors shall be selected solely by and at the absolute discretion of the Board of Directors of SmarterKids prior to the Effective Time; and the persons to serve initially on the Board of Directors of Holdings at the Effective Time who are Independent Directors shall be mutually agreed upon by Earlychildhood and SmarterKids prior to the Effective Time. In the event that, prior to the Effective Time, any person so selected to serve on the Board of Directors of Holdings after the Effective Time is unable or unwilling to serve in such position, the Management Committee or Board of Directors which selected such person shall designate another of its members or another person to serve in such person's stead in accordance with the provisions of the immediately preceding sentence. The term "Earlychildhood Director" means any person serving on the Management Committee of Earlychildhood on the date hereof or any other person so designated who becomes a Director of Holdings at the Effective Time and any successor director appointed or elected pursuant to the Bylaws of Holdings; the term "SmarterKids Director" means any person serving as a Director of SmarterKids on the date hereof or any other person so designated who becomes a Director of Holdings at the Effective Time and any successor director appointed or elected pursuant to the Bylaws of Holdings and the term "Independent Director" means any person who becomes a Director of Holdings at the Effective Time and is not an employee of Earlychildhood, SmarterKids or Holdings at any time during the term in which they serve as an Independent Director, and any successor director appointed or elected pursuant to the Bylaws of Holdings. A-45 (b) Subject to Section 8.5, at the Effective Time, (i) Ronald Elliott, shall hold the position of Chairman of the Board of Holdings, (ii) Al Noyes, shall hold the position of Chief Executive Officer of Holdings, (iii) Judy McGuinn shall hold the position of Chief Operating Officer of Holdings and (iv) Bob Cahill shall hold the position of Chief Financial Officer of Holdings. If any of the persons identified in the preceding sentence is unable or unwilling to hold such offices as set forth above, his successor shall be selected by the Board of Directors of Holdings in accordance with the Bylaws of Holdings. Section 5.23 Name of Holdings. Prior to the Effective Time, Earlychildhood and SmarterKids shall use reasonable efforts to decide on a new corporate name for Holdings. Section 5.24 Conveyance Taxes. Earlychildhood and SmarterKids shall cooperate in the preparation, execution and filing of all returns, questionnaires, applications or other documents regarding any real property transfer or gains, sales, use, transfer, value added, stock transfer and stamp taxes, any transfer, recording, registration and other fees or any similar taxes (together, "Conveyance Taxes") which become payable in connection with the transactions contemplated by this Agreement that are required or permitted to be filed on or before the Effective Time. Earlychildhood shall pay with respect to the Contribution, and SmarterKids shall pay with respect to the SmarterKids Merger, without deduction or withholding from any amount payable to the holders of LLC Interests or SmarterKids Common Stock, as the case may be, any such Conveyance Taxes imposed by any Governmental Entity (and any penalties and interest with respect to such Conveyance Taxes), which become payable in connection with the transactions contemplated by this Agreement, on behalf of their stockholders or holders of LLC interests, as the case may be. Section 5.25 SmarterKids Minimum Closing Cash. As of the Effective Time, SmarterKids covenants, agrees and commits that it shall have Cash on Hand (as defined by GAAP) of not less than $18,000,000 after deducting (a) all of the fees, costs and expenses incurred in connection with the Transactions (including, without limitation, (i) attorney, accounting and other professional fees and expenses incurred in the negotiation and performance of the Transaction Documents, the preparation, filing and effectiveness of the Proxy Statement/Prospectus and the Registration Statement and the consummation of the Transactions and (ii) all fees of financial advisors incurred in connection with the Transactions) and (b) all of the fees, costs and expenses incurred or reasonably likely to be incurred in connection with realizing all contemplated cost savings resulting from the integration of the businesses (including, without limitation, costs associated with the integration of the respective technologies) of Earlychildhood and SmarterKids (the "Minimum Closing Cash"). Prior to the Effective Time, SmarterKids shall provide Earlychildhood with written verification satisfactory to Earlychildhood evidencing the Minimum Closing Cash, and Earlychildhood shall have the right to investigate and confirm the existence thereof in such manner as it deems necessary. Section 5.26 Blohm Consulting Agreement. At the Effective Time, Holdings shall enter into a consulting agreement with David Blohm, substantially in the form attached hereto as Exhibit N. ARTICLE VI. CONDITIONS TO THE TRANSACTIONS Section 6.1 Conditions to Each Party's Obligation to Effect the Transactions. The respective obligations of each party to this Agreement to effect the Transactions shall be subject to the satisfaction or waiver in writing by each of SmarterKids and Earlychildhood prior to the Effective Time of the following conditions: (a) HSR Act. The waiting period applicable, if any, to the consummation of the Transactions under the HSR Act shall have expired or been terminated. (b) Approvals. All authorizations, consents, orders or approvals of, or declarations or filings with, or expirations of waiting periods imposed by, any Governmental Entity (including, without limitation, an SEC order of effectiveness with respect to the Proxy Statement/Prospectus) the failure of which to file, A-46 obtain or occur is reasonably likely to have an Earlychildhood Material Adverse Effect, a SmarterKids Material Adverse Effect or a Holdings Material Adverse Effect (as defined below) shall have been filed, obtained or occurred. (c) Registration Statement. The Registration Statement shall have become effective under the Securities Act and shall not be the subject of any stop order or proceedings seeking a stop order. (d) No Injunctions. No Governmental Entity shall have enacted, issued, promulgated, enforced or entered any order, executive order, stay, decree, judgment or injunction or statute, rule, regulation which is in effect and which has the effect of making the Transactions illegal or otherwise prohibiting consummation of the Transactions. (e) National Listing or Nasdaq Quotation. The shares of Holdings Common Stock to be issued in the Transactions shall have been approved for listing on a national securities exchange or for quotation on The Nasdaq Stock Market, subject to official notice of issuance. (f) Consents Under Earlychildhood Agreements. Earlychildhood shall have obtained the consent or approval of any person whose consent or approval shall be required under any agreement or instrument in order to permit the consummation of the transactions contemplated hereby, except those of which, if not obtained, would not, individually or in the aggregate, have (i) an Earlychildhood Material Adverse Effect or (ii) a material adverse effect on the business, assets, properties, financial condition or results of operations of Holdings after giving effect to the Transactions (a "Holdings Material Adverse Effect"). (g) Consents Under SmarterKids Agreements. SmarterKids shall have obtained the consent or approval of any person whose consent or approval shall be required under any agreement or instrument in order to permit the consummation of the transactions contemplated hereby, except those which, if not obtained, would not, individually or in the aggregate, have (i) a SmarterKids Material Adverse Effect or (ii) a Holdings Material Adverse Effect. (h) Corporate Governance. Earlychildhood and SmarterKids shall have taken all actions necessary so that (i) not later than the Effective Time, the Certificate of Incorporation and Bylaws of Holdings shall have been amended to be substantially in the form of Exhibit E and Exhibit F attached hereto; and (ii) at the Effective Time, the composition of the Board of Directors of Holdings shall comply with Section 5.20 hereof (assuming Earlychildhood has designated the Earlychildhood Directors and SmarterKids has designated the SmarterKids Directors, in each case as contemplated by Section 5.20(a) hereof). (i) Transaction Documents. Each of the Transaction Documents shall have been executed by each of the parties thereto and shall be in full force and effect and legally binding against the parties thereto and no material breach by any party shall have occurred thereunder as of the Closing Date. Section 6.2 Additional Conditions to Obligations of Earlychildhood. The obligation of Earlychildhood to effect the Contribution is subject to the satisfaction of each of the following conditions prior to the Effective Time, any of which may be waived in writing exclusively by Earlychildhood: (a) Stockholder Approval. This Agreement and the SmarterKids Merger shall have been approved in the manner required under the DGCL by the holders of the issued and outstanding shares of SmarterKids Common Stock. (b) Representations and Warranties. The representations and warranties of SmarterKids set forth in this Agreement shall be true and correct as of the date of this Agreement and (except to the extent such representations and warranties speak as of an earlier date) as of the Closing Date as though made on and as of the Closing Date, except for, (i) changes contemplated by this Agreement and (ii) inaccuracies which, individually or in the aggregate, have not had and are not reasonably likely to have a SmarterKids Material Adverse Effect or a Holdings Material Adverse Effect (without regard to any materiality limitations contained in any such representation or warranty), or a material adverse effect upon the consummation of the transactions contemplated hereby; and Earlychildhood shall have received a certificate signed on behalf of SmarterKids by the chief executive officer and the chief financial officer of SmarterKids to such effect. A-47 (c) Performance of Obligations of SmarterKids. SmarterKids shall have performed in all material respects all material obligations required to be performed by it under this Agreement at or prior to the Closing Date, and Earlychildhood shall have received a certificate signed on behalf of SmarterKids by the chief executive officer and the chief financial officer of SmarterKids to such effect. (d) SmarterKids Material Adverse Effect. No SmarterKids Material Adverse Effect or SmarterKids Material Adverse Change shall have occurred since the date of this Agreement and be continuing. (e) Minimum Closing Cash. SmarterKids shall have Cash on Hand (as defined by GAAP) of not less than the amount of the Minimum Closing Cash, verified as set forth in Section 5.24. (f) Tax Opinion. Earlychildhood shall have received a written opinion from Latham & Watkins, counsel to Earlychildhood, to the effect that the Contribution will be treated for Federal income tax purposes as a transfer of property to Holdings qualifying under Section 351 of the Code (it being agreed that Earlychildhood, Holdings and SmarterKids shall provide reasonable cooperation, including the delivery of such certifications as shall be reasonably requested, to Latham & Watkins to enable it to render such opinion). Section 6.3 Additional Conditions to Obligations of SmarterKids. The obligations of SmarterKids to effect the SmarterKids Merger are subject to the satisfaction of each of the following conditions prior to the Effective Time, any of which may be waived in writing exclusively by SmarterKids: (a) Representations and Warranties. The representations and warranties of Earlychildhood set forth in this Agreement shall be true and correct as of the date of this Agreement and (except to the extent such representations and warranties speak as of an earlier date) as of the Closing Date as though made on and as of the Closing Date, except for, (i) changes contemplated by this Agreement, and (ii) inaccuracies which, individually or in the aggregate, have not had and are not reasonably likely to have an Earlychildhood Material Adverse Effect or Holdings Material Adverse Effect (without regard to any materiality limitations contained in any such representation or warranty), or a material adverse effect upon the consummation of the transactions contemplated hereby; and SmarterKids shall have received a certificate signed on behalf of Earlychildhood by its chief executive officer or chief financial officer to such effect. (b) Performance of Obligations of Earlychildhood. Earlychildhood shall have performed in all material respects all material obligations required to be performed by it under this Agreement at or prior to the Closing Date; and SmarterKids shall have received a certificate signed on behalf of Earlychildhood by its chief executive officer or chief financial officer to such effect. (c) Earlychildhood Material Adverse Effect. No Earlychildhood Material Adverse Effect or Earlychildhood Material Adverse Change shall have occurred since the date of this Agreement and be continuing. (d) Tax Opinion. SmarterKids shall have received a written opinion from Testa, Hurwitz & Thibeault, counsel to SmarterKids, to the effect that the SmarterKids Merger will be treated for Federal income tax purposes as a reorganization under Section 368(a) of the Code or, taken together with the Contribution, as a transfer of property to Holdings qualifying under Section 351 of the Code (it being agreed that Earlychildhood, Holdings and SmarterKids shall provide reasonable cooperation, including the delivery of such certifications as shall be reasonably requested, to Testa, Hurwitz & Thibeault to enable it to render such opinion). (e) Transaction Documents. Earlychildhood shall have duly executed each of the Transaction Documents to which it is a party, and such Transaction Documents shall be in full force and effect and legally binding against Earlychildhood and no material breach by Earlychildhood shall have occurred thereunder as of the Closing Date. A-48 ARTICLE VII. TERMINATION AND AMENDMENT Section 7.1 Termination. This Agreement may be terminated at any time prior to the Effective Time (with respect to Sections 7.1(b) through 7.1(f), by written notice by the terminating party to the other party), whether before or after approval of the matters presented in connection with the Transactions by the stockholders of SmarterKids: (a) by mutual written consent of Earlychildhood and SmarterKids; or (b) by either Earlychildhood or SmarterKids if the Transactions shall not have been consummated by April 30, 2001 (the "Outside Date"); provided, however, that if the Transactions shall have not been consummated by the Outside Date due to the failure of the condition set forth in Section 6.1(b), the Outside Date shall be extended to July 31, 2001; and provided, further, however, that the right to terminate this Agreement under this Section 7.1(b) shall not be available to any party whose failure to fulfill any obligation under this Agreement has been the cause of or resulted in the failure of the Transactions to occur on or before such date; or (c) by either Earlychildhood or SmarterKids if a court of competent jurisdiction or other Governmental Entity shall have issued a nonappealable final order, decree or ruling or taken any other nonappealable final action, in each case having the effect of permanently restraining, enjoining or otherwise prohibiting the Transactions; or (d) by Earlychildhood, if, at the SmarterKids Stockholders' Meeting (including any adjournment or postponement thereof), the requisite vote of the stockholders of SmarterKids in favor of the approval and adoption of this Agreement and the SmarterKids Merger shall not have been obtained; or (e) by Earlychildhood, if (i) the SmarterKids Board of Directors shall have withdrawn or modified in any manner its recommendation that its stockholders vote in favor of this Agreement or the SmarterKids Merger; (ii) SmarterKids shall have failed to include in the Proxy Statement/Prospectus the recommendation of its Board of Directors in favor of the approval of this Agreement and the SmarterKids Merger; (iii) after the receipt by SmarterKids of an Acquisition Proposal, Earlychildhood requests in writing that the SmarterKids Board of Directors reconfirm its recommendation of this Agreement and the SmarterKids Merger to the stockholders of SmarterKids and the SmarterKids Board of Directors fails to do so within ten (10) business days after its receipt of Earlychildhood's request; (iv) the SmarterKids Board of Directors or any committee thereof shall have approved or recommended to the stockholders of SmarterKids an Acquisition Proposal, other than the Transactions; (v) a tender offer or exchange offer for 20% or more of the outstanding shares of SmarterKids Common Stock is commenced (other than by Earlychildhood or an Affiliate of Earlychildhood) and the SmarterKids Board of Directors does not oppose such tender or exchange offer; (vi) SmarterKids shall have entered into any letter of intent or similar document or any agreement, contract or commitment accepting or expressing an intent to accept an Acquisition Proposal; or (vii) SmarterKids fails to call and hold the SmarterKids Stockholders' Meeting by the Outside Date (provided that Earlychildhood's right to terminate this Agreement under this clause (vii) shall not be available if at such time SmarterKids would be entitled to terminate this Agreement under Section 7.1(f)); (f) by SmarterKids, prior to the approval by its stockholders of the SmarterKids Merger, if (i) the SmarterKids Board of Directors reasonably determines in good faith (after consultation with a financial advisor of nationally recognized reputation) that (X) the Acquisition Proposal is more favorable or is reasonably likely to lead to an Acquisition Proposal that is more favorable to the SmarterKids stockholders from a financial point of view than the Transactions, and (Y) is made by a Third Party reasonably believed by the SmarterKids Board of Directors to be financially capable of completing such Acquisition Proposal, and (ii) the SmarterKids Board of Directors reasonably determines in good faith (after having consulted with and considered the advice of its outside legal counsel) that the failure to take such actions would cause the members of the SmarterKids Board of Directors to breach their fiduciary duties to the A-49 SmarterKids stockholders under applicable law; provided, that SmarterKids shall have given Earlychildhood three (3) business days' notice prior to such termination and otherwise complied with the provisions of Section 5.3; and, provided further, that such termination shall not be effective until the fee specified in Section 7.3(b) has been paid to Earlychildhood; or (g) by Earlychildhood or SmarterKids, if there has been a breach of any representation, warranty, covenant or agreement on the part of the other party set forth in this Agreement, which breach (i) will cause the conditions set forth in Section 6.2(b) or (c) (in the case of termination by Earlychildhood) or 6.3(a) or (b) (in the case of termination by SmarterKids) not to be satisfied, and (ii) shall not have been cured within thirty (30) business days following receipt by the breaching party of written notice of such breach from the other party. Section 7.2 Effect of Termination. In the event of termination of this Agreement as provided in Section 7.1, written notice shall be given to the other party hereto and this Agreement shall, subject to the provisions of Section 7.1(f), immediately become void and there shall be no liability or obligation on the part of Earlychildhood, SmarterKids, Holdings or their respective officers, directors, members, stockholders or Affiliates, except as set forth in Sections 5.19 and 7.3 and except that such termination shall not limit liability for a willful breach of this Agreement; provided that, the provisions of Sections 5.19 and 7.3 of this Agreement and the Confidentiality Agreements shall remain in full force and effect and survive any termination of this Agreement. Section 7.3 Fees and Expenses. (a) Except as set forth in this Section 7.3, if the Transactions are terminated, all fees and expenses incurred in connection with this Agreement and the transactions contemplated hereby shall be paid by the party incurring such expenses. (b) If this Agreement is terminated by either party pursuant to Section 7.1(g) hereof, then the non-terminating party (the "Breaching Party") shall pay the Expenses (as defined below) incurred by the non-Breaching Party up to a maximum of $350,000; provided, however, that if this Agreement is terminated by SmarterKids pursuant to Section 7.1(g) and, at the time of such termination, Earlychildhood is permitted to terminate this Agreement pursuant to Section 7.1(e), Earlychildhood shall not be required to pay any of SmarterKids' Expenses pursuant to this Section 7.3(b). As used in this Agreement "Expenses" shall include all reasonable out-of-pocket fees and expenses (including without limitation, all reasonable fees and expenses of counsel, accountants, investment bankers, experts and consultants to a party hereto) incurred by a party or on its behalf in connection with or related to the authorization, preparation, negotiation, execution and performance of this Agreement and the transactions contemplated hereby, including the preparation, printing, filing and mailing of the Proxy Statement/Prospectus and the solicitation of stockholder approvals and all other matters related to the transactions contemplated hereby. SmarterKids' payment of the Expenses incurred by Earlychildhood pursuant to this subsection shall be the sole and exclusive remedy of Earlychildhood against SmarterKids and its directors, officers, employees, agents, advisory or other representatives with respect to the occurrences giving rise to such payment, except for liabilities or damages caused by the willful breach of any representations, warranties, covenants or agreements herein by SmarterKids. Earlychildhood's payment of the Expenses incurred by SmarterKids pursuant to this subsection shall be the sole and exclusive remedy of SmarterKids against Earlychildhood and any of its Subsidiaries and their respective managers, directors, officers, employees, agents, advisors or other representatives with respect to the occurrences giving rise to such payment, except for liabilities or damages caused by the willful breach of any representations, warranties, covenants or agreements herein by Earlychildhood. A-50 (c) SmarterKids shall pay Earlychildhood a termination fee (the "Termination Fee") of $1,300,000 (a portion of which may be deemed to include the reimbursement of Expenses) in cash if any of the following events occurs: (i) the termination of this Agreement by Earlychildhood pursuant to Section 7.1(d), and (x) at the time of such termination a definitive proposal for an Acquisition Proposal has been provided to SmarterKids by a Third Party and (y) within twelve (12) months of such termination, either SmarterKids shall have entered into a definitive agreement with respect to, or consummated, a transaction in connection with such Acquisition Proposal; (ii) the termination of this Agreement by SmarterKids pursuant to Section 7.1 hereof and at such time Earlychildhood shall have been permitted to terminate this Agreement under Section 7.1(e); (iii) the termination of this Agreement by Earlychildhood pursuant to Section 7.1(e); or (iv) the termination of this Agreement by SmarterKids pursuant to Section 7.1(f). (d) In the event of a termination pursuant to clause (i) above, the Termination Fee shall be paid upon the earlier of the consummation or entering into of a definitive agreement for an Acquisition Proposal, and in the event of a termination pursuant to clause (ii), (iii) or (iv) above, the Termination Fee shall be paid concurrently with such termination. (e) SmarterKids' payment of the Termination Fee pursuant to subsection (b) above shall be the sole and exclusive remedy of Earlychildhood against SmarterKids and its directors, officers, employees, agents, advisors or other representatives with respect to the occurrences giving rise to such payment; provided that this limitation shall not apply in the event of a willful breach of this Agreement by SmarterKids. Section 7.4 Amendment. This Agreement may be amended by the parties hereto, by action taken or authorized by their Management Committee or Board of Directors, as the case may be, at any time before or after approval of the matters presented in connection with the SmarterKids Merger by the stockholders of SmarterKids, but, after any such approval, no amendment shall be made which by law requires further approval by such stockholders without such further approval. This Agreement may not be amended except by an instrument in writing signed on behalf of each of the parties hereto. Section 7.5 Extension; Waiver. At any time prior to the Effective Time, the parties hereto, by action taken or authorized by their Management Committee or Board of Directors, as the case may be, may, to the extent legally allowed, (i) extend the time for the performance of any of the obligations or other acts of the other parties hereto, (ii) waive any inaccuracies in the representations and warranties of the other parties hereto contained herein or in any document delivered pursuant hereto and (iii) waive compliance with any of the agreements or conditions of the other parties hereto contained herein. Any agreement on the part of a party hereto to any such extension or waiver shall be valid only if set forth in a written instrument signed on behalf of such party. Any waiver or failure to insist on strict compliance with any obligation, covenant, agreement or condition contained in this Agreement shall not operate as a waiver of, or estoppel with respect to, any subsequent or other failure. A-51 ARTICLE VIII. MISCELLANEOUS Section 8.1 Nonsurvival of Representations, Warranties and Agreements. None of the representations, warranties and agreements in this Agreement or in any instrument delivered pursuant to this Agreement shall survive the Effective Time, except for the agreements contained in Sections 1.6, 1.7, 1.8, 2.1, 2.2, 2.4, 2.5, 5.12, 5.15, 5.16, 5.17, 5.18, 5.19, 5.22, 5.24, and this Article VIII, and the agreements of the Affiliates delivered pursuant to Section 5.13. The Confidentiality Agreement shall survive the execution and delivery of this Agreement. Section 8.2 Notices. All notices and other communications hereunder shall be in writing and shall be deemed given if delivered personally, telecopied (which is confirmed) or mailed by registered or certified mail (return receipt requested) to the parties at the following addresses (or at such other address for a party as shall be specified by like notice): (a) if to Earlychildhood, to Earlychildhood.com, LLC 2 Lower Ragsdale Drive Suite 200 Monterey, CA 93940 Attention: Ronald Elliott Telecopy: (831) 771-5587 with a copy to Latham & Watkins 633 West Fifth Street, Suite 4000 Los Angeles, CA 90071-2007 Attention: Jeffrey L. Kateman, Esq. Telecopy: (213) 891-8763 (b) if to SmarterKids, to SmarterKids.com, Inc. 15 Crawford Street Needham, MA 02494 Attention: Robert Cahill Telecopy: (781) 449-4887 with a copy to: Testa, Hurwitz & Thibeault 125 High Street Boston, MA 02110 Attention: Gordon Hayes, Esq. Telecopy: (617) 248-7100 A-52 Section 8.3 Interpretation. When a reference is made in this Agreement to Sections, such reference shall be to a Section of this Agreement unless otherwise indicated. The table of contents and headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. Whenever the words "include," "includes" or "including" are used in this Agreement they shall be deemed to be followed by the words "without limitation." The phrase "made available" in this Agreement shall mean that the information referred to has been made available if requested by the party to whom such information is to be made available. The phrases "the date of this Agreement", "the date hereof," and terms of similar import, unless the context otherwise requires, shall be deemed to refer to November 14, 2000. Section 8.4 Counterparts. This Agreement may be executed in two or more counterparts, all of which shall be considered one and the same agreement and shall become effective when two or more counterparts have been signed by each of the parties and delivered to the other parties, it being understood that all parties need not sign the same counterpart. Section 8.5 Entire Agreement; No Third Party Beneficiaries. This Agreement and all documents and instruments referred to herein (a) constitute the entire agreement and supersedes all prior agreements and understandings, both written and oral, among the parties with respect to the subject matter hereof and thereof, and (b) except as provided in Section 5.19, are not intended to confer upon any person (including, without limitation, the individuals identified in Section 5.19 and 5.22) other than the parties hereto any rights or remedies hereunder; provided that the Confidentiality Agreement shall remain in full force and effect until the Effective Time. Each party hereto agrees that, except for the representations and warranties contained in this Agreement, neither Earlychildhood nor SmarterKids makes any other representations or warranties, and each hereby disclaims any other representations and warranties made by itself or any of its officers, directors, managers, members, employees, agents, financial and legal advisors or other representatives, with respect to the execution and delivery of this Agreement or the transactions contemplated hereby, notwithstanding the delivery or disclosure to the other or the other's representatives of any documentation or other information with respect to any one or more of the foregoing. Section 8.6 Governing Law. This Agreement shall be governed and construed in accordance with the laws of the State of Delaware without regard to any applicable conflicts of law. Section 8.7 Assignment. Neither this Agreement nor any of the rights, interests or obligations hereunder shall be assigned by any of the parties hereto (whether by operation of law or otherwise) without the prior written consent of the other parties. Subject to the preceding sentence, this Agreement will be binding upon, inure to the benefit of and be enforceable by the parties and their respective successors and assigns. [Signature Page Follows] A-53 IN WITNESS WHEREOF, Earlychildhood, SmarterKids, Holdings and Merger Sub have caused this Agreement to be signed by their respective duly authorized officers as of the date first written above. EARLYCHILDHOOD.COM, LLC /s/ Ronald C. Elliott ------------------------------------- By: Ronald C. Elliott Its: Chief Executive Officer SMARTERKIDS.COM, INC. /s/ David A. Blohm ------------------------------------- By: David A. Blohm Its: Chief Executive Officer S-E EDUCATIONAL HOLDINGS CORP. /s/ Ronald C. Elliott ------------------------------------- By: Ronald C. Elliott Its: Chairman of the Board S-E EDUCATIONAL MERGER CORP. /s/ Ronald C. Elliott ------------------------------------- By: Ronald C. Elliott Its: Chairman of the Board A-54 ANNEX B STOCKHOLDER SUPPORT AGREEMENT This STOCKHOLDER SUPPORT AGREEMENT, dated as of November 14, 2000 (the "Agreement"), is by and among Earlychildhood.com, LLC, a California limited liability company ("Earlychildhood") and the stockholders of SmarterKids.com, Inc., a Delaware corporation ("SmarterKids") listed on the signature page(s) hereto (collectively, the "Stockholders" and, individually, a "Stockholder"). Capitalized terms used in this Agreement, unless specifically defined herein, shall have the meanings given to them in the Contribution Agreement and Plan of Reorganization and Merger, dated as of the date hereof (the "Merger Agreement"), by and among Earlychildhood, SmarterKids, S-E Educational Holdings Corp., a newly-formed Delaware corporation, one-half of the issued and outstanding capital stock of which is owned by each of Earlychildhood and SmarterKids ("Holdings") and S-E Educational Merger Corp., a newly-formed Delaware corporation and a wholly-owned subsidiary of Holdings ("Merger Sub"). WHEREAS, as of the date hereof, each of the Stockholders own of record and beneficially (i) the shares of common stock, $.01 par value per share (the "Common Stock"), of SmarterKids as is set forth next to the name of such Stockholder in Column II of Annex A hereto and (ii) the options to acquire shares of Common Stock as is set forth next to the name of such Stockholder on Schedule 1.1(c) hereto (collectively, the "Shares"); WHEREAS, concurrently with the execution of this Agreement, Earlychildhood and SmarterKids have entered into the Merger Agreement pursuant to which, and upon the terms and subject to the conditions set forth therein, the combination of Earlychildhood and SmarterKids shall be effected through (i) the contribution to Holdings by the holders of LLC Interests of all of the right, title and interest in and to their entire ownership interest in Earlychildhood (the "Contribution") and (ii) the merger of Merger Sub with and into SmarterKids such that SmarterKids becomes a wholly-owned subsidiary of Holdings (the "Merger" and, collectively with the Contribution, the "Transactions"); WHEREAS, as a condition to the willingness of Earlychildhood and SmarterKids to enter into the Merger Agreement, Earlychildhood has required that the Stockholders agree, and in order to induce Earlychildhood to enter into the Merger Agreement, the Stockholders have agreed, to enter into this Agreement; and WHEREAS, prior to the date hereof, Earlychildhood and the Stockholders had no agreement, arrangement or understanding (as such terms are used in Section 203 of the DGCL) for the purpose of acquiring, holding, voting or disposing of the Shares. NOW, THEREFORE, in consideration of the foregoing premises and the representations, warranties, covenants and agreements set forth herein, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and subject to the terms and conditions set forth herein, the parties hereto hereby agree as follows: ARTICLE I. Section 1.1 Representations and Warranties of the Stockholders. As of the date hereof and as of the date of the Closing under the Merger Agreement, each Stockholder on its own behalf hereby represents and warrants to Earlychildhood with respect to itself and its ownership of the Shares as follows: (a) Stockholder is the sole owner of record and beneficial owner (as defined in Rule 13d-3 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which meaning will apply for all purposes of this Agreement) of, and has good title to, all of the Shares set forth adjacent to such Stockholder's name on Annex A, free and clear of any mortgage, pledge, hypothecation, rights of others, claim, security interest, charge, encumbrance, title defect, title retention agreement, voting trust agreement, B-1 interest, option, lien, charge or similar restriction (including any restriction on the right to vote, sell or otherwise dispose of the Shares) or limitation (each, a "Lien") except for immaterial Liens which shall not materially affect such Stockholder's ability to perform its obligations under this Agreement. (b) The Shares constitute all of the securities (as defined in Section 3(10) of the Exchange Act, which definition will apply for all purposes of this Agreement) of SmarterKids beneficially owned, directly or indirectly, by Stockholder, excluding any securities beneficially owned by any of its affiliates or associates (as such terms are defined in Rule 12b-2 under the Exchange Act, which definitions will apply for all purposes of this Agreement), as to which it does not have voting or investment power. (c) Except as set forth on Schedule 1.1(c), and except for the Shares, Stockholder does not, directly or indirectly, beneficially own or have any option, warrant or other right to acquire any securities of SmarterKids that are or may by their terms become entitled to vote or any securities that are convertible or exchangeable into or exercisable for any securities of SmarterKids that are or may by their terms become entitled to vote, nor is Stockholder subject to any contract, commitment, arrangement, understanding or relationship (whether or not legally enforceable), other than this Agreement, that allows or obligates it to vote or acquire any securities of SmarterKids. Stockholder has the exclusive power to vote the Shares set forth adjacent to such Stockholder's name on Annex A and has not granted a proxy to any other individual, corporation, partnership (general or limited), limited liability company, joint venture, association, trust, unincorporated organization or other entity (collectively, a "Person") to vote such Shares, subject to the limitations set forth in this Agreement. (d) Each Stockholder that is a corporation or partnership, as the case may be, is duly organized, validly existing and in good standing under the laws of its jurisdiction of organization and has the power and authority to execute and deliver this Agreement and to consummate the transactions contemplated hereby, and has taken all necessary action to authorize the execution, delivery and performance of this Agreement. (e) This Agreement and each Transaction Document to which Stockholder is a party has been duly executed and delivered by Stockholder and, assuming due authorization, execution and delivery of this Agreement by Earlychildhood and SmarterKids, constitute a valid and binding obligation of Stockholder enforceable against Stockholder in accordance with their terms, except that (i) the enforceability hereof or thereof may be subject to applicable bankruptcy, insolvency or other similar laws, now or hereinafter in effect, affecting creditors' rights generally and (ii) the availability of the remedy of specific performance or injunctive or other forms of equitable relief may be subject to equitable defenses and would be subject to the discretion of the court before which any proceeding therefor may be brought. (f) Neither the execution and delivery of this Agreement and each of the Transaction Documents to which Stockholder is a party, nor the performance by Stockholder of its obligations hereunder or thereunder will, nor will the consummation of the transactions contemplated by this Agreement and the Merger Agreement, conflict with, result in a violation or breach of, or constitute a default (or an event that, with notice or lapse of time or both, would result in a default) or give rise to any right of termination, amendment, cancellation, or acceleration or result in the creation of any Lien on any Shares under, or require a consent or waiver under (collectively, a "Conflict"), (i) its organizational documents, (ii) any note, bond, mortgage, indenture lease, contract, commitment, agreement, understanding, arrangement or restriction of any kind to which Stockholder is a party or by which Stockholder is bound, to the extent such Conflict would materially affect Stockholder's ability to consummate the transactions contemplated hereby or (iii) any permit, franchise, license, statute, injunction, judgment, writ, decree, order, ruling, rule or regulation applicable to Stockholder, to the extent such Conflict would materially affect Stockholder's ability to consummate the transactions contemplated hereby. (g) Neither the execution and delivery of this Agreement nor the performance by Stockholder of its obligations hereunder will violate any law, decree, statute, rule or regulation applicable to Stockholder or require any order, consent, authorization or approval of, filing or registration with, or declaration or notice B-2 to, any corporation, Person, firm, Governmental Entity or public or judicial authority, other than any required notices or filings pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the rules and regulations promulgated thereunder or the federal securities laws. There is no beneficiary or holder of a voting trust certificate or other interest of any trust of which any of the Stockholders is a trustee whose consent is required for the execution and delivery of this Agreement or the compliance by the Stockholders with the terms hereof. ARTICLE II. Section 2.1 Transfer of the Shares; Non-Interference. (a) During the term of this Agreement, no Stockholder shall (i) tender into any tender or exchange offer or otherwise offer to sell, sell, transfer, pledge, assign, hypothecate or otherwise dispose of, or encumber with any Lien, any of the Shares, (ii) other than in connection with this Agreement, deposit the Shares into a voting trust, enter into any voting agreement or similar arrangement with respect to the Shares or grant any proxy or power of attorney with respect to the Shares, or take any action inconsistent with this Agreement or the Merger Agreement without having obtained the prior written consent of Earlychildhood, (iii) other than this Agreement enter into any contract, option or other arrangement or undertaking with respect to the direct or indirect sale, transfer, pledge, assignment, hypothecation or other disposition of any interest in or the voting of any shares of Common Stock or any other securities of SmarterKids, (iv) take any action that would make any representation of such Stockholder contained herein untrue or incorrect or would result in a breach by such Stockholder of its obligations under this Agreement or a breach by SmarterKids of its obligations under the Merger Agreement or (v) take any action that would have the effect of preventing or disabling such Stockholder from performing its obligations under this Agreement or SmarterKids from performing its obligations under the Merger Agreement. (b) Nothing herein shall prevent a Stockholder from transferring Shares by gift, transfer to a trust or distribution, provided that (i) any such gift, transfer or distribution is permissible under the form of Lock-Up Agreement attached as Exhibit C to the Merger Agreement and (ii) each donee, transferee or distributee, as applicable, executes, concurrently with such gift, transfer or distribution, a counterpart signature page hereto and agrees to be bound hereby. Section 2.2 Adjustments. (a) In the event (i) of any stock dividend, stock split, recapitalization, reclassification, combination or exchange of shares of capital stock or other securities of SmarterKids on, of or affecting the Shares or the like or any other action that would have the effect of changing any of the Stockholders' ownership of SmarterKids's capital stock or other securities or (ii) any of the Stockholders becomes the beneficial owner of any additional shares of Common Stock or other securities of SmarterKids, then the terms of this Agreement will apply to the shares of capital stock held by any such Stockholder immediately following the effectiveness of the events described in clause (i) or any such Stockholder becoming the beneficial owner thereof, as described in clause (ii), as though they were Shares hereunder and the term Shares shall be deemed to refer to and include such shares of Common Stock and other securities. (b) Each Stockholder hereby agrees, while this Agreement is in effect, promptly to notify Earlychildhood of the number of any new shares of the Common Stock acquired by Stockholder, if any, after the date hereof and to update Annex A hereof, as applicable, to increase the number of Shares set forth therein to reflect any changes resulting from the events discussed in Section 2.2(a) above. To the extent required under the Merger Agreement, each of the events described in Section 2.2(a) shall require the prior written consent of Earlychildhood. Section 2.3 Stop Transfer. Each Stockholder hereby agrees with, and covenants to, each other party hereto, that such Stockholder shall not request that SmarterKids register the transfer (book entry or otherwise) of any certificate or uncertificated interest representing any of its Shares, unless such transfer is made in B-3 compliance with this Agreement (including the provisions of Section 2.1 hereof). SmarterKids agrees with, and covenants to, each other party hereto that SmarterKids shall not register the transfer (book entry or otherwise) of any certificate or uncertificated interest representing any of the Shares, unless such transfer is made in compliance with this Agreement (including the provisions of Section 2.1 hereof). ARTICLE III. Section 3.1 Voting of Shares; No Inconsistent Agreement. (a) Until the termination of this Agreement in accordance with the terms hereof, each Stockholder hereby agrees that, at any meeting (whether annual or special and whether or not an adjourned or postponed meeting) of the stockholders of SmarterKids, however called, and in any action by written consent of the stockholders of SmarterKids, such Stockholder will vote (or cause to be voted) all of its Shares (i) in favor of the Merger, the approval and adoption of the Merger Agreement and the other transactions contemplated by the Merger Agreement or any amendment thereto; (ii) in favor of any other matter necessary to the consummation of the Merger and the transactions contemplated by the Merger Agreement and considered and voted upon by the stockholders of SmarterKids; and (iii) against any Alternative Transaction and against any action or agreement that would result in a breach in any respect of any covenant, representation or warranty or any other obligation or agreement under this Agreement or the Merger Agreement or which is intended to, or could reasonably be expected to, impede, interfere with, delay, postpone or materially adversely effect this Agreement, the Merger Agreement, the Merger, the other transactions contemplated by this Agreement and the Merger Agreement or the benefits to Earlychildhood resulting herefrom or therefrom. In addition, no Stockholder will take any action, directly or indirectly, until the termination of this Agreement in contravention of this Agreement or the Merger Agreement or to cause SmarterKids to take any action in contravention of the Merger Agreement or the transactions contemplated thereby. Stockholder also agrees that it will, upon request by Earlychildhood, furnish written confirmation, in form and substance reasonably satisfactory to Earlychildhood, of such Stockholder's support for the Merger Agreement. Each Stockholder acknowledges receipt and review of a copy of the Merger Agreement and the opportunity to consult its own legal counsel in regard to the Merger Agreement and this Agreement. (b) Each Stockholder agrees that it shall not enter into any agreement or understanding with any Person the effect of which would be inconsistent with or violative of the provisions and agreements contained herein, including in this Section 3.1. Section 3.2 No Solicitation. Prior to the termination of this Agreement in accordance with its terms, each Stockholder agrees (a) that it will not, nor will it authorize or permit any of its officers, directors, employees, financial advisors, attorneys, accountants and other representatives or agents, directly or indirectly through another person, to (i) solicit, initiate, facilitate or encourage any inquiries, offers or proposals by or from a Third Party that constitute, or could reasonably be expected to lead to, any Acquisition Proposal, (ii) enter into or execute any agreement with respect to an Acquisition Proposal, (iii) engage in or continue negotiations or discussions with any Third Party concerning, or, except pursuant to a governmental request for information, otherwise communicate or provide any non- public information to any Third Party relating to any Acquisition Proposal, (iv) make or authorize any public statement, recommendation or solicitation in support of any Acquisition Proposal or (v) take, or consent to take, any other action inconsistent with its obligations under this Section 3.2 or SmarterKids's obligations under Section 5.3 of the Merger Agreement; and (b) that it will notify Earlychildhood in writing as promptly as practicable (and in any event within 24 hours) if any Acquisition Proposal is received or any inquiries, proposals or offers with respect to an Acquisition Proposal are received by or any information or documents are requested from or any negotiations or discussions are sought to be initiated or continued with, it or any of its Affiliates, such written notice to contain the identity of the other party (including the name of such other party and a copy of any offer or proposal and any supporting documentation), and the terms and conditions of such proposal or offer. B-4 ARTICLE IV. Section 4.1 Termination. This Agreement shall become effective on the date hereof and shall continue in effect until the earlier of (i) the termination of the Merger Agreement in accordance with its terms and (ii) the consummation of the Transactions. Section 4.2 Expenses. Except as otherwise expressly provided in the Merger Agreement, all costs and expenses incurred by any of the parties hereto will be borne by the party incurring such costs and expenses. Earlychildhood, on the one hand, and the Stockholders, on the other hand, will indemnify and hold harmless the other from and against any and all claims or liabilities for finder's fees or brokerage commissions or other like payments incurred by reason of action taken by him, it or any of them, as the case may be. Section 4.3 Reliance. Each Stockholder agrees and acknowledges that Earlychildhood is entering into the Merger Agreement in reliance upon each Stockholder's execution and delivery of this Agreement. Section 4.4 Further Assurances. Each party hereto will execute and deliver all such further documents and instruments and take all such further action as may be necessary in order to consummate the transactions contemplated hereby. In addition to the foregoing, each Stockholder agrees that, if requested by Earlychildhood, it will appoint Earlychildhood, or any nominee thereof, with full power of substitution during the term of this Agreement, as its attorney- in-fact and proxy for purposes of voting (or causing the voting of) all Shares beneficially owned by such Stockholder in accordance with Section 3.1 hereof and taking all such other action as may be required to give effect to this Agreement. Such proxy and power of attorney will be coupled with an interest and shall be irrevocable during and for the term of this Agreement. Section 4.5 Enforcement of the Agreement. The Stockholders acknowledge that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that the parties hereto will be entitled to an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the terms and provisions hereof in any court of the United States or any state having jurisdiction, this being in addition to any other remedy to which they are entitled at law or in equity. Section 4.6 Miscellaneous. (a) All representations and warranties contained herein will terminate upon the termination of this Agreement. The covenants and agreements made herein will survive the Closing Date in accordance with their respective terms. (b) Any provision of this Agreement may be waived at any time by the party that is entitled to the benefits thereof. No such waiver, amendment or supplement will be effective unless in writing and signed by the party or parties sought to be bound thereby. Any waiver by any party of a breach of any provision of this Agreement will not operate as or be construed to be a waiver of any other breach of such provision or of any breach of any other provision of this Agreement. The failure of a party to insist upon strict adherence to any term of this Agreement or one or more sections hereof will not be considered a waiver or deprive that party of the right thereafter to insist upon strict adherence to that term or any other term of this Agreement. (c) This Agreement constitutes the entire agreement among the parties hereto with respect to the subject matter hereof, and supersedes all prior agreements among such parties with respect to such matters. This Agreement may not be amended, changed, supplemented, waived or otherwise modified, except upon the delivery of a written agreement executed by the parties hereto. (d) This Agreement will be governed by and construed in accordance with the laws of the State of Delaware, without regard to the conflicts of laws principles thereof. (e) With respect to any suit, action or proceeding initiated by a party to this Agreement arising out of, under or in connection with this Agreement, each Stockholder and Earlychildhood hereby submit to the B-5 exclusive jurisdiction of any state or federal court sitting in the State of Delaware and irrevocably waive, to the fullest extent permitted by law, any objection that they may now have or hereafter obtain to the laying of venue in any such court in any such suit, action or proceeding. (f) The descriptive headings contained herein are for convenience and reference only and will not affect in any way the meaning or interpretation of this Agreement. (g) All notices and other communications hereunder will be in writing and will be given (and will be deemed to have been duly given upon receipt) by delivery in person, by facsimile, or by registered or certified mail, postage prepaid, return receipt requested, addressed as follows: If to Earlychildhood: Earlychildhood.com, LLC 2 Lower Ragsdale Drive Suite 200 Monterey, CA 93940 Attention: Ronald Elliott Facsimile: (831) 771-5587 With a copy to: Latham & Watkins 633 W. Fifth St., Suite 4000 Los Angeles, CA 90071 Attention: Jeffrey L. Kateman, Esq. Facsimile: (213) 891-8763 If to SmarterKids: SmarterKids.com, Inc. 15 Crawford Street Needham, MA 02494 Attention: Bob Cahill Facsimile: (781) 449-4887 With a copy to: Testa, Hurwitz & Thibeault, LLP 125 High Street Boston, MA 02110 Attention: Gordon H. Hayes, Jr., Esq. Facsimile: (617) 248-7100 If to a Stockholder: At the address(es) beneath such Stockholder's name on Annex A to this Agreement. or to such other address as any party may have furnished to the other parties in writing in accordance herewith. (h) This Agreement may be executed in any number of counterparts, each of which will be deemed to be an original, but all of which together will constitute one agreement. (i) This Agreement shall be executed at the same time as the Merger Agreement and at such time shall be valid and binding obligations of each of the parties and signatories thereto. (j) Neither this Agreement nor any of the rights or obligations of any party hereto may be assigned without the prior written consent of the other parties hereto, except that Earlychildhood may, without such B-6 consent, assign this Agreement and any of such rights and obligations to one or more of its affiliates. Any such assignment shall not, however, act as a release of the assigning Person. Subject to the foregoing, this Agreement shall inure to the benefit of and be binding upon the successors and assigns of each of the parties, and no other Person shall have any right, benefit or obligation hereunder. (k) If any term or provision of this Agreement is determined to be invalid, illegal or incapable of being enforced by any rule of law or public policy, all other terms and provisions of this Agreement will nevertheless remain in full force and effect so long as the economic or legal substance of the transactions contemplated hereby is not affected in any manner adverse to any party hereto. Upon any such determination that any term or other provision is invalid, illegal or incapable of being enforced, the parties hereto will negotiate in good faith to modify this Agreement so as to effect the original intent of the parties as closely as possible in an acceptable manner to the end that the transactions contemplated by this Agreement are consummated to the extent possible. (l) All rights, powers and remedies provided under this Agreement or otherwise available in respect hereof at law or in equity will be cumulative and not alternative, and the exercise of any thereof by either party will not preclude the simultaneous or later exercise of any other such right, power or remedy by such party. [Signature pages follow] B-7 IN WITNESS WHEREOF, the parties hereto have duly executed this Stockholder Support Agreement on the date first above written. EARLYCHILDHOOD.COM, LLC /s/ Ronald C. Elliott By: _________________________________ Name:Ronald C. Elliott Title:Chief Executive Officer STOCKHOLDERS: NORTH BRIDGE VENTURE PARTNERS III, L.P. By: NORTH BRIDGE VENTURE MANAGEMENT III, L.P., its General Partner /s/ Richard D'Amore By: _________________________________ Name:Richard D'Amore Title:General Partner COMMONWEALTH CAPITAL VENTURES II, L.P. By: COMMONWEALTH CAPITAL VENTURES II, L.P., its General Partner /s/ Michael T. Fitzgerald By: _________________________________ Name:Michael T. Fitzgerald Title:General Partner DAVID BLOHM, an Individual /s/ David Blohm _____________________________________ David Blohm JEFF PUCCI, an Individual /s/ Jeff Pucci _____________________________________ Jeff Pucci RICHARD VIARD, an Individual /s/ Richard Viard _____________________________________ Richard Viard B-8 ALBERT NOYES, an Individual /s/ Albert Noyes _____________________________________ Albert Noyes RICHARD SECOR, an Individual /s/ Richard Secor _____________________________________ Richard Secor RICHARD D'AMORE, an Individual /s/ Richard D'Amore _____________________________________ Richard D'Amore MICHAEL FITZGERALD, an Individual /s/ Michael Fitzgerald _____________________________________ Michael Fitzgerald MICHAEL KOLOWICH, an Individual /s/ Michael Kolowich _____________________________________ Michael Kolowich BRIAN HICKEY, an Individual /s/ Brian Hickey _____________________________________ Brian Hickey ROBERT CAHILL, an Individual /s/ Robert Cahill _____________________________________ Robert Cahill B-9 ANNEX A TO STOCKHOLDER SUPPORT AGREEMENT SHARES OWNED BY STOCKHOLDERS
Shares held as of the date Stockholder hereof - ----------- --------- North Bridge Venture Partners III, L.P................................ 2,967,817 Commonwealth Capital Ventures II, L.P................................. 1,858,908 Jeff Pucci............................................................ 501,000 Richard Viard......................................................... 499,500 Albert Noyes.......................................................... 247,000 Michael Kolowich...................................................... 155,000
SCHEDULE 1.1(c) CONVERTIBLE SECURITIES BENEFICIALLY OWNED BY STOCKHOLDERS
Outstanding Optionee Options - -------- ----------- David Blohm......................................................... 1,072,000 Robert Cahill....................................................... 245,000 Richard D'Amore..................................................... 45,000 Michael Fitzgerald.................................................. 45,000 Brian Hickey........................................................ 45,000 Michael Kolowich.................................................... 75,000 Albert Noyes........................................................ 439,000 Jeff Pucci.......................................................... 570,000 Richard Secor....................................................... 310,000 Richard Viard....................................................... 570,000
B-10 ANNEX C [LOGO of Chase H&Q] One Bush Street San Francisco, CA 94104 Tel 415-371-3000 November 14, 2000 Confidential The Board of Directors SmarterKids.com 15 Crawford Street Needham, MA 02494 Ladies and Gentlemen: You have requested our opinion as to the fairness from a financial point of view to the holders of the outstanding shares of common stock (the "Common Stock") of SmarterKids.com, Inc. ("SmarterKids.com" or the "Company") of the consideration to be received by such stockholders in connection with the proposed merger of S-E Merger Corp. ("Merger Sub"), a subsidiary of S-E Holdings Corp. ("Holdings"), with and into SmarterKids.com (the "Proposed Transaction") pursuant to the Contribution Agreement and Plan of Reorganization and Merger to be dated as of November 14, 2000, by and among Earlychildhood.com LLC, SmarterKids.com, Holdings and Merger Sub (the "Agreement"). We understand that the terms of the Agreement provide, among other things, that each issued and outstanding share of Common Stock of the Company shall be cancelled and shall be converted automatically into the right to receive [x/y] of one share of Common Stock of Holdings (the "Exchange Ratio"), as more fully set forth in the Agreement. For purposes of this opinion, we have assumed that the Contribution (as such term is defined in the Agreement) will be treated for Federal income tax purposes as a transfer of property to Holdings qualifying under Section 351 of the Internal Revenue Code of 1986, as amended (the "Code"), and that the Proposed Transaction will be treated for Federal income tax purposes as a reorganization under Section 368(a) of the Code or, taken together with the Contribution, as a transfer of property to Holdings qualifying under Section 351 of the Code. Chase H&Q, a division of Chase Securities Inc. ("Chase H&Q"), as part of its investment banking services, is regularly engaged in the valuation of businesses and their securities in connection with mergers and acquisitions, strategic transactions, corporate restructurings, negotiated underwritings, secondary distributions of listed and unlisted securities, private placements and valuations for corporate and other purposes. We have acted as a financial advisor to the Board of Directors of SmarterKids.com in connection with the Proposed Transaction, and we will receive a fee, a substantial portion of which is conditioned on the consummation of the Proposed Transaction, for our services, which include the rendering of this opinion. In the past, we have provided investment banking and other financial advisory services to SmarterKids.com, including as lead manager in SmarterKids.com's initial public offering in November 1999, and have received fees for rendering these services. In the ordinary course of business, Chase H&Q acts as a market maker and broker in the publicly traded securities of SmarterKids.com and receives customary compensation in connection therewith, and has in the past provided research coverage for SmarterKids.com. In the ordinary course of business, Chase H&Q also actively trades in the equity and derivative securities of SmarterKids.com for its own account and for the accounts of its customers and, accordingly, may at any time hold a long or short position in such securities. Chase H&Q may in the future provide additional investment banking or other financial advisory services to SmarterKids.com or Earlychildhood. In connection with our review of the Proposed Transaction, and in arriving at our opinion, we have, among other things: (i) reviewed the publicly available consolidated financial statements of SmarterKids.com for recent years and interim period to date and certain other relevant financial and operating data of SmarterKids.com made available to us from published sources, including Wall Street analysts' research reports, and from the internal records of SmarterKids.com and reviewed the financial statements of Earlychildhood for recent years and interim periods to date and certain other relevant financial and operating data of Earlychildhood made available to us from the internal records of Earlychildhood; (ii) reviewed certain internal financial and operating information relating to SmarterKids.com and Earlychildhood prepared by the senior management of SmarterKids.com and Earlychildhood; (iii) discussed the business, financial condition and prospects of SmarterKids.com, Earlychildhood and Holdings with certain members of senior management SmarterKids.com and Earlychildhood; (iv) reviewed the recent reported prices and trading activity for the common stock of SmarterKids.com and compared such information and certain financial information for SmarterKids.com with similar information for certain other companies engaged in businesses we consider comparable; (v) reviewed the financial terms, to the extent publicly available, of certain comparable merger and acquisition transactions; (vi) reviewed a draft of the Agreement, dated as of November 13, 2000; and (vii) performed such other analyses and examinations and considered such other information, financial studies, analyses and investigations and financial, economic and market data as we deemed relevant. In rendering our opinion, we have assumed and relied upon the accuracy and completeness of all of the information concerning SmarterKids.com, Earlychildhood and Holdings considered in connection with our review of the Proposed Transaction, and we have not assumed any responsibility for independent verification of, and did not independently verify, such information. We have not prepared any independent valuation or appraisal of any of the assets or liabilities of SmarterKids.com, Earlychildhood or Holdings, nor have we conducted a physical inspection of the properties, facilities or other asses of SmarterKids.com or Earlychildhood. With respect to the financial forecasts and projections made available to us and in our analysis, we have assumed that they reflect the best currently available estimates and judgments of the expected future financial performance of SmarterKids.com, Earlychildhood and Holdings. In rendering our opinion, we express no view as to the reasonableness of such forecasts and projections or the assumptions on which they are based. For purposes of this opinion, we have assumed that neither Earlychildhood, Holdings nor SmarterKids.com is a party to any pending transactions, including external financings, recapitalizations or material merger discussions, other than the Proposed Transaction and those activities undertaken in the ordinary course of conducting their respective businesses. Our opinion is necessarily based upon market, economic, financial and other conditions as they exist and can be evaluated as of the date of this letter and any change in such conditions would require a reevaluation of this opinion. We express no opinion as to the price at which the Common Stock will trade. In rendering this opinion, we have assumed that the proposed merger will be consummated substantially on the terms discussed in the Agreement, without any waiver of any material terms or conditions by any party thereto. C-2 It is understood that this letter is for the information of the Board of Directors and may not by used for any other purpose without our prior written consent; provided, however, that this letter may be reproduced in full in any proxy statement filed by SmarterKids.com in connection with the Proposed Transaction. This letter does not constitute a recommendation to any stockholder of SmarterKids.com as to how such stockholder should vote on the Proposed Transaction. Based upon and subject to the foregoing and after considering such other matters as we deem relevant, we are of the opinion that as of the date hereof the Exchange Ratio is fair to holders of the Common Stock from a financial point of view. Very truly yours, [LOGO] /s/ James Secretarski By __________________________________ Managing Director ANNEX D FORM OF RESTATED CERTIFICATE OF INCORPORATION OF LEARNINGSTAR CORP. The present name of the Corporation is LearningStar Corp. The Corporation was incorporated by the filing of its original Certificate of Incorporation with the Secretary of State of the State of Delaware on November 6, 2000. This Restated Certificate of Incorporation of the Corporation, which both restates and further amends the provisions of the Corporation's Certificate of Incorporation, was duly adopted in accordance with the provisions of Sections 242 and 245 of the General Corporation Law of the State of Delaware (the "DGCL") and by the unanimous written consent of its stockholders in accordance with Section 228 of the DGCL. The Certificate of Incorporation of the Corporation is hereby amended and restated to read in its entirety as follows: FIRST: The name of the Corporation is LearningStar Corp. SECOND: The address of the registered office of the Corporation in the State of Delaware is Corporation Service Company, 2711 Centerville Road, Suite 400, in the City of Wilmington, County of New Castle, State of Delaware. The name of its registered agent at that address is Corporation Service Company. THIRD: The purpose of the Corporation is to engage in any lawful act or activity for which a corporation may be organized under the DGCL. FOURTH: A. Capital Stock. The total number of shares of capital stock which the Corporation shall have authority to issue shares (the "Capital Stock"), consisting of shares of Common Stock, par value $.01 per share (the "Common Stock"), and shares of Preferred Stock, par value of $.01 per share (the "Preferred Stock"). B. Common Stock. The shares of authorized Common Stock of the Corporation shall be identical in all respects and shall have equal rights and privileges. C. Preferred Stock. Shares of Preferred Stock may be issued from time to time in one or more series, as provided for herein or as provided for by the Board of Directors as permitted hereby. All shares of Preferred Stock shall be of equal rank and shall be identical, except in respect of the terms fixed herein for the series provided for herein or fixed by the Board of Directors for any series provided for by the Board of Directors as permitted hereby. The Board of Directors is hereby authorized, by resolution or resolutions, to establish, out of the unissued shares of Preferred Stock not then allocated to any series of Preferred Stock, additional series of Preferred Stock. Before any shares of any such additional series are issued, the Board of Directors shall fix and determine, and is hereby expressly empowered to fix and determine, by resolution or resolutions, the number of shares constituting such series and the distinguishing characteristics and the relative voting powers, rights, preferences, privileges and immunities, if any, and any qualifications, limitations or restrictions thereof, of the shares thereof, so far as not inconsistent with the provisions of this Article FOURTH and a certificate of said resolution or resolutions (a "Certificate of Designation") shall be filed in accordance with the DGCL. Without limiting the generality of the foregoing, the Board of Directors may fix and determine: 1. The designation of such series and the number of shares which shall constitute such series of such shares, which number the Board of Directors may thereafter (except where otherwise provided in the Certificate of Designation) increase or decrease (but not below the number of shares thereof then outstanding); D-1 2. The rate of dividend, if any, payable on shares of such series; 3. Whether the shares of such series shall be cumulative, non-cumulative or partially cumulative as to dividends, and the dates from which any cumulative dividends are to accumulate; 4. Whether the shares of such series may be redeemed, and, if so, the price or prices at which and the terms and conditions on which shares of such series may be redeemed; 5. The amount payable upon shares of such series in the event of the voluntary or involuntary dissolution, liquidation or winding up of the affairs of the Corporation; 6. The sinking fund provisions, if any, for the redemption of shares of such series; 7. The voting rights, if any, of the shares of such series; 8. Whether the shares of the series shall be convertible into or exchangeable for shares of any other class or series, or any other security, of the Corporation or any other corporation, and, if so, the specifications of such other class or series or such other security, the conversion or exchange price or prices or rate or rates, and adjustments thereof, the date or dates at which such shares shall be convertible or exchangeable and all other terms and conditions upon which such conversion or exchange may be made; 9. The terms and conditions, if any, on which shares of such series may be converted into shares of capital stock of the Corporation of any other class or series; 10. Whether the shares of such series are to be preferred over shares of capital stock of the Corporation of any other class or series as to dividends, or upon the voluntary or involuntary dissolution, liquidation, or winding up of the affairs of the Corporation, or otherwise; 11. Restrictions on the issuance of shares of the same series or of any other class or series; and 12. Any other characteristics, preferences, limitations, rights, privileges, immunities or terms not inconsistent with the provisions of this Article FOURTH. D. Voting Power for Holders of Common and Preferred Stock. Except as otherwise provided in this Restated Certificate of Incorporation, each holder of Common Stock shall be entitled to one vote for each share of Common Stock held by such holder on all matters submitted to stockholders for a vote and each holder of any series of Preferred Stock shall be entitled to such number of votes for each share held by such holder as may be specified herein or in the Certificate of Designation in respect thereof. Except as otherwise provided by law, the presence, in person or by proxy, of the holders of record of issued and outstanding shares of Capital Stock entitling the holders thereof to cast a majority of the votes entitled to be cast by the holders of issued and outstanding shares of Capital Stock entitled to vote shall constitute a quorum at all meetings of the stockholders. FIFTH: The Board of Directors shall have the power to make, adopt, alter, amend, change or repeal the bylaws of the Corporation (as may be amended from time to time, the "Bylaws") by resolution adopted by the affirmative vote of a majority of the entire Board of Directors, subject to any law or Bylaw provision requiring the affirmative vote of a larger percentage of the members of the Board of Directors. In addition to any other vote required by law, the affirmative vote of the holders of at least 75% of the voting power of all outstanding shares of the Corporation then entitled to vote generally in the election of directors, voting together as a single class shall be required to make, adopt, alter, amend, change or repeal the Bylaws of the Corporation or any provision of this Restated Certificate of Incorporation. SIXTH: A. Number; Election and Terms of Directors. Subject to Section C of this Article SIXTH, the number of directors of the Corporation which shall constitute the entire Board shall be not less than three nor D-2 more than fifteen directors. Within such limits, the exact number of directors constituting the entire Board shall be fixed from time to time pursuant to a resolution adopted by a majority of the total number of directors which the Corporation would have if there were no vacancies. Subject to Section C of this Article SIXTH, the Board of Directors shall be divided into three classes, designated Class I, Class II and Class III. Class I, Class II and Class III shall each initially consist of three directors. Class I directors shall be initially elected for a term expiring at the first annual meeting of stockholders of the Corporation following the date hereof, Class II directors shall be initially elected for a term expiring at the second annual meeting of stockholders of the Corporation following the date hereof, and Class III directors shall be initially elected for a term expiring at the third annual meeting of stockholders of the Corporation following the date hereof. At each annual meeting of stockholders, beginning in 2001, successors to the class of directors whose term expires at that annual meeting shall be elected for a three-year term A director shall hold office until the annual meeting for the year in which his term expires and until his successor shall be elected and shall qualify, subject, however, to such director's prior death, resignation, retirement, disqualification or removal from office. Unless and except to the extent that the Bylaws of the Corporation shall so require, the election of directors of the Corporation need not be by written ballot. B. Vacancies and Newly Created Directorships. Subject to Section C of this Article SIXTH unless the Board of Directors otherwise determines, vacancies resulting from death, resignation, retirement, disqualification, removal from office or other cause, and newly-created directorships resulting from any increase in the authorized number of directors, may be filled only by the affirmative vote of a majority of the remaining directors, though less than a quorum of the Board of Directors. Any director so chosen pursuant to the preceding sentence shall hold office for the remainder of the full term expiring at the annual meeting of the stockholders at which the term of office of the class to which such director has been elected expires and until such director's successor shall have been duly elected and qualified. If the number of directors is changed, any increase or decrease shall be apportioned among the classes so as to maintain the number of directors in each class as nearly equal as possible, and any additional director of any class elected to fill a vacancy resulting from an increase in such class shall hold office for a term that shall coincide with the remaining term of that class. In no case will a decrease in the number of authorized directors constituting the Board of Directors shorten the term of any incumbent director. C. Removal. Any director may be removed from office, but only for cause, and any such removal shall require, in addition to any other vote required by law, the affirmative vote of the holders of at least 75% of the voting power of all shares of Capital Stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class. D. Rights of Holders of Preferred Stock. Notwithstanding the foregoing, whenever the holders of any one or more series of Preferred Stock issued by the Corporation shall have the right, voting separately as a class or series, to elect directors at an annual or special meeting of stockholders, the election, term of office, removal, filling of vacancies and other features of such directorships shall be governed by the terms of this Restated Certificate of Incorporation and the Certificate of Designation applicable thereto, and such directors so elected shall not be divided into classes pursuant to this Article SIXTH unless expressly provided by such terms. SEVENTH: Special meetings of the stockholders of the Corporation, for any purpose or purposes, may only be called at any time by a majority of the entire Board of Directors or by either the Chairman or the Chief Executive Officer of the Corporation. EIGHTH: No stockholder action may be taken except at a duly called annual or special meeting of stockholders of the Corporation and stockholders of the Corporation may not take any action by written consent in lieu of a meeting of stockholders. NINTH: A. Indemnification. The Corporation shall indemnify (A) its directors and officers, whether serving the Corporation or, at its request, any other entity, to the fullest extent required or permitted by the DGCL now or hereafter in force, and shall advance expenses to the fullest extent permitted by law and (B) D-3 other employees and agents to such extent as shall be expressly authorized by the Board of Directors or the Bylaws and as permitted by law. The foregoing rights of indemnification shall not be exclusive of any other rights to which those seeking indemnification may be entitled. The Board of Directors may take such action as is necessary to carry out these indemnification provisions and is expressly empowered to adopt, approve and amend from time to time such bylaws, resolutions or contracts implementing such provisions or such further indemnification arrangements as may be permitted by law. No amendment of this Restated Certificate of Incorporation or repeal of any of its provisions shall limit or eliminate the right to indemnification provided under this Article NINTH with respect to any acts or omissions occurring prior to such amendment or repeal. TENTH: To the fullest extent permitted by the DGCL, as the same exists or may hereafter be amended, no director of this Corporation shall be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director. No amendment of this Restated Certificate of Incorporation or repeal of any of its provisions shall limit or eliminate any right or protection of any director of this Corporation under this Article TENTH for or with respect to any acts or omissions of such director occurring prior to such amendment for repeal. ELEVENTH: The Corporation reserves the right to amend, alter, change or repeal any provision contained in this Restated Certificate of Incorporation and other provisions authorized by the laws of the State of Delaware in force at that time may be added or inserted, in the manner now or thereafter prescribed by statute, and all rights, preferences and privileges of whatsoever nature conferred upon stockholders, directors or any other persons whomsoever by and pursuant to this Restated Certificate of Incorporation in its present form or as hereafter amended are granted subject to this reservation. D-4 IN WITNESS WHEREOF, said Corporation has caused this Restated Certificate of Incorporation to be signed by Albert Noyes, its Chief Executive Officer on this day of , 2001. LEARNINGSTAR CORP. ------------------------------------- Name: Albert Noyes Title: Chief Executive Officer D-5 ANNEX E FORM OF AMENDED AND RESTATED BYLAWS OF LEARNINGSTAR CORP. TABLE OF CONTENTS
Page ---- ARTICLE I. OFFICES...................... E-1 Section 1. REGISTERED OFFICES...... E-1 Section 2. OTHER OFFICES........... E-1 Section 3. BOOKS AND RECORDS....... E-1 ARTICLE II. MEETINGS OF STOCKHOLDERS.... E-1 Section 1. ANNUAL MEETINGS......... E-1 Section 2. SPECIAL MEETINGS........ E-1 Section 3. PLACE OF MEETINGS....... E-1 Section 4. NOTICE OF MEETING....... E-1 Section 5. LIST OF STOCKHOLDERS ENTITLED TO VOTE........ E-2 Section 6. QUORUM AND ADJOURNMENT.. E-2 Section 7. PROXIES................. E-2 Section 8. NOTICE OF STOCKHOLDERS BUSINESS AND NOMINATIONS............. E-2 Section 9. VOTING.................. E-5 Section 10. STOCK LEDGER............ E-5 Section 11. NO STOCKHOLDER ACTION BY WRITTEN CONSENT......... E-5 Section 12. ORGANIZATION............ E-5 Section 13. FIXING DATE FOR DETERMINATION OF STOCKHOLDERS OF RECORD.. E-5 Section 14. INSPECTORS OF ELECTION.. E-5 Section 15. CONDUCT OF MEETINGS..... E-6 ARTICLE III. BOARD OF DIRECTORS......... E-6 Section 1. GENERAL POWERS.......... E-6 Section 2. NUMBER OF DIRECTORS; TENURE AND QUALIFICATIONS.......... E-6 Section 3. MEETINGS................ E-7 Section 4. QUORUM.................. E-7 Section 5. VACANCIES AND NEWLY CREATED DIRECTORSHIPS... E-7 Section 6. ACTIONS OF BOARD OF DIRECTORS............... E-7 Section 7. MEETINGS BY MEANS OF CONFERENCE TELEPHONE.... E-7 Section 8. EXECUTIVE AND OTHER COMMITTEES.............. E-7 Section 9. REMOVAL................. E-8 Section 10. COMPENSATION............ E-8 Section 11. INTERESTED DIRECTORS.... E-8 Section 12. ORGANIZATION............ E-8 ARTICLE IV. OFFICERS.................... E-9 Section 1. GENERAL................. E-9 Section 2. ELECTION AND TERM OF OFFICERS................ E-9 Section 3. CHAIRMAN OF THE BOARD... E-9 Section 4. CHIEF EXECUTIVE OFFICER................. E-9 Section 5. VICE CHAIRMAN........... E-9 Section 6. PRESIDENT............... E-9 Section 7. CHIEF OPERATING OFFICER................. E-10 Section 8. CHIEF FINANCIAL OFFICER................. E-10 Section 9. EXECUTIVE VICE PRESIDENTS AND SENIOR VICE PRESIDENTS......... E-10 Section 10. VICE PRESIDENTS......... E-10 Section 11. TREASURER AND ASSISTANT TREASURERS.............. E-10 Section 12. SECRETARY AND ASSISTANT SECRETARIES............. E-10 Section 13. OTHER OFFICERS.......... E-11
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Page ---- ARTICLE V. STOCK....................................................... E-11 Section 1. STOCK CERTIFICATES..................................... E-11 Section 2. LOST, STOLEN OR DESTROYED CERTIFICATES................. E-11 Section 3. TRANSFERS.............................................. E-11 ARTICLE VI. INDEMNIFICATION AND INSURANCE.............................. E-11 ACTION OTHER THAN BY OR IN THE RIGHT OF THE Section 1. CORPORATION............................................ E-11 Section 2. ACTION BY OTHER OR IN THE RIGHT OF THE CORPORATION..... E-12 Section 3. DETERMINATION OF RIGHT OF INDEMNIFICATION.............. E-12 Section 4. INDEMNIFICATION AGAINST EXPENSES OF SUCCESSFUL PARTY... E-12 Section 5. ADVANCES OF EXPENSES................................... E-12 RIGHT OF AGENT TO INDEMNIFICATION UPON APPLICATION; Section 6. PROCEDURE UPON APPLICATION............................. E-12 Section 7. OTHER RIGHTS AND REMEDIES.............................. E-13 Section 8. INSURANCE.............................................. E-13 Section 9. PRESUMPTIONS AND EFFECT OF CERTAIN PROCEEDINGS......... E-13 Section 10. OTHER ENTERPRISES, FINES, AND SERVING AT CORPORATION'S REQUEST................................................ E-14 Section 11. SAVINGS CLAUSE......................................... E-14 Section 12. CERTAIN DEFINITIONS.................................... E-14 ARTICLE VII. MISCELLANEOUS PROVISIONS.................................. E-15 Section 1. FISCAL YEAR............................................ E-15 Section 2. DIVIDENDS.............................................. E-15 Section 3. SEAL................................................... E-15 Section 4. AUDITS................................................. E-15 Section 5. RESIGNATIONS........................................... E-15 Section 6. CONTRACTS.............................................. E-15 Section 7. PROXIES................................................ E-15 Section 8. WAIVER OF NOTICE OF MEETINGS OF STOCKHOLDERS, DIRECTORS AND COMMITTEES......................................... E-15 ARTICLE VIII. AMENDMENTS............................................... E-16 Section 1. AMENDMENTS............................................. E-16
ii FORM OF AMENDED AND RESTATED BYLAWS OF LEARNINGSTAR CORP. ARTICLE I. Offices Section 1. Registered Office. The registered office of LearningStar Corp. (the "Corporation") in the State of Delaware shall be located at Corporation Service Company, 2711 Centerville Road, Suite 400, in the City of Wilmington, County of New Castle, State of Delaware. Section 2. Other Offices. The Corporation may also have offices at such other places both within and without the State of Delaware as the Board of Directors of the Corporation (the "Board of Directors") may from time to time designate or the business of the Corporation may require. Section 3. Books and Records. The books and records of the Corporation may be kept outside the State of Delaware at such place or places as may from time to time be designated by the Board of Directors. ARTICLE II. Meetings of Stockholders Section 1. Annual Meetings. The annual meeting of stockholders shall be held on such date and at such time as may be fixed by resolution of the Board of Directors. Section 2. Special Meetings. Unless otherwise prescribed by law or by the Restated Certificate of Incorporation of the Corporation (as may be amended from time to time, the "Certificate of Incorporation"), special meetings of stockholders, for any purpose or purposes, may only be called by the Chairman of the Board or by the Board of Directors pursuant to a resolution adopted by a majority of the entire Board of Directors. Section 3. Place of Meetings. Meetings of the stockholders for the election of directors or for any other purpose shall be held at such time and place, either within or without the State of Delaware as shall be designated by the Board of Directors or the Chairman of the Board. If no such designation is made, the place of meeting shall be the principal office of the Corporation. Notwithstanding the foregoing, the board of directors may determine that the meeting shall not be held at any place, but instead may be held solely by means of remote communication in accordance with applicable law. Section 4. Notice of Meeting. Notice of an annual or special meeting stating the place, if any, date and hour of the meeting, the means of remote communications, if any, by which the stockholders and proxy holders may be deemed to be present in person and vote at such meeting, and in the case of a special meeting, the purpose or purposes for which the meeting is being called, shall be given to each stockholder entitled to vote at such meeting not less than ten (10) nor more than sixty (60) days before the date of the meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail with postage thereon prepaid, addressed to the stockholder at his address as it appears on the stock books of the Corporation. Only such business shall be conducted at a special meeting of stockholders as shall have been brought before the meeting pursuant to the Corporation's notice of meeting. Any previously scheduled meeting of the stockholders may be postponed, and (unless the Certificate of Incorporation otherwise provides) any special meeting of the stockholders may be canceled, by resolution of the Board of Directors upon public notice given prior to the date previously scheduled for such meeting of stockholders. E-1 Section 5. List of Stockholders Entitled to Vote. The officer of the Corporation who has charge of the stock ledger of the Corporation shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, as required by applicable law. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder of the Corporation who is present. Section 6. Quorum and Adjournment. Except as otherwise provided by law or by the Certificate of Incorporation, the holders of a majority of the capital stock issued and outstanding and entitled to vote generally in the election of directors (the "Voting Stock"), present in person or represented by proxy, shall constitute a quorum at all meetings of the stockholders for the transaction of business, except that when specified business is to be voted on by a class or series of stock voting as a class, the holders of a majority of the shares of such class or series shall constitute a quorum of such class or series for the transaction of such business. Shares of its own capital stock belonging to the Corporation or to a subsidiary of the Corporation, if a majority of the shares entitled to vote in the election of directors of such subsidiary is held, directly or indirectly, by the Corporation, shall neither be entitled to vote nor be counted for quorum purposes; provided, however, that the foregoing shall not limit the right of the Corporation or any subsidiary of the Corporation to vote stock, including but not limited to its own stock, held by it in a fiduciary capacity. The Chairman of the meeting may adjourn the meeting from time to time if a quorum shall not be present or represented by proxy at any meeting of the stockholders. The meeting may be adjourned without notice other than announcement at the meeting, until a quorum shall be present or represented by proxy. At such adjourned meeting at which a quorum shall be present or represented, any business may be transacted which might have been transacted at the meeting as originally noticed. If the adjournment is for more than thirty (30) days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder entitled to vote at the meeting. Section 7. Proxies. At all meetings of stockholders, a stockholder entitled to vote may vote by proxy (or in such manner permitted by the General Corporation Law of the State of Delaware (the "DGCL") by the stockholder, or by his duly authorized attorney in fact. A proxy shall be irrevocable if it states that it is irrevocable and if, and only so long as, it is coupled with an interest sufficient in law to support an irrevocable power. A stockholder may revoke any proxy which is not irrevocable by attending the meeting and voting in person or by filing an instrument in writing revoking the proxy or by delivering a proxy in accordance with applicable law bearing a later date to the Secretary of the Corporation. Section 8. Notice of Stockholder Business and Nominations. (A) Annual Meetings of Stockholders. (1)Nominations of persons for election to the Board of Directors of the Corporation and the proposal of business to be considered by the stockholders may be made at an annual meeting of stockholders (a) pursuant to the Corporation's notice of meeting (or any supplement thereto), (b) by or at the direction of a majority of the Board of Directors or (c) by any stockholder of the Corporation who was a stockholder of record at the time the notice provided for in this Bylaw is delivered to the Secretary of the Corporation, who is entitled to vote at the meeting and who complies with the notice procedures set forth in this Bylaw. (2) For nominations or other business to be properly brought before an annual meeting by a stockholder pursuant to clause (c) of paragraph (A)(1) of this Bylaw, the stockholder must have given timely notice thereof in writing to the Secretary of the Corporation and such other business must otherwise be a proper matter for stockholder action. To be timely, a stockholder's notice shall be delivered to the Secretary at the principal executive offices of the Corporation not later than the close of business on the 70th day nor earlier than the close of business on the 90th day prior to the first anniversary of the preceding year's annual meeting; E-2 provided, however, that in the event that the date of the annual meeting is more than 30 days before or more than 60 days after such anniversary date, notice by the stockholder to be timely must be so delivered not earlier than the close of business on the 90th day prior to such annual meeting nor later than the close of business on the later of the 70th day prior to such annual meeting or the 10th day following the day on which public announcement of the date of such meeting is first made by the Corporation. In no event shall the public announcement of an adjournment or postponement of an annual meeting commence a new time period (or extend any time period) for the giving of a stockholder's notice as described above. Such stockholder's notice shall set forth (a) as to each person whom the stockholder proposes to nominate for election or re-election as a director all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors in an election contest, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), including, but not limited to, information required to be disclosed by Items 4(b) and 6 of Schedule 14A under the Exchange Act and information which would be required to be filed on Schedule 14C under the Exchange Act, and Rule 14a-11 thereunder (including such person's written consent to being named in the proxy statement as a nominee and to serving as a director if elected); (b) as to any other business that the stockholder proposes to bring before the meeting, a brief description of the business desired to be brought before the meeting, the text of the proposal or business (including the text of any resolutions proposed for consideration and in the event that such business includes a proposal to amend the Bylaws of the Corporation, the language of the proposed amendment), the reasons for conducting such business at the meeting and any material interest in such business of such stockholder and the beneficial owner, if any, on whose behalf the proposal is made; and (c) as to the stockholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made (i) the name and address, as they appear on the Corporation's books, of such stockholder and any other stockholders known by such stockholder to be supporting such nominees or proposal, and of any such beneficial owner, (ii) the class and number of shares of the Corporation which are owned beneficially and of record by such stockholder and, to the extent known, by any other stockholders known by such stockholder to be supporting such nominees or proposal and such beneficial owner, (iii) a representation that the stockholder is a holder of record of stock of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to propose such business or nomination, and (iv) a representation whether the stockholder or the beneficial owner, if any, intends or is a part of a group which intends to (a) deliver a proxy statement and a form of proxy to holders of at least the percentage of the Corporation's outstanding common stock required to approve or adopt the proposal or elect the nominee and/or (b) otherwise solicit proxies from stockholders in support of such proposal or nomination. The foregoing notice requirements shall be deemed satisfied by a stockholder if the stockholder has notified the Corporation of his or her intention to present a proposal at an annual meeting in compliance with Rule 14a-8 (or any successor thereof) promulgated under the Exchange Act and such stockholder's proposal has been included in a proxy statement that has been prepared by the Corporation to solicit proxies for such annual meeting. The Corporation may require any proposed nominee to furnish such other information as it may reasonably require to determine the eligibility of such proposed nominee to serve as a director of the Corporation. (3) Notwithstanding anything in the second sentence of paragraph (A)(2) of this Bylaw to the contrary, in the event that the number of directors to be elected to the Board of Directors of the Corporation is increased and there is no public announcement by the Corporation naming all of the nominees for director or specifying the size of the increased Board of Directors at least 70 days prior to the first anniversary of the preceding year's annual meeting, a stockholder's notice required by this Bylaw shall also be considered timely, but only with respect to nominees for any new positions created by such increase, if it shall be delivered to the Secretary at the principal executive offices of the Corporation by not later than the close of business on the 10th day following the day on which such public announcement is first made by the Corporation. (B) Special Meetings of Stockholders. Only such business shall be conducted at a special meeting of stockholders as shall have been brought before the meeting pursuant to the Corporation's notice of meeting. Nominations of persons for election to the Board of Directors may be made at a special meeting of stockholders at which directors are to be elected pursuant to the Corporation's notice of meeting (a) by or at the E-3 direction of the Board of Directors or (b) provided that the Board of Directors has determined that the directors shall be elected at such meeting, by any stockholder of the Corporation who was a stockholder of record at the time the notice provided for in this Bylaw is delivered to the Secretary of the Corporation, who is entitled to vote at the meeting and who complies with the notice procedures set forth in this Bylaw. In the event the Corporation calls a special meeting of stockholders for the purpose of electing one or more directors to the Board of Directors, any such stockholder may nominate a person or persons (as the case may be), for election to such position(s) as specified in the Corporation's notice of meeting, if the stockholder's notice required by paragraph (A)(2) of this Bylaw shall be delivered to the Secretary at the principal executive offices of the Corporation not earlier than the close of business on the 90th day prior to such special meeting and not later than the close of business on the 70th day prior to such special meeting or the 10th day following the day on which public announcement is first made of the date of the special meeting and of the nominees proposed by the Board of Directors to be elected at such meeting. In no event shall the public announcement of an adjournment of a special meeting commence a new time period (or extend any time period) for the giving of a stockholder's notice as described above. (C) General. (1)Only such persons who are nominated in accordance with the procedures set forth in this Bylaw shall be eligible to be elected at an annual or special meeting of stockholders of the Corporation to serve as directors and only such business shall be conducted at a meeting of stockholders as shall have been brought before the meeting in accordance with the procedures set forth in this Bylaw. Except as otherwise provided by law, the Chairman of the meeting shall have the exclusive power and duty to (i) determine whether a nomination or any business proposed to be brought before the meeting was made or proposed, as the case may be, in accordance with the procedures set forth in this Bylaw (including whether the stockholder or beneficial owner, if any, on whose behalf the nomination or proposal is made, solicited (or is part of a group which solicited) or did not so solicit, as the case may be, proxies in support of such stockholder's nominee or proposal in compliance with such stockholder's representation as required by clause (A)(2)(c)(iv) of this Bylaw) and (ii) if any proposed nomination or business is not in compliance with this Bylaw, including if the stockholder solicits or is part of a group which solicits proxies in support of such stockholder's proposal without such stockholder having made the representation required by either clause (c)(iii) or (c)(iv) of paragraph (A)(2) of this Bylaw, to declare that such defective proposal or nomination shall be disregarded or that such proposed business shall not be transacted. Notwithstanding the foregoing provisions of this Bylaw, if the stockholder (or a qualified representative of the stockholder) does not appear at the annual or special meeting of stockholders of the Corporation to present a nomination or business, such nomination shall be disregarded and such proposed business shall not be transacted, notwithstanding that proxies in respect of such vote may have been received by the Corporation. (2)For purposes of this Bylaw, "public announcement" shall mean disclosure in a press release reported by the Dow Jones News Services, Associated Press or comparable national news service or in a document publicly filed by the Corporation with the Securities and Exchange Commission pursuant to Section 13, 14 or 15(d) of the Exchange Act. (3) Notwithstanding the foregoing provisions of this Bylaw, a stockholder shall also comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Bylaw. Nothing in this Bylaw shall be deemed to affect any rights (i) of stockholders to request inclusion of proposals in the Corporation's proxy statement pursuant to Rule 14a-8 of the Exchange Act or (ii) of the holders of any series of Preferred Stock to elect directors under specified circumstances. Section 9. Voting. Unless otherwise required by law, the Certificate of Incorporation, the rules or regulations of any stock exchange applicable to the Corporation or these Bylaws, any question (other than the election of directors) brought before any meeting of stockholders shall be decided by the vote of the holders of a majority of the stock represented and entitled to vote thereat. Subject to the rights of the holders of any series of Preferred Stock to elect directors under specified circumstances, at all meetings of stockholders for the E-4 election of directors, a plurality of the votes cast shall be sufficient to elect. Each stockholder represented at a meeting of stockholders shall be entitled to cast one vote for each share of the capital stock entitled to vote thereat held by such stockholder, unless otherwise provided by the Certificate of Incorporation. Such votes may be cast in person or by proxy but no proxy shall be voted after three years from its date, unless such proxy provides for a longer period. The Board of Directors, in its discretion, or the officer of the Corporation presiding at a meeting of stockholders, in his or her discretion, may require that any votes cast at such meeting be cast by written ballot. Section 10. Stock Ledger. The stock ledger of the Corporation shall be the only evidence as to who are the stockholders entitled to examine the stock ledger, the list required by Section 5 of this Article II or the books of the Corporation, or to vote in person or by proxy at any meeting of stockholders. Section 11. No Stockholder Action by Written Consent. Any action required or permitted to be taken by the stockholders of the Corporation must be effected at a duly called annual or special meeting of such holders and may not be effected by any consent in writing by such holders. Section 12. Organization. Meetings of stockholders shall be presided over by the Chairman of the Board, if any, or in his or her absence by the Vice Chairman of the Board, if any, or in his or her absence by the Chief Executive Officer or the President, or in their absence by a Vice President, or in the absence of the foregoing persons by a chairman designated by the Board of Directors, or in the absence of such designation by a chairman chosen at the meeting. The Secretary shall act as secretary of the meeting, but in his or her absence the chairman of the meeting may appoint any person to act as secretary of the meeting. Section 13. Fixing Date for Determination of Stockholders of Record. In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board of Directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the Board of Directors, and which record date: (1) in the case of determination of stockholders entitled to vote at any meeting of stockholders or adjournment thereof, shall, unless otherwise required by law, not be more than sixty (60) nor less than ten (10) days before the date of such meeting; and (2) in the case of any other action, shall not be more than sixty (60) days prior to such other action. If no record date is fixed: (1) the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the date next preceding the day on which notice is given, or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held; and (2) the record date for determining stockholders for any other purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution relating thereto. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. Section 14. Inspectors of Election. The Corporation may, and shall if required by law, in advance of any meeting of stockholders, appoint one or more inspectors of election, who may be employees of the Corporation, to act at the meeting or any adjournment thereof and to make a written report thereof. The Corporation may designate one or more persons as alternate inspectors to replace any inspector who fails to act. In the event that no inspector so appointed or designated is able to act at a meeting of stockholders, the person presiding at the meeting shall appoint one or more inspectors to act at the meeting. Each inspector, before entering upon the discharge of his or her duties, shall take and sign an oath to execute faithfully the duties of inspector with strict impartiality and according to the best of his or her ability. The inspector or inspectors so appointed or designated shall (i) ascertain the number of shares of capital stock of the Corporation outstanding and the voting power of each such share, (ii) determine the shares of capital stock of the corporation represented at the meeting and the validity of proxies and ballots, (iii) count all votes and ballots, (iv) determine and retain for a reasonable period a record of the disposition of any challenges made to any determination by the inspectors, E-5 and (v) certify their determination of the number of shares of capital stock of the Corporation represented at the meeting and such inspectors' count of all votes and ballots. Such certification and report shall specify such other information as may be required by law. In determining the validity and counting of proxies and ballots cast at any meeting of stockholders of the Corporation, the inspectors may consider such information as is permitted by applicable law. No person who is a candidate for an office at an election may serve as an inspector at such election. Section 15. Conduct of Meetings. The date and time of the opening and the closing of the polls for each matter upon which the stockholders will vote at a meeting shall be announced at the meeting by the person presiding over the meeting. The Board of Directors may adopt by resolution such rules and regulations for the conduct of the meeting of stockholders as it shall deem appropriate. Except to the extent inconsistent with such rules and regulations as adopted by the Board of Directors, the person presiding over any meeting of stockholders shall have the right and authority to convene and to adjourn the meeting, to prescribe such rules, regulations and procedures and to do all such acts as, in the judgment of such chairman, are appropriate for the proper conduct of the meeting. Such rules, regulations or procedures, whether adopted by the Board of Directors or prescribed by the presiding officer of the meeting, may include, without limitation, the following: (i) the establishment of an agenda or order of business for the meeting; (ii) rules and procedures for maintaining order at the meeting and the safety of those present; (iii) limitations on attendance at or participation in the meeting to stockholders of record of the Corporation, their duly authorized and constituted proxies or such other persons as the chairman of the meeting shall determine; (iv) restrictions on entry to the meeting after the time fixed for the commencement thereof; and (v) limitations on the time allotted to questions or comments by participants. The presiding officer at any meeting of stockholders, in addition to making any other determinations that may be appropriate to the conduct of the meeting, shall, if the facts warrant, determine and declare to the meeting that a matter or business was not properly brought before the meeting and any such matter or business not properly brought before the meeting shall not be transacted or considered. Unless and to the extent determined by the Board of Directors or the person presiding over the meeting, meetings of stockholders shall not be required to be held in accordance with the rules of parliamentary procedure. ARTICLE III. BOARD OF DIRECTORS Section 1. General Powers. The business and affairs of the Corporation shall be managed under the direction of the Board of Directors. In addition to the powers and authorities by these Bylaws expressly conferred upon them, the Board of Directors may exercise all such powers of the Corporation and do all such lawful acts and things as are not by statute or by the Certificate of Incorporation or by these Bylaws required to be exercised or done by the stockholders. Section 2. Number of Directors; Tenure and Qualifications. Subject to the rights of the holders of any series of Preferred stock to elect directors under specified circumstances, the number of directors of the Corporation which shall constitute the entire board shall be fixed from time to time as provided in the Certificate of Incorporation. Directors need not be stockholders. The directors, other than those who may be elected by the holders of any series of Preferred Stock under specified circumstances, shall be divided, with respect to the time for which they severally hold office, into three classes, as nearly equal in number as is reasonably possible, with the term of office of the first class to expire at the [first annual meeting of stockholders following the Effective Time], the term of office of the second class to expire at the [second annual meeting of stockholders following the Effective Time] and the term of office of the third class to expire at the [third annual meeting of stockholders following the Effective Time], with each director to hold office until his or her successor shall have been duly elected and qualified. At each annual meeting of stockholders commencing with the [first annual meeting of stockholders following the Effective Time], (i) directors elected to succeed those directors whose terms then expire shall be elected for a term of office to expire at the third E-6 succeeding annual meeting of stockholders after their election, with each director to hold office until his or her successor shall have been duly elected and qualified, and (ii) if authorized by a resolution of the Board of Directors, directors may be elected to fill any vacancy on the Board of Directors, regardless of how such vacancy shall have been created. Any director may resign at any time upon notice given in writing or by electronic transmission. Section 3. Meetings. The Board of Directors of the Corporation may hold meetings, both regular and special, either within or without the State of Delaware. Regular meetings of the Board of Directors may be held without notice at such time and at such place as may from time to time be determined by the Board of Directors. Special meetings of the Board of Directors may be called by the Chairman of the Board, the Chief Executive Officer or a majority of the entire Board of Directors. Notice thereof stating the place, date and hour of the meeting shall be given to each director either by mail not less than forty- eight (48) hours before the date of the meeting, by telephone or telegram on twenty-four (24) hours notice, or on such shorter notice as the person or persons calling such meeting may deem necessary or appropriate in the circumstances. Section 4. Quorum. Subject to Section 5 of this Article III and except as may be otherwise specifically provided by law, the Certificate of Incorporation or these Bylaws, at all meetings of the Board of Directors or any committee thereof, a majority of the entire Board of Directors or such committee, as the case may be, shall constitute a quorum for the transaction of business and the act of a majority of the directors present at any meeting at which there is a quorum shall be the act of the Board of Directors or such committee, as the case may be. If a quorum shall not be present at any meeting of the Board of Directors or of any committee thereof, a majority of the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present. Section 5. Vacancies and Newly Created Directorships. Except as otherwise provided in the Certificate of Incorporation and subject to applicable law and the rights of the holders of any series of Preferred Stock, and unless the Board of Directors otherwise determines, vacancies resulting from death, resignation, retirement, disqualification, removal from office or other cause, and newly created directorships resulting from any increase in the authorized number of directors, may be filled only by the affirmative vote of a majority of the remaining directors, though less than a quorum of the Board of Directors. Any director so chosen pursuant to the foregoing sentence shall hold office for the remainder of the full term expiring at the annual meeting of stockholders at which the term of office of the class to which they have been elected expires and until such director's successor shall have been duly elected and qualified. No decrease in the number of authorized directors constituting the Board of Directors shall shorten the term of any incumbent director. Section 6. Actions of Board of Directors. Unless otherwise provided by the Certificate of Incorporation or these Bylaws, any action required or permitted to be taken at any meeting of the Board of Directors or of any committee thereof may be taken without a meeting, if all the members of the Board of Directors or committee, as the case may be, consent thereto in writing or by electronic transmission, and the writing or writings or electronic transmission or transmissions are filed with the minutes of proceedings of the Board of Directors or committee, as applicable. Such filing shall be in paper form if the minutes are maintained in paper form and shall be in electronic form if the minutes are maintained in electronic form. Section 7. Meetings by Means of Conference Telephone. Unless otherwise provided by the Certificate of Incorporation or these Bylaws, members of the Board of Directors of the Corporation, or any committee designated by the Board of Directors, may participate in a meeting of the Board of Directors or such committee by means of a conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this Article III, Section 7 shall constitute presence in person at such meeting. Section 8. Executive and Other Committees. The Board of Directors may, by resolution designate an Executive Committee to exercise, subject to applicable provisions of law, all of the powers of the Board of Directors in the management of the business and affairs of the Corporation when the Board of Directors is not E-7 in session, including, without limitation, the power to declare dividends, to authorize the issuance of the Corporation's capital stock and to adopt a certificate of ownership and merger pursuant to Section 253 of the DGCL, and may, by resolution similarly adopted, designate one or more other committees. The Executive Committee and each such other committee shall consist of two or more directors of the Corporation. The Board of Directors may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of any such committee. In the absence or disqualification of a member of a committee, and in the absence of a designation by the Board of Directors of an alternate member to replace the absent or disqualified member, the member or members thereof present at any meeting and not disqualified from voting, whether or not he, she or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any absent or disqualified member. Any committee, other than the Executive Committee (the powers of which are expressly provided for herein), may to the extent permitted by law exercise such powers and shall have such responsibilities as shall be specified in the designating resolution. Each committee shall keep regular minutes and report to the Board of Directors when required. Section 9. Removal. Subject to the rights of holders of any series of Preferred Stock to elect directors under specified circumstances, any director may be removed from office, but only for cause, and only by the affirmative vote of the holders of at least 75% of the voting power of all the then outstanding shares of Voting Stock, voting together as a single class. Section 10. Compensation. The directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors and may be paid a fixed sum for attendance at each meeting of the Board of Directors or a stated salary as director. No such payment shall preclude any director from serving the Corporation in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings. Section 11. Interested Directors. No contract or transaction between the Corporation and one or more of its directors or officers, or between the Corporation and any other corporation, partnership, association, or other organization in which one or more of its directors or officers are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the Board of Directors or committee thereof which authorizes the contract or transaction, or solely because his, her or their votes are counted for such purpose if (i) the material facts as to his, her or their relationship or interest and as to the contract or transaction are disclosed or are known to the Board of Directors or the committee, and the Board of Directors or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors may be less than a quorum; or (ii) the material facts as to his, her or their relationship or interest and as to the contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the stockholders; or (iii) the contract or transaction is fair as to the Corporation as of the time it is authorized, approved or ratified, by the Board of Directors, a committee thereof or the stockholders. Common or interested directors may be counted in determining the presence of a quorum at a meeting of the Board of Directors or of a committee which authorizes the contract or transaction. Section 12. Organization. Meetings of the Board of Directors shall be presided over by the Chairman of the Board, if any, or in his or her absence by the Vice Chairman of the Board, if any, or in his or her absence by the Chief Executive Officer, or in his or her absence by a chairman chosen at the meeting. The Secretary shall act as secretary of the meeting, but in his absence the chairman of the meeting may appoint any person to act as secretary of the meeting. E-8 ARTICLE IV. OFFICERS Section 1. General. The officers of the Corporation shall be elected by the Board of Directors and shall consist of: a Chairman of the Board; a Chief Executive Officer; a Vice Chairman; a President; a Chief Operating Officer; a Chief Financial Officer; a Secretary; and a Treasurer. The Board of Directors, in its discretion, may also elect one or more Executive Vice Presidents, Senior Vice Presidents, Vice Presidents, Assistant Secretaries, Assistant Treasurers, a Controller and such other officers as in the judgment of the Board of Directors may be necessary or desirable. Any number of offices may be held by the same person and more than one person may hold the same office, unless otherwise prohibited by law, the Certificate of Incorporation or these Bylaws. The officers of the Corporation need not be stockholders of the Corporation nor, need such officers be directors of the Corporation. Section 2. Election and Term of Office. The Board of Directors at its first meeting held after each annual meeting of stockholders shall elect the officers of the Corporation who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board of Directors; and all officers of the Corporation shall hold office until their successors are chosen and qualified, or until their earlier resignation or removal. Except as otherwise provided in this Article IV, any officer elected by the Board of Directors may be removed with or without cause at any time by the affirmative vote of a majority of the Board of Directors. Any vacancy occurring in any office of the Corporation shall be filled by the Board of Directors. The salaries of all officers who are directors of the Corporation shall be fixed by the Board of Directors. Section 3. Chairman of the Board. The Chairman of the Board shall be a member of the Board of Directors, shall serve at the discretion of the Board of Directors and shall exercise and perform such duties and have such powers as may be prescribed by the Board of Directors or these Bylaws, all in accordance with basic policies as established by and subject to the oversight of the Board of Directors. Section 4. Chief Executive Officer. The Chief Executive Officer of the Corporation shall serve at the discretion of the Board of Directors and shall supervise, coordinate and manage the Corporation's business and activities and supervise, coordinate and manage its operating expenses and capital allocation, shall have general authority to exercise all the powers necessary for the Chief Executive Officer of the Corporation and shall perform such other duties and have such other powers as may be prescribed by the Board of Directors or these Bylaws, all in accordance with basic policies as established by and subject to the oversight of the Board of Directors. Section 5. Vice Chairman. The Vice Chairman shall be a member of the Board of Directors and shall serve at the discretion of the Board of Directors. The Vice Chairman shall exercise and perform such duties and have such powers as may be prescribed by the Board of Directors or these Bylaws, all in accordance with basic policies as established by and subject to the oversight of the Board of Directors. In the absence or disability of the Chairman of the Board, the duties of the Chairman of the Board shall be performed, and the Chairman of the Board's authority may be exercised by the Vice Chairman and, in the event the Vice Chairman is absent or disabled, such duties shall be performed and such authority may be exercised by a director designated for such purpose by the Board of Directors. Section 6. President. The President shall serve at the discretion of the Board of Directors and shall supervise, coordinate and manage the Corporation's business and activities and supervise, coordinate and manage its operating expenses and capital allocation, shall have general authority to exercise all the powers necessary for the President of the Corporation and shall perform such other duties and have such other powers as may be prescribed by the Board of Directors or these, all in accordance with basic policies as established by and subject to the oversight of the Board of Directors, the Chairman of the Board and the Chief Executive Officer. E-9 Section 7. Chief Operating Officer. The Chief Operating Officer shall report to the President, and shall supervise, coordinate and manage the Corporation's business and activities and supervise, coordinate and manage its operating expenses and capital allocation, shall have general authority to exercise all the powers necessary for the Chief Operating Officer of the Corporation and shall perform such other duties and have such other powers as may be prescribed by the Board of Directors or these Bylaws, all in accordance with basic policies as established by and subject to the oversight of the Board of Directors, the Chairman of the Board and the Chief Executive Officer. Section 8. Chief Financial Officer. The Chief Financial Officer shall report to the President, and be an Executive Vice President, a Senior Vice President or a Vice President and shall act in an executive financial capacity. The Chief Financial Officer shall establish and maintain the accounting records of the Corporation in accordance with generally accepted accounting principles applied on a consistent basis, maintain proper internal control of the assets of the Corporation and shall perform such other duties as the Board of Directors, the Chairman of the Board, the Chief Executive Officer, or the Vice Chairman and President may prescribe. Section 9. Executive Vice Presidents and Senior Vice Presidents. The Executive Vice Presidents and the Senior Vice Presidents shall report to the President, and perform such duties as may be delegated or prescribed by the Board of Directors, Chief Executive Officer or Vice Chairman and President of the Corporation. Section 10. Vice Presidents. Each Vice President shall report to the President, and perform such duties and have such powers as the Board of Directors from time to time may prescribe or as delegated by the Vice Chairman and President. Section 11. Treasurer and Assistant Treasurers. The Treasurer shall report to the President, and have the custody of the corporate funds and securities and shall keep full and accurate accounts of receipts and disbursements in books belonging to the Corporation and shall deposit all moneys and other valuable effects in the name and to the credit of the Corporation in such depositories as may be designated by the Board of Directors. The Treasurer shall disburse the funds of the Corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements, and shall render to the Vice Chairman and President and the Board of Directors, at its regular meetings, or when the Board of Directors so requires, an account of all his or her transactions as Treasurer and of the financial condition of the Corporation. If required by the Board of Directors, the Treasurer shall give the Corporation a bond (which shall be renewed every six years) in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors for the faithful performance of the duties of his or her office and for the restoration to the Corporation, in case of his or her death, resignation, retirement or removal from office, of all books, papers, vouchers, money and other property of whatever kind in his or her possession or under his or her control belonging to the Corporation. The Assistant Treasurers in the order of their seniority shall, in the absence or disability of the Treasurer, perform the duties and exercise the powers of the Treasurer and shall perform such other duties as the Board of Directors shall prescribe. Section 12. Secretary and Assistant Secretaries. The Secretary shall report to the President, and shall attend all meetings of the Board of Directors and all meetings of stockholders and record all votes and proceedings thereat in a book or books to be kept for that purpose; the Secretary shall also perform like duties for the standing committees when required. The Secretary shall give, or cause to be given, notice of all meetings of the stockholders and special meetings of the Board of Directors, and shall perform such other duties as may be prescribed by the Board of Directors, the Chairman of the Board or Vice Chairman and President, who shall supervise the Secretary. The Secretary shall have custody of the seal of the Corporation and the Secretary or any Assistant Secretary, if there be one, shall have authority to affix the same to any instrument requiring it and when so affixed, it may be attested by the signature of the Secretary or by the signature of any Assistant Secretary. The Board of Directors may give general authority to any other officer to affix the seal of the Corporation and to attest the affixing by his or her signature. The Secretary shall see that all books, reports, statements, certificates and other documents and records required by law to be kept or filed are properly kept or filed, as the case may be. E-10 The Assistant Corporate Secretary or the Assistant Secretaries in order of their seniority, shall, in the absence or disability of the Secretary, perform the duties and exercise the powers of the Secretary and shall perform such other duties as the Board of Directors shall prescribe. Section 13. Other Officers. Such other officers as the Board of Directors may choose shall perform such duties and have such powers as from time to time may be assigned to them by the Board of Directors. The Board of Directors may delegate to any other officer of the Corporation the power to choose such other officers and to prescribe their respective duties and powers. ARTICLE V. STOCK Section 1. Stock Certificates. The interest of each stockholder of the Corporation shall be evidenced by certificates for shares of stock or shall be uncertificated. The certificate for shares of stock of the Corporation shall be in such form, not inconsistent with the Certificate of Incorporation, as the appropriate officers of the Corporation may from time to time prescribe. The certificates of stock shall be signed, countersigned and registered in such manner as the Board of Directors may by resolution prescribe, which resolution may permit all or any of the signatures on such certificates to be in facsimile. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the Corporation with the same effect as if he or she were such officer, transfer agent or registrar at the date of issue. Section 2. Lost, Stolen or Destroyed Certificates. The Board of Directors may direct new certificate(s) to be issued in place of any certificate(s) theretofore issued by the Corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to be lost, stolen or destroyed. When authorizing such issue of new certificate(s), the Board of Directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate(s), or such owner's legal representative, to advertise the same in such manner as the Board of Directors shall require and/or to give the Corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the Corporation with respect to the certificate(s) alleged to have been lost, stolen or destroyed. Section 3. Transfers. Stock of the Corporation shall be transferable in the manner prescribed by law and in these Bylaws. Transfers of stock shall be made on the books of the Corporation only by the person named in the certificate or by such person's attorney lawfully constituted in writing and upon the surrender of the certificate therefor, which shall be canceled before a new certificate shall be issued. ARTICLE VI. INDEMNIFICATION AND INSURANCE Section 1. Action Other Than By or In The Right of The Corporation. The Corporation shall indemnify and hold harmless, to the fullest extent permitted by applicable law as it presently exists or may hereafter be amended, an Agent (as hereinafter defined) against costs, charges and Expenses (as hereinafter defined), judgments, fines and amounts paid in settlement actually and reasonably incurred by an Agent in connection with an action, suit or proceeding (of the type referenced in the definition of "Agent"), and any appeal therefrom, if the Agent acted in good faith and in a manner the Agent reasonably believed to be in or not opposed to the best interests of the Corporation, and with respect to any criminal action or proceeding, had no reasonable cause to believe such conduct was unlawful. The termination of any action, suit or proceeding (whether by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent) shall E-11 not, of itself, create a presumption that the Agent did not act in good faith and in a manner which the Agent reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, that such person had reasonable cause to believe that the Agent's conduct was unlawful. Section 2. Action By Or In The Right Of The Corporation. The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed judicial action or suit brought by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that such person is or was an Agent, against costs, charges and Expenses actually and reasonably incurred by an Agent in connection with the defense or settlement of such action or suit and any appeal therefrom if the Agent acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the Corporation, except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for gross negligence or willful misconduct in the performance of the Agent's duty to the Corporation unless and only to the extent that the Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such costs, charges and Expenses which the Court of Chancery or other such court shall deem proper. Section 3. Determination of Right of Indemnification. Any indemnification under Section 1 or 2 of this Article VI (unless ordered by a court) shall be paid by the Corporation if a determination is reasonably and promptly made (i) by the Board of Directors by a majority vote of Disinterested Directors (as hereinafter defined) even though less than a quorum, or (ii) by a committee of Disinterested Directors designated by majority vote of such directors, even though less than a quorum, or (iii) if such a quorum is not obtainable, or, even if obtainable, if a quorum of Disinterested Directors so directs, by Independent Counsel in a written opinion, or (iv) by the stockholders, that such person has met the applicable standard of conduct set forth in Section 1 and 2 of Article VI. Section 4. Indemnification Against Expenses of Successful Party. Notwithstanding the other provisions of this Article VI, to the extent that an Agent has been successful on the merits or otherwise, including, without limitation, the dismissal of an action without prejudice, the settlement of an action without admission of liability, or the defense of any claim, issue or matter therein, or on appeal from any such proceeding, action, claim or matter, such Agent shall be indemnified against all costs, charges and Expenses incurred in connection therewith. Section 5. Advances of Expenses. Except as limited by Section 6 of this Article VI, costs, charges, and Expenses incurred by an Agent in any action, suit, proceeding or investigation or any appeal therefrom shall be paid by the Corporation in advance of the final disposition of such matter, if the Agent shall undertake to repay such amount in the event that it is ultimately determined, as provided herein, that such person is not entitled to indemnification. Notwithstanding the foregoing, no advance shall be made by the Corporation if a determination is reasonably and promptly made (i) by the Board of Directors by a majority vote of a quorum of Disinterested Directors, (ii) if such a quorum is not obtainable or, even if obtainable, a quorum of Disinterested Directors so directs, by Independent Counsel in a written opinion, that, based upon the facts known to the Board of Directors or counsel at the time such determination is made, the Agent acted in bad faith and in a manner that such person did not believe to be in the best interests of the Corporation, or (iii) with respect to any criminal proceeding, that such person believed or had reasonable cause to believe his or her conduct was unlawful. In no event shall any advance be made in instances where the Board of Directors or Independent Counsel reasonably determines that the Agent deliberately breached such person's duty to the Corporation or its stockholders. Section 6. Right of Agent to Indemnification Upon Application; Procedure Upon Application. Any indemnification under Section 1, 2 or 4 or advance under Section 5 of this Article VI, shall be made promptly, and in any event within 60 days, upon the written request of the Agent, unless with respect to applications E-12 under Section 1, 2 or 5, a determination is reasonably and promptly made by the Board of Directors by a majority vote of a quorum of Disinterested Directors that such Agent acted in a manner set forth in such Sections as to justify the Corporation's not indemnifying or making an advance to the Agent. In the event no quorum of Disinterested Directors is obtainable, the Board of Directors shall promptly direct that Independent Counsel shall decide whether the Agent acted in the manner set forth in such Sections as to justify the Corporation's not indemnifying or making an advance to the Agent. The right to indemnification or advances as granted by this Article shall be enforceable by the Agent in any court of competent jurisdiction, if the Board of Directors or Independent Counsel denies the claim in whole or in part, or if no disposition of such claim is made within 60 days. The Agent's costs, charges and Expenses incurred in connection with successfully establishing such person's right to indemnification, in whole or in part, in any such proceeding shall also be indemnified by the Corporation. Section 7. Other Rights and Remedies. The indemnification provided by this Article VI shall not be deemed exclusive of, and shall not affect, any other rights to which an Agent seeking indemnification may be entitled under any law, Bylaw, or charter provision, agreement, vote of stockholders or Disinterested Directors or otherwise, both as to action in such person's official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be an Agent and shall inure to the benefit of the heirs, executors and administrators of such a person. All rights to indemnification under this Article VI shall be deemed to be a contract between the Corporation and the Agent who serves in such capacity at any time while the Certificate of Incorporation and other relevant provisions of the DGCL and other applicable law, if any, are in effect. Any repeal or modification thereof shall not affect any rights or obligations then existing. Section 8. Insurance. The Corporation may purchase and maintain insurance on behalf of any person who is or was an Agent against any liability asserted against such person and incurred by him or her in any such capacity, or arising out of such person's status as such, whether or not the Corporation would have the power to indemnify such person against such liability under the provisions of this Article VI. The Corporation may create a trust fund, grant a security interest or use other means (including, without limitation, a letter of credit) to ensure the payment of such sums as may become necessary to effect indemnification as provided herein. Section 9. Presumptions and Effect of Certain Proceedings. If a Change of Control (as hereinafter defined) shall have occurred, in making a determination with respect to entitlement to indemnification hereunder, the person, persons or entity making such determination shall presume that the Agent is entitled to indemnification under this Article if the Agent has submitted a request for indemnification in accordance with Section 6 of this Article VI, and the Corporation shall have the burden of proof to overcome that presumption in connection with the making by any person, persons or entity of any determination contrary to that presumption. If the person, persons or entity empowered or selected under Section 6 of this Article VI to determine whether the Agent is entitled to indemnification shall not have made such determination within 60 days after receipt by the Corporation of the request therefor, the requisite determination of entitlement to indemnification shall be deemed to have been made and the Agent shall be entitled to such indemnification, absent (i) a misstatement by the Agent of a material fact, or an omission of a material fact necessary to make the Agent's statement not materially misleading, in connection with the request for indemnification, or (ii) a prohibition of such indemnification under applicable law; provided, however, that such 60-day period may be extended for a reasonable time, not to exceed an additional 30 days, if the person, persons or entity making the determination with respect to entitlement to indemnification in good faith requires such additional time for the obtaining or evaluating of documentation and/or information relating thereto; and provided, further, that the foregoing provisions of this Section 9 shall not apply (a) if the determination of entitlement to indemnification is to be made by the stockholders pursuant to Section 6 and if (A) within 15 days after receipt by the Corporation of the request for such determination the Board of Directors has resolved to submit such determination to the stockholders for their consideration at an annual meeting thereof to be held within 75 days after such receipt E-13 and such determination is made thereat, or (B) a special meeting of the stockholders is called within 15 days after such receipt for the purpose of making such determination, such meeting is held for such purpose within 60 days after having been so called and such determination is made thereat, or (b) if the determination of entitlement to indemnification is to be made by Independent Counsel pursuant to Section 5 of this Article VI. The termination of any proceeding or of any claim, issue or matter therein by judgment, order, settlement or conviction, or upon a plea of nolo contendere or its equivalent, shall not (except as otherwise expressly provided in this Article VI) of itself adversely affect the right of the Agent to indemnification or create a presumption that the Agent did not act in good faith and in a manner which such person reasonably believed to be in or not opposed to the best interests of the Corporation, or, with respect to any criminal proceeding, that the Agent had reasonable cause to believe that such person's conduct was unlawful. Section 10. Other Enterprises, Fines, and Serving at Corporation's Request. For the purposes of this Article VI, references to "other enterprise" in Section 12(A) below shall include employee benefit plans; references to "fines" shall include any excise taxes assessed on a person with respect to any employee benefit plan; and references to "serving at the request of the Corporation" shall include any service by the Agent as a director, officer or employee of the Corporation which imposes duties on, or involves services by, such Agent with respect to any employee benefit plan, its participants, or beneficiaries; and a person who acted in good faith and in a manner such person reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interests of the Corporation" as referred to in this Article VI. Section 11. Savings Clause. If this Article or any portion thereof shall be invalidated on any ground by any court of competent jurisdiction, then the Corporation shall nevertheless indemnify each Agent as to costs, charges and Expenses, judgments, fines and amounts paid in settlement with respect to any action, suit, proceeding or investigation, and any appeal therefrom, whether civil, criminal or administrative, and whether internal or external, including a grand jury proceeding and an action or suit brought by or in the right of the Corporation, to the full extent permitted by any applicable portion of this Article that shall not have been invalidated, and to the fullest extent permitted by applicable law. Section 12. Certain Definitions. For the purposes of this Article VI: "Agent" means any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding or investigation, whether civil, criminal or administrative, and whether external or internal to the Corporation (other than a judicial action or suit brought by or in the right of the Corporation) by reason of the fact that he or she is or was or has agreed to be a director, officer or employee of the Corporation, or that, being or having been such a director, officer or employee, he or she is or was serving at the request of the Corporation as a director, officer or employee of another corporation, partnership, joint venture, trust or other enterprise. "Change of Control" means a change in control of the Corporation of a nature that would be required to be reported in response to Item 5(f) of Schedule 14A of Regulation 14A (or in response to any similar item on any similar schedule or form) promulgated under the Exchange Act, whether or not the Corporation is then subject to such reporting requirement; provided, however, that, without limitation, such a Change in Control shall be deemed to have occurred if: (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Corporation representing 25% or more of the combined voting power of the Corporation's then outstanding securities without the prior approval of at least two-thirds of the members of the Board of Directors in office immediately prior to such person attaining such percentage interest; (ii) the Corporation is a party to a merger, consolidation, sale of assets or other reorganization, or a proxy contest, as a consequence of which members of the Board of Directors in office immediately prior to such transaction or event constitute less than a majority of the Board of Directors thereafter; or (iii) during any period of three consecutive years, individuals who at the beginning of such period constituted the Board of Directors E-14 (including for this purpose any new director whose election or nomination for election by the Corporation's stockholders was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of such period) cease for any reason to constitute at least a majority of the Board of Directors. "Disinterested Director" means a director of the Corporation who is not and was not a party to the matter in respect of which indemnification is sought by the claimant. "Expenses" shall include all reasonable attorneys' fees, retainers, court costs, transcript costs, fees of experts, witness fees, travel expenses, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees, and all other disbursements or expenses of the types customarily incurred in connection with prosecuting, defending, preparing to prosecute or defend, investigating, or being or preparing to be a witness in a proceeding. "Independent Counsel" means a law firm, a member of a law firm, or an independent practitioner, that is experienced in matters of corporation law and shall include any person who, under the applicable standards of professional conduct then prevailing, would not have a conflict of interest in representing either the Corporation or the claimant in an action to determine the claimant's rights under this Article VI. ARTICLE VII. MISCELLANEOUS PROVISIONS Section 1. Fiscal Year. The fiscal year of the Corporation shall begin on the first day of January and end of the thirty-first day of December each year. Section 2. Dividends. The Board of Directors may from time to time declare, and the Corporation may pay, dividends on its outstanding shares in the manner and upon the terms and conditions provided by law and the Certificate of Incorporation. Dividends may be paid in cash, in property, or in shares of the capital stock of the Corporation. Before payment of any dividend, there may be set aside out of any funds of the Corporation available for dividends, such sum or sums as the directors may, from time to time in their absolute discretion, think proper as a reserve fund to meeting contingencies, or for equalizing dividends, or for repairing or maintaining any property of the Corporation, or for such other purpose as the directors shall think conducive to the interest of the Corporation, and the directors may abolish any such reserve in the manner in which it was created. Section 3. Seal. The corporate seal shall have inscribed thereon the name of the Corporation, the year of incorporation and the words "Corporation Seal, Delaware." Said seal may be used by causing it or a facsimile thereof to be impressed or affixed or reproduced or otherwise. Section 4. Audits. The accounts, books and records of the Corporation shall be audited upon the conclusion of each fiscal year by an independent certified public accountant selected by the Board of Directors, and it shall be the duty of the Board of Directors to cause such audit to be done annually. Section 5. Resignations. Any officer, whether elected or appointed, may resign at any time by giving written notice of such resignation to the Chairman of the Board, the Chief Executive Officer or the Secretary, and such resignation shall be deemed to be effective as of the close of business on the date said notice is received by the Chairman of the Board, Chief Executive Officer or Secretary, or at such later time as is specified therein. No formal action shall be required of the Board of Directors or the stockholders to make any such resignation effective. Section 6. Contracts. Except as otherwise required by law, the Certificate of Incorporation or these Bylaws, any contracts or other instruments may be executed and delivered in the name and on behalf of the Corporation by such officer or officers of the Corporation as the Board of Directors may from time to time E-15 direct. Such authority may be general or confined to specific instances as the Board may determine. The Chairman of the Board, Chief Executive Officer, Vice Chairman and President, or any Executive Vice President, Senior Vice President or Vice President may execute bonds, contracts, deeds, leases and other instruments to be made or executed for or on behalf of the Corporation. Section 7. Proxies. Unless otherwise provided by resolution adopted by the Board of Directors, the Chairman of the Board, Chief Executive Officer, Vice Chairman and President, any Executive Vice President, Senior Vice President or Vice President may from time to time appoint an attorney or attorneys or agent or agents of the Corporation, in the name and on behalf of the Corporation, to case the votes which the Corporation may be entitled to case as the holder of stock or other securities in any other corporation, any of whose stock or other securities may be held by the Corporation, at meetings of the holders of stock or other securities or such other corporation, or to consent in writing, in the name of the Corporation as such holder, to any action by such other corporation, and may instruct the person or persons so appointed as to the manner of casting such votes or giving such consent, and may execute or cause to be executed in the name and on behalf of the Corporation and under its corporate seal or otherwise, all such written proxies or other instruments as he may deem necessary or proper in the premises. Section 8. Waiver of Notice of Meetings of Stockholders, Directors and Committees. Any waiver of notice, whether before or after the time stated therein, shall be deemed equivalent to notice. Attendance of a person at a meeting shall constitute a waiver of notice of such meeting, except when the person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at nor the purpose of any regular or special meeting of the stockholders, directors, or members of a committee of directors need be specified in any waiver of notice. ARTICLE VIII. AMENDMENTS Section 1. Amendments. These Bylaws may be altered, amended, or repealed at any meeting of the Board of Directors or of the stockholders, provided that notice of the proposed change was given in the notice of the meeting and, in the case of a meeting of the Board of Directors, in a notice given not less than two days prior to the meeting; provided, however, that, in the case of amendments by stockholders, notwithstanding any other provisions of these Bylaws or any provision of law which might otherwise permit a lesser vote or no vote, but in addition to any affirmative vote of the holders of any particular class or series of the capital stock of the Corporation required by law, the Certificate of Incorporation or these Bylaws, the affirmative vote of the holders of at least 75% of the voting power of all the then outstanding shares of the Voting Stock, voting together as a single class, shall be required to alter, amend or repeal any provision of these Bylaws. E-16 PART II INFORMATION NOT REQUIRED IN PROSPECTUS Item 20. Indemnification of Directors and Officers. As permitted by Section 102 of the Delaware General Corporation Law (the "DGCL"), Article Tenth of the Restated Certificate of Incorporation of the Registrant eliminates the personal liability of its directors to the Registrant or its stockholders for monetary damages for breach of fiduciary duty as a director, to the fullest extent permitted by the DGCL, as the same exists or may hereafter be amended. Section 145 of the DGCL, Article Ninth of the Restated Certificate of Incorporation of the Registrant and Article VI of the Amended and Restated Bylaws of the Registrant authorize and empower the Registrant to indemnify its directors, officers, and employees against liabilities incurred in connection with, and related expenses resulting from, any claim, action or suit brought against any such person as a result of such person's relationship with the Registrant, provided that such persons acted in accordance with a stated standard of conduct in connection with the acts or events on which such claim, action or suit is based. The finding of either civil or criminal liability on the part of such persons in connection with such acts or events is not necessarily determinative of the question of whether such persons have met the required standard of conduct and are, accordingly, entitled to be indemnified. The Registrant will carry policies of insurance covering the officers and directors of the Registrant for legal liability and which will pay on behalf of the Registrant expenses of indemnification of officers and directors. Item 21. Exhibits and Financial Statement Schedules. (a) The following exhibits are filed herewith or incorporated by reference herein:
Exhibit Number Exhibit Title ------- ------------- *2.1 Contribution Agreement and Plan of Reorganization by and among the Registrant, SmarterKids.com, Inc., Earlychildhood.com LLC and S-E Educational Merger Corp., dated as of November 14, 2000 (attached as Annex A to the Proxy Statement-Prospectus contained in this Registration Statement). *3.1 Registrant's Certificate of Incorporation, as amended, as currently in effect. *3.2 Form of Registrant's Restated Certificate of Incorporation (attached as Annex D to the Proxy Statement-Prospectus contained in this Registration Statement). *3.3 Form of Registrant's Amended and Restated Bylaws (attached as Annex E to the Proxy Statement-Prospectus contained in this Registration Statement). 4.1 Form of Specimen Certificate for Registrant's Common Stock. 5.1 Opinion of Testa, Hurwitz & Thibeault, LLP regarding the legality of the securities being issued. 8.1 Opinion of Testa, Hurwitz & Thibeault, LLP regarding certain tax matters. 8.2 Opinion of Latham & Watkins regarding certain tax matters. *9.1 Stockholder Support Agreement by and among Earlychildhood.com LLC and certain stockholders of SmarterKids.com, Inc. dated as of November 14, 2000 (attached as Annex B to the Proxy Statement-Prospectus contained in this Registration Statement).
II-1
Exhibit Number Exhibit Title ------- ------------- *9.2 Consent and Non-Contravention Agreement dated as of November 14, 2000 by and among Earlychildhood.com LLC, the holders of the outstanding membership interests in Earlychildhood.com LLC and SmarterKids.com, Inc. +*10.1 Form of 2000 Stock Plan of the Registrant. +*10.2 Form of 2000 Non-Employee Director Stock Option Plan of the Registrant. +*10.3 Form of Employee Stock Purchase Plan of the Registrant. *10.4 Registration Rights Agreement dated November 14, 2000 by and among Registrant and certain stockholders named therein. 10.5 Form of Affiliate Agreement. 10.6 Form of Lockup Agreement. *10.7 Form of Consulting Agreement to be executed by and between Registrant and David Blohm upon completion of the combination. *10.8 Lease Agreements dated as of September 1, 1998 and April 16, 1999 between SmarterKids.com, Inc. and McFarland FLP. *10.9 Lease Agreement dated as of September 8, 1999 between SmarterKids.com, Inc. and BHX, LLC as Trustee of Crawford Realty Trust. *10.10 Lease Agreement dated as of April 7, 2000 between SmarterKids.com, Inc. and Keep Your Day Job, LLC. *10.11 Business Agreement dated as of March 9, 1999 between National Computer Systems and SmarterKids.com, Inc. *10.12 Loan and Security Agreement dated as of November 24, 1999 between SmarterKids.com, Inc. and Silicon Valley Bank. +*10.13 Form of Executive Option Agreement of SmarterKids.com, Inc. +*10.14 Form of Change of Control Agreement for Executive Officers of SmarterKids.com, Inc. +*10.15 Form of Change of Control Agreement for Senior Executive Officers of SmarterKids.com, Inc. *10.16 Executive Management Agreement. 10.17 Amended and Restated Credit Agreement dated as of December 31, 1999 by and among Earlychildhood.com LLC, each of the banks which is or may from time to time become a signatory thereto and Paribas Bank, Chicago Branch, as Agent. +*10.18 Employment Agreement dated as of May 5, 1999 by and between Earlychildhood.com LLC and Ronald Elliott. +*10.19 Employment Agreement dated as of May 5, 1999 by and between Earlychildhood.com LLC and Judith McGuinn, as amended on January 3, 2000. +10.20 Earlychildhood.com LLC 2000 Management Equity Incentive Option Plan. 10.21 Lease Agreement dated as of March 30, 2000 by and between Earlychildhood.com LLC and PTF For Operating Engineers, LLC. 10.22 Lease Agreement dated as of January 24, 1997 by and between QTL Corporation and Dauphin Associates, Inc. 10.23 Lease Agreement dated as of November 17, 1998 by and between QTL Corporation and Robert M. Mumma, II, G.R.A.T. 10.24 Lease Agreement dated as of April 22, 1996, as amended, by and between QTL Corporation and Rubin Brothers, Inc.
II-2
Exhibit Number Exhibit Title ------- ------------- 10.25 Lease Agreement dated as of December 3, 1993, as amended, by and between Educational Products, Inc. and H B Industrial Properties. 10.26 Lease Agreement dated as of March 23, 1999 by and between QTL Corporation and Spieker Properties, L.P. 10.27 Lease Agreement dated as of November 22, 1999 by and between Earlychildhood.com LLC and Spieker Properties, L.P. *10.28 Lease Agreement dated as of May 5, 1999 by and between Earlychildhood.com LLC and Elliott-Mair Salinas LLC. 10.29 Lease Agreement dated as of January 29, 1996, as amended, by and between Colorations, Inc. and Shaheen & Company. 10.30 Lease Agreement dated as of August 17, 2000 by and between Earlychildhood.com LLC and Mann Realty Associates, Inc. *21.1 Subsidiaries of the Registrant. 23.1 Consent of Testa, Hurwitz & Thibeault, LLP (included in Exhibit 5.1 and Exhibit 8.1). *23.2 Consent of PricewaterhouseCoopers LLP. *23.3 Report on Schedule and Consent of KPMG LLP. *23.4 Consent of KPMG (Educational Products, Inc.). 23.5 Consent of Latham & Watkins (included in Exhibit 8.2). *24.1 Power of Attorney (see page II-4). *99.1 Consent of J.P. Morgan H&Q, a division of Chase Securities Inc. (included in Annex C to the Proxy Statement-Prospectus contained in this Registration Statement). *99.3 Form of proxy to be used in soliciting SmarterKids.com's stockholders for its special meeting. *99.4 SmarterKids.com Stockholder Letter, dated , 2001. *99.5 SmarterKids.com Notice of Special Meeting of Stockholders, dated , 2001. - -------- * Filed herewith. + Management contracts or compensatory plans or arrangements required to be filed as Exhibits to this Form S-4 by Item 601(b)(10)(iii) of Regulation S-K.
(b) Financial Statement Schedules. Schedule II Valuation and Qualifying Accounts
Additions ------------------- Balance at Charged to Charged Balance at beginning costs and to other end of of period expenses accounts Deductions period ---------- ---------- -------- ---------- ---------- Allowance for doubtful accounts: Nine months ended December 31, 1998...... 68 96 -- (95) 69 === === === ==== === Year ended December 31, 1999................... 69 144 35(/1/) (105) 143 === === === ==== === Nine months ended September 30, 2000..... 143 246 -- (148) 241 === === === ==== ===
- -------- (1) Balance acquired through the purchase of Educational Products, Inc. All SmarterKids.com, Inc. schedules have been omitted because they are not required or because the required information is included in the various financial statements and notes thereto. (c) Report, Opinion or Appraisal. The opinion of J.P. Morgan H&Q, a division of Chase Securities Inc., financial advisor to SmarterKids.com, Inc. is attached as Annex C to the Proxy Statement-Prospectus included in this Registration Statement. II-3 Item 22. Undertakings. (a)(1) The undersigned Registrant hereby undertakes as follows: that prior to any public reoffering of the securities registered hereunder through use of a prospectus which is a part of this Registration Statement, by any person or party who is deemed to be an underwriter within the meaning of Rule 145(c), the undersigned Registrant undertakes that such reoffering prospectus will contain the information called for by the applicable registration form with respect to reofferings by persons who may be deemed underwriters, in addition to the information called for by the other Items of the applicable form. (2) The Registrant undertakes that every prospectus (i) that is filed pursuant to paragraph (1) immediately preceding, or (ii) that purports to meet the requirements of Section 10(a)(3) of the Act and is used in connection with an offering of securities subject to Rule 415, will be filed as a part of an amendment to the Registration Statement and will not be used until such amendment is effective, and that, for purposes of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new Registration Statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) Insofar as the indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such directors officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit, to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. (4) The undersigned Registrant hereby undertakes to respond to requests for information that is incorporated by reference into the prospectus pursuant to Items 4, 10(b), 11 or 13 of Form S-4, within one business day of receipt of such request, and to send the incorporated documents by first class mail or other equally prompt means. This includes information contained in documents filed subsequent to the effective date of the Registration Statement through the date of responding to the request. (5) The undersigned Registrant hereby undertakes to supply by means of a post-effective amendment all information concerning a transaction, and the company being acquired involved therein, that was not the subject of and included in the Registration Statement when it became effective. II-4 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in Needham, Massachusetts, on the 9th day of January, 2001. LearningStar Corp. /s/ Al Noyes By: _________________________________ Al Noyes Chief Executive Officer KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Al Noyes and Robert Cahill and each of them acting individually, as such person's true and lawful attorneys-in-fact and agents, each with full power of substitution, for such person, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Registration Statement or under Rule 462(b) of the Securities Act of 1933, as amended, and to file same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as such person might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his or her substitutes, may do or cause to be done by virtue thereof. Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed by the following persons on behalf of the Registrant and in capacities and on the dates indicated:
Signature Title Date --------- ----- ---- /s/ Ronald C. Elliott Chairman of the Board January 8, 2001 ______________________________________ Ronald C. Elliott /s/ Al Noyes Chief Executive Officer January 8, 2001 ______________________________________ (Principal Executive Al Noyes Officer) /s/ Robert J. Cahill Chief Financial Officer January 8, 2001 ______________________________________ (Principal Financial Robert J. Cahill Officer) /s/ Scott L. Graves Director January 8, 2001 ______________________________________ Scott L. Graves /s/ Stephen Kaplan Director January 8, 2001 ______________________________________ Stephen Kaplan
II-5
Signature Title Date --------- ----- ---- /s/ Michael Kolowich Director January 8, 2001 ______________________________________ Michael Kolowich /s/ Robert W. MacDonald Director January 8, 2001 ______________________________________ Robert W. MacDonald
II-6 EXHIBIT INDEX
Exhibit Number Exhibit Title ------- ------------- *2.1 Contribution Agreement and Plan of Reorganization by and among the Registrant, SmarterKids.com, Inc., Earlychildhood.com LLC and S-E Educational Merger Corp., dated as of November 14, 2000 (attached as Annex A to the Proxy Statement-Prospectus contained in this Registration Statement). *3.1 Registrant's Certificate of Incorporation, as amended, as currently in effect. *3.2 Form of Registrant's Restated Certificate of Incorporation (attached as Annex D to the Proxy Statement-Prospectus contained in this Registration Statement). *3.3 Form of Registrant's Amended and Restated Bylaws (attached as Annex E to the Proxy Statement-Prospectus contained in this Registration Statement). 4.1 Form of Specimen Certificate for Registrant's Common Stock. 5.1 Opinion of Testa, Hurwitz & Thibeault, LLP regarding the legality of the securities being issued. 8.1 Opinion of Testa, Hurwitz & Thibeault, LLP regarding certain tax matters. 8.2 Opinion of Latham & Watkins regarding certain tax matters. *9.1 Stockholder Support Agreement by and among Earlychildhood.com, LLC and certain stockholders of SmarterKids.com, Inc. dated as of November 14, 2000 (attached as Annex B to the Proxy Statement-Prospectus contained in this Registration Statement). *9.2 Consent and Non-Contravention Agreement dated as of November 14, 2000 by and among Earlychildhood.com LLC, the holders of the outstanding membership interests in Earlychildhood.com LLC and SmarterKids.com, Inc. +*10.1 Form of 2000 Stock Plan of the Registrant. +*10.2 Form of 2000 Non-Employee Director Stock Option Plan of the Registrant. +*10.3 Form of Employee Stock Purchase Plan of the Registrant. *10.4 Registration Rights Agreement dated November 14, 2000 by and among Registrant and certain stockholders named therein. 10.5 Form of Affiliate Agreement. 10.6 Form of Lockup Agreement. *10.7 Form of Consulting Agreement to be executed by and between Registrant and David Blohm upon completion of the combination. *10.8 Lease Agreements dated as of September 1, 1998 and April 16, 1999 between SmarterKids.com, Inc. and McFarland FLP. *10.9 Lease Agreement dated as of September 8, 1999 between SmarterKids.com, Inc. and BHX, LLC as Trustee of Crawford Realty Trust. *10.10 Lease Agreement dated as of April 7, 2000 between SmarterKids.com, Inc. and Keep Your Day Job, LLC. *10.11 Business Agreement dated as of March 9, 1999 between National Computer Systems and SmarterKids.com, Inc. *10.12 Loan and Security Agreement dated as of November 24, 1999 between SmarterKids.com, Inc. and Silicon Valley Bank. +*10.13 Form of Executive Option Agreement of SmarterKids.com, Inc.
Exhibit Number Exhibit Title ------- ------------- +*10.14 Form of Change of Control Agreement for Executive Officers of SmarterKids.com, Inc. +*10.15 Form of Change of Control Agreement for Senior Executive Officers of SmarterKids.com, Inc. *10.16 Executive Management Agreement. 10.17 Amended and Restated Credit Agreement dated as of December 31, 1999 by and among Earlychildhood.com LLC, each of the banks which is or may from time to time become a signatory thereto and Paribas Bank, Chicago Branch, as Agent. +*10.18 Employment Agreement dated as of May 5, 1999 by and between Earlychildhood.com LLC and Ronald Elliott. +*10.19 Employment Agreement dated as of May 5, 1999 by and between Earlychildhood.com LLC and Judith McGuinn, as amended on January 3, 2000. + 10.20 Earlychildhood.com LLC 2000 Management Equity Incentive Option Plan. 10.21 Lease Agreement dated as of March 30, 2000 by and between Earlychildhood.com LLC and PTF For Operating Engineers, LLC. 10.22 Lease Agreement dated as of January 24, 1997 by and between QTL Corporation and Dauphin Associates, Inc. 10.23 Lease Agreement dated as of November 17, 1998 by and between QTL Corporation and Robert M. Mumma, II, G.R.A.T. 10.24 Lease Agreement dated as of April 22, 1996, as amended, by and between QTL Corporation and Rubin Brothers, Inc. 10.25 Lease Agreement dated as of December 3, 1993, as amended, by and between Educational Products, Inc. and H B Industrial Properties. 10.26 Lease Agreement dated as of March 23, 1999 by and between QTL Corporation and Spieker Properties, L.P. 10.27 Lease Agreement dated as of November 22, 1999 by and between Earlychildhood.com LLC and Spieker Properties, L.P. *10.28 Lease Agreement dated as of August 9, 2000 by and between Earlychildhood.com LLC and Elliott-Mair Salinas LLC. 10.29 Lease Agreement dated as of January 29, 1996, as amended, by and between Colorations, Inc. and Shaheen & Company. 10.30 Lease Agreement dated as of August 17, 2000 by and between Earlychildhood.com LLC and Mann Realty Associates, Inc. *21.1 Subsidiaries of the Registrant. 23.1 Consent of Testa, Hurwitz & Thibeault, LLP (included in Exhibit 5.1 and Exhibit 8.1). *23.2 Consent of PricewaterhouseCoopers LLP. *23.3 Report on Schedule and Consent of KPMG LLP. *23.4 Consent of KPMG LLP (Educational Products, Inc.). 23.5 Consent of Latham & Watkins (included in Exhibit 8.2). *24.1 Power of Attorney (see page II-4).
Exhibit Number Exhibit Title ------- ------------- *99.1 Consent of J.P. Morgan H&Q, a division of Chase Securities Inc. (included in Annex C to the Proxy Statement-Prospectus contained in this Registration Statement). *99.3 Form of proxy to be used in soliciting SmarterKids.com's stockholders for its special meeting. *99.4 SmarterKids.com Stockholder Letter, dated , 2001. *99.5 SmarterKids.com Notice of Special Meeting of Stockholders, dated , 2001.
- -------- * Filed herewith. + Management contracts or compensatory plans or arrangements required to be filed as Exhibits to this Form S-4 by Item 601(b)(10)(iii) of Regulation S-K. (b) Financial Statement Schedules. Schedule II Earlychildhood LLC Valuation and Qualifying Accounts
Additions ------------------- Balance at Charged to Charged Balance at beginning costs and to other end of of period expenses accounts Deductions period ---------- ---------- -------- ---------- ---------- Allowance for doubtful accounts: Nine months ended December 31, 1998...... 68 96 -- (95) 69 === === === ==== === Year ended December 31, 1999................... 69 144 50(/1/) (105) 129 === === === ==== === Nine months ended September 30, 2000..... 143 246 -- (148) 241 === === === ==== ===
- -------- (1) Balance acquired through the purchase of Educational Products, Inc. All SmarterKids.com, Inc. schedules have been omitted because they are not required or because the required information is included in the various financial statements and notes thereto. (c) Report, Opinion or Appraisal. The opinion of J.P. Morgan H&Q, a division of Chase Securities Inc., financial advisor to SmarterKids.com, Inc., is attached as Annex C to the Proxy Statement-Prospectus included in this Registration Statement. EX-3.1 2 0002.txt CERTIFICATE OF INCORPORATION Exhibit 3.1 CERTIFICATE OF INCORPORATION OF S-E EDUCATIONAL HOLDINGS CORP. 1. The name of the corporation is: S-E Educational Holdings Corp. 2. The address of its registered office in the State of Delaware is 2711 Centerville Road, Suite 400, in the City of Wilmington, County of New Castle. The name of its registered agent at such address is Corporation Service Company. 3. The nature of the business or purposes to be conducted or promoted is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware. 4. The total number of shares of stock which the corporation shall have authority to issue is One Thousand (1,000), all of which shall be Common Stock, and the par value of each share shall be one cent ($.01). 5. The name and mailing address of the incorporator is: Victoria C. Phelps Latham & Watkins 633 West Fifth Street Suite 4000 Los Angeles, California 90071 6. In furtherance and not in limitation of the powers conferred by statute, the Board of Directors is expressly authorized to adopt, amend or repeal the bylaws of the corporation. 7. Election of directors need not be by written ballot unless the bylaws of the corporation shall so provide. 8. No director of the corporation shall be personally liable to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of the law, (iii) under Section 174 of the General Corporation Law of Delaware, or (iv) for any transaction from which the director derived an improper personal benefit. I, THE UNDERSIGNED, being the sole incorporator hereinbefore named, for the purpose of forming a corporation pursuant to the General Corporation Law of the State of Delaware, do make this certificate, herein declaring and certifying that this is my act and deed and the facts herein stated are true, and accordingly have hereunto set my hand this 6th day of November, 2000. /s/ Victoria C. Phelps -------------------------------- Victoria C. Phelps, Incorporator CERTIFICATE OF AMENDMENT OF CERTIFICATE OF INCORPORATION OF S-E EDUCATIONAL HOLDINGS CORP. S-E EDUCATIONAL HOLDINGS CORP., a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, DOES HEREBY CERTIFY: FIRST: That, by written consent of the Board of Directors of said corporation as of January 3, 2001, resolutions were duly adopted setting forth a proposed amendment to the Certificate of Incorporation of said corporation, declaring said amendment to be advisable and directing its officers to submit said amendment to the stockholders of said corporation for consideration thereof. The resolutions setting forth the proposed amendment are as follows: WHEREAS, it is deemed to be advisable and in the best interest of the Corporation and its stockholders that the Corporation's Certificate of Incorporation be amended to change the name of the Corporation to LearningStar Corp.; NOW, THEREFORE, BE IT RESOLVED, that Article 1 of the Corporation's Certificate of Incorporation be amended to read as follows: "1. The name of the corporation is LearningStar Corp." RESOLVED FURTHER, that the officers of the Corporation be, and each of them hereby is, authorized, empowered and directed, on behalf of the Corporation, to submit the foregoing amendment to the stockholders of the Corporation for consideration thereof; and RESOLVED FURTHER, that, following approval of the foregoing amendment by the stockholders of the Corporation, the officers of the Corporation be, and each of them hereby is, authorized, empowered and directed, on behalf of the Corporation, to prepare or cause to be prepared and to execute a Certificate of Amendment of the Corporation's Certificate of Incorporation, to file or cause to be filed said Certificate of Amendment with the Delaware Secretary of State, and to execute such other documents and take such other actions as such officer or officers shall deem necessary, appropriate or advisable in order to carry out the intent and purposes of the foregoing resolutions. SECOND: That, thereafter, by written consent of the holders of all of the issued and outstanding shares of capital stock of said corporation, the necessary number of shares required by statute were voted in favor of the amendment. THIRD: That said amendment was duly adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware. IN WITNESS WHEREOF, S-E EDUCATIONAL HOLDINGS CORP. has caused this certificate to be signed by Ronald Elliott, its President, this 3rd day of January, 2001. S-E EDUCATIONAL HOLDINGS CORP. By: /s/ Ronald Elliott ---------------------------- Name: Ronald Elliott Title: President EX-9.2 3 0003.txt CONSENT & NON-CONTRAVENTION AGREEMENT EXHIBIT 9.2 CONSENT AND NON-CONTRAVENTION AGREEMENT This CONSENT AND NON-CONTRAVENTION AGREEMENT, dated as of November 14, 2000 (the "Agreement"), is by and among Earlychildhood.com, LLC, a California limited liability company ("Earlychildhood"), the holders of the outstanding membership interests in Earlychildhood listed on the signature page(s) hereto (collectively, the "Holders" and, individually, a "Holder") and SmarterKids.com, Inc., a Delaware corporation ("SmarterKids") Capitalized terms used in this Agreement, unless specifically defined herein, shall have the meanings given to them in the Contribution Agreement and Plan of Reorganization and Merger, dated as of the date hereof (the "Merger Agreement"), by and among Earlychildhood, SmarterKids, S-E Educational Holdings Corp., a newly-formed Delaware corporation, one-half of the issued and outstanding capital stock of which is owned by each of Earlychildhood and SmarterKids ("Holdings") and S-E Educational Merger Corp., a newly-formed Delaware corporation and a wholly-owned subsidiary of Holdings ("Merger Sub"). WHEREAS, as of the date hereof, each of the Holders owns of record and beneficially membership interests in Earlychildhood (the "LLC Interests") as is set forth on a percentage interest basis next to the name of such Holder in Column II on Annex A hereto; WHEREAS, concurrently with the execution of this Agreement, Earlychildhood and SmarterKids have entered into the Merger Agreement pursuant to which, and upon the terms and subject to the conditions set forth therein, the combination of Earlychildhood and SmarterKids shall be effected through (i) the contribution to Holdings by the holders of LLC Interests of all of the right, title and interest in and to their entire ownership interest in Earlychildhood (the "Contribution") and (ii) the merger of Merger Sub with and into SmarterKids such that SmarterKids becomes a wholly-owned subsidiary of Holdings (the "Merger" and, collectively with the Contribution, the "Transactions"); WHEREAS, at the Effective Time, pursuant to Section 2.1 of the Merger Agreement, all outstanding LLC Interests shall be exchanged for shares of Holdings Common Stock and cash in lieu of fractional shares of Holdings Common Stock to be issued or paid in consideration therefor and pursuant to Section 2.3 of the Merger Agreement, all outstanding options to purchase LLC Interests will be converted into options to purchase shares of Holdings Common Stock; WHEREAS, pursuant to this Agreement, each Holder hereby acknowledges and agrees that such Holder shall, at the Effective Time, receive in exchange for the LLC Interests contributed by such Holder in the Contribution, such number of shares of Holdings Common Stock as is set forth next to the name of such Holder in Column IV of Annex A hereto; and WHEREAS, as a condition to the willingness of Earlychildhood and SmarterKids to enter into the Merger Agreement, SmarterKids has required that the Holders agree, and in order to induce SmarterKids to enter into the Merger Agreement, the Holders have agreed, to enter into this Agreement. NOW, THEREFORE, in consideration of the foregoing premises and the representations, warranties, covenants and agreements set forth herein, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and subject to the terms and conditions set forth herein, the parties hereto hereby agree as follows: ARTICLE I. SECTION 1.1. REPRESENTATIONS AND WARRANTIES OF THE HOLDERS. As of the date hereof and as of the date of the Closing under the Merger Agreement, each Holder on its own behalf hereby represents and warrants with respect to itself and its ownership of the LLC Interests as follows: (a) Holder is the sole owner of record and beneficial owner (as defined in Rule 13d-3 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which meaning will apply for all purposes of this Agreement) of, and has good title to, the LLC Interests set forth adjacent to such Holder's name on Annex A, free and clear of any mortgage, pledge, hypothecation, rights of others, claim, security interest, charge, encumbrance, title defect, title retention agreement, voting trust agreement, interest, option, lien, charge or similar restriction (including any restriction on the right to vote, sell or otherwise dispose of the LLC Interests) or limitation (each, a "Lien") except for immaterial Liens which shall not materially affect such Holder's ability to perform its obligations under this Agreement. (b) Except as set forth on Annex A, and except for the LLC Interests, Holder does not, directly or indirectly, beneficially own or have any option, warrant or other right to acquire any securities of Earlychildhood or any securities that are convertible or exchangeable into or exercisable for any securities of Earlychildhood, nor is Holder subject to any contract, commitment, arrangement, understanding or relationship (whether or not legally enforceable), other than this Agreement and the Operating Agreement, that allows or obligates it to vote or acquire any securities of Earlychildhood. Holder has the exclusive power to vote and dispose of the LLC Interests set forth adjacent to such Holder's name on Annex A and has not granted a proxy to any other individual, corporation, partnership (general or limited), limited liability company, joint venture, association, trust, unincorporated organization or other entity (collectively, a "Person") to vote or dispose of such LLC Interests, subject to the limitations set forth in this Agreement. (c) Each Holder that is a corporation or partnership, as the case may be, is duly organized, validly existing and in good standing under the laws of its jurisdiction of organization and has the power and authority to execute and deliver this Agreement and to consummate the transactions contemplated hereby, and has taken all necessary action to authorize the execution, delivery and performance of this Agreement. (d) This Agreement and each Transaction Document to which Holder is a party has been duly executed and delivered by Holder and, assuming due authorization, execution and delivery of this Agreement by Earlychildhood and SmarterKids, constitutes a valid and binding obligation of Holder enforceable against Holder in accordance with their terms, except that (i) the enforceability hereof or thereof may be subject to applicable bankruptcy, insolvency or other similar laws, now or hereinafter in effect, affecting creditors' rights generally and (ii) the -2- availability of the remedy of specific performance or injunctive or other forms of equitable relief may be subject to equitable defenses and would be subject to the discretion of the court before which any proceeding therefor may be brought. (e) Neither the execution and delivery of this Agreement and each Transaction Document to which Holder is a party, nor the performance by Holder of its obligations hereunder or thereunder will, nor will the consummation of the transactions contemplated by this Agreement and the Merger Agreement, conflict with, result in a violation or breach of, or constitute a default (or an event that, with notice or lapse of time or both, would result in a default) or give rise to any right of termination, amendment, cancellation, or acceleration of any obligation or loss of any material benefit, or result in the creation of any Lien on the LLC Interests under, or require a consent or waiver under (collectively, a "Conflict"), (i) its organizational documents, (ii) any note, bond, mortgage, indenture, lease, contract, commitment, agreement, understanding, arrangement or restriction of any kind to which Holder is a party or by which Holder is bound, to the extent such Conflict would materially affect Holder's ability to consummate the transactions contemplated hereby or (iii) any permit, franchise, license, statute, injunction, judgment, writ, decree, order, ruling, rule or regulation applicable to Holder, to the extent such Conflict would materially affect Holder's ability to consummate the transactions contemplated hereby. (f) Neither the execution and delivery of this Agreement nor the performance by Holder of its obligations hereunder will violate any law, decree, statute, rule or regulation applicable to Holder or require any order, consent, authorization or approval of, filing or registration with, or declaration or notice to, any corporation, Person, firm, Governmental Entity or public or judicial authority, other than any required notices or filings pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the rules and regulations promulgated thereunder or the federal securities laws. There is no beneficiary or holder of a voting trust certificate or other interest of any trust of which any of the Holders is a trustee whose consent is required for the execution and delivery of this Agreement or the compliance by the Holders with the terms hereof. ARTICLE II. SECTION 2.1. TRANSFER OF THE SHARES; NON-INTERFERENCE. (a) During the term of this Agreement, no Holder shall (i) tender into any tender or exchange offer or otherwise sell, offer to sell, transfer, pledge, assign, hypothecate or otherwise dispose of, or encumber with any Lien, any of the LLC Interests; provided, that any Holder may distribute LLC Interests on a pro rata basis to its members or partners to the extent it is obligated to do so under the terms of its organizational documents, so long as, in either case, such member or partner, as the case may be, executes, concurrently with such transfer, a counterpart signature page hereto and agrees to be bound hereby, (ii) other than in connection with this Agreement, deposit the LLC Interests into a voting trust, enter into any voting agreement or similar arrangement with respect to the LLC Interests or grant any proxy or power of attorney with respect to the LLC Interests, or take any action inconsistent with this Agreement or the Merger Agreement without having obtained the prior written consent of SmarterKids, -3- (iii) other than this Agreement, enter into any contract, option or other arrangement or undertaking with respect to the direct or indirect sale, transfer, pledge, assignment, hypothecation or other disposition of the LLC Interests, (iv) take any action that would make any representation of such Holder contained herein untrue or incorrect or would result in a breach by such Holder of its obligations under this Agreement or a breach by Earlychildhood of its obligations under the Merger Agreement or (v) take any action that would have the effect of preventing or disabling such Holder from performing its obligations under this Agreement or Earlychildhood from performing its obligations under the Merger Agreement. (b) Nothing herein shall prevent a Holder from transferring LLC Interests by gift, transfer to a trust or distribution, provided that (i) any such gift, transfer or distribution is permissible under Lock-Up Agreement attached as Exhibit C to the Merger Agreement and (ii) each donee transferee or distributee, as applicable, executes, concurrently with such gifts, transfer or distribution, a counterpart signature page hereto and agrees to be bound hereby. SECTION 2.2. ADJUSTMENTS. (a) In the event (i) of any equity dividend, equity split, recapitalization, reclassification, combination or exchange of equity interests in Earlychildhood on, of or affecting the LLC Interests or the like or any other action that would have the effect of changing any of the Holders' ownership of membership interests in Earlychildhood or (ii) any of the Holders becomes the beneficial owner of any additional membership interests in Earlychildhood, then the terms of this Agreement will apply to the membership interests in Earlychildhood held by any such Holder immediately following the effectiveness of the events described in clause (i) or any such Holder becoming the beneficial owner thereof, as described in clause (ii), as though they were LLC Interests hereunder and the term LLC Interests shall be deemed to refer to and include such membership interests in Earlychildhood. (b) Each Holder hereby agrees, while this Agreement is in effect, that Annex A hereof shall be updated from time to time, as applicable, to increase the LLC Interests set forth therein to reflect any changes resulting from the events described in Section 2.2(a) above. To the extent required under the Merger Agreement, each of the events described in Section 2.2(a) above shall require the prior written consent of SmarterKids. SECTION 2.3. STOP TRANSFER. Each Holder hereby agrees with, and covenants to, each other party hereto, that such Holder shall not request that Earlychildhood register or permit the transfer of any of the LLC Interests, unless such transfer is made in compliance with this Agreement (including the provisions of Section 2.1 hereof). Earlychildhood agrees with, and covenants to, each other party hereto that Earlychildhood shall not register or permit the transfer of any of the LLC Interests, unless such transfer is made in compliance with this Agreement (including the provisions of Section 2.1 hereof). -4- ARTICLE III. SECTION 3.1. CONTRIBUTION OF LLC INTERESTS; NO INCONSISTENT AGREEMENT. (a) Each Holder hereby agrees and commits that at the Closing, following the satisfaction or, if applicable, waiver, of the conditions set forth in the Merger Agreement, such Holder will contribute to Holdings, all of the right, title and interest in and to such Holder's entire ownership interest in Earlychildhood (as set forth in Annex A) and will accept in consideration therefor, (i) that number of shares of Holdings Common Stock as is set forth next to such Holder's name in Column IV of Annex A hereof, as such number of shares of Holdings Common Stock may adjusted from time to time in accordance with the terms of the Merger Agreement or any amendment thereto and (ii) an amount of cash in lieu of fractional shares as calculated pursuant to the Merger Agreement; provided, however, that the obligations of such Holder in this Section 3.1(a) shall not survive the termination of this Agreement in accordance with the terms hereof. Each of the Holders agrees that it will vote (or cause to be voted) its LLC Interests against any Earlychildhood Acquisition Proposal and against any action or agreement that would result in a breach in any respect of any covenant, representation or warranty or any other obligation or agreement under this Agreement or the Merger Agreement or which is intended to, or could reasonably be expected to, impede, interfere with, delay, postpone or materially adversely effect this Agreement, the Merger Agreement, the Contribution, the other transactions contemplated by this Agreement and the Merger Agreement or the benefits to SmarterKids resulting herefrom or therefrom. In addition, no Holder will take any action, directly or indirectly, until the termination of this Agreement to contravene, withdraw, modify or supersede its consent to the Merger Agreement and the Contribution or to cause Earlychildhood to take any action in contravention of the Merger Agreement or the transactions contemplated thereby. Each Holder acknowledges receipt and review of a copy of the Merger Agreement and the opportunity to consult its own legal counsel in regard to the Merger Agreement and this Agreement. (b) Each Holder agrees that it shall not enter into any agreement or understanding with any Person the effect of which would be inconsistent with or violative of the provisions and agreements contained herein, including in this Section 3.1. SECTION 3.2. NO SOLICITATION. Prior to the termination of this Agreement in accordance with its terms, each Holder agrees (a) that it will not, nor will it authorize or permit any of its employees, financial advisors, attorneys, accountants or other representatives or agents to, directly or indirectly through another Person, (i) solicit, initiate or encourage any inquiries, offers or proposals by or from any Other Party that constitute, or could reasonably be expected to lead to, any Earlychildhood Acquisition Proposal, (ii) enter into or execute any agreement with respect to an Earlychildhood Acquisition Proposal, (iii) engage in or continue negotiations or discussions with any Other Party concerning, or, except pursuant to a governmental request for information, otherwise communicate or explore or provide any non-public information to any Other Party relating to, any Earlychildhood Acquisition Proposal, (iv) make or authorize any public statement, recommendation or solicitation in support of any Earlychildhood Acquisition Proposal, or (v) take, or consent to take, any other action inconsistent with its obligations under this Section 3.2 or Earlychildhood's obligation under Section 5.4 of the Merger Agreement, and -5- (b) that it will notify SmarterKids in writing as promptly as practicable (and in any event within 24 hours) if any Earlychildhood Acquisition Proposal is received or any inquiries, proposals or offers with respect to an Earlychildhood Acquisition Proposal are received by, any information or documents are requested from, or any negotiations or discussions are sought to be initiated or continued with, it or any of its Affiliates, such written notice to contain the identity of the other party (including the name of such other party and a copy of any offer or proposal and any supporting documentation), and the terms and conditions of such proposal or offer. ARTICLE IV. SECTION 4.1. TERMINATION. This Agreement shall become effective on the date hereof and shall continue in effect until the earlier of (i) the termination of the Merger Agreement in accordance with its terms and (ii) the consummation of the Transactions. SECTION 4.2. EXPENSES. All costs and expenses incurred by any of the parties hereto will be borne by Earlychildhood. SECTION 4.3. RELIANCE. Holder agrees and acknowledges that SmarterKids is entering into the Merger Agreement in reliance upon each Holder's execution and delivery of this Agreement. SECTION 4.4. FURTHER ASSURANCES. Each party hereto will execute and deliver all such further documents and instruments and take all such further action as may be necessary in order to consummate the transactions contemplated hereby. SECTION 4.5. ENFORCEMENT OF THE AGREEMENT. The Holders acknowledge that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that parties hereto will be entitled to an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the terms and provisions hereof in any court of the United States or any state having jurisdiction, this being in addition to any other remedy to which they are entitled at law or in equity. SECTION 4.6. MISCELLANEOUS. (a) All representations, warranties, covenants and agreements contained herein will terminate upon the termination of this Agreement. (b) Any provision of this Agreement may be waived at any time by the party that is entitled to the benefits thereof. No such waiver, amendment or supplement will be effective unless in writing and signed by the party or parties sought to be bound thereby. Any waiver by any party of a breach of any provision of this Agreement will not operate as or be construed to be a waiver of any other breach of such provision or of any breach of any other provision of this Agreement. The failure of a party to insist upon strict adherence to any term of this Agreement or one or more sections hereof will not be considered a waiver or deprive that party of the right thereafter to insist upon strict adherence to that term or any other term of this Agreement. -6- (c) This Agreement constitutes the entire agreement among the parties hereto with respect to the subject matter hereof, and supersedes all prior agreements among such parties with respect to such matters. This Agreement may not be amended, changed, supplemented, waived or otherwise modified, except upon the delivery of a written agreement executed by the parties hereto. (d) This Agreement will be governed by and construed in accordance with the laws of the State of Delaware, without regard to the conflicts of laws principles thereof. (e) With respect to any suit, action or proceeding initiated by a party to this Agreement arising out of, under or in connection with this Agreement, each Holder, Earlychildhood and SmarterKids submits to the exclusive jurisdiction of any state or federal court sitting in the State of Delaware and irrevocably waive, to the fullest extent permitted by law, any objection that they may now have or hereafter obtain to the laying of venue in any such court in any such suit, action or proceeding. (f) The descriptive headings contained herein are for convenience and reference only and will not affect in any way the meaning or interpretation of this Agreement. (g) All notices and other communications hereunder will be in writing and will be given (and will be deemed to have been duly given upon receipt) by delivery in person, by facsimile, or by registered or certified mail, postage prepaid, return receipt requested, addressed as follows: If to Earlychildhood: Earlychildhood.com, LLC 2 Lower Ragsdale Drive Suite 200 Monterey, CA 93940 Attention: Ronald Elliott Facsimile: (831) 771-5587 If to a Stockholder: At the address(es) beneath such Stockholder's name on Annex A to this Agreement. In each case, with copies to: (i) Latham & Watkins 633 W. Fifth St., Suite 4000 Los Angeles, CA 90071 Attention: Jeffrey L. Kateman, Esq. Facsimile: (213) 891-8763 (ii) SmarterKids.com, Inc. -7- 15 Crawford Street Needham, MA 02494 Attention: Bob Cahill Facsimile: (781) 449-4887 (iii) Testa, Hurwitz & Thibeault, LLP 125 High Street Boston, MA 02110 Attention: Gordon H. Hayes, Jr., Esq. Facsimile: (617) 248-7100 or to such other address as any party may have furnished to the other parties in writing in accordance herewith. (h) This Agreement may be executed in any number of counterparts, each of which will be deemed to be an original, but all of which together will constitute one agreement. (i) This Agreement shall be executed at the same time as the Merger Agreement and at such time shall be valid and binding obligations of each of the parties and signatories thereto. (j) Neither this Agreement nor any of the rights or obligations of any party hereto may be assigned without the prior written consent of the other parties hereto. Any such assignment shall not, however, act as a release of the assigning Person. Subject to the foregoing, this Agreement shall inure to the benefit of and be binding upon the successors and assigns of each of the parties, and no other Person shall have any right, benefit or obligation hereunder. (k) If any term or provision of this Agreement is determined to be invalid, illegal or incapable of being enforced by any rule of law or public policy, all other terms and provisions of this Agreement will nevertheless remain in full force and effect so long as the economic or legal substance of the transactions contemplated hereby is not affected in any manner adverse to any party hereto. Upon any such determination that any term or other provision is invalid, illegal or incapable of being enforced, the parties hereto will negotiate in good faith to modify this Agreement so as to effect the original intent of the parties as closely as possible in an acceptable manner to the end that the transactions contemplated by this Agreement are consummated to the extent possible. (l) All rights, powers and remedies provided under this Agreement or otherwise available in respect hereof at law or in equity will be cumulative and not alternative, and the exercise of any thereof by either party will not preclude the simultaneous or later exercise of any other such right, power or remedy by such party. -8- IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement on the date first above written. EARLYCHILDHOOD.COM, LLC By: /s/ Ronald C. Elliott -------------------------------------- Name: Ronald C. Elliott Title: SMARTERKIDS.COM, INC. By: /s/ David Blohm -------------------------------------- Name: Title: HOLDERS: EDUCATIONAL SIMON, L.L.C., a Delaware limited liability company By: /s/ Michael B. Lenard -------------------------------------- Name: Michael B. Lenard Title: Vice President QTL CORPORATION, a California corporation By: /s/ Ronald C. Elliott -------------------------------------- Name: Ronald C. Elliott Title: RICHARD A. PHELAN, an Individual /s/ Richard A. Phelan -------------------------------------- Richard A. Phelan -9- RONALD W. PHELAN, an Individual /s/ Ronald W. Phelan -------------------------------------- Ronald W. Phelan ACACIA CAPITAL PARTNERS, LLC, a California limited liability company /s/ Duncan Thomas -------------------------------------- Name: Duncan Thomas Title: Partner RANDY DEAN, an Individual /s/ Randy Dean -------------------------------------- Randy Dean DR. JUDITH HERR, an Individual /s/ Dr. Judith Herr -------------------------------------- Dr. Judith Herr STEPHEN KAPLAN, an Individual /s/ Stephen Kaplan -------------------------------------- Stephen Kaplan -10- ANNEX A
Column I Column II Column III Column IV -------- --------- ---------- --------- Number of shares of Holdings Common Stock to Current LLC Interest as be Received at the Name of Holder Class of Interest of the date hereof Effective Time -------------- ----------------- ------------------ -------------- Educational Simon, L.L.C. Class A 47.12111% 23,537,465 QTL Corporation Class B 41.05427% 19,205,598 Ronald Phelan Class B 1.26662% 592,537 Richard Phelan Class B 2.50307% 1,170,961 Acacia Capital Partners, LLC Class C .43493% 101,621 Randy Dean Class C .33333% 77,882 Dr. Judith Herr Class C .33333% 77,882 Stephan Kaplan Class C .33333% 77,882
-11- EX-10.1 4 0004.txt 2000 STOCK PLAN Exhibit 10.1 LEARNINGSTAR CORP. 2000 STOCK OPTION AND INCENTIVE PLAN 1. Purpose. The purpose this 2000 Stock Option and Incentive Plan (the "Plan") is to encourage key employees and directors of LearningStar Corp. (the "Company"), any future parent or subsidiary of the Company (each a "Related Company" and, collectively, the "Related Companies") and certain consultants of the Company or a Related Company, by providing opportunities to participate in the ownership of the Company and its future growth through (a) the grant of options which qualify as "incentive stock options" ("ISOs") under Section 422(b) of the Internal Revenue Code of 1986, as amended (the "Code"); (b) the grant of options which do not qualify as ISOs ("Non-Qualified Options"); (c) awards of stock in the Company ("Awards"); and (d) opportunities to make direct purchases of stock in the Company ("Purchases"). Both ISOs and Non- Qualified Options are referred to hereafter individually as an "Option" and collectively as "Options." Options, Awards and authorizations to make Purchases are referred to hereafter collectively as "Stock Rights." As used herein, the terms "parent" and "subsidiary" mean "parent corporation" and "subsidiary corporation," respectively, as those terms are defined in Section 424 of the Code. 2. Administration of the Plan. A. Board or Committee Administration. The Plan shall be administered by the Board of Directors of the Company (the "Board") or by a committee appointed by the Board (the "Committee"); provided that the Plan shall be administered: (i) to the extent required by applicable regulations under Section 162(m) of the Code, by two or more "outside directors" (as defined in applicable regulations thereunder) and (ii) to the extent required by Rule 16b-3 promulgated under the Securities Exchange Act of 1934 or any successor provision ("Rule 16b-3"), by two or more independent directors appointed by and holding office at the pleasure of the Board, each of whom is both a "non-employee director" as defined by Rule 16b-3 and an "outside director" for purposes of Section 162(m) of the Code. Hereinafter, all references in this Plan to the "Committee" shall mean the Board if no Committee has been appointed. Subject to ratification of the grant or authorization of each Stock Right by the Board (if so required by applicable state law), and subject to the terms of the Plan, the Committee shall have the authority to (i) determine to whom (from among the class of employees eligible under paragraph 3 to receive ISOs) ISOs shall be granted, and to whom (from among the class of individuals and entities eligible under paragraph 3 to receive Non-Qualified Options and Awards and to make Purchases) Non-Qualified Options, Awards and authorizations to make Purchases may be granted; (ii) determine the time or times at which Options or Awards shall be granted or Purchases made; (iii) determine the purchase price of shares subject to each Option or Purchase, which prices shall not be less than the minimum price specified in paragraph 6; (iv) determine whether each Option granted shall be an ISO or a Non-Qualified Option; (v) determine (subject to paragraph 7) the time or times when each Option shall become exercisable and the duration of the exercise period; (vi) extend the period during which outstanding Options may be exercised; (vii) determine whether restrictions such as repurchase options are to be imposed on shares subject to Options, Awards and Purchases and the nature of such restrictions, if any, (viii) interpret the Plan and prescribe and rescind rules and regulations relating to it and (ix) to amend any outstanding Stock Rights; provided that no such amendment shall effect the rights of optionees under the Plan without the written consent of such optionee. If the Committee determines to issue a Non-Qualified Option, it shall take whatever actions it deems necessary, under Section 422 of the Code and the regulations promulgated thereunder, to ensure that such Option is not treated as an ISO. The interpretation and construction by the Committee of any provisions of the Plan or of any Stock Right granted under it shall be final unless otherwise determined by the Board. The Committee may from time to time adopt such rules and regulations for carrying out the Plan as it may deem advisable. No member of the Board or the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any Stock Right granted under it. B. Committee Actions. The Committee may select one of its members as its chairman, and shall hold meetings at such time and places as it may determine. A majority of the Committee shall constitute a quorum and acts of a majority of the members of the Committee at a meeting at which a quorum is present, or acts reduced to or and approved in writing by all the members of the Committee (if consistent with applicable state law), shall be the valid acts of the Committee. From time to time the Board may increase the size of the Committee and appoint additional members thereof, remove members (with or without cause) and appoint new members in substitution therefor, fill vacancies however caused, or remove all members of the Committee and thereafter directly administer the Plan. C. Grant of Stock Rights to Board Members. Stock Rights may be granted to members of the Board. All grants of Stock Rights to members of the Board shall in all other respects be made in accordance with the provisions of this Plan applicable to other eligible persons. Consistent with the provisions of the first sentence of paragraph 2(A) above, members of the Board who either (i) are eligible to receive grants of Stock Rights pursuant to the Plan or (ii) have been granted Stock Rights may vote on any matters affecting the administration of the Plan or the grant of any Stock Rights pursuant to the Plan, except that no such member shall act upon the granting to himself or herself of Stock Rights, but any such member may be counted in determining the existence of a quorum at any meeting of the Board during which action is taken with respect to the granting to such member of Stock Rights. 3. Eligible Employees and Others. ISOs may be granted only to employees of the Company or any Related Company. Non-Qualified Options, Awards and authorizations to make Purchases may be granted to any employee, officer or director (whether or not also an employee) of the Company or any Related Company. Non-Qualified Options, Awards and authorizations to make Purchases may be also granted to consultants of the Company or any Related Company if, and only if, (i) the consultant or adviser renders bona fide services to the Company or any Related Company; (ii) the services rendered by the consultant or adviser are not in connection with the offer or sale of securities in a capital-raising transaction and do not directly or indirectly promote or maintain a market for the securities of the Company or any Related Company; and (iii) the consultant or adviser is a natural person who has contracted directly with the Company or any Related Company to render such services. The granting of any 2 Stock Right to any individual or entity shall neither entitle that individual or entity to, nor disqualify such individual or entity from, participation in any other grant of Stock Rights. 4. Stock Authorized for Issuance under the Plan. A. Number of Shares. The stock subject to Stock Rights shall be authorized but unissued shares of common stock of the Company, par value $.01 per share (the "Common Stock"), or shares of Common Stock reacquired by the Company in any manner. The aggregate number of shares which may be issued pursuant to the Plan is [______________], subject to adjustment as provided in paragraph 13. If any Stock Right granted under the Plan shall expire or terminate for any reason without having been exercised in full or shall cease for any reason to be exercisable in whole or in part or shall be repurchased by the Company, the shares of Common Stock subject to such Stock Right shall again be available for grants of Stock Rights under the Plan, provided however, that the cumulative number of such shares that may be so reissued under the Plan shall not exceed [______________]. B. Per Participant Limit. Subject to adjustment as provided in paragraph 13, no participant in the Plan may be granted Stock Rights during any one fiscal year to purchase more than [_____________] shares of Common Stock. 5. Granting of Stock Rights. Stock Rights may be granted after the Plan is approved by the Board, and Stock Rights may no longer be granted after the tenth (10th) anniversary of the date that the Plan is adopted by the Board. The date of grant of a Stock Right under the Plan shall be the date specified by the Committee at the time it grants the Stock Right; provided, however, that such date shall not be prior to the date on which the Committee acts to approve the grant. 6. Minimum Option Price; ISO Limitations. A. Price for Non-Qualified Options, Awards and Purchases. The exercise price per share specified in the agreement relating to each Non- Qualified Option granted, and the purchase price per share of stock granted in any Award or authorized as a Purchase, under the Plan shall in no event be less than the minimum legal consideration required therefor under the laws of any jurisdiction in which the Company or its successors in interest may be organized. Non-Qualified Options granted under the Plan, with an exercise price less than the fair market value per share of Common Stock on the date of grant, are intended to qualify as performance-based compensation under Section 162(m) of the Code and any applicable regulations thereunder. Any such Non-Qualified Options granted under the Plan shall be exercisable only upon the attainment of a pre-established, objective performance goal established by the Committee and subject to any additional limitations set forth in Section 162(m) of the Code, including all amendments thereto. B. Price for ISOs. The exercise price per share specified in the agreement relating to each ISO granted under the Plan shall not be less than the fair market value per share of Common Stock on the date of such grant. In the case of an ISO to be granted 3 to an employee owning stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any Related Company, the price per share specified in the agreement relating to such ISO shall not be less than one hundred ten percent (110%) of the fair market value per share of Common Stock on the date of grant. For purposes of determining stock ownership under this paragraph, the rules of Section 424(d) of the Code shall apply. C. $100,000 Annual Limitation on ISO Vesting. Each eligible employee may be granted Options treated as ISOs only to the extent that, in the aggregate under this Plan and all incentive stock option plans of the Company and any Related Company, ISOs do not become exercisable for the first time by such employee during any calendar year with respect to stock having a fair market value (determined at the time the ISOs were granted) in excess of $100,000. The Company intends to designate any Options granted in excess of such limitation as Non-Qualified Options. D. Determination of Fair Market Value. If, at the time an Option is granted under the Plan, the Company's Common Stock is publicly traded, "fair market value" shall be determined as of the date of grant or, if the prices or quotes discussed in this sentence are unavailable for such date, the last business day for which such prices or quotes are available prior to the date of grant and shall mean (i) the average (on that date) of the high and low prices of the Common Stock on the principal national securities exchange on which the Common Stock is traded, if the Common Stock is then traded on a national securities exchange; or (ii) the last reported sale price (on that date) of the Common Stock on the Nasdaq National Market, if the Common Stock is not then traded on a national securities exchange; or (iii) the closing bid price (or average of bid prices) last quoted (on that date) by an established quotation service for over-the-counter securities, if the Common Stock is not reported on the Nasdaq National Market. If the Common Stock is not publicly traded at the time an Option is granted under the Plan, "fair market value" shall mean the fair value of the Common Stock as determined by the Committee after taking into consideration all factors which it deems appropriate, including, without limitation, recent sale and offer prices of the Common Stock in private transactions negotiated at arm's length. 7. Option Duration. Subject to earlier termination as provided in paragraphs 9 and 10 or in the agreement relating to such Option, each Option shall expire on the date specified by the Committee, but not more than (i) ten years from the date of grant in the case of Options generally, and (ii) five years from the date of grant in the case of ISOs granted to an employee owning stock possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company or any Related Company, as determined under paragraph 6(B). Subject to earlier termination as provided in paragraphs 9 and 10, the term of each ISO shall be the term set forth in the original instrument granting such ISO, except with respect to any part of such ISO that is converted into a Non-Qualified Option pursuant to paragraph 17. 8. Exercise of Option. Subject to the provisions of paragraphs 9 through 12, each Option granted under the Plan shall be exercisable as follows: 4 A. Vesting. The Option shall either be fully exercisable on the date of grant or shall become exercisable thereafter in such installments as the Committee may specify. B. Full Vesting of Installments. Once an installment becomes exercisable it shall remain exercisable until expiration or termination of the Option, unless otherwise specified by the Committee. C. Partial Exercise. Each Option or installment may be exercised at any time or from time to time, in whole or in part, for up to the total number of shares with respect to which it is then exercisable. D. Acceleration of Vesting. The Committee shall have the right to accelerate the date that any installment of any Option becomes exercisable; provided that the Committee shall not, without the consent of an optionee, accelerate the permitted exercise date of any installment of any Option granted to any employee as an ISO (and not previously converted into a Non- Qualified Option pursuant to paragraph 17) if such acceleration would violate the annual vesting limitation contained in Section 422(d) of the Code, as described in paragraph 6(C). 9. Termination of Employment. Unless otherwise specified in the agreement relating to such ISO, if an ISO optionee ceases to be employed by the Company and all Related Companies other than by reason of death or disability as defined in paragraph 10, no further installments of his or her ISOs shall become exercisable, and his or her ISOs shall terminate on the earlier of (a) ninety (90) days after the date of termination of his or her employment, or (b) their specified expiration dates, except to the extent that such ISOs (or unexercised installments thereof) have been converted into Non-Qualified Options pursuant to paragraph 17. For purposes of this paragraph 9, employment shall be considered as continuing uninterrupted during any bona fide leave of absence (such as those attributable to illness, military obligations or governmental service); provided that the period of such leave does not exceed 90 days or, if longer, any period during which such optionee's right to reemployment is guaranteed by statute. A bona fide leave of absence with the written approval of the Committee shall not be considered an interruption of employment under this paragraph 9, provided that such written approval contractually obligates the Company or any Related Company to continue the employment of the optionee after the approved period of absence. ISOs granted under the Plan shall not be affected by any change of employment within or among the Company and Related Companies, so long as the optionee continues to be an employee of the Company or any Related Company. Nothing in the Plan shall be deemed to give any grantee of any Stock Right the right to be retained in employment or other service by the Company or any Related Company for any period of time. 10. Death; Disability. A. Death. If an ISO optionee ceases to be employed by the Company and all Related Companies by reason of his or her death, any ISO owned by such optionee may be exercised, to the extent otherwise exercisable on the date of death, by the estate, personal representative or beneficiary who has acquired the ISO by will or by the laws of 5 descent and distribution, until the earlier of (i) the specified expiration date of the ISO or (ii) 180 days from the date of the optionee's death. B. Disability. If an ISO optionee ceases to be employed by the Company and all Related Companies by reason of his or her disability, such optionee shall have the right to exercise any ISO held by him or her on the date of termination of employment, for the number of shares for which he or she could have exercised it on that date, until the earlier of (i) the specified expiration date of the ISO or (ii) 180 days from the date of the termination of the optionee's employment. For the purposes of the Plan, the term "disability" shall mean "permanent and total disability" as defined in Section 22(e)(3) of the Code or any successor statute. 11. Assignability. No Stock Right shall be assignable or transferable by the grantee except by will, by the laws of descent and distribution. Except as set forth in the previous sentence, during the lifetime of a grantee each Stock Right shall be exercisable only by such grantee. 12. Terms and Conditions of Options. Options shall be evidenced by instruments (which need not be identical) in such forms as the Committee may from time to time approve. Such instruments shall conform to the terms and conditions set forth in paragraphs 6 through 11 hereof and may contain such other provisions as the Committee deems advisable which are not inconsistent with the Plan, including restrictions applicable to shares of Common Stock issuable upon exercise of Options. The Committee may specify that any Non- Qualified Option shall be subject to the restrictions set forth herein with respect to ISOs, or to such other termination and cancellation provisions as the Committee may determine. The Committee may from time to time confer authority and responsibility on one or more of its own members and/or one or more officers of the Company to execute and deliver such instruments. The proper officers of the Company are authorized and directed to take any and all action necessary or advisable from time to time to carry out the terms of such instruments. 13. Adjustments. Upon the occurrence of any of the following events, an optionee's rights with respect to Options granted to such optionee hereunder shall be adjusted as hereinafter provided, unless otherwise specifically provided in the written agreement between the optionee and the Company relating to such Option: A. Stock Dividends and Stock Splits. If the shares of Common Stock shall be subdivided or combined into a greater or smaller number of shares or if the Company shall issue any shares of Common Stock as a stock dividend on its outstanding Common Stock, the number of shares of Common Stock deliverable upon the exercise of Options shall be appropriately increased or decreased proportionately, and appropriate adjustments shall be made in the purchase price per share to reflect such subdivision, combination or stock dividend. B. Consolidations or Mergers. If the Company is to be consolidated with or acquired by another entity in a merger or other reorganization in which the holders of the outstanding voting stock of the Company immediately preceding the consummation of such event, shall, immediately following such event, hold, as a group, less than a 6 majority of the voting securities of the surviving or successor entity, or in the event of a sale of all or substantially all of the Company's assets or otherwise (each, an "Acquisition"), the Committee or the board of directors of any entity assuming the obligations of the Company hereunder (the "Successor Board"), shall, as to outstanding Options, either (i) make appropriate provision for the continuation of such Options by substituting on an equitable basis for the shares then subject to such Options either (a) the consideration payable with respect to the outstanding shares of Common Stock in connection with the Acquisition, (b) shares of stock of the surviving or successor corporation or (c) such other securities as the Successor Board deems appropriate, the fair market value of which shall not materially exceed the fair market value of the shares of Common Stock subject to such Options immediately preceding the Acquisition; or (ii) upon written notice to the optionees, provide that all Options must be exercised, to the extent then exercisable or to be exercisable as a result of the Acquisition, within a specified number of days of the date of such notice, at the end of which period the Options shall terminate; or (iii) terminate all Options in exchange for a cash payment equal to the excess of the fair market value of the shares subject to such Options (to the extent then exercisable or to be exercisable as a result of the Acquisition) over the exercise price thereof. C. Recapitalization or Reorganization. In the event of a recapitalization or reorganization of the Company (other than a transaction described in subparagraph B above) pursuant to which securities of the Company or of another corporation are issued with respect to the outstanding shares of Common Stock, an optionee upon exercising an Option shall be entitled to receive for the purchase price paid upon such exercise the securities he or she would have received if he or she had exercised such Option prior to such recapitalization or reorganization. D. Modification of ISOs. Notwithstanding the foregoing, any adjustments made pursuant to subparagraphs A, B or C with respect to ISOs shall be made only after the Committee, after consulting with counsel for the Company, determines whether such adjustments would constitute a "modification" of such ISOs (as that term is defined in Section 424 of the Code) or would cause any adverse tax consequences for the holders of such ISOs. If the Committee determines that such adjustments made with respect to ISOs would constitute a modification of such ISOs or would cause adverse tax consequences to the holders, it may refrain from making such adjustments. E. Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the Company, each Option shall terminate immediately prior to the consummation of such proposed action or at such other time and subject to such other conditions as shall be determined by the Committee. F. Issuances of Securities. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares subject to Options. No adjustments 7 shall be made for dividends paid in cash or in property other than securities of the Company. G. Fractional Shares. No fractional shares shall be issued under the Plan and the optionee shall receive from the Company cash in lieu of such fractional shares. H. Adjustments. Upon the happening of any of the events described in subparagraphs A, B or C above, the class and aggregate number of shares set forth in paragraph 4 hereof that are subject to Stock Rights which previously have been or subsequently may be granted under the Plan shall also be appropriately adjusted to reflect the events described in such subparagraphs. The Committee or the Successor Board shall determine the specific adjustments to be made under this paragraph 13 and, subject to paragraph 2, its determination shall be conclusive. 14. Means of Exercising Options. An Option (or any part or installment thereof) shall be exercised by giving written notice to the Company at its principal office address, or to such transfer agent as the Company shall designate. Such notice shall identify the Option being exercised and specify the number of shares as to which such Option is being exercised, accompanied by full payment of the purchase price therefor either (a) in United States dollars in cash or by check, (b) at the discretion of the Committee, through delivery of shares of Common Stock having a fair market value equal as of the date of the exercise to the cash exercise price of the Option, (c) at the discretion of the Committee, by delivery of the grantee's personal recourse note bearing interest payable not less than annually at no less than 100% of the lowest applicable Federal rate, as defined in Section 1274(d) of the Code, (d) at the discretion of the Committee and consistent with applicable law, through the delivery of an assignment to the Company of a sufficient amount of the proceeds from the sale of the Common Stock acquired upon exercise of the Option and an authorization to the broker or selling agent to pay that amount to the Company, which sale shall be at the participant's direction at the time of exercise, or (e) at the discretion of the Committee, by any combination of (a), (b), (c) and (d) above. If the Committee exercises its discretion to permit payment of the exercise price of an ISO by means of the methods set forth in clauses (b), (c), (d) or (e) of the preceding sentence, such discretion shall be exercised in writing at the time of the grant of the ISO in question. The holder of an Option shall not have the rights of a shareholder with respect to the shares covered by such Option until the date of issuance of a stock certificate to such holder for such shares. Except as expressly provided above in paragraph 13 with respect to changes in capitalization and stock dividends, no adjustment shall be made for dividends or similar rights for which the record date is before the date such stock certificate is issued. 15. Conditions on Delivery of Stock. The Company shall not be obligated to deliver any shares of Common Stock pursuant to the Plan or to remove restrictions from shares previously delivered under the Plan until (i) all conditions of the Award have been met or removed to the satisfaction of the Company, (ii) in the opinion of the Company's counsel, all other legal matters in connection with the issuance and delivery of such shares have been satisfied, including any applicable securities laws and any applicable stock exchange or stock market rules and regulations, and (iii) the optionee has executed and delivered to the Company such representations or agreements as the Company may consider appropriate to satisfy the requirements of any applicable laws, rules or regulations. 8 16. Term and Amendment of Plan. This Plan shall be submitted for the approval of the Company's stockholders within twelve months after the date of the Board's initial approval of the Plan. The Plan shall expire after the 10th anniversary of the date that the Plan is approved by the Board (except as to Options outstanding on that date). The Board may at any time wholly or partially amend, alter, suspend or terminate the Plan. However, without approval of the Company's stockholders given within twelve (12) months before or after action by the Board, no action of the Board may, except as provided in paragraph 13, increase the limits imposed in paragraph 4 on the maximum number of shares which may be issued under the Plan or extend the term of the Plan under this paragraph 16. The Board shall obtain stockholder approval of any Plan amendment to the extent necessary and desirable to comply with applicable tax laws. No amendment, alteration, suspension or termination of the Plan shall impair the rights of any optionee, unless mutually agreed otherwise between the optionee and the Company, which agreement must be in writing and signed by the optionee and the Company. Termination of the Plan shall not affect the Committee's ability to exercise the powers granted to it hereunder with respect to Stock Rights granted or awarded under the Plan prior to the date of such termination. 17. Conversion of ISOs into Non-Qualified Options. The Committee, at the written request or with the written consent of any optionee, may in its discretion take such actions as may be necessary to convert such optionee's ISOs (or any installments or portions of installments thereof) that have not been exercised on the date of conversion into Non-Qualified Options at any time prior to the expiration of such ISOs, regardless of whether the optionee is an employee of the Company or a Related Company at the time of such conversion. Such actions may include, but shall not be limited to, extending the exercise period or reducing the exercise price of the appropriate installments of such ISOs. At the time of such conversion, the Committee (with the consent of the optionee) may impose such conditions on the exercise of the resulting Non- Qualified Options as the Committee in its discretion may determine, provided that such conditions shall not be inconsistent with this Plan. Nothing in the Plan shall be deemed to give any optionee the right to have such optionee's ISOs converted into Non-Qualified Options, and no such conversion shall occur until and unless the Committee takes appropriate action. 18. Application of Funds. The proceeds received by the Company from the sale of shares pursuant to Options granted and Purchases authorized under the Plan shall be used for general corporate purposes. 19. Notice to Company of Disqualifying Disposition. By accepting an ISO granted under the Plan, each optionee agrees to notify the Company in writing immediately after such optionee makes a Disqualifying Disposition (as described in Sections 421, 422 and 424 of the Code and regulations thereunder) of any stock acquired pursuant to the exercise of ISOs granted under the Plan. A Disqualifying Disposition is generally any disposition occurring on or 9 before the later of (a) the date two years following the date the ISO was granted or (b) the date one year following the date the ISO was exercised. 20. Withholding of Additional Income Taxes. Upon the exercise of a Non- Qualified Option, the grant of an Award, the making of a Purchase of Common Stock for less than its fair market value, the making of a Disqualifying Disposition (as defined in paragraph 19), the vesting or transfer of restricted stock or securities acquired on the exercise of an Option hereunder, or the making of a distribution or other payment with respect to such stock or securities, the Company may withhold taxes in respect of amounts that constitute compensation includible in gross income. The Committee in its discretion may condition (i) the exercise of an Option, (ii) the grant of an Award, (iii) the making of a Purchase of Common Stock for less than its fair market value, or (iv) the vesting or transferability of restricted stock or securities acquired by exercising an Option, on the grantee's making satisfactory arrangement for such withholding. Such arrangement may include payment by the grantee in cash or by check of the amount of the withholding taxes or, at the discretion of the Committee, by the grantee's delivery of previously held shares of Common Stock or the withholding from the shares of Common Stock otherwise deliverable upon exercise of a Option shares having an aggregate fair market value equal to the amount of such withholding taxes. Notwithstanding any other provision of the Plan, the number of shares of Common Stock which may be withheld upon the exercise or vesting of any right under the Plan, or which may be repurchased from the participant within six months after such shares were acquired by the participant from the Company, in order to satisfy the participant's federal and state income and payroll tax liabilities with respect to the exercise or vesting of the right shall be limited to the number of shares which have a fair market value equal to the aggregate amount of such liabilities based on the minimum statutory withholding rates for federal and state tax income and payroll tax purposes that are applicable to such supplemental taxable income. 21. No Right To Employment or Other Status. No person shall have any claim or right to be granted a Stock Right, and the grant of a Stock Right shall not be construed as giving the grantee the right to continued employment or any other relationship with the Company. The Company expressly reserves the right at any time to dismiss or otherwise terminate its relationship with a grantee free from any liability or claim under the Plan. 22. Governmental Regulation. The Company's obligation to sell and deliver shares of the Common Stock under this Plan is subject to the approval of any governmental authority required in connection with the authorization, issuance or sale of such shares. Government regulations may impose reporting or other obligations on the Company with respect to the Plan. For example, the Company may be required to send tax information statements to employees and former employees that exercise ISOs under the Plan, and the Company may be required to file tax information returns reporting the income received by grantees of Options in connection with the Plan. 23. Governing Law. The validity and construction of the Plan and the instruments evidencing Options shall be governed by the laws of the state of Delaware. 10 EX-10.2 5 0005.txt 2000 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN EXHIBIT 10.2 LEARNINGSTAR CORP. -------------------------- 2000 NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN 1. Purpose. This 2000 Non-Employee Director Stock Option Plan (the "Plan") is intended to promote the interests of LearningStar Corp. (the "Company") by providing an inducement to obtain and retain the services of qualified persons who are not employees or officers of the Company to serve as members of its Board of Directors (the "Board"). 2. Available Shares. The total number of shares of Common Stock, par value $.01 per share, of the Company (the "Common Stock") for which Options (as defined below) may be granted under the Plan shall not exceed [__________] shares, subject to adjustment in accordance with paragraph 10 of the Plan. Shares subject to the Plan are authorized but unissued shares or shares that were previously issued and subsequently reacquired by the Company. If any Options granted under the Plan are surrendered or lapse without exercise, in whole or in part, the shares reserved therefor shall continue to be available under the Plan. 3. Administration. The Plan shall be administered by the Board or by a committee appointed by the Board (the "Committee"). In the event the Board fails to appoint or refrains from appointing a Committee, the Board shall have all power and authority to administer the Plan. In such event, the word "Committee" wherever used herein shall be deemed to mean the Board. The Committee shall, subject to the provisions of the Plan, have the power to construe the Plan, to determine all questions hereunder, and to adopt and amend such rules and regulations for the administration of the Plan as it may deem desirable. No member of the Board or the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any Option granted under it. 4. Automatic Grant of Options. The Plan shall first become effective on the date that the Plan is approved by the Board (the "Effective Date"). Subject to the availability of shares under the Plan, (a) each person who first becomes a member of the Board after the Effective Date and who is not an employee or officer of the Company (each a "Non-Employee Director" and, collectively, "Non-Employee Directors") shall be automatically granted on the date such person is first elected to the Board, without further action by the Board, an option to purchase [45,000] shares of the Common Stock, provided, that the grant described in this clause (a) shall not be made to any person who served as a non-employee director of Smarterkids.com, Inc. prior to the Effective Date, and (b) each Non-Employee Director (whether or not such person was elected initially before or after the Effective Date) upon reelection to the Board of Directors during the term of the Plan, shall be automatically granted on each such date an option to purchase an additional [2,000] shares of Common Stock (each an, "Option" and, collectively, the "Options"). The Options to be granted under this paragraph 4 shall be the only Options granted at any time to any Non-Employee Director (each an "Optionee" and, collectively, the "Optionees") under the Plan. The number of shares covered by Options granted under this paragraph 4 shall be subject to adjustment pursuant to paragraph 10 of the Plan. Notwithstanding anything to the contrary set forth herein, if the Plan is not approved by a majority of the Company's stockholders present, or represented, and voting on such matter at the first meeting of stockholders of the Company following the Effective Date, then the Plan and the Options granted pursuant to this Section 4 shall terminate and become void, and no further Options shall be granted under the Plan. 5. Option Price. The purchase price of the shares of stock covered by an Option granted pursuant to the Plan shall be 100% of the fair market value of such shares (the "Exercise Price") on the day the Option is granted (the "Grant Date"), subject to adjustments pursuant to paragraph 10 of the Plan. For purposes of the Plan, if, at the time an option is granted under the Plan, the Company's Common Stock is publicly traded, "fair market value" shall be determined as of the last business day for which the prices or quotes discussed in this sentence are available prior to the Grant Date and shall mean (i) the average (on that date) of the high and low prices of the Common Stock on the principal national securities exchange on which the Common Stock is traded, if the Common Stock is then traded on a national securities exchange; or (ii) the last reported sale price (on that date) of the Common Stock on the Nasdaq National Market, if the Common Stock is not then traded on a national securities exchange; or (iii) the closing bid price (or average of bid prices) last quoted (on that date) by an established quotation service for over- the-counter securities, if the Common Stock is not traded on the Nasdaq National Market. However, if the Common Stock is not publicly traded at the time an option is granted under the Plan, "fair market value" shall be deemed to be the fair value of the Common Stock as determined by the Committee after taking into consideration all factors which it deems appropriate, including, without limitation, recent sale and offer prices of the Common Stock in private transactions negotiated at arm's length. 6. Period of Option. Unless sooner terminated in accordance with the provisions of paragraph 8 of the Plan, an Option granted hereunder shall expire on the date which is ten (10) years after the date of grant of the Option. 7. Vesting of Shares and Non-Transferability of Options. (a) Vesting of Shares. Subject to paragraphs 8 and 10 of the Plan, Options held by each Optionee shall vest and become exercisable in accordance with the following schedule, provided that the Optionee has continuously served as a member of the Board through the following vesting dates: Percentage Date of Vesting - -------------------------------------------------------------------------------- 33 1/3% One year from the date of grant - -------------------------------------------------------------------------------- 66 2/3% Two years from the date of grant - -------------------------------------------------------------------------------- 100% Three years from the date of grant - -------------------------------------------------------------------------------- The number of shares as to which Options may be exercised shall be cumulative, so that once the Option becomes exercisable as to any shares it shall continue to be exercisable as to such shares, until expiration or termination of the Option as provided in the Plan. 2 (b) Non-transferability. Any Option granted pursuant to the Plan shall not be assignable or transferable other than by will or the laws of descent and distribution or pursuant to a domestic relations order and, subject to paragraph 8(b), shall only be exercisable during the Optionee's lifetime. 8. Termination of Option Rights. -------------------------------- (a) In the event an Optionee ceases to be a member of the Board for any reason other than death or permanent disability, any unexercised portion of Options granted to such Optionee shall, to the extent not then vested, immediately terminate and become void; any portion of an Option which is then vested but has not been exercised at the time the Optionee so ceases to be a member of the Board may be exercised by the Optionee within 90 days after the date the Optionee ceased to be a member of the Board; and all Options shall terminate after such 90 days have expired. (b) In the event that an Optionee ceases to be a member of the Board by reason of his or her death or permanent disability, any Option granted to such Optionee shall be immediately and automatically accelerated and become fully vested and exercisable by the Optionee (or by the Optionee's personal representative, heir or legatee, in the event of death) until the scheduled expiration date of the Option. (c) No portion of an Option may be exercised if the Optionee is removed from the Board of Directors for any one of the following reasons: (i) disloyalty, gross negligence, dishonesty or breach of fiduciary duty to the Company; or (ii) the commission of an act of embezzlement, fraud or deliberate disregard of the rules or policies of the Company which results in loss, damage or injury to the Company, whether directly or indirectly; or (iii) the unauthorized disclosure of any trade secret or confidential information of the Company; or (iv) the commission of an act which constitutes unfair competition with the Company, or which induces any customer of the Company to break a contract with the Company; or (v) any activity on behalf of any organization or entity which is a competitor of the Company, unless such conduct is approved by a majority of the members of the Board of Directors. 9. Exercise of Option. Subject to the terms and conditions of the Plan and the option agreements, an Option granted hereunder shall, to the extent then exercisable, be exercisable in whole or in part by giving written notice addressed to the Company at [_____________________________], or the last address indicated by the Company, stating the number of shares with respect to which the Option is being exercised, accompanied by payment in full for such shares. Payment may be (a) in United States dollars in cash or by check, (b) in whole or in part in shares of the Common Stock of the Company already owned by the person or persons exercising the Option or shares subject to the Option being exercised (subject to such restrictions and guidelines as the Board may adopt from time to time), valued at fair market value determined in accordance with the provisions of paragraph 5 or (c) consistent with applicable law, through the delivery of an assignment to the Company of a sufficient amount of the proceeds from the sale of the Common Stock acquired upon exercise of the Option and an authorization to the broker or selling agent to pay that amount to the Company, which sale shall be at the Optionee's direction at 3 the time of exercise. There shall be no such exercise at any one time as to fewer than the lesser of one hundred (100) shares or the total number of shares that the Optionee may exercise under his or her respective Option. The Company's transfer agent shall, on behalf of the Company, prepare a certificate or certificates representing such shares acquired pursuant to exercise of the Option, shall register the Optionee as the owner of such shares on the books of the Company and shall cause the fully executed certificate(s) representing such shares to be delivered to the Optionee as soon as practicable after payment of the Exercise Price in full. The holder of an Option shall not have any rights of a stockholder with respect to the shares covered by the Option, except to the extent that certificates for such shares are delivered to him or her upon the due exercise of the Option. 10. Adjustments Upon Changes in Capitalization and Other Events. Upon the occurrence of any of the following events, an Optionee's rights with respect to Options granted to him or her hereunder shall be adjusted as hereinafter provided: (a) Stock Dividends and Stock Splits. If the shares of Common Stock shall be subdivided or combined into a greater or smaller number of shares or if the Company shall issue any shares of Common Stock as a stock dividend on its outstanding Common Stock, the number of shares of Common Stock deliverable upon the exercise of Options shall be appropriately increased or decreased proportionately, and appropriate adjustments shall be made in the purchase price per share to reflect such subdivision, combination or stock dividend. (b) Recapitalization Adjustments. In the event of a reorganization, recapitalization, merger, consolidation, or any other change in the corporate structure or shares of the Company, to the extent permitted by Rule 16b-3 under the Securities Exchange Act of 1934, the Committee shall make adjustments in the number and kind of shares authorized by the Plan and in the number and kind of shares covered by the Plan, and in the Exercise Price of outstanding Options under the Plan necessary to maintain the proportionate interest of the Optionee and preserve, without exceeding, the value of such Option. Notwithstanding the foregoing, no such adjustment shall be made which would, within the meaning of any applicable provisions of the Internal Revenue Code of 1986, as amended, constitute a modification, extension or renewal of any Option or a grant of additional benefits to the holder of any Option. (c) Issuances of Securities. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or Exercise Price of shares subject to Options. No adjustments shall be made for dividends paid in cash or in property except as set forth in subsection (a) above. (d) Adjustments. The Board shall determine the specific adjustments to be made under this paragraph 10 and its determination shall be conclusive. 4 11. Restrictions on Issuance of Shares. Notwithstanding the provisions of paragraphs 4 and 9 of the Plan, the Company shall have no obligation to deliver any certificate or certificates upon exercise of an Option until one of the following conditions shall be satisfied: (i) The shares subject to the Option are effectively registered under applicable Federal and state securities laws as now in force or hereafter amended; or (ii) Counsel for the Company shall have given an opinion that the issuance of such shares is exempt from registration under Federal and state securities laws as now in force or hereafter amended; and that the Company has complied with all applicable laws and regulations with respect thereto, including without limitation all regulations required by any stock exchange upon which the Company's outstanding Common Stock is then listed. 12. Legend on Certificates. The certificates representing shares issued pursuant to the exercise of an Option granted hereunder shall include such appropriate legends, and such written instructions to the Company's transfer agent, as may be deemed necessary or advisable by counsel to the Company in order to comply with the requirements of the Securities Act of 1933, as amended (the "Securities Act") or any state securities laws. 13. Representation of Optionee. If requested by the Company, the Optionee shall deliver to the Company written representations and warranties upon exercise of the Option that are necessary to show compliance with Federal and state securities laws, including representations and warranties to the effect that a purchase of shares under the Option is made for investment and not with a view to their distribution (as that term is used in the Securities Act). 14. Option Agreement. Each Option granted under the provisions of the Plan shall be evidenced by an option agreement, which agreement shall be duly executed and delivered on behalf of the Company and by the Optionee to whom such Option is granted. The option agreement shall contain such terms, provisions and conditions not inconsistent with the Plan as may be determined by the officer executing such option agreement. 15. Termination and Amendment of Plan. Options may no longer be granted under the Plan after the tenth (10th) anniversary of the date that the Plan is approved by the Board, and the Plan shall terminate when all Options granted or to be granted hereunder are no longer outstanding. The Board may at any time wholly or partially amend, alter, suspend or terminate the Plan. However, without approval of the Company's stockholders given within twelve (12) months before or after the action by the Board, no action of the Company's Board of Directors may, except as provided in paragraph 10, increase the limits imposed in paragraph 2 on the maximum number of shares which may be issued under the Plan or extend the term of the Plan under paragraph 15. The Board shall obtain stockholder approval of any Plan amendment to the extent necessary and desirable to comply with applicable tax laws. 5 No amendment, alteration, suspension or termination of the Plan shall impair the rights of any Optionee, unless mutually agreed otherwise between the Optionee and the Company, which agreement must be in writing and signed by the Optionee and the Company. Termination of the Plan shall not affect the Committee's ability to exercise the powers granted to it hereunder with respect to Options granted or awarded under the Plan prior to the date of such termination. 16. Withholding of Income Taxes. Upon the exercise of an Option, the Committee at its sole discretion may either require payment in cash or a deduction from other compensation payable to each Optionee of any sums required by federal, state or local tax law to be withheld with respect to the issuance, vesting, exercise or payment of any Option. The Committee may also in its sole discretion and in satisfaction of the foregoing requirement allow such Optionee to elect to have the Company withhold shares of Common Stock otherwise issuable under such Option (or allow the return of shares of Common Stock) having a fair market value equal to the sums required to be withheld. Notwithstanding any other provision of the Plan, the number of shares of Common Stock which may be withheld upon the exercise or vesting of any right under the Plan, or which may be repurchased from the Optionee within six months after such shares were acquired by the Optionee from the Company, in order to satisfy the Optionee's federal and state income and payroll tax liabilities with respect to the exercise or vesting of the right shall be limited to the number of shares which have a fair market value equal to the aggregate amount of such liabilities based on the minimum statutory withholding rates for federal and state tax income and payroll tax purposes that are applicable to such supplemental taxable income. 17. Compliance with Regulations. It is the Company's intent that the Plan comply in all respects with Rule 16b-3 under the Securities Exchange Act of 1934 (or any successor or amended provision thereof) and any applicable Securities and Exchange Commission interpretations thereof. If any provision of the Plan is deemed not to be in compliance with Rule 16b-3, the provision shall be null and void. 18. Governing Law. The validity and construction of the Plan and the instruments evidencing Options shall be governed by the laws of the state of Delaware, without giving effect to its principles of conflicts of law thereof. 19. Approval of Stockholders of the Company. The Plan shall be submitted for the approval of the Company's stockholders within twelve months after the date of the Board of Director's initial approval of the Plan. 6 EX-10.3 6 0006.txt EMPLOYEE STOCK PURCHASE PLAN Exhibit 10.3 EDUCATIONAL HOLDINGS CORP. 2000 EMPLOYEE STOCK PURCHASE PLAN Article 1 - Purpose. - -------------------- This 2000 Employee Stock Purchase Plan (the "Plan") is intended to encourage stock ownership by all eligible employees of Educational Holdings Corp., a Delaware corporation (the "Company"), and its participating subsidiaries (as defined in Article 17) so that they may share in the growth of the Company by acquiring or increasing their proprietary interest in the Company. The Plan is designed to encourage eligible employees to remain in the employ of the Company and its participating subsidiaries. The Plan is intended to constitute an "employee stock purchase plan" within the meaning of Section 423(b) of the Internal Revenue Code of 1986, as amended (the "Code"). Article 2 - Administration of the Plan. - --------------------------------------- The Plan may be administered by a committee appointed by the Board of Directors of the Company (the "Committee"). The Committee shall consist of not less than two members of the Company's Board of Directors. The Board of Directors may from time to time remove members from, or add members to, the Committee. Vacancies on the Committee, howsoever caused, shall be filled by the Board of Directors. The Committee may select one of its members as Chairman, and shall hold meetings at such times and places as it may determine. Acts by a majority of the Committee, or acts reduced to or approved in writing by a majority of the members of the Committee, shall be the valid acts of the Committee. The interpretation and construction by the Committee of any provisions of the Plan or of any option granted under it shall be final, unless otherwise determined by the Board of Directors. The Committee may from time to time adopt such rules and regulations for carrying out the Plan as it may deem best, provided that any such rules and regulations shall be applied on a uniform basis to all employees under the Plan. No member of the Board of Directors or the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any option granted under it. In the event the Board of Directors fails to appoint or refrains from appointing a Committee, the Board of Directors shall have all power and authority to administer the Plan. In such event, the word "Committee" wherever used herein shall be deemed to mean the Board of Directors. Article 3 - Eligible Employees - ------------------------------ All employees of the Company or any of its participating subsidiaries whose customary employment is more than 20 hours per week and for more than five months in any calendar year and who have completed 90 days employment with the Company shall be eligible to receive options under the Plan to purchase common stock of the Company, and all eligible employees shall have the same rights and privileges hereunder, except as otherwise set forth in the Plan or as required under applicable tax laws. Persons who are eligible employees on the first business day of any Payment Period (as defined in Article 5) shall receive their options as of such day. Persons who become eligible employees after any date on which options are granted under the Plan shall be granted options on the first day of the next succeeding Payment Period on which options are granted to eligible employees under the Plan. In no event, however, may an employee be granted an option if such employee, immediately after the option was granted, would be treated as owning stock possessing five percent or more of the total combined voting power or value of all classes of stock of the Company or of any parent corporation or subsidiary corporation, as the terms "parent corporation" and "subsidiary corporation" are defined in Section 424(e) and (f) of the Code. For purposes of determining stock ownership under this paragraph, the rules of Section 424(d) of the Code shall apply, and stock which the employee may purchase under outstanding options shall be treated as stock owned by the employee. Article 4 - Stock Subject to the Plan. - -------------------------------------- The stock subject to the options under the Plan shall be shares of the Company's authorized but unissued common stock, par value $.01 per share (the "Common Stock"), or shares of Common Stock reacquired by the Company, including shares purchased in the open market. The aggregate number of shares which may be issued pursuant to the Plan is [___________], subject to adjustment as provided in Article 12. If any option granted under the Plan shall expire or terminate for any reason without having been exercised in full or shall cease for any reason to be exercisable in whole or in part, the unpurchased shares subject thereto shall again be available under the Plan. Article 5 - Payment Period and Stock Options. - --------------------------------------------- Payment Periods shall consist of the six-month periods commencing on January 1 and July 1 and ending on June 30 and December 31 of each calendar year. On the first business day of each Payment Period, the Company shall grant to each eligible employee who is then a participant in the Plan an option to purchase on the last day of such Payment Period, at the Option Price hereinafter provided for, a maximum of [1,000] shares, on condition that such employee remains eligible to participate in the Plan throughout the remainder of such Payment Period. The participant shall be entitled to exercise the option so granted only to the extent of the participant's accumulated payroll deductions on the last day of such Payment Period. If the participant's accumulated payroll deductions on the last day of the Payment Period would enable the participant to purchase more than [1,000] shares except for the [1,000]-share limitation, the excess of the amount of the accumulated payroll deductions over the aggregate purchase price of the [1,000] shares shall be promptly refunded to the participant by the Company, without interest. The Option Price per share for each Payment Period shall be the lesser of (i) 85% of the average market price of the Common Stock on the first business day of the Payment Period and (ii) 85% of the average market price of the Common Stock on the last business day of the Payment Period, in either event rounded up to the nearest cent. The foregoing limitation on the number of shares subject to option and the Option Price shall be subject to adjustment as provided in Article 12. 2 For purposes of the Plan, the term "average market price" on any date means (i) the average (on that date) of the high and low prices of the Common Stock on the principal national securities exchange on which the Common Stock is traded, if the Common Stock is then traded on a national securities exchange; or (ii) the last reported sale price (on that date) of the Common Stock on the Nasdaq National Market, if the Common Stock is not then traded on a principal national securities exchange; (iii) the average of the closing bid and asked prices last quoted (on that date) by an established quotation service for over-the-counter securities, if the Common Stock is not reported on the Nasdaq National Market; or (iv) if the Common Stock is not publicly traded, the fair market value of the Common Stock as determined by the Committee after taking into consideration all factors which it deems appropriate, including, without limitation, recent sale and offer prices of the Common Stock in private transactions negotiated at arm's length. For purposes of the Plan, the term "business day" means a day on which there is trading on the Nasdaq National Market or the aforementioned national securities exchange, whichever is applicable pursuant to the preceding paragraph; and if neither is applicable, a day that is not a Saturday, Sunday or legal holiday in the state of Delaware. No employee shall be granted an option which permits the employee's right to purchase stock under the Plan, and under all other Section 423(b) employee stock purchase plans of the Company and any parent or subsidiary corporations, to accrue at a rate which exceeds $25,000 of fair market value of such stock (determined on the date or dates that options on such stock were granted) for each calendar year in which such option is outstanding at any time. The purpose of the limitation in the preceding sentence is to comply with Section 423(b)(8) of the Code. If the participant's accumulated payroll deductions on the last day of the Payment Period would otherwise enable the participant to purchase Common Stock in excess of the Section 423(b)(8) limitation described in this paragraph, the excess of the amount of the accumulated payroll deductions over the aggregate purchase price of the shares actually purchased shall be promptly refunded to the participant by the Company, without interest. Article 6 - Exercise of Option. - ------------------------------- Each eligible employee who continues to be a participant in the Plan on the last day of a Payment Period shall be deemed to have exercised his or her option on such date and shall be deemed to have purchased from the Company such number of full shares of Common Stock reserved for the purpose of the Plan as the participant's accumulated payroll deductions on such date shall pay for at the Option Price, subject to the [1,000]-share limit of the option and the Section 423(b)(8) limitation described in Article 5. If the individual is not a participant on the last day of a Payment Period, then he or she shall not be entitled to exercise his or her option. Only full shares of Common Stock may be purchased under the Plan. Unused payroll deductions remaining in a participant's account at the end of a Payment Period by reason of the inability to purchase a fractional share shall be carried forward to the next Payment Period. Article 7 - Authorization for Entering the Plan. - ------------------------------------------------ An employee may elect to enter the Plan by filling out, signing and delivering to the Company an authorization: 3 A. Stating the percentage to be deducted regularly from the employee's pay; B. Authorizing the purchase of stock for the employee in each Payment Period in accordance with the terms of the Plan; and C. Specifying the exact name or names in which stock purchased for the employee is to be issued as provided under Article 11 hereof. Such authorization must be received by the Company at least ten days before the first day of the next succeeding Payment Period and shall take effect only if the employee is an eligible employee on the first business day of such Payment Period. Unless a participant files a new authorization or withdraws from the Plan, the deductions and purchases under the authorization the participant has on file under the Plan shall continue from one Payment Period to succeeding Payment Periods as long as the Plan remains in effect. The Company shall accumulate and hold for each participant's account the amounts deducted from his or her pay. No interest shall be paid on these amounts. Article 8 - Maximum Amount of Payroll Deductions. - ------------------------------------------------- An employee may authorize payroll deductions in an amount (expressed as a whole percentage) not less than one percent (1%) but not more than ten percent (10%) of the employee's total compensation, including base pay or salary and any overtime, bonuses or commissions. Article 9 - Change in Payroll Deductions. - ----------------------------------------- Deductions may not be increased or decreased during a Payment Period. However, a participant may withdraw in full from the Plan. Article 10 - Withdrawal from the Plan. - -------------------------------------- A participant may withdraw from the Plan (in whole but not in part) at any time prior to the last day of a Payment Period by delivering a withdrawal notice to the Company. To re-enter the Plan, an employee who has previously withdrawn must file a new authorization at least ten days before the first day of the next Payment Period in which he or she wishes to participate. The employee's re-entry into the Plan becomes effective at the beginning of such Payment Period, provided that he or she is an eligible employee on the first business day of the Payment Period. Article 11 - Issuance of Stock. - ------------------------------- Certificates for stock issued to participants shall be delivered as soon as practicable after each Payment Period by the Company's transfer agent. 4 Stock purchased under the Plan shall be issued only in the name of the participant, or if the participant's authorization so specifies, in the name of the participant and another person of legal age as joint tenants with rights of survivorship. Article 12 - Adjustments. - ------------------------- Upon the happening of any of the following described events, a participant's rights under options granted under the Plan shall be adjusted as hereinafter provided: A. In the event that the shares of Common Stock shall be subdivided or combined into a greater or smaller number of shares or if, upon a reorganization, split-up, liquidation, recapitalization or the like of the Company, the shares of Common Stock shall be exchanged for other securities of the Company, each participant shall be entitled, subject to the conditions herein stated, to purchase such number of shares of Common Stock or amount of other securities of the Company as were exchangeable for the number of shares of Common Stock that such participant would have been entitled to purchase except for such action, and appropriate adjustments shall be made in the purchase price per share to reflect such subdivision, combination or exchange; and B. In the event the Company shall issue any of its shares as a stock dividend upon or with respect to the shares of stock of the class which shall at the time be subject to an option hereunder, each participant upon exercising such option shall be entitled to receive (for the purchase price paid upon such exercise) the shares as to which the participant is exercising his or her option and, in addition thereto (at no additional cost), such number of shares of the class or classes in which such stock dividend or dividends were declared or paid, and such amount of cash in lieu of fractional shares, as is equal to the number of shares thereof and the amount of cash in lieu of fractional shares, respectively, which the participant would have received if the participant had been the holder of the shares as to which the participant is exercising his or her option at all times between the date of the granting of such option and the date of its exercise. Upon the happening of any of the foregoing events, the class and aggregate number of shares set forth in Article 4 hereof which are subject to options which have been or may be granted under the Plan and the limitations set forth in the second paragraph of Article 5 shall also be appropriately adjusted to reflect the events specified in paragraphs A and B above. Notwithstanding the foregoing, any adjustments made pursuant to paragraphs A or B shall be made only after the Committee, based on advice of counsel for the Company, determines whether such adjustments would constitute a "modification" (as that term is defined in Section 424 of the Code). If the Committee determines that such adjustments would constitute a modification, it may refrain from making such adjustments. If the Company is to be consolidated with or acquired by another entity in a merger, a sale of all or substantially all of the Company's assets or otherwise (an "Acquisition"), the Committee or the board of directors of any entity assuming the obligations of the Company hereunder (the "Successor Board") shall, with respect to options then outstanding under the Plan, either (i) make appropriate provision for the continuation of such options by arranging for the 5 substitution on an equitable basis for the shares then subject to such options either (a) the consideration payable with respect to the outstanding shares of the Common Stock in connection with the Acquisition, (b) shares of stock of the successor corporation, or a parent or subsidiary of such corporation, or (c) such other securities as the Successor Board deems appropriate, the fair market value of which shall not materially exceed the fair market value of the shares of Common Stock subject to such options immediately preceding the Acquisition; or (ii) terminate each participant's options in exchange for a cash payment equal to the excess of (a) the fair market value on the date of the Acquisition, of the number of shares of Common Stock that the participant's accumulated payroll deductions as of the date of the Acquisition could purchase, at an option price determined with reference only to the first business day of the applicable Payment Period and subject to the [1,000]-share, Code Section 423(b)(8) and fractional-share limitations on the amount of stock a participant would be entitled to purchase, over (b) the result of multiplying such number of shares by such option price. The Committee or Successor Board shall determine the adjustments to be made under this Article 12, and its determination shall be conclusive. Article 13 - No Transfer or Assignment of Employee's Rights. - ------------------------------------------------------------ An option granted under the Plan may not be transferred or assigned and may be exercised only by the participant. Article 14 - Termination of Employee's Rights. - ---------------------------------------------- Whenever a participant ceases to be an eligible employee because of retirement, voluntary or involuntary termination, resignation, layoff, discharge, death or for any other reason, his or her rights under the Plan shall immediately terminate, and the Company shall promptly refund, without interest, the entire balance of his or her payroll deduction account under the Plan. Notwithstanding the foregoing, eligible employment shall be treated as continuing intact while a participant is on military leave, sick leave or other bona fide leave of absence, for up to 90 days, or for so long as the participant's right to re-employment is guaranteed either by statute or by contract, if longer than 90 days. If a participant's payroll deductions are interrupted by any legal process, a withdrawal notice shall be considered as having been received from the participant on the day the interruption occurs. Article 15 - Termination and Amendments to Plan. - ------------------------------------------------ Unless terminated sooner as provided below, the Plan shall terminate on the tenth (10th) anniversary of the date that the Plan is approved by the Board. The Plan may be terminated at any time by the Company's Board of Directors but such termination shall not affect options then outstanding under the Plan. The Plan shall terminate in any case when all or substantially all of the unissued shares of stock reserved for the purposes of the Plan have been purchased. If at any time shares of stock reserved for the purpose of the Plan remain available for purchase but not in sufficient number to satisfy all then unfilled purchase requirements, the available shares shall be apportioned among participants in proportion to the amount of payroll deductions accumulated on 6 behalf of each participant that would otherwise be used to purchase stock, and the Plan shall terminate. Upon such termination or any other termination of the Plan, all payroll deductions not used to purchase stock shall be refunded, without interest. The Committee or the Company's Board of Directors may at any time wholly or partially amend, alter or suspend the Plan. However, without approval of the Company's shareholders given within twelve (12) months before or after the action by the Board, no action of the Committee or the Company's Board of Directors may, except as provided in paragraph 12, increase the limits imposed in paragraph 4 on the maximum number of shares which may be issued under the Plan or extend the term of the Plan under paragraph 15. The Company's Board of Directors shall obtain shareholder approval of any Plan amendment to the extent necessary and desirable to comply with applicable tax laws. No amendment, alteration, suspension or termination of the Plan shall impair the rights of any participant, unless mutually agreed otherwise between the participant and the Company, which agreement must be in writing and signed by the participant and the Company. Termination of the Plan shall not affect the Committee's ability to exercise the powers granted to it hereunder with respect to options granted or awarded under the Plan prior to the date of such termination. Article 16 - Limits on Sale of Stock Purchased under the Plan. - -------------------------------------------------------------- The Plan is intended to provide shares of Common Stock for investment and not for resale. The Company does not, however, intend to restrict or influence any employee in the conduct of his or her own affairs. An employee may, therefore, sell stock purchased under the Plan at any time the employee chooses, subject to compliance with any applicable federal or state securities laws and subject to any restrictions imposed under Article 21 to ensure that tax withholding obligations are satisfied. THE EMPLOYEE ASSUMES THE RISK OF ANY MARKET FLUCTUATIONS IN THE PRICE OF THE STOCK. Article 17 - Participating Subsidiaries. - ---------------------------------------- The term "participating subsidiary" shall mean any present or future subsidiary of the Company, as that term is defined in Section 424(f) of the Code, which is designated from time to time by the Board of Directors to participate in the Plan. The Board of Directors shall have the power to make such designation before or after the Plan is approved by the stockholders. Article 18 - Optionees Not Stockholders. - ---------------------------------------- Neither the granting of an option to an employee nor the deductions from his or her pay shall constitute such employee as a stockholder of the shares covered by an option until such shares have been actually purchased by the employee. 7 Article 19 - Application of Funds. - ---------------------------------- The proceeds received by the Company from the sale of Common Stock pursuant to options granted under the Plan shall be used for general corporate purposes. Article 20 - Notice to Company of Disqualifying Disposition. - ------------------------------------------------------------ By electing to participate in the Plan, each participant agrees to notify the Company in writing immediately after the participant transfers Common Stock acquired under the Plan, if such transfer occurs within two years after the first business day of the Payment Period in which such Common Stock was acquired. Each participant further agrees to provide any information about such a transfer as may be requested by the Company or any subsidiary corporation in order to assist it in complying with the tax laws. Such dispositions generally are treated as "disqualifying dispositions" under Sections 421 and 424 of the Code, which have certain tax consequences to participants and to the Company and its participating subsidiaries. Article 21 - Withholding of Additional Income Taxes. - ---------------------------------------------------- By electing to participate in the Plan, each participant acknowledges that the Company and its participating subsidiaries are required to withhold taxes with respect to the amounts deducted from the participant's compensation and accumulated for the benefit of the participant under the Plan, and each participant agrees that the Company and its participating subsidiaries may deduct additional amounts from the participant's compensation, when amounts are added to the participant's account, used to purchase Common Stock or refunded, in order to satisfy such withholding obligations. Each participant further acknowledges that when Common Stock is purchased under the Plan the Company and its participating subsidiaries may be required to withhold taxes with respect to all or a portion of the difference between the fair market value of the Common Stock purchased and its purchase price, and each participant agrees that such taxes may be withheld from compensation otherwise payable to such participant. It is intended that tax withholding shall be accomplished in such a manner that the full amount of payroll deductions elected by the participant under Article 7 shall be used to purchase Common Stock. However, if amounts sufficient to satisfy applicable tax withholding obligations have not been withheld from compensation otherwise payable to any participant, then, notwithstanding any other provision of the Plan, the Company may withhold such taxes from the participant's accumulated payroll deductions and apply the net amount to the purchase of Common Stock, unless the participant pays to the Company, prior to the exercise date, an amount sufficient to satisfy such withholding obligations. Each participant further acknowledges that the Company and its participating subsidiaries may be required to withhold taxes in connection with the disposition of stock acquired under the Plan and agrees that the Company or any participating subsidiary may take whatever action it considers appropriate to satisfy such withholding requirements, including deducting from compensation otherwise payable to such participant an amount sufficient to satisfy such withholding requirements or conditioning any disposition of Common Stock by the participant upon the payment to the Company or such subsidiary of an amount sufficient to satisfy such withholding requirements. Notwithstanding any other provision of the Plan, the number of shares of Common Stock which may be withheld upon the exercise or vesting of any right under the Plan, or which may be repurchased from the participant within six months after such shares were 8 acquired by the participant from the Company, in order to satisfy the participant's federal and state income and payroll tax liabilities with respect to the exercise or vesting of the right shall be limited to the number of shares which have a fair market value equal to the aggregate amount of such liabilities based on the minimum statutory withholding rates for federal and state tax income and payroll tax purposes that are applicable to such supplemental taxable income. Article 22 - Governmental Regulations. - -------------------------------------- The Company's obligation to sell and deliver shares of Common Stock under the Plan is subject to the approval of any governmental authority required in connection with the authorization, issuance or sale of such shares. Government regulations may impose reporting or other obligations on the Company with respect to the Plan. For example, the Company may be required to identify shares of Common Stock issued under the Plan on its stock ownership records and send tax information statements to employees and former employees who transfer title to such shares. Article 23 - Governing Law. - --------------------------- The validity and construction of the Plan shall be governed by the laws of Delaware, without giving effect to the principles of conflicts of law thereof. Article 24 - Approval of Stockholders of the Company. - ----------------------------------------------------- The Plan shall be submitted for the approval of the Company's shareholders within twelve months after the date of the Board of Director's initial approval of the Plan. 9 EX-10.4 7 0007.txt REGISTRATION RIGHTS AGREEMENT EXHIBIT 10.4 REGISTRATION RIGHTS AGREEMENT This REGISTRATION RIGHTS AGREEMENT (the "Agreement") is entered into as of November 14, 2000 by and among S-E Educational Holdings, a Delaware corporation (the "Company"), and certain stockholders of the Company identified from time to time on Schedule A hereto. RECITALS: -------- A. Concurrent with the execution and delivery of this Agreement, the parties have entered into a Contribution Agreement and Plan of Reorganization and Merger, dated as of the date hereof (the "Merger Agreement"), by and among the Company, Earlychildhood.com LLC, a California limited liability company ("Earlychildhood"), SmarterKids.com, Inc., a Delaware corporation ("SmarterKids"), and S-E Educational Merger Corp., a newly-formed Delaware corporation and a wholly-owned subsidiary of the Company ("Merger Sub"). B. Pursuant to the Merger Agreement, and upon the terms and subject to the conditions set forth therein, the combination of Earlychildhood and SmarterKids shall be effected through (i) the contribution to the Company by the holders of LLC Interests (as defined in the Merger Agreement) of all of the right, title and interest in and to their entire ownership interest in Earlychildhood (the "Contribution") and (ii) the merger of Merger Sub with and into SmarterKids such that SmarterKids becomes a wholly-owned subsidiary of the Company (the "Merger" and, collectively with the Contribution, the "Transactions"). C. Concurrent with the execution and delivery of this Agreement, and as a condition and inducement to the parties' willingness to enter into the Merger Agreement, certain holders of LLC Interests in Earlychildhood and certain stockholders of SmarterKids have entered into a Lockup Agreement, dated as of the date hereof (the "Lockup Agreement"), pursuant to which such persons have agreed, among other things, not to sell the shares of Common Stock such persons receive in the Transactions until the earlier to occur of (i) 180 days from the Effective Time (as defined in the Merger Agreement) and (ii) the date upon which a secondary offering of the Company's Common Stock for the purposes of effecting the orderly sale of such shares has been consummated. D. The Holders (as defined herein) desire to enter into this Agreement for the purpose of providing a single, comprehensive, agreement governing the resale registration by the Company for the benefit of the Holders of the Common stock of the Company received by the Holders in the Transactions. AGREEMENT: --------- NOW THEREFORE, in consideration of the premises and the mutual covenants and agreements of the parties contained herein, the parties agree as follows: 1. Definitions. As used herein, the terms below shall have the following meanings. Any such term, unless the context otherwise requires, may be used in the singular or plural, depending upon the reference. "Affiliate" shall have the meaning provided in the Exchange Act and the rules and regulations of the SEC promulgated thereunder. "Common Stock" shall mean the common stock, par value $0.01 per share, of the Company. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. "Demand Holder" means any Holder or group of Holders controlling at least 20% of the Registrable Securities then outstanding. "Form S-3" shall mean such form under the Securities Act as in effect on the date hereof or any registration form under the Securities Act subsequently adopted by the SEC which permits inclusion or incorporation of comparable information by reference to other documents filed by the Company with the SEC. "Holder" shall mean any Person who is the record owner of (i) Registrable Securities or (ii) other securities of the Company convertible into, or exercisable for, Registrable Securities, or any assignee thereof in accordance with Sections 13 and 26 hereof. The identity of the Holders shall be set forth on Schedule A which shall be revised from time to time as appropriate. "Initiating Holders" shall have the meaning provided in Section 2(b). "Other Stockholders" shall mean (i) any officers or directors of the Company with respect to securities of the Company which are not Registrable Securities, (ii) any Holders with respect to securities of the Company which are not Registrable Securities and (iii) all other stockholders of the Company who are entitled, by contract with the Company, to have securities included in a registration; it being understood, in each case, that the only securities of the Company to be registered hereunder shall be shares of Common Stock. "Person" shall mean an individual, partnership, limited liability company, joint venture, corporation, trust or unincorporated organization or any other similar entity. "Register," "registered," and "registration" shall refer to a registration effected by preparing and filing a registration statement or similar document in compliance with the Securities Act, and the declaration or ordering of effectiveness of such registration statement or document by the SEC. "Registrable Securities" shall mean (a) shares of Common Stock beneficially owned by any Holder which were received in the Transactions, (b) shares of Common Stock issuable upon conversion or exercise of any convertible securities, warrants, options or rights beneficially owned by any Holder which were received in the Transactions or (c) any Common Stock of the Company issued to a Holder as (or issuable upon the conversion or exercise of any warrant, option, right or other security which is issued as) a dividend or other distribution with respect to, or in exchange for or in replacement of, any of the securities described in (a) or (b) above; provided, however, that shares of Common Stock or other securities shall only be treated as Registrable Securities if and so long as (i) they have not, after the Closing Date (as defined in the Merger Agreement), been sold to or through a broker or dealer or underwriter in a public distribution or otherwise pursuant to an effective Registration Statement under the Securities Act or (ii) they have not, after the Closing Date (as defined in 2 the Merger Agreement), been sold to or through a broker or dealer or underwriter in a public distribution or otherwise pursuant to an effective Registration Statement under the Securities Act or (ii) they have not, after the Closing Date (as defined in the Merger Agreement), been sold in a transaction exempt from the registration and prospectus delivery requirements of the Securities Act under Section 4(l) thereof (including any sale pursuant to Rules 144 or 145 of the Securities Act or any similar provision) so that all transfer restrictions and restrictive legends with respect thereto are removed upon the consummation of such sale. In no event shall any securities of the Company other than Common Stock (or any successor security) constitute Registrable Securities. The number of shares of "Registrable Securities then outstanding" shall be determined by the number of shares of Common Stock outstanding which are, and the number of shares of Common Stock issuable pursuant to then exercisable or convertible securities which are, Registrable Securities. The number of shares of Registrable Securities owned by any Holder shall be deemed to include the number of shares of Common Stock issuable pursuant to equity securities convertible into, or exercisable for, convertible securities (regardless of whether such securities are then convertible or exercisable, except for compensatory stock options, which shall not be deemed outstanding unless they have vested). "Securities Act" shall mean the Securities Act of 1933, as amended. "SEC" shall mean the Securities and Exchange Commission, or any other federal agency at the time administering the Securities Act. 2. Request for Registration. (a) Demand Rights; General. If the Company shall receive at any time after the date 180 days after the Closing Date (as defined in the Merger Agreement), a written request from a Demand Holder that the Company file a registration statement under the Securities Act covering the registration of such Registrable Securities as shall be identified in the notice, then the Company shall, within ten (10) days of the receipt thereof, give written notice of such request to all Holders and shall, subject to the limitations of Sections 2(c) and 2(d), use its best efforts to effect within ninety (90) days of the receipt of such request, and in any event as soon as practicable, the registration on a Form S-1 registration statement under the Securities Act for resale of all Registrable Securities which the Holders request to be registered within fifteen (15) business days of receipt by each Holder from the Company of notice of the pending registration. Such notice shall be provided by the Company to all non-requesting Holders in accordance with Section 23 promptly after receipt of notice by it from the Demand Holder initiating the registration request. (b) Underwriter; Cut-back. If the Demand Holder initiating the registration request under Section 2(a) or Section 12 (the "Initiating Holder") intends to distribute the Registrable Securities covered by its request by means of an underwriting, it shall so advise the Company as a part of the request made pursuant to this Agreement and the Company shall include such information in the written notice to be delivered by the Company referred to in such Section. The selection of the managing underwriter by the Initiating Holder in any registration under this Section 2 shall require the consent of a majority of the Company's Board of Directors, such consent not to be unreasonably withheld. In the case of an underwritten offering, the right of any 3 Holder to include Registrable Securities in such registration and the right of any Other Stockholder to include shares of Common Stock in such registration shall be conditioned upon such Holder's or Other Stockholder's, as applicable, participation in such underwriting on customary terms. All Holders and Other Stockholders proposing to distribute their securities through such underwriting shall (together with the Company as provided in Section 4(e)) enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting. Notwithstanding any other provision of this Agreement, if the underwriter advises the Initiating Holder in writing that marketing factors require a limitation of the number of shares to be underwritten, then the Initiating Holder shall so advise the Company which shall so advise all Holders of Registrable Securities which would otherwise be underwritten pursuant hereto and all Other Stockholders having securities which would otherwise be underwritten pursuant hereto, and (i) first, the number of shares of the Company held by Other Stockholders (other than Registrable Securities) shall be excluded from such underwriting on a pro rata basis according to the total number of securities (other than Registrable Securities) requested for registration by such Other Stockholder to the extent deemed advisable by the managing underwriter, including down to zero and (ii) thereafter, if a further limitation of the number of shares is required, the number of shares of Registrable Securities that may be included in the underwriting shall be allocated on pro rata basis among all Holders according to the total amount of Registrable Securities requested for registration by each selling Holder. If any Holder of Registrable Securities or Other Stockholder who has requested inclusion in such registration as provided above disapproves of the terms of the underwriting, such Person may elect to withdraw therefrom by written notice to the Company, and the securities so withdrawn shall also be withdrawn from the registration. If the managing underwriter has not limited the number of Registrable Securities and other securities to be underwritten, the Company may include securities for its own account in such registration, if the managing underwriter so agrees and if the number of Registrable Securities and other securities which would otherwise have been included in such registration and underwriting will not thereby be limited. (c) Limit on Demand Registrations. The Company is obligated to effect only two (2) Demand Registrations pursuant to Section 2(a) and is obligated to effect such Demand Registration only so long as the Registrable Securities subject to such Demand Registration have a fair market value (based on the closing market price on the trading day immediately prior to the date of the written request referred to in Section 2(a) (as reported in the Wall Street Journal), of not less than $10,000,000). For purposes of this Section 2(c), no such Demand Registration shall be deemed to have taken place unless (i) the registration statement filed pursuant to such Demand Registration has been declared effective by the SEC and sales of the securities have been permitted consistent with the plan of distribution described in the registration statement or (ii) a Demand Registration shall be forfeited by operation of Section 6. (d) Right to Defer; General. Notwithstanding the foregoing, if the Company shall furnish to the Holders requesting a registration statement pursuant to this Agreement a certificate signed by the Secretary of the Company stating that, in the good faith judgment of the Board of Directors of the Company as set forth in a duly adopted written resolution, it would be materially detrimental to the Company and its stockholders for such registration statement to be filed and it is therefore necessary to defer the filing of such registration statement, the Company shall have the right to defer such filing for a period of not more than ninety (90) days after 4 receipt of the request of the Initiating Holder, provided, however, that the Company may not utilize this right more than once in any twelve month period. 3. Company Registration. If (but without any obligation to do so) the Company proposes to register (other than a registration effected by the Company pursuant to Section 2 or Section 12 of this Agreement) any of its Common Stock under the Securities Act in connection with the public offering of such securities solely for cash (other than (i) a registration relating to the sale of securities to participants in a Company stock plan, (ii) a registration on any form which does not include or incorporate by reference substantially the same information as would be required to be included in a registration statement covering the sale of the Registrable Securities or (iii) a SEC Rule 145 transaction), the Company shall, at such time, promptly give each Holder written notice of such registration. Upon the written request of each Holder given within fifteen (15) business days after delivery of such notice by the Company in accordance with Section 23 hereof, the Company shall cause to be registered under the Securities Act all of the Registrable Securities that each such Holder has requested to be registered subject to the underwriter cutback and other provisions of Section 8 hereof. 4. Obligations of the Company. Whenever required under this Agreement to effect the registration of any Registrable Securities, the Company shall, as expeditiously as reasonably possible: (a) SEC Filing. Prepare and file with the SEC a registration statement with respect to such Registrable Securities and use its best efforts to cause such registration statement to become effective, and, upon the request of the Holders of a majority of the Registrable Securities registered thereunder, keep such registration statement effective for up to ninety (90) days or until all of the shares of Common Stock registered thereunder are sold, whichever occurs sooner. (b) Amendments. Prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection with such registration statement as may be necessary to comply with the provisions of the Securities Act with respect to the disposition of all securities covered by such registration statement, and furnish such copies thereof to the Holders and any underwriters as they may reasonably request. (c) Prospectus. Furnish to the Holders and any underwriters such numbers of copies of a prospectus, including a preliminary prospectus, in conformity with the requirements of the Securities Act, and such other documents as they may reasonably request in order to facilitate the disposition of Registrable Securities owned by them, and cause all related filings to be made with the SEC as required by Rule 424. (d) Blue Sky Qualification. Use all reasonable commercial efforts to register and qualify the securities covered by such registration statement under such other securities or Blue Sky laws of such jurisdictions as shall be reasonably requested by the Holders and any underwriters, provided that the Company shall not be required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process in any such states or jurisdictions. 5 (e) Underwriting Agreement. In the event of any underwritten public offering, enter into and perform its obligations under an underwriting agreement, in usual and customary form, with the managing underwriter of such offering, provided that such managing underwriter has been selected, to the extent applicable, consistent with the provisions of Section 2(b). Each Holder participating in such underwriting shall also enter into and perform its obligations under such an agreement. (f) Prospectus Delivery. Promptly notify each Holder of Registrable Securities covered by the registration statement at any time when the Company becomes aware of the happening of any event as a result of which the registration statement or the prospectus included in such registration statement or any supplement to the prospectus (as then in effect) contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements therein (in the case of the prospectus, in light of the circumstances under which they were made) not misleading or, if for any other reason it shall be necessary during such time period to amend or supplement the registration statement or the prospectus in order to comply with the Securities Act, whereupon, in either case, each Holder shall immediately cease to use such registration statement or prospectus for any purpose and, as promptly as practicable thereafter, the Company shall prepare and file with the SEC, and furnish without charge to the appropriate Holders and managing underwriters, if any, a supplement or amendment to such registration statement or prospectus which will correct such statement or omission or effect such compliance and such copies thereof as the Holders and any underwriters may reasonably request. 5. Furnish Information. It shall be a condition precedent to the obligations of the Company to take any action pursuant to this Agreement with respect to the Registrable Securities of any selling Holder that such Holder shall furnish to the Company such information regarding itself, the Registrable Securities held by it, and the intended method of disposition of such securities as shall be required to effect the registration of such Holder's Registrable Securities. Such information shall be used specifically for inclusion in the registration statement and the prospectus and any supplement thereto with respect to the Registrable Securities. The selling Holders shall promptly notify the Company at any time when any such Holder becomes aware that any information furnished pursuant to this Section 5 becomes materially incorrect. 6. Expenses of Demand Registration. All expenses other than underwriting discounts and commissions and stock transfer taxes incurred in connection with the registration and sale of Registrable Securities pursuant to Section 2, including (without limitation) all registration, filing and qualification fees, printers' and accounting fees, reasonable fees and disbursements of counsel for the Company, and the reasonable fees and disbursements of one counsel for the selling Holders shall be borne by the Company, which counsel the Company may request be the Company's counsel if such counsel is reasonably acceptable to the Initiating Holders and, if not, shall be selected by the Initiating Holders; provided, however, that in the event the Holders retain separate counsel, the reasonable fees and expenses to be reimbursed shall not exceed $50,000 in a subsequent registration without the prior consent of the Company. Notwithstanding the foregoing, however, in the event a registration request is subsequently withdrawn at the request of the Holders of a majority of the Registrable Securities to be registered (other than as a result of information concerning the business or financial condition of the Company which is made known to the Holders after the date on which such registration was requested), then either (i) such expenses shall be borne solely by the Initiating Holders and not 6 by the Company (in which case all Holders participating in such registration shall bear such expenses pro rata based on the Registrable Securities to be registered), or (ii) one of the demand registration rights provided for in Section 2(a) shall be deemed forfeited. The election permitted by the previous sentence shall be made by the Initiating Holders in proportion to the Registrable Securities to be registered by each. 7. Expenses of Company Registration. The Company shall bear and pay all expenses incurred in connection with any registration, filing or qualification of Registrable Securities pursuant to Section 3, including (without limitation) all registration, filing, and qualification fees, printers and accounting fees relating or apportionable thereto and fees and disbursements of one counsel for the selling Holders selected by them (which the Company may request be the Company's counsel if such counsel is reasonably acceptable to such selling Holders), but excluding underwriting discounts and commissions and stock transfer taxes relating to Registrable Securities; provided, however, that in the event the Holders retain separate counsel, the reasonable fees and expenses to be reimbursed shall not exceed $20,000 in a subsequent registration without the prior consent of the Company. 8. Underwriting Requirements. In connection with any offering contemplated by this Agreement which constitutes an underwriting, the Company shall not be required to include any of the Holders' Registrable Securities or any securities of any Other Stockholders in such underwriting unless such Holders or Other Stockholders, as applicable, accept the terms of the underwriting as agreed upon between the Company and the underwriters selected by the person(s) entitled to select the underwriters, and then only in such quantity as the underwriters determine in their sole discretion will not jeopardize the success of the offering by the Company, such determination to be confirmed in writing upon the request of any Holder. If the total amount of Registrable Securities or other securities requested by Holders and Other Stockholders, as applicable, to be included in such offering exceeds the amount of securities sold other than by the Company that the underwriters determine in their sole discretion is compatible with the success of the offering, then the Company shall be required to include in the offering only (i) that number of Registrable Securities (up to 100% of the Registrable Securities requested to be included in such registration) which the underwriters determine in their sole discretion will not jeopardize the success of the offering (the securities so included to be apportioned pro rata among all selling Holders according to the total amount of Registrable Securities requested for registration by each selling Holder or in such other proportions as shall mutually be agreed to by such selling Holders) and (ii) if all Registrable Securities requested for registration by the selling Holders are included in such offering, that number of securities of the Company which the underwriters determine in their sole discretion will not jeopardize the success of the offering (the securities so included to be apportioned pro rata among all Other Stockholders according to the total amount of securities (other than Registrable Securities) requested for registration by such Other Stockholders). If any Holder of Registrable Securities or Other Stockholder who has requested inclusion in such registration as provided above disapproves of the terms of the underwriting, such Person may elect to withdraw therefrom by written notice to the Company, and the securities so withdrawn shall also be withdrawn from the registration. 9. Delay of Registration. No Holder shall have any right to obtain or seek an injunction restraining or otherwise delaying any such registration as the result of any controversy that might arise with respect to the interpretation or implementation of this Agreement. 7 10. Indemnification. In the event any Registrable Securities are included in a registration statement under this Agreement: (a) Indemnification by the Company. To the fullest extent permitted by law, the Company will indemnify and hold harmless each Holder and its officers, directors, stockholders, partners, owners and agents, any underwriter (as defined in the Securities Act) for such Holder, and each person, if any, who controls such Holder or underwriter within the meaning of the Securities Act or the Exchange Act, against any losses, claims, damages, or liabilities (joint or several) to which they may become subject under the Securities Act, the Exchange Act, or other federal or state law, insofar as such losses, claims, damages, or liabilities (or actions in respect thereof) arise out of or are based upon any of the following statements, omissions or violations (collectively a "Violation"): (i) any untrue statement or alleged untrue statement of a material fact contained in such registration statement, including any preliminary prospectus or final prospectus contained therein or any amendments or supplements thereto, (ii) the omission or alleged omission to state therein a material fact required to be stated therein, or necessary to make the statements therein not misleading, or (iii) any violation or alleged violation by the Company of the Securities Act, the Exchange Act, or any state securities law or any rule or regulation promulgated under the Securities Act, the Exchange Act, or any state securities law; and the Company will pay to each such Holder, underwriter or controlling person, as incurred, any legal or other expenses reasonably incurred by one law firm retained by them, plus appropriate local counsel in connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement contained in this Section 10(a) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability, or action if such settlement is effected without the consent of the Company (which consent shall not be unreasonably withheld), nor shall the Company be liable in any such case for any such loss, claim, damage, liability, or action to which any Holder, underwriter or controlling person may become subject to the extent that it arises out of or is based upon a Violation which occurs in reliance upon and in conformity with written information furnished expressly for use in connection with such registration by such Holder, underwriter or controlling person. (b) Indemnification by Selling Holder. To the fullest extent permitted by law, each selling Holder severally, but not jointly, will indemnify and hold harmless the Company, each of its directors, each of its officers who has signed the registration statement, each person, if any, who controls the Company within the meaning of the Securities Act or the Exchange Act, any underwriter, any other Holder selling securities in such registration statement and any controlling person of any such underwriter or other Holder against any losses, claims, damages, or liabilities (joint or several) to which any of the foregoing persons may become subject, under the Securities Act, the Exchange Act or other federal or state law, insofar as such losses, claims, damages, or liabilities (or actions in respect thereto) arise out of or are based upon any Violation, in each case to the extent (and only to the extent) that such Violation occurs in reliance upon and in conformity with written information furnished by such Holder expressly for use in connection with such registration; and each such Holder will pay, as incurred, any legal or other expenses reasonably incurred by any person intended to be indemnified pursuant to this Section 10(b), in connection with investigating or defending any such loss, claim, damage, liability, or action; provided, however, that the indemnity agreement contained in this Section 10(b) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability or action if such 8 settlement is effected without the consent of the Holder, which consent shall not be unreasonably withheld; provided, further, that, in no event shall any indemnity under this Section 10(b) exceed the net after-tax proceeds from the offering actually received by such Holder. (c) Procedures. Promptly after receipt by an indemnified party under this Section 10 of notice of the commencement of any action (including any governmental action), such indemnified party will, if a claim in respect thereof is to be made against any indemnifying party under this Section 10, deliver to the indemnifying party a written notice of the commencement thereof and the indemnifying party shall have the right to participate in, and, to the extent the indemnifying party so desires, jointly with any other indemnifying party similarly noticed, to assume the defense thereof with counsel mutually satisfactory to the parties; provided, however, that an indemnified party (together with all other indemnified parties which may be represented without conflict by one counsel) shall have the right to retain one separate counsel (plus appropriate local counsel), with the fees and expenses to be paid by the indemnifying party, if representation of such indemnified party by the counsel retained by the indemnifying party would be inappropriate due to actual or potential differing interests between such indemnified party and any other party represented by such counsel in such proceeding. The failure to deliver written notice to the indemnifying party within a reasonable time of the commencement of any such action shall relieve such indemnifying party of any liability to the indemnified party under this Section 10 to the extent (and only the extent) that it is actually prejudiced thereby, but the omission so to deliver written notice to the indemnifying party will not relieve it of any liability that it may have to any indemnified party otherwise than under this Section 10. (d) Contribution. If the indemnification provided for in this Section 10 from the indemnifying party is unavailable to an indemnified party hereunder in respect of any losses, claims, damages, liabilities or expenses referred to therein, then the indemnifying party, in lieu of indemnifying such indemnified party, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages, liabilities or expenses in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and the indemnified parties on the other in connection with the actions which resulted in such losses, claims, damages, liabilities or expenses, as well as any other relevant equitable considerations. The relative fault of such indemnifying party and indemnified parties shall be determined by reference to, among other things, whether any action in question, including any untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact, has been made by, or related to information supplied by, such indemnifying party or indemnified parties, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such action; provided, however, that in no event shall the liability of any selling Holder hereunder be greater in amount than the difference between the dollar amount of the net after-tax proceeds received by such Holder upon the sale of the Registrable Securities giving rise to such contribution obligation and all amounts previously contributed by such Holder with respect to such losses, claims, damages, liabilities and expenses. The amount paid or payable to a party as a result of the losses, claims damages, liabilities and expenses referred to above shall be deemed to include any legal or other fees or expenses reasonably incurred by such party in connection with any investigation or proceeding. 9 The parties hereto agree that it would not be just and equitable if contribution pursuant to this Section 10(d) were determined by pro rata allocation or by any other method of allocation which does not take into account the equitable considerations referred to in the immediately preceding paragraph. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any Person who was not guilty of such fraudulent misrepresentation. (e) Survival. The obligations of the Company and Holders under this Section 10 shall survive the completion of any offering of Registrable Securities in a registration statement under this Agreement, and otherwise. 11. Reports Under Exchange Act. With a view to making available to the Holders the benefits of Rule 144 promulgated under the Securities Act and any other rule or regulation of the SEC that may at any time permit a Holder to sell securities of the Company to the public without registration generally or pursuant to a registration on Form S-3, the Company agrees to: (a) make and keep public information available, as those terms are understood and defined in SEC Rule 144, at all times after the effective date of the first registration statement filed by the Company for the offering of its securities to the general public; (b) use all reasonable commercial efforts, including voluntarily registering its Common Stock under Section 12 of the Exchange Act, to qualify for registration on Form S-3 for the sale of their Registrable Securities as soon as it becomes eligible to file such resale registration statement; (c) file with the SEC in a timely manner all reports and other documents required of the Company under the Securities Act and the Exchange Act; and (d) furnish to any Holder, so long as the Holder owns any Registrable Securities, promptly upon request (i) a written statement by the Company that it has complied with the reporting requirements of SEC Rule 144, the Securities Act and the Exchange Act, (at any time after it has become subject to such reporting requirements), or that it qualifies as a registrant whose securities may be resold pursuant to Form S-3 (at any time after it so qualifies), (ii) a copy of the most recent annual and/or quarterly report of the Company and such other reports and documents so filed by the Company, and (iii) such other information as may be reasonably requested in availing any Holder of any rule or regulation of the SEC which permits the selling of any such securities without registration or pursuant to such form. 12. Form S-3 Registration. In case the Company shall receive from any Holder or Holders of at least the lesser of (x) 5,000,000 shares of Common Stock (adjusted for all stock splits or similar transactions) or (y) Registrable Securities with a fair market value, based on the closing market price on the trading day immediately prior to the date of notice (as reported in the Wall Street Journal), of not less than $2,500,000, a written request or requests 10 that the Company effect a registration on Form S-3 and any related reasonable qualification or compliance with respect to such Registrable Securities, the Company will: (a) promptly give written notice of the proposed registration, and any related qualification or compliance, to all other Holders; and (b) as soon as practicable, effect such registration and all such qualifications and compliance as may be so requested and as would permit or facilitate the sale and distribution of all or a portion of each such Holder's Registrable Securities as are specified in such request, together with all or such portion of the Registrable Securities or other securities, as the case may be, of any other Holder or Other Stockholder, as applicable, joining in such request as are specified in a written request given within ten (10) business days after delivery of such notice by the Company in accordance with Section 23 hereof; provided, however, that the Company shall not be obligated to effect any such registration, qualification or compliance, pursuant to this Section 12: (i) if Form S-3 is not available for such offering by the Holders; (ii) if the Company shall furnish to the Holders a certificate signed by the Secretary of the Company stating that in the good faith judgment of the Board of Directors of the Company as set forth in a duly adopted written resolution, it would be detrimental to the Company and its stockholders for such Form S-3 registration to be effected at such time, in which event the Company shall have the right to defer the filing of the Form S-3 registration statement for a period of not more than sixty (60) days after receipt of the request of the Holders under this Section 12; provided, however, that the Company shall not utilize this right more than once in any twelve month period; (iii) if the Company has, within the twelve (12) month period preceding the date of such request, already effected two registrations for the Holders pursuant to Section 2 and/or this Section 12; or (iv) in any particular jurisdiction in which the Company would be required to qualify to do business or to execute a general consent to service of process in effecting such registration, qualification or compliance. (c) Subject to the foregoing, the Company shall file a registration statement covering the Registrable Securities and other securities so requested to be registered as soon as reasonably practicable after receipt of the request or requests of the Holders. All expenses incurred in connection with such registrations requested by the Holders, including (without limitation) all registration, filing, qualification, printer's and accounting fees, the reasonable fees and disbursements of counsel for the Company and the reasonable fees and expenses of one counsel for the selling Holders, which counsel the Company may request be the Company's counsel if such counsel is reasonably acceptable to such selling Holders and, if not, shall be selected by the Initiating Holders; provided, however, that (i) the underwriters' discounts or commissions and stock transfer taxes associated with Registrable Securities shall not be borne by the Company, but shall be borne by the applicable Holders of such Registrable Securities and (ii) in the event the Selling Holders retain separate counsel, the reasonable fees and expenses reimbursed shall not exceed $25,000 ($12,500 if the registration is not underwritten) without the prior consent of the Company. Registrations effected 11 pursuant to this Section 12 shall not be counted as demands for registration effected pursuant to Section 2. (d) For purposes of this Section 12, the provisions of Section 4 applicable to Form S-3 offerings shall apply and, if any such registration is to be an underwritten offering, such registration shall be subject to underwriter, cut-back and other provisions as provided in Section 2(b). 13. Assignment of Registration Rights. Except as otherwise provided herein, the rights to cause the Company to register Registrable Securities pursuant to this Agreement may be assigned only to a purchaser, assignee or transferee (each a "transferee") of in excess of 1,000,000 of the underlying Registrable Securities; provided, however, that such transferee must be (i) a member, partner or stockholder of such Holder and be receiving such Registrable Securities upon distribution by such Holder of all Registrable Securities held by such Holder to its members, partners or stockholders in accordance with their proportionate ownership of the Holder, or (ii) an Affiliate of the Holder; and, provided, further, that such transferee must have executed a joinder agreement substantially in the form of Exhibit 1 and become bound to this Agreement. The Company may, at is election, require that this covenant be enforced by requiring all Holders to legend their share certificates in a manner consistent with the provisions of this Agreement. 14. Limitations on Subsequent Registration Rights. From and after the date of this Agreement, the Company shall not, without the prior written consent of the Holders of a majority of the then outstanding shares Registrable Securities, enter into any agreement with any holder or prospective holder of any securities of the Company which would allow such holder or prospective holder to include such securities in any registration filed under Sections 2, 3 or 12 hereof, unless under the terms of such agreement, such holder or prospective holder may include such securities in any such registration only to the extent that the inclusion of its securities will not reduce the amount of the Registrable Securities of the Holders which are included; provided, however, that this Section 14 shall not apply to issuances to employees, directors or consultants approved by the Board of Directors. 15. "Market Stand-Off" Agreement. Each Holder hereby agrees that for a period of ninety (90) days after any registration effected subsequent hereto pursuant to Sections 2, 3 or 12 (provided the Holders are given written notice of the offering and the right to participate therein as provided for in this Agreement), such Holder shall not, unless otherwise agreed to by the managing underwriters, directly or indirectly sell, offer to sell, contract to sell (including, without limitation, any short sale), grant any option to purchase or otherwise transfer or dispose of (other than to donees who agree to be similarly bound) any securities of the Company held by it at any time during such period except Common Stock included in such registration; provided, however, that all executive officers and directors of the Company and all other persons with registration rights (whether or not pursuant to this Agreement) enter into similar agreements. In addition, each Holder agrees to acknowledge the undertaking provided for in this Section 15 by entering into customary written "lock-up" agreements with the managing underwriters of the relevant underwriting. This requirement shall not apply to a Holder that, at the time of receipt of the referenced notice from the Company, (a) beneficially owned less than 1% of the outstanding shares of each class of the capital stock of the Company, 12 (b) is not an Affiliate or an employee of the Company and (c) waives any further benefits of this Agreement for it or any subsequent assignee or transferee of its Registrable Securities. In order to enforce the foregoing covenant, the Company may impose stop- transfer instructions with respect to the Registrable Securities of each Holder (and the shares or securities of every other person subject to the foregoing restriction) until the end of such period. 16. Amendment of Registration Rights. Any provision of this Agreement may be amended and the observance thereof may be waived (either generally or in a particular instance and either retroactively or prospectively), only with the written consent of the Company and the holders of a majority of the then outstanding shares of Registrable Securities; provided, however, that if any amendment proposed hereunder would reasonably be expected to adversely affect any right granted to a specific Holder herein (including the rights granted in Section 2(a)(i)), such amendment shall require the consent of such Holder. Any amendment or waiver effected in accordance with this Section 16 shall be binding upon each Holder of any Registrable Securities then outstanding, each future holder of all such Registrable Securities and the Company. 17. Termination. The rights provided in this Agreement shall terminate on the earlier of (i) five years from the Closing Date (as defined in the Merger Agreement), or (ii) once the Company has registered the resale of all of the shares of Registrable Securities under the Exchange Act. 18. Governing Law. This Agreement shall be construed in accordance with and governed by the laws of the State of Delaware (without giving effect to its conflicts of law principles), except with respect to matters of law concerning the internal corporate affairs of any corporate entity which is a party to or the subject of this Agreement, and as to those matters the law of the jurisdiction under which the respective entity derives its powers shall govern. 19. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 20. Titles and Subtitles. The titles and subtitles used in this Agreement are used for convenience only and are not to be considered in construing or interpreting this Agreement. 21. Negotiation of Agreement. Each party hereto represents and agrees with each other that it has been represented by or had the opportunity to be represented by, independent counsel of its own choosing, and that it has had the full right and opportunity to consult with its respective attorney(s), that to the extent, if any, that it desired, it availed itself of this right and opportunity, that it or its authorized officers (as the case may be) have carefully read and fully understand this Agreement in its entirety and have had it fully explained to them by such party's respective counsel, that each is fully aware of the contents thereof and its meaning, intent and legal effect, and that it or its authorized officer (as the case may be) is competent to execute this Agreement and has executed this Agreement free from coercion, duress or undue influence. This Agreement is the product of negotiations between the parties 13 hereto represented by counsel and any rules of construction relating to interpretation against the drafter of an agreement, shall not apply to this Agreement and are expressly waived. 22. Notices. Any notice, request, instruction or other document to be given hereunder by any party hereto to another party hereto shall be in writing, shall be deemed to have been duly given or delivered when delivered personally or telecopied (receipt confirmed, with a copy sent by reputable overnight courier), or one business day after delivery to a reputable overnight courier, postage prepaid, to the address of the party set forth below such person's signature on this Agreement or to such address as the party to whom notice is to be given may provide in a written notice to each of the other parties to this Agreement, a copy of which written notice shall be on file with the Secretary of the Company. 23. Severability. If one or more provisions of this Agreement are held to be unenforceable under applicable law, such provision shall be excluded from this Agreement and the balance of the Agreement shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms to the fullest extent permitted by law. 24. Further Assurances. Each of the parties shall, without further consideration, use reasonable efforts to execute and deliver such additional documents and take such other action as the other parties, or any of them may reasonably request to carry out the intent of this Agreement and the transactions contemplated hereby. 25. Successors and Assigns. This Agreement shall be binding upon and all rights hereto shall inure to the benefit of the Company, its successors and permitted assigns, and shall be binding upon and all rights hereto shall inure to the benefit of the other parties hereto and their respective heirs, successors and permitted assigns. 26. Entire Agreement. This Agreement embodies the entire agreement and understanding of the parties hereto in respect of the actions and transactions contemplated by this Agreement. There are no restrictions, promises, inducements, representations, warranties, covenants or undertakings with regard to the registration of the Company's capital stock pursuant to the Securities Act, other than those expressly set forth or referred to in this Agreement. (Signature Pages Follow) 14 IN WITNESS WHEREOF, the parties hereto have caused this Registration Rights Agreement to be duly executed as of the date first above written. S-E EDUCATIONAL HOLDINGS CORP. By: /s/ Ronald C. Elliott ----------------------------- Name: Ronald C. Elliott Title: Address: 2 Lower Ragsdale Suite 200 Monterey, CA 93940 EDUCATIONAL SIMON, L.L.C., a Delaware limited liability company By: /s/ Michael B. Lenard ----------------------------- Name: Michael B. Lenard Title: Vice President Address: QTL CORPORATION, a California corporation By: /s/ Ronald C. Elliott ----------------------------- Name: Ronald C. Elliott Title: Address: ACACIA CAPITAL PARTNERS, LLC, a California limited liability company By: /s/ C.D.N. Thomas ----------------------------- Name: C.D.N. Thomas Title: Partner Address: 12301 Wilshire Blvd., Suite 414 Los Angeles, CA 90025 NORTH BRIDGE VENTURE PARTNERS III, L.P. By: NORTH BRIDGE VENTURE MANAGEMENT III, L.P., its General Partner By: /s/ Richard A. D'Amore ----------------------------- Name: Richard A. D'Amore Title: General Partner Address: COMMONWEALTH CAPITAL VENTURES II, L.P. By: COMMONWEALTH CAPITAL VENTURES II, L.P., its General Partner By: /s/ Michael Fitzgerald ----------------------------- Name: Michael Fitzgerald Title: General Partner Address: RONALD PHELAN, an Individual By: /s/ Ronald Phelan ----------------------------- Ronald Phelan Address: RICHARD PHELAN, an Individual By: /s/ Richard Phelan ----------------------------- Richard Phelan Address: RANDY DEAN, an Individual By: /s/ Randy Dean ----------------------------- Randy Dean Address: DR. JUDITH HERR, an Individual By: /s/ Dr. Judith Herr ----------------------------- Dr. Judith Herr Address: STEPHEN KAPLAN, an Individual By: /s/ Stephen Kaplan ----------------------------- Stephen Kaplan Address: RICHARD SECOR, an Individual By: /s/ Richard Secor ----------------------------- Richard Secor Address: 15 Crawford St. Needham, MA 02067 RICHARD D'AMORE, an Individual By: /s/ Richard D'Amore ----------------------------- Richard D'Amore Address: MICHAEL FITZGERALD, an Individual By: /s/ Michael Fitzgerald ----------------------------- Michael Fitzgerald Address: MICHAEL KOLOWICH, an Individual By: /s/ Michael Kolowich ----------------------------- Michael Kolowich Address: DAVID BLOHM, an Individual By: /s/ David Blohm ----------------------------- David Blohm Address: 12 Rambling Rd. Sudbury, MA 01726 JEFF PUCCI, an Individual By: /s/ Jeffrey A. Pucci ----------------------------- Jeff Pucci Address: 205 Rosemary St. Needham, MA 02494 RICHARD VIARD, an Individual By: /s/ Richard Viard ----------------------------- Richard Viard Address: 169 North St. Walpole, MA 02081 ALBERT NOYES, an Individual By: /s/ Albert Noyes ----------------------------- Albert Noyes Address: 237 Varich Rd. Needham, MA 02468 BRIAN HICKEY, an Individual By: /s/ Brian Hickey ----------------------------- Brian Hickey Address: ROBERT CAHILL, an Individual By: /s/ Robert Cahill ----------------------------- Robert Cahill Address: 15 SCHEDULE A HOLDERS: Educational Simon, L.L.C. QTL Corporation Acacia Capital Partners, LLC North Bridge Venture Partners III, L.P. Commonwealth Capital Partners II, L.P. Ronald Phelan Richard Phelan Randy Dean Dr. Judith Herr Stephen Kaplan David Blohm Jeff Pucci Richard Viard Albert Noyes Richard Secor Richard D'Amore Michael Fitzgerald Michael Kolowich Brian Hickey Robert Cahill 16 EX-10.7 8 0008.txt FORM OF CONSULTING AGREEMENT Exhibit 10.7 CONSULTING AGREEMENT -------------------- THIS CONSULTING AGREEMENT (the "Agreement") is made and entered into as of ________, 2001 by and between S-E Educational Holdings Corp., a Delaware corporation ("Holdings"), and David Blohm ("Blohm"). Capitalized terms used in this Agreement and not otherwise defined shall have the meanings ascribed to them in that certain Contribution Agreement and Plan of Reorganization and Merger dated as of November -, 2000 by and among Earlychildhood.com, LLC ("Earlychildhood"), SmarterKids.com, Inc. ("SmarterKids"), Holdings and S-E Educational Merger Corp., a wholly-owned subsidiary of Holdings (the "Merger Agreement"). WHEREAS, effective as of the Effective Time, Holdings wishes to retain the services of Blohm on the terms and conditions set forth herein, and Blohm wishes to provide services to Holdings on the terms and conditions set forth herein. NOW, THEREFORE, in consideration of the foregoing, the parties agree as follows: 1. Consulting Services. ------------------- (a) Immediately after the Effective Time, Blohm shall make himself available to provide independent consulting services upon reasonable advance notice and for reasonable intervals of time for a period of eighteen (18) months (the "Consulting Period"), recognizing that Blohm may be providing consulting services to other parties during such period. For such consulting services, Holdings shall pay Blohm at a rate of $18,750 for each month of the Consulting Period. During the Consulting Period, Holdings shall also continue to provide Blohm his then current employee benefits, including but not limited to health, dental, short-term disability, life insurance and long-term disability coverage, regardless of whether Blohm has been employed by a subsequent employer in any capacity during the Consulting Period. (b) During the Consulting Period, Holdings will reimburse Blohm for his reasonable expenses, in connection with the provisions of the consulting services, including, but not limited to, travel, accommodations and meals. Such reimbursement shall include, but not be limited to, the reasonable cost of travel to and from Boston, Massachusetts to Monterey, California and the other offices of Holdings and its Subsidiaries and the reasonable cost of all accommodations and meals, in each case, when traveling at the request of Holdings on the business of Holdings or any of its Subsidiaries outside of his residence location. Holdings shall also reimburse Blohm for all other reasonable expenses incurred in the performance of this consulting services including expenses relating to cellular telephone service and mileage. (c) All options to purchase common stock of Holdings ("Holdings Options") held by Blohm at the commencement of the Consulting Period shall continue to vest during the Consulting Period, during the entirety of which time he shall be deemed to be maintaining a business relationship with Holdings sufficient to cause his Holdings Options to continue to vest 1 under the terms of Holdings' option plans. Immediately prior to the expiration of the Consulting Period, however ended, any remaining unvested Holding Options held by Blohm shall vest and become immediately exercisable. Blohm shall have until two (2) years following the last day of the Consulting Period to exercise any previously unexercised Holdings Options. 2. Severance Payments. Immediately after the expiration of the Consulting Period, Holdings shall pay Blohm $4,166.67 for each subsequent month thereafter for a period of two (2) years. 3 Termination. ----------- (a) Blohm's consulting relationship with Holdings may be terminated by the Holdings' Board of Directors or the chief executive officer of Holdings at any time for Cause (as defined in Section 3(b) below) upon written notice to Blohm, which notice shall specify the reason for termination. Such notice shall be given at any time prior to termination in the case of matters described in clauses 3(b)(ii) or (iii), and shall be given not less than 30 days prior to the date of termination, in the case of matters described in clauses 3(b)(i) or (iv), and in the case of matters described in clauses 3(b)(i) or (iv), shall be rescinded if Blohm cures any misconduct, negligent act, breach or failure giving rise to such notice to the reasonable satisfaction of the Holdings' Board of Directors, including curing any damage suffered by Holdings as a result thereof. In addition, Blohm's consulting relationship with Holdings may be terminated by Holding's Board of Directors or the chief executive officer of Holdings at any time for any reason other than for Cause (any such termination being referred to herein as a termination "Without Cause"), subject to the provisions below. (b) As used herein, "Cause" shall mean (i) willful misconduct or gross negligence by Blohm in respect of his material obligations under this Agreement, (ii) conviction of a felony involving moral turpitude, (iii) theft of Holdings' property or other disloyal or dishonest conduct of Blohm that materially harms Holdings, its Subsidiaries or its business or (in the case of dishonest conduct) undermines the confidence of the Holdings Board of Directors, or (iv) willful breach of this Agreement. (c) In the event that Blohm's consulting relationship is terminated for Cause or he voluntarily ceases to agree to perform consulting services, this Agreement shall automatically terminate and Holdings shall pay Blohm his consulting fees and severance payments, as the case may be, through the date of termination. (d) In the event that Blohm's consulting relationship is terminated by Holdings Without Cause, or is terminated by reason of Blohm's death or Disability (as defined below) prior to the expiration of the Consulting Period, Holdings shall (A) continue to pay to Blohm (or Blohm's heirs, assigns or beneficiaries, in the case of his death) his consulting fees and severance payments for the period of time between the date of such termination and the expiration of this Agreement, and (B) either provide continued family medical and dental insurance coverage in a form substantially similar to such coverage that Blohm received during the Consulting Period, or reimbursement for the reasonable cost of obtaining any such benefits for any portion of the period beginning at the commencement of the Consulting Period and 2 ending 18 months thereafter. All Holdings Options held by Blohm (or by his heirs, assigns or beneficiaries) shall accelerate and be fully exercisable for a period of two (2) years following the date of such termination for whichever reason. "Disability" shall mean "permanent and total disability" as defined in Section 22(e)(3) of the Internal Revenue Code or any successor statute. (e) Termination of this Agreement shall not discharge any liability of either Holdings or Blohm existing at the date of termination. Further, notwithstanding any termination, the provisions of Sections 4, 5 and 6 hereof shall survive in accordance with their terms. 4. Term. This Agreement shall continue through the date of the last payment or benefit provided for hereunder, and remains subject to termination in accordance with the terms hereof, provided that Sections 5 or 6 shall survive such expiration in accordance with their terms. 5. Indemnification. During and after the term of this Agreement, Holdings agrees that if Blohm is made a party, or compelled to testify or otherwise participate in, any action, suit or proceeding (a "Proceeding"), by reason of the fact that he is or was a director or officer of SmarterKids or Holdings (or any of its Subsidiaries), Blohm shall be indemnified by Holdings to the fullest extent permitted under Section 145 of the Delaware General Corporation Law or (but not to any lesser extent) as authorized by Holdings' certificate of incorporation or bylaws or resolutions of the Holdings Board of Directors against all costs, expenses, liabilities, damages and losses reasonably incurred or suffered by Blohm in connection therewith, and such indemnification shall continue as to Blohm even if he has ceased to be a director or officer of Holdings or a Subsidiary of Holdings for the period in which any such Proceeding which commenced within the period of any such statute of limitations is pending. Holdings shall advance to Blohm all reasonable costs and expenses incurred by him in connection with a Proceeding within ten (10) days after receipt by Holdings of a written request for such advance. Such request shall include an itemized list of the costs and expenses and an undertaking by Blohm to repay the amount of such advance if it shall ultimately be determined, in a final judgment for which the time to appeal has expired, that, pursuant to applicable law, he is not entitled to be indemnified against such costs and expenses. 6. Arbitration. Any claim arising out of or relating to this Agreement (including disputes regarding the presence or absence of "Cause" in the event of a termination), or otherwise arising out of or relating to the Blohm's rendering services to Holdings, will be subject to arbitration in Boston, Massachusetts, in accordance with the Federal Arbitration Act and the rules of the American Arbitration Association relating to commercial disputes. The prevailing party in any such arbitration shall be entitled to recover from the other party its reasonable expenses incurred in connection with such arbitration, including the reasonable fees and expenses of counsel. 7. Severability. If any provision of this Agreement is determined to be invalid or unenforceable, it shall be adjusted rather than voided, to achieve the intent of the parties to the extent possible, and the remainder of the Agreement shall be enforced to the maximum extent possible. 3 8. Entire Agreement. This Agreement constitutes the entire agreement between Blohm and Holdings with respect to the terms and conditions of rendering Blohm's services to Holdings, and, as of the Effective Time, supersedes all prior or concurrent arrangements, discussions, agreements or understandings with respect to the Blohm's services. 9. Governing Law. This Agreement shall be governed by the laws of the Commonwealth of Massachusetts without regard to principles of conflicts of law. 10. Amendment. No amendment shall be valid unless in writing and signed by each of Holdings and Blohm. 11. Notice. Any notice, or other written communication to be given pursuant to this Agreement for whatever reason shall be deemed duly given and received (a) if delivered personally, from the date of delivery, or (b) by certified mail, postage pre-paid, return receipt requested, three (3) days after the date of mailing, addressed to the above parties as follows: If to Holdings: S-E Educational Holdings Corp. __________________________ __________________________ Attn: Board of Directors with a copy to: Latham & Watkins 633 West Fifth Street, Suite 4000 Los Angeles, California 90071 Attn: Jeffrey L. Kateman, Esq. and Testa, Hurwitz & Thibeault, LLP 125 High Street Boston, Massachusetts 02110 Attn: Gordon H. Hayes, Jr., Esq. If to Blohm: _________________________ _________________________ [REMAINDER OF PAGE LEFT INTENTIONALLY BLANK] 4 IN WITNESS WHEREOF, the parties hereto have executed this Agreement the date and year first above written. S-E EDUCATIONAL HOLDINGS CORP. By:____________________________ Name________________________ Title_______________________ _______________________________ David Blohm 5 AGREEMENT --------- THIS AGREEMENT (the "Agreement") is made and entered into as of ______, 2001 by and between S-E Educational Holdings Corp., a Delaware corporation ("Holdings"), and David Blohm ("Blohm"), dated as of [DATE]. WHEREAS, contemporaneous with this Agreement, Holdings and Blohm have entered into a certain Consulting Agreement, dated as of [DATE] (the "Consulting Agreement"); WHEREAS, Holdings and Blohm intend that certain amounts otherwise payable by Holdings to Blohm pursuant to the Consulting Agreement or otherwise shall be limited such that they do not give rise to any "excess parachute payments" within the meaning of Section 280G of the Internal Revenue Code of 1986, as amended (the "Code"); NOW, THEREFORE, in consideration of the foregoing, the parties agree as follows: 1. Reduction of Certain Payments. Notwithstanding anything to the contrary in the Consulting Agreement, to the extent that any portion of any payment or distribution by Holdings to or for the benefit of the Blohm, whether paid or payable or distributed or distributable pursuant to the terms of the Consulting Agreement or otherwise (a "Payment") would be an "excess parachute payment" (as defined in Section 280G of the Code) but for the application of this Agreement, then the amount of all such Payments otherwise payable to Blohm pursuant to the Consulting Agreement shall be reduced, subject to the provisions below, to the minimum extent necessary (but in no event to less than zero) so that no portion of any Payment, as so reduced, constitutes an excess parachute payment. Such reduction shall be made from the Payments pursuant to the Consulting Agreement in the following order: (i) first, to the extent of the severance payments pursuant to Section 2(a) of the Consulting Agreement; (ii) second, to the extent of the payments pursuant to Section 1(a) of the Consulting Agreement for consulting services; (iii) third, to the extent of any other Payments, except for any option acceleration, pursuant to the Consulting Agreement; and (iv) fourth, to the extent of the acceleration of any unvested options pursuant to the Consulting Agreement. Any reduction pursuant to (i), (ii), (iii), or (iv) shall first be made from payments or acceleration that otherwise occur later in time. For purposes of any reduction, no portion of any Payment shall be taken into account to the extent that such Payment, in the opinion of Holdings, after consultation with its tax and accounting advisors, does not constitute a "parachute payment" within the meaning of Section 280G(b)(2) of the Code. 2. Disputes. Any dispute regarding any calculation or reduction of payments pursuant to this Agreement will be subject to a determination by a nationally respected accounting firm acceptable to both parties. In any such dispute, Holdings shall pay all reasonable expenses incurred in connection with such dispute. 3. Severability. If any provision of this Agreement is determined to be invalid or unenforceable, it shall be adjusted rather than voided, to achieve the intent of the parties to the 6 extent possible, and the remainder of the Agreement shall be enforced to the maximum extent possible. 4. Governing Law. This Agreement shall be governed by the laws of the Commonwealth of Massachusetts without regard to principles of conflicts of law. 5. Amendment. No amendment shall be valid unless in writing and signed by each of Holdings and Blohm. 6. Notice. Any notice, or other written communication to be given pursuant to this Agreement for whatever reason shall be deemed duly given and received (a) if delivered personally, from the date of delivery, or (b) by certified mail, postage pre-paid, return receipt requested, three (3) days after the date of mailing, addressed to the above parties as follows: If to Holdings: S-E Educational Holdings Corp. ____________________________ ____________________________ Attn: Board of Directors with a copy to: Latham & Watkins 633 West Fifth Street, Suite 4000 Los Angeles, California 90071 Attn: Jeffrey L. Kateman, Esq. and Testa, Hurwitz & Thibeault, LLP 125 High Street Boston, Massachusetts 02110 Attn: Gordon H. Hayes, Jr., Esq. If to Blohm: _________________________ _________________________ [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 7 IN WITNESS WHEREOF, the parties hereto have executed this Agreement the date and year first above written. S-E EDUCATIONAL HOLDINGS CORP. By: _________________________ Name ____________________ Title ___________________ _________________________ David Blohm 8 EX-10.8 9 0009.txt LEASE AGREEMENTS DATE 9/1/98 EXHIBIT 10.8 ------------ STANDARD FORM COMMERCIAL LEASE Member Greater Boston Real Estate Board 1. PARTIES LESSOR, which expression shall include McFarland FLP heirs, (fill in) successors, and assigns where the context so admits, does hereby lease to 2. PREMISES LESSEE, which expression shall include Virtual Knowledge, (fill in and Inc. successors, executors, administrators, and assigns include, if where the context so admits, and the LESSEE hereby leases applicable, the following described premises: suite number, floor number, 7,715 rentable square feet on the top floor of 200 and square feet) Highland Avenue, Needham, Massachusetts together with the right to use in common, with others entitled thereto, the hallways, stairways, and elevators, necessary for access to said leased premises and lavatories nearest thereto. 3. TERM The term of this lease shall be for see section 23 A (fill in) commencing on and ending on 4. [deleted] 5. [deleted] 6. [deleted] 7. UTILITIES The Lessor shall pay, as they become due, all bills for electricity and other utilities (whether they are used for furnishing heat or other purposes) that are furnished to the leased premises and presently separately metered, and all bills for fuel furnished to a separate tank servicing delete "air the leased promises exclusively. The LESSOR agrees to conditioning" provide all other utility service and to furnish if not reasonably hot and cold water and reasonable heat and applicable air conditioning (except to the extent that the same are furnished through separately metered utilities or separate fuel tanks as set forth above) to the leased premises, the hallways, stairways, elevators, and lavatories during normal business hours on regular business days of the heating and air conditioning seasons of each year, to furnish elevator service and to light passageways and stairways during business hours, and to furnish such cleaning service as is customary in similar buildings in said city or town, all subject to interruption due to any accident, to the making of repairs, alterations, or improvements, to labor difficulties, to trouble in obtaining fuel, electricity, service, or supplies from the sources from which they are usually obtained for said building, or to any cause beyond the LESSOR'S control. Lessee shall be separately metered and pay for lights and plugs. LESSOR shall have no obligation to provide utilities or equipment other than the utilities and equipment within the premises as of the commencement date of this -2- lease. In the event LESSEE requires additional utilities or equipment, the installation shall be subject to the written consent of the LESSOR. 8. USE OF LEASED The LESSEE shall use the leased promises only for the PREMISES purpose of General Office Use (fill in) 9. COMPLIANCE WITH The LESSEE acknowledges that no trade or occupation shall LAWS be conducted in the leased premises or use made thereof which will be unlawful, improper, noisy or offensive, or contrary to any law or any municipal by-law or ordinance in force in the city or town in which the premises are situated. 10. FIRE INSURANCE The LESSEE shall not permit any use of the leased premises which will make voidable any insurance on the property of which the leased premises are a part, or on the contents of said property or which shall be contrary to any law or regulation from time to time established by the New England Fire Insurance Rating Association, or any similar body succeeding to its powers. The LESSEE shall on demand reimburse the LESSOR, and all other tenants, all extra insurance premiums caused by the LESSEE'S use of the premises. 11. MAINTENANCE The LESSEE agrees to maintain the leased premises in good condition, damage by fire and other casualty only excepted, and whenever necessary, to replace plate glass A. LESSEE'S and other glass therein, acknowledging that the leased OBLIGATIONS premises are now in good order and the glass whole. The LESSEE shall not permit the leased premises to be overloaded, damaged, stripped, or defaced, nor suffer any waste. LESSEE shall obtain written consent of LESSOR before erecting any sign on the premises. B. LESSOR'S The LESSOR agrees to maintain the structure of the OBLIGATIONS building of which the leased premises are a part in the same condition as it is at the commencement of the term or as it may be put in during the term of this lease, reasonable wear and tear, damage by fire and other casualty only excepted, unless such maintenance is required because of the LESSEE or those for whose conduct the LESSEE is legally responsible. 12. ALTERATIONS- The LESSEE shall not make structural alterations or ADDITIONS additions to the leased premises, but may make non- structural alterations provided the LESSOR consents thereto in writing, which consent shall not be unreasonably withheld or delayed. All such allowed alterations shall be at LESSEE'S expense and shall be in quality at least equal to the payment compensation. LESSEE shall not permit any mechanics' liens, or similar liens, to remain upon the leased premises for labor and material furnished to LESSEE or claimed to have been furnished by the LESSEE in connection with work of any character performed or claimed to have been performed at the direction of LESSEE and shall cause any such lien to be released of record forthwith without cost to LESSOR. Any alterations or improvements made by the LESSEE shall become the property of the LESSOR at the termination of occupancy as provided herein. 13. ASSIGNMENT- The LESSEE shall not assign or sublet the whole or any part of the leased premises -3- SUBLEASING without LESSOR'S prior written consent which consent shall be unreasonably withheld or delayed. Notwithstanding such consent, LESSEE shall remain liable to LESSOR for the payment of all ______ and for the full performance of the covenants and conditions of this lease. 14. SUBORDINA- This lease shall be subject and subordinate to any and all TION mortgages, now or at any time hereafter, a lien or liens on the property of which the leased premises are a part and the LESSEE shall, when requested, promptly execute and deliver such written instruments as shall be necessary to show the subordination of this lease to said mortgages, deeds of trust or other such instruments in the nature of a mortgage. 15. LESSOR'S ACCESS The LESSOR or agents of the LESSOR may, at reasonable times, enter to view the leased premises and may remove placards and signs not approved and affixed as herein provided, and make repairs and alterations as LESSOR should elect to do and may show the leased premises to others, and at any time within three (3) months before the expiration of the term, may affix to any suitable part of the leased premises a notice for letting or selling the leased premises or property of which the leased premises are a part and keep the same as affixed without hindrance or molestation. 16. INDEMNIFICA- The LESSEE shall save the LESSOR harmless from all loss TION AND and damage occasioned by the use or escape of water or by LIABILITY the bursting of pipes, as well as from any claim or damage (fill in) resulting from neglect in not removing snow and ice from the roof of the building or from the sidewalks bordering upon the premises so leased, or by any nuisance made or suffered on the leased premises, unless such loss is caused by the neglect of the LESSOR. The removal of snow and ice from the sidewalks bordering upon the leased premises shall be Lessor's responsibility. 17. LESSEE'S The LESSEE shall maintain with respect by the leased LIABILITY premises and the property of which the leased premises are INSURANCE a part comprehensive public liability insurance in the (fill in) amount of $1,000,000 with property damage insurance in limits of $50,000 - $100,000 in responsible companies qualified to do business in Massachusetts and in good standing therein insuring the LESSOR as well as LESSEE against injury to persons or damage to property as provided. The LESSEE shall deposit with the LESSOR certificates for such insurance at or prior to the commencement of the term, and thereafter within thirty (30) days prior to the expiration of any such policies. All such insurance certificates shall provide that such policies shall not be cancelled without at least ten (10) days prior written notice to each assured named therein. 18. FIRE, Should a substantial portion of the leased premises, or of CASUALTY - the property of which they are a part, be substantially EMINENT damaged by the fire or other casualty, or be taken by DOMAIN eminent domain, the LESSOR may elect to terminate this lease. When such fire, casualty, or taking renders the leased premises unsuitable for their intended use, a just and proportionate abatement of rent shall be made, and the LESSEE may elect to terminate this lease if: (a) The LESSOR fails to give written notice within thirty (30) days of -4- intention to restore leased premises, or (b) The LESSOR fails to restore the leased premises to a condition substantially suitable for their intended use within ninety (90) days of said fire, casualty or taking. The LESSOR reserves, and the LESSEE imparts to the Lessor, all rights which the LESSEE may have for damages or injury to the leased premises for any taking by eminent domain, except for damage to the LESSEE'S fixtures, property, or equipment. 19. DEFAULT AND In the event that: BANKRUPTCY (fill in) (a) The LESSEE shall default in the payment of any installment of rent or other sum herein specified and such default shall continue for ten (10) days after written notice thereof; or (b) The LESSEE shall default in the observance or performance of any other of the LESSEE'S covenants, agreements, or obligations hereunder and such default shall not be corrected within thirty (30) days after written notice thereof; or (c) The LESSEE shall be declared bankrupt or insolvent according to law, or, if any assignment shall be made of LESSEE'S property for the benefit of creditors, then the LESSOR shall have the right thereafter, while such default continues, to re-enter and take complete possession of the leased premises, to declare the term of this lease ended, and remove the LESSEE'S effects, without prejudice to any remedies which might be otherwise used for arrears of rent or other default. The LESSEE shall indemnify the LESSOR against all loss of rent and other payments which the LESSOR may incur by reason of such termination during the residue of the term. If the LESSEE shall default, after reasonable notice thereof, in the observance or performance of any conditions or covenants on LESSEE'S part to be observed or performed under or by virtue of any of the provisions in any article of this lease, the LESSOR, without being under any obligation to do so and without thereby waiving such default, may remedy such default for the account and at the expense of the LESSEE. If the LESSOR makes any expenditures or incurs any obligations for the payment of money in connection therewith, including but not limited to, reasonable attorney's fees in instituting, prosecuting or defending any action or proceeding, such sums paid or obligations insured, with interest at the rate of six (6) percent per annum and costs, shall be paid to the LESSOR by the LESSEE as additional rent. 20. NOTICE Any notice from the LESSOR to the LESSEE relating to the (fill in) leased premises or to the occupancy thereof, shall be deemed duly served, if left at the leased premises addressed to the LESSEE, or if mailed to the leased premises, registered or certified mail, return receipt requested, postage prepaid, addressed to the LESSEE. Any notice from the LESSEE to the LESSOR relating to the leased premises or to the occupancy thereof, shall be deemed duly served, if mailed to the LESSOR by -6- IN WITNESS WHEREOF, the said parties hereunto set their hands and seals this ________________ day of ______________ 19___ /s/ Illegible /s/ Illegible _________________________ __________________________ LESSEE LESSOR _________________________ __________________________ LESSEE LESSOR ________________________ BROKER(S) -7- STANDARD FORM COMMERCIAL LEASE 1. PARTIES LESSOR, which expression shall include McFarland (fill in) FLP heirs, successors, and assigns where the context so admits, does hereby lease to SmarterKids.com LESSEE, which expression shall include their successors, executors, administrators, and assigns where the context so admits and the LESSEE hereby leases the following described premises: 2. PREMISES 5,000 rentable square feet on the third floor 200 (fill in and include, if Highland Avenue, Needham, MA applicable, suite number, floor number and square together with the right to use in common, with feet) others entitled thereto, the hallways, stairways, and elevators, necessary for access to said leaded premises, and lavatories nearest thereto. 3. TERM The term of this lease shall be for SEE SECTION (fill in) 27A commencing on __________________ and ending on _________________________________. 4. RENT The LESSEE shall pay to the LESSOR fixed rent at (fill in) the rate of SEE SECTION 27B dollars per year, payable in advance in monthly installments of ______, subject to proration in the case of any partial calendar month. All rent shall be payable without offset or deduction. 5. SECURITY DEPOSIT [Intentionally Omitted] (fill in) 6. RENT ADJUSTMENT [Intentionally Omitted] A. TAX [Intentionally Omitted] ESCALATION (fill in or delete) B. OPERATING [Intentionally Omitted] COST ESCALATION (fill in or delete) C. CONSUMER [Intentionally Omitted] PRICE -10- 13. ASSIGNMENT - The LESSEE shall not assign or sublet the whole or any SUBLEASING part of the leased premises without LESSOR's prior written consent which consent shall not be unreasonably withheld or delayed. Lessor has first refusal rights. Notwithstanding such consent, LESSEE shall remain liable to LESSOR for the payment of all rent and for the full performance of the covenants and conditions of this lease. 14. This lease shall be subject and subordinate to any and SUBORDINATION all mortgages, deeds of trust and other instruments in the nature of a mortgage, now or at any time hereafter, a lien or liens on the property of which the leased premises are a part and the LESSEE shall, when requested, promptly execute and deliver such written instruments as shall be necessary to show the subordination of this lease to said mortgages, deeds of trust or other such instrument sin the nature of a mortgage. 15. LESSOR'S The LESSOR or agents of the LESSOR may, at reasonable ACCESS times, enter to view the leased premises and may remove placards and signs not approved and affixed as herein provided, and make repairs and alterations as LESSOR should elect to do and may show the leased premises to others, and at any time within three (3) months before the expiration of the term, may affix to any suitable part of the leased premises a notice for letting or selling the leased premises or property of which the leased premises are a part and keep the same so affixed without hindrance or molestation. 16. The LESSEE shall save the LESSOR harmless from all loss INDEMNIFICATION and damage occasioned by anything occurring on the AND LIABILITY leased premises unless caused by the negligence or (fill in) misconduct of the LESSOR, and from all loss and damage wherever occurring occasioned by any omission, fault, neglect or other misconduct of the LESSEE. The removal of snow and ice from the sidewalks bordering upon the leased premises shall be LESSOR's responsibility. 17. LESSEE'S LIABILITY The LESSEE shall maintain with respect to the leased INSURANCE premises and the property of which the leased premises (fill in) are a part comprehensive public liability insurance in the amount of $1,000,000 with property damage insurance in limits of $50,000 -$100,000 in responsible companies qualified to do business in Massachusetts and in good standing therein insuring the LESSOR as well as LESSEE against injury to persons or damage to property as provided. The LESSEE shall deposit with the LESSOR certificates for such insurance at or prior to the commencement of the term, and thereafter within thirty (30) days prior to the expiration of any such policies. All such insurance certificates shall provide that such policies shall not be cancelled -11- without at least ten (10) days prior written notice to each assured named therein. 18. FIRE, CASUALTY - Should a substantial portion of the leased premises, or EMINENT DOMAIN of the property of which they are a part, be substantially damaged by fire or other casualty, or be taken by eminent domain, the LESSOR may elect to terminate this lease. When such fire, casualty, or taking renders the leased premises substantially unsuitable for their intended use, a just and proportionate abatement of rent shall be made, and the LESSEE may elect to terminate this lease if: (a) The LESSOR fails to give written notice within thirty (30) days of intention to restore leased premises; or (b) The LESSOR fails to restore the leased premises to a condition substantially suitable for their intended use within ninety (90) days of said fire, casualty or taking. The LESSOR reserves, and the LESSEE grants to the LESSOR, all rights which the LESSEE may have for damages or injury to the leased premises for any taking by eminent domain, except for damage to the LESSEE's fixtures, property, or equipment. 19. DEFAULT AND In the event that: BANKRUPTCY (fill in) (a) The LESSEE shall default in the payment of any installment of rent or other sum herein specified and such default shall continue for ten (10) days after written notice thereof; or (b) The LESSEE shall default in the observance or performance of any other of the LESSEE's covenants, agreements, or obligations hereunder and such default shall not be corrected within thirty (30) days after written notice thereof; or (c) The LESSEE shall be declared bankrupt or insolvent according to law, or, if any assignment shall be made of LESSEE's property for the benefit of creditors, then the LESSOR shall have the right thereafter, while such default continues, to re-enter and take complete possession of the leased premises, to declare the term of this lease ended, and remove the LESSEE's effects, without prejudice to any remedies which might be otherwise used for arrears of rent or other default. The LESSEE shall indemnify the LESSOR against all loss of rent and other payments which the LESSOR may incur by reason of such termination during the residue of the term. If the LESSEE shall default, after reasonable notice thereof, in the observance or performance of any conditions or covenants on LESSEE's part to -12- be observed or performed under or by virtue of any of the provisions in any article of this lease, the LESSOR, without being under any obligation to do so and without thereby waiving such default, may remedy such default for the account and at the expense of the LESSEE. If the LESSOR makes any expenditures or incurs any obligations for the payment of money in connection therewith, including but not limited to, reasonable attorney's fees in instituting, prosecuting or defending any action or proceeding, such sums paid or obligations insured, with interest at the rate of six (6) per cent per annum and costs, shall be paid to the LESSOR by the LESSEE as additional rent. 20. NOTICE Any notice from the LESSOR to the LESSEE relating to the (fill in) leased premises or to the occupancy thereof, shall be deemed duly served, if left at the leased premises addressed to the LESSEE, or if mailed to the leased premises, registered or certified mail, return receipt requested, postage prepaid, addressed to the LESSEE. Any notice from the LESSEE to the LESSOR relating to the leased premises or to the occupancy thereof, shall be deemed duly served, if mailed to the LESSOR by registered or certified mail, return receipt requested, postage prepaid, addressed to the LESSOR at such address as the LESSOR may from time to time advise in writing. All rent notices shall be paid and sent to the LESSOR at 15 Cefalo Road, Boston, MA 02132. 21. SURRENDER The LESSEE shall at the expiration or other termination of this lease remove all LESSEE's goods and effects from the leased premises (including, without hereby limiting the generality of the foregoing, all signs and lettering affixed or painted by the LESSEE, either inside or outside the leased premises). LESSEE shall deliver to the LESSOR the leased premises and all keys, locks thereto, and other fixtures connected therewith and all alterations and additions made to or upon the leased premises, in good condition, damage by fire or other casualty only excepted. In the event of the LESSEE's failure to remove any of LESSEE's property from the premises, LESSOR is hereby authorized, without liability to LESSEE for loss or damage thereto, and at the sole risk of LESSEE, to remove and store any of the property at LESSEE's expense, or to retain same under LESSOR's control or to sell at public or private sale, without notice any or all of the property not so removed and to apply the net proceeds of such sale to the payment of any sum due hereunder, or to destroy such property. 22. BROKERAGE [Intentionally Omitted] (fill in or delete) EX-10.9 10 0010.txt LEASE AGREEMENT DATED 9/8/99 EXHIBIT 10.9 ------------ R-09/09/99 FINAL OFFICE LEASE OF PREMISES AT 15-19 CRAWFORD STREET, NEEDHAM, MASSACHUSETTS FROM BHX, LLC, AS TRUSTEE OF CRAWFORD REALTY TRUST TO SMARTERKIDS.COM, INC., A DELAWARE CORPORATION TABLE OF CONTENTS -----------------
Page ---- SUMMARY OF BASIC TERMS ARTICLE I ............................................................. 10 - --------- ARTICLE II ............................................................. 17 - ---------- Section 2.1 Lease of The Premises........................................ 17 ----------- --------------------- Section 2.2 Communications Antenna; Backup Generator..................... 17 ----------- --------------------------------------- Section 2.3 Parking...................................................... 18 ----------- ------- Section 2.4 Commencement Date: Lease Term: Right to Extend............... 18 ----------- ---------------------------------------------- Section 2.5 Security Deposit............................................. 18 ----------- ---------------- Section 2.6 Lease Amendment.............................................. 20 ---------- --------------- ARTICLE III ............................................................. 20 - ----------- Section 3.1 Landlord's Work.............................................. 20 ----------- --------------- Section 3.2 Tenant's Work; Pre-Term Occupancy............................ 23 ----------- --------------------------------- Section 3.3 Approval of Plans and Specifications......................... 24 ----------- ------------------------------------ Section 3.4 Signs........................................................ 24 ----------- ----- ARTICLE IV ............................................................. 25 - ---------- Section 4.1 Base Rent.................................................... 25 ----------- ---------- Section 4.2 Certain Additional Rent...................................... 26 ----------- ------------------------ Section 4.3 Net Lease.................................................... 27 ----------- ---------- Section 4.4 Taxes........................................................ 27 ----------- ------ Section 4.5 Insurance Costs.............................................. 28 ----------- ---------------- Section 4.6 Operating Costs.............................................. 28 ----------- ---------------- Section 4.7 Payment for Electricity...................................... 28 ----------- ------------------------ Section 4.8 Annual Statement: Tenant's Audit............................. 28 ----------- --------------------------------- ARTICLE V ............................................................. 29 - --------- Section 5.1 Permitted Use................................................ 29 ----------- ------------- Section 5.2 Restrictions on Use.......................................... 29 ----------- ------------------- Section 5.3 Hazardous Materials.......................................... 30 ----------- ------------------- ARTICLE VI ............................................................. 30 - ---------- Section 6.1 Landlord's Services.......................................... 30 ----------- ------------------- Section 6.2 Extraordinary Use............................................ 31 ----------- ----------------- Section 6.3 Interruption; Delay.......................................... 31 ----------- ------------------- Section 6.4 Additional Services.......................................... 32 ----------- ------------------- Section 6.5 Tenant's Right to Cure....................................... 32 ----------- ---------------------- Section 6.6 Exoneration and Indemnification.............................. 32 ----------- ------------------------------- ARTICLE VII ............................................................. 33 - -----------
Section 7.1 Rent......................................................... 33 ----------- ---- Section 7.2 Utilities.................................................... 33 ----------- --------- Section 7.3 No Waste..................................................... 33 ----------- -------- Section 7.4 Maintenance; Repairs, and Yield-Up........................... 33 ----------- ---------------------------------- Section 7.5 Alterations by Tenant........................................ 34 ----------- --------------------- Section 7.6 Trade Fixtures and Equipment................................. 35 ----------- ---------------------------- Section 7.7 Compliance with Laws......................................... 35 ----------- -------------------- Section 7.8 Contents at Tenant's Risk.................................... 35 ----------- ------------------------- Section 7.9 Exoneration: Indemnification and Insurance................... 36 ----------- ------------------------------------------ Section 7.10 Landlord's Access............................................ 37 ------------ ----------------- Section 7.11 No Liens..................................................... 37 ------------ -------- Section 7.12 Compliance with Rules and Regulations........................ 37 ------------ ------------------------------------- ARTICLE VIII ............................................................. 37 - ------------ Section 8.1 Subletting and Assignment.................................... 37 ----------- ------------------------- ARTICLE IX ............................................................. 40 - ---------- Section 9.1 Subordination to Mortgages and Ground Leases................. 40 ----------- -------------------------------------------- Section 9.2 Lease Superior at Mortgagee's or Ground Lessor's Election.... 40 ----------- --------------------------------------------------------- Section 9.3 Notice to Mortgagee and Ground Lessor........................ 41 ----------- ------------------------------------- Section 9.4 Limitations on Obligations of Mortgagees, around Lessors and ----------- ------------------------------------------------------------ Successors................................................... 41 ---------- Section 9.5 Estoppel Certificate By Tenant and Information Concerning ----------- --------------------------------------------------------- Tenant....................................................... 41 ------ ARTICLE X ............................................................. 42 - --------- Section 10.1 Damage From Casualty......................................... 42 ------------ -------------------- Section 10.2 Abatement of Rent............................................ 42 ------------ ----------------- Section 10.3 Limitation on Landlord's and Tenant's Obligations............ 43 ------------ ------------------------------------------------- Section 10.4 Landlord's Right to Terminate................................ 43 ------------ ----------------------------- Section 10.5 Tenant's Right to Terminate.................................. 43 ------------ --------------------------- ARTICLE XI ............................................................. 43 - ---------- Section 11.1 Eminent Domain, Right to Terminate and Abatement in Rent..... 43 ------------ -------------------------------------------------------- Section 11.2 Restoration.................................................. 44 ------------ ----------- Section 11.3 Landlord to Control Eminent Domain Action.................... 44 ------------ ----------------------------------------- ARTICLE XII ............................................................. 44 - ----------- Section 12.1 Event of Default............................................. 44 ------------ ---------------- Section 12.2 Landlord's Remedies.......................................... 45 ------------ ------------------ Section 12.3 Reimbursement of Landlord.................................... 46 ------------ ------------------------- Section 12.4 Landlord's Right to Perform Tenant's Covenants............... 46 ------------ ---------------------------------------------- Section 12.5 Cumulative Remedies.......................................... 47 ------------ ------------------- Section 12.6 Expenses of Enforcement...................................... 47 ------------ ----------------------- Section 12.7 Landlord's Default........................................... 47 ------------ ------------------ Section 12.8 Limitation of Landlord's Liability........................... 48 ------------ ---------------------------------- Section 12.9 Late Payment and Administrative Expense...................... 48 ------------ --------------------------------------- ARTICLE XIII ............................................................. 48 - ------------
Section 13.1 Brokers............................................................ 49 ------------ ------- Section 13.2 Quiet Enjoyment.................................................... 49 ------------ --------------- Section 13.3. [intentionally omitted]............................................ 49 ------------- ----------------------- Section 13.4 Notices............................................................ 49 ------------ ------- Section 13.5 Waiver of Subrogation.............................................. 49 ------------ --------------------- Section 13.6 Entire Agreement: Execution; Time of the Essence, Headings, Table ------------ ----------------------------------------------------------------- of Contents........................................................ 50 ---------- Section 13.7 Partial Invalidity................................................. 50 ------------ ------------------ Section 13.8 No Waiver.......................................................... 50 ------------ --------- Section 13.9 Holdover........................................................... 50 ------------ ------- Section 13.10 When Lease Becomes Binding........................................ 51 ------------- -------------------------- Section 13.11 No Recordation.................................................... 51 ------------- -------------- Section 13.12 As Is............................................................. 51 ------------- ----- Section 13.13 Tenant's Financial Statements: Certain Representations and ------------- ---------------------------------------------------------- Warranties of Tenant.............................................. 51 -------------------- Section 13.14 Confidentiality................................................... 52 ------------- --------------- Section 13.15 Summary of Basic Terms............................................ 52 ------------- ---------------------- Section 13.16 [intentionally omitted]........................................... 52 ------------- ----------------------- Section 13.17 Year 2000 Compliance.............................................. 52 ------------- --------------------
Exhibits: - --------- A - Property Description B - Site Plan C - Building Floor Plan D - Base Building Work E - Tenant Improvements Plans and Specifications F - Tenant's Work G - Rules and Regulations H - Clerk's Certificate I - Form of Letter of Credit SUMMARY OF BASIC TERMS OFFICE LEASE OF PREMISES AT 15-19 CRAWFORD STREET, NEEDHAM, MASSACHUSETTS TO SMARTERKIDS.COM, INC. DATED AS OF SEPTEMBER 8, 1999 - -------------------------------------------------------------------------------- The following is a summary of certain basic terms of this Lease which is intended for the convenience and reference of the parties. Capitalized terms used, but not defined, in this Summary of Basic Terms, have their defined meanings in this Lease. In addition, some of the following items or terms are incorporated into this Lease by reference to the item or term or to this "Summary of Basic Terms." 1. Landlord: BHX, LLC, a Massachusetts limited liability company, as Trustee -------- of Crawford Really Trust, under Declaration of Trust dated June 9, 1997, and filed with the Norfolk Registry District of the Land Court on June 9, 1997 as Document No. 764674. 2. Tenant: SmarterKids.com, Inc., a Delaware corporation. ------ 3A. Premises: The Building, as depicted on Exhibit B to this Lease, comprised -------- --------- of an agreed upon 37,539 leasable square feet of office space (the "Office ------ Space") and an agreed upon 1,613 leasable square feet of storage space (the ----- "Storage Space"). The Office Space and Storage Space are depicted on ------------- Exhibit C. --------- 3B. Landlord's Property: The real property with the Building and any other ------------------- improvements now or hereafter thereon, now commonly known as 15-19 Crawford Street, Needham, Massachusetts, as described on Exhibit A to this Lease. --------- 3C. Leasable Square Footage of the Building: An agreed upon 39,152 square --------------------------------------- feet. 3D. Leasable Square Footage of the Office Space: An agreed upon 37,539 square ------------------------------------------- feet. 3E. Leasable Square Footage of the Storage Space: An agreed upon 1,613 square -------------------------------------------- feet. 4A. Completion Date: November 15, 1999, subject to extension due to Excusable --------------- Delay as provided in Section 3.1(b). 4B. Landlord's Work: Landlord shall perform Landlord's Work as set forth in --------------- Section 3.1 and Exhibits D and E. ---------------- 4C. Tenant's Work: Tenant shall perform the Tenants Work as set forth in ------------- Section 3.2 and on Exhibit F. --------- 4D. Tenant Improvements Allowance. Landlord shall provide Tenant an allowance ----------------------------- for the Tenant Improvements Costs (the "Tenant Improvements Allowance"), in ----------------------------- an amount equal to the lesser of (i) $17.00 multiplied by the Leasable Square Footage of the Office Space or (ii) the actual amount of the Tenant Improvements Costs. In the event that the Tenant Improvements Allowance exceeds $12.00 multiplied by the Leasable Square Footage of the Office Space, then the Base Rent for the Office Space shall be increased so as to amortize such excess over the Initial Term with interest at the rate of 10% per annum. All Tenant Improvements Costs in excess of the Tenant Improvements Allowance shall be paid by Tenant as part of Tenant's Contribution. 4E. Tenant's Contribution: Tenant shall contribute $0.00 toward the cost of --------------------- ---- the Tenant Improvements Work, payment of which shall be Made at the time of execution of this Lease. Thereafter, Tenant's Contribution is subject to increase as provided in Section 3.1. 5A. Lease Term: From the Commencement Date until October 31, 2004. ---------- 5B. Commencement Date: The later of (i) the Substantial Completion Date or ----------------- (ii) November 1, 1999; provided, however, that if Tenant occupies any portion of the Premises prior thereto, the Commencement Date shall be the date on which Tenant first occupies a portion of the Premises. 5C. Rights of Extension: Tenant shall have the right to extend the Lease Term ------------------- for one (1) term of five (5) years in accordance with Section 2.4. 6. Permitted Use: The Office Space shall be used for offices and no other ------------- use. The Storage Space shall be used for warehouse and storage purposes and no other use. 7. Tenant's Trade Style (d/b/2): SmarterKids.com. ---------------------------- 8. Security Deposit: $500,000.00. The Security Deposit shall be in the form ---------------- of cash or an unconditional, irrevocable letter of credit which meets the requirements of Section 2.5. 9. Tenant's Parking Allocation: Tenant shall have the right to use the --------------------------- parking spaces located on the Landlord's Property, subject to the provisions of Section 2.3. 10. Base Rent: Base Rent for the Lease Term is as follows: ---------
ANNUAL MONTHLY PSF PERIOD RATE RATE RATE - ------------------------------------------------------------------------------------------------------ From the Commencement Date Through October 31, 2004 (inclusive), Tenant will pay Base Rent, as follows: Office Space: $ 998,537.40 $83,211.45 $26.60 Storage Space: $ 16,130.00 $ 1,344.17 $10.00 ------------------------------- Total: $1,014,667.40 $84,555.62 N/A
The Base Rent is subject to increase as provided in Item 4D of the Summary of Basic Terms. The Base Rent during any Extension Term will be determined in accordance with Section 4.1 (b). 11A. Additional Rent: Tenant's Tax Escalation, Tenant's Insurance Escalation, --------------- Tenant's Electricity Costs, Tenant's Operating Cost Escalation and/or Other Additional Rent. 11B. Tenant's Tax Escalation: Taxes for any Tax Fiscal Year minus the Tax ----------------------- Base; payable monthly (when base exceeded) in equal installments. "Tax --- Base" means Taxes for the Base Tax Fiscal Year. ---- 11C. Tenant's Insurance Escalation: Insurance Costs for any calendar year ----------------------------- minus the Insurance Cost Base; payable (when base exceeded) in equal monthly installments. "Insurance Cost Base" means Insurance Costs for the Base Year. 11D. Payment of Tenant's Electricity Cost: Tenant shall pay its actual costs ------------------------------------ for for electricity provided to the Premises ("Tenant's Electricity Cost"). ------------------------- At Landlord's sole option, Landlord may require that Tenant make monthly estimated payments of the Tenant's Electricity Cost provided to the Premises based on $1.00 per square foot of the Leasable Square Footage in the Premises and shall initially equal $39,152.00 per year and $3,262.67 monthly. Landlord may adjust the amount collected from Tenant on account of Tenant's Electricity Cost from time to time based upon Landlord's estimate of the actual amount of Tenant's Electricity Cost. 11E. Tenant's Operating Cost Escalation: Operating Costs for any calendar year ---------------------------------- minus the Operating Cost Base; payable monthly (when base exceeded) in equal installments. "Operating Cost Base" means Operating Costs for the ------------------- Base Year. 11F. Other Additional Rent: Includes all fees, charges, expenses, fines, --------------------- assessments, interest, indemnities, or other sums other than Base Rent, Tenant's Tax Escalation, Tenant's Insurance Escalation and Tenant's Operating Cost Escalation due under this Lease. 11G. Base Year: When referring to Taxes, Base Tax Fiscal Year shall mean Tax --------- Fiscal Year 2001 (which is from July 1, 2000 through June 30, 2001). When referring to Insurance Costs or Operating Costs, Base Year shall mean calendar year 2000. 12. Heat and Utilities: To be supplied by Landlord (including water and sewer ------------------ charges) as part of the Operating Costs (except that Tenant's Electricity Cost shall not be included in Operating Costs and, unless Landlord elects to collect Tenants Electricity Cost in accordance with the terms of this Lease, shall be paid directly by Tenant). 13. First Payment: First month's Base Rent in the amount of $84,555.62, plus ------------- the first month's installment of Tenants Electricity Cost in the amount of $3,262.67, plus the letter of credit constituting the Security Deposit in the amount of $500,000.00, have been delivered to Landlord upon execution of this Lease. 14. Brokers: The Bulfinch Companies, Inc., having an office at First Needham ------- Place, 250 First Avenue, Suite 200, Needham, Massachusetts 02494 and Cushman and Wakefield of Massachusetts, Inc., having an office at 101 Arch Street, 21/st/ Floor, Boston, Massachusetts 02110. 15A. Tenant's Address For Notices, Telephone Number, Fax Number and Taxpayer ----------------------------------------------------------------------- Identification No.: ------------------ 1. Before the Commencement Date: 200 Highland Avenue, #401 Needham, MA 02494 Attn: Robert Cahill, Vice President Finance Telephone: (781) 449-7567; Fax: (781) 449-4887 Email: bcahill@smarterkids.com 2. After the Commencement Date: 15-19 Crawford Street Needham, MA 02494 Attn: Robert Cahill, Vice President Finance Telephone: (781) 449-7567; Fax: (781) 449-4887 Email: bcahill@smarterkids.com 3. Tenant F.I.D.#04-3226127 With a copy to: Joseph Torpy, Esq. Testa, Hurwitz & Thibeault, LLP 125 High Street Boston, MA 02110 Telephone: (617) 248-7000; Fax: (617) 248-7100 Email: torpy@tht.com 15B. Landlord's Address for Notices: ------------------------------ BHX, LLC, as Trustee of Crawford Realty Trust c/o The Bulfinch Companies, Inc. First Needham Place 250 First Avenue, Suite 200 Needham, MA 02494 Attention: Robert A Schlager Telephone: (781) 707-4000; Fax: (781) 707-4001 Email: ras@bulfinch.com with a copy to: Vorys, Sater, Seymour and Pease LLP Suite 2100, Atrium Two 221 E. Fourth Street Cincinnati, OH 45202-0236 Attn: Charles C. Bissinger, Jr., Esq. Telephone: (513) 723-4000; Fax: (513) 723-4056 Email: ccbissinger@vssp.com 15C. Guarantor: Not applicable as of the date of execution of this Lease. --------- OFFICE LEASE ------------ THIS LEASE (this "Lease"), made as of the 8th day of September, 1999, between BHX, LLC, a Massachusetts limited liability company, as Trustee of Crawford Realty Trust, under Declaration of Trust dated June 9, 1997, and filed with the Norfolk Registry District of the Land Court on June 9, 1997 as Document No. 764674, and SmarterKids.com, Inc., a Delaware corporation, is as follows. W I T N E S S E T H: - - - - - - - - - - ARTICLE I --------- CERTAIN DEFINITIONS ------------------- In addition to the words and terms defined elsewhere in this Lease, the following words and terms shall have in this Lease the meanings set forth in this Article (whether or not underscored): "Additional Rent" means (a) Tenants Tax Escalation, (b) Tenant's Insurance --------------- Escalation, (c) Tenant's Operating Cost Escalation, (d) Tenant's Electricity Costs, and (e) all Other Additional Rent. "Applicable Interest Rate" means the lesser of (a) a rate per annum equal ------------------------ to five percent (5%) plus the prime rate of Fleet National Bank, Boston, Massachusetts (or any successor) in effect an the day the payment became due and subject to change thereafter or (b) the maximum rate permitted by applicable law. "Bankruptcy Laws" means any existing or future bankruptcy, insolvency, --------------- reorganization, dissolution, liquidation or arrangement or readjustment of debt law or any similar existing or future law of any applicable jurisdiction, or any laws amendatory thereof or supplemental thereto, including, without limitation, the United States Bankruptcy Code of 1978, as amended (11 U.S.C. Section 101 et seq.), as any or all of the foregoing may be amended or supplemented from time to time. "Base Building Work" means the work described in Exhibit D hereto. ------------------ --------- "Base Tax Fiscal Year" means the Tax Fiscal Year beginning July 1, 2000, -------------------- and ending June 30, 2001. "Base Rent" has the meaning set forth in Item 10 of the Summary of Basic --------- Terms. "Base Year" has the meaning set forth in Item 11G of the Summary of Basic --------- Terms. "Brokers" has the meaning set forth in Item 14 of the Summary of Basic ------- Terms. "Building" means the building located on Landlord's Property. The address -------- of the Building is 15-19 Crawford Street, Needham, Massachusetts. "Building Floor Plan" means the floor plan of the Building attached hereto ------------------- as Exhibit C. "Business Day" means Monday through Friday, except holidays. The term ------------ "holiday" shall mean the federal day of celebration of the following holidays: New Year's Day, Martin Luther King Day, President's Day, Memorial Day, July 4th, Labor Day, Columbus Day, Veterans Day, Thanksgiving, Christmas and any other weekday on which banks in the City of Boston, Massachusetts, are closed or required to be closed. "Business Hours" means Monday through Friday, 8:00 a.m. to 6:00 p.m., and -------------- Saturday, 8:00 a.m. to 1:00 p.m., except holidays. The term `holiday" shall mean the federal day of celebration of the following holidays: New Year's Day, Martin Luther King Day, Presidents Day, Memorial Day, July 4th, Labor Day, Columbus Day, Veterans Day, Thanksgiving, Christmas and any other weekday on which banks in the City of Boston, Massachusetts, are closed or required to be closed. "Commencement Date" has the meaning set forth in Item 5B of the Summary of ----------------- Basic Terms. "Completion Date" has the meaning set forth in Item 4A of the Summary of --------------- Basic Terms. "Construction Notice" has the meaning set forth in Section 3.1(a). ------------------- "Environmental Law" means the Comprehensive Environmental Response, ----------------- Compensation, and Liability Act ("CERCLA"), 42 U.S.C. (S)9601 et seq., the ------ -- ---- Resource Conservation and Recovery Act, 42 U.S.C. (S)6901 et seq., the Hazardous -- ---- Materials Transportation Act, 49 U.S.C. (S)1802 et seq., the Toxic Substances -- ---- Control Act, 15 U.S.C. (S)2601 et seq., the Federal Water Pollution Control Act, -- ---- 33 U.S.C. (S)1251 et seq., the Clean Water Act, 33 U.S.C. (S)1321 et seq., the -- ---- -- ---- Clean Air Act, 42 U.S.C. (S)7401 et seq., the Massachusetts Oil and Hazardous -- ---- Material Release Prevention and Response Act, Chapter 21E of the Massachusetts General Laws, all regulations promulgated thereunder, and any other federal, state, county, municipal, local or other statute, law, ordinance or regulation (including any state or local board of health rules, regulation, or code), or any common law (including common law that may impose strict liability or liability based on negligence), which may relate to or deal with human health, the environment, natural resources, or Hazardous Materials, all as may be from time to time amended or modified. "Event of Default" means the occurrence of any of the events listed in ---------------- Section 12.1 of this Lease and the expiration of any applicable cure periods. "Excusable Delay" means those matters which are beyond Landlord's --------------- reasonable control including, without limitation, the following: delays caused by Tenant (or by Tenant's Invitees), or delays caused by, or resulting from, acts of God, accidents, breakdowns, war, civil commotion, fire or other casualty, labor difficulties, shortages of labor, material or equipment, governmental regulations or orders, weather conditions or other causes beyond Landlord's reasonable control. "Extension Term" means the period of time beginning at the end of the -------------- Initial Term and ending at 11:59 p.m. on October 31, 2009. "Final Amounts Due" has the meaning set forth in Section 2.5. ----------------- "GAAP" means generally accepted accounting principles, consistently ---- applied. "Guarantor" means any Person now or hereafter guarantying any of Tenant's --------- obligations under this Lease. "Hazardous Materials" or "Hazardous Substances" means, at any time, (a) any ------------------- -------------------- "hazardous substance" as defined in (S)101(14) of CERCLA (42 U.S.C. (S)9601(14)) or regulations promulgated thereunder, (b) any "solid waste," "hazardous waste," or "infectious waste," as such terms are defined in any Environmental Law at such time; (c) asbestos, urea-formaldehyde, polychlorinated biphenyls ("PCBs"), biomedical materials or waste, nuclear fuel or material, chemical waste, radioactive material, explosives, known carcinogens, petroleum products and by- products and other dangerous, toxic or hazardous pollutants, contaminants, chemicals, materials or substances which may be hazardous to human or animal health or the environment or which are listed or identified in, or regulated by, any Environmental Law; and (d) any additional substances or materials which at such time are classified or considered to be hazardous or toxic under any Environmental Law. "Initial Term" means the period beginning at 12:01 A.M. on the Commencement ------------ Date and ending at 11:59 P.M. on October 31, 2004. "Insurance Base" has the meaning set fourth in Item 11C of the Summary of -------------- Basic Terms. "Insurance Costs" includes the cost of insuring the entire Landlord's --------------- Property, including without limitation the buildings and improvements now or hereafter situated thereon, and all operations conducted in connection therewith, with such policies, coverages and companies and in such limits as may be selected by Landlord (and/or which may be required by Landlord's lenders), including, but not limited to, fire insurance with extended or with all-risk coverage, comprehensive public liability insurance covering personal injury, deaths and property damage with a personal injury endorsement covering false arrest, detention or imprisonment, malicious prosecution, libel and slander, and wrongful entry or eviction, rent loss or business interruption insurance, workers compensation insurance, plate glass insurance, contractual liability insurance, boiler insurance, and fidelity bonds. "Invitees" means employees, workers, visitors, guests, customers, -------- suppliers, agents, contractors, representatives, licensees and other invitees. "Land" means the land located at 15-19 Crawford Street, Needham, ---- Massachusetts more particularly described in Exhibit A attached hereto and --------- incorporated by reference herein and which is depicted on the Site Plan. "Landlord" means BHX, LLC, a Massachusetts limited liability company as -------- Trustee of Crawford Realty Trust under Declaration of Trust dated June 9, 1997, and filed with the Norfolk Registry District of the Land Court on June 9, 1997 as Document No. 764674, its successors and assigns. "Landlord's Architect" means Smits Associates Architects, Inc. or any other -------------------- architect or architectural firm designated by Landlord. "Landlord's Property" means the Land, the Building and all present or ------------------- future appurtenances and/or improvements to the Land and/or the Building. "Landlord's Work" means the Base Building Work and the Tenant Improvements --------------- Work. "Leasable Square Footage of the Building" has the meaning set forth in Item --------------------------------------- 3C of the Summary of Basic Terms. "Leasable Square Footage of the Office Space" has the meaning set forth in ------------------------------------------- Item 3D of the Summary of Basic Terms. "Leasable Square Footage of the Storage Space" has the meaning set forth in -------------------------------------------- Item 3E of the Summary of Basic Terms. "Lease Term" means the Initial Term and, if Tenant timely and properly ---------- exercises its right to extend pursuant to Section 2.4 of this Lease, the Extension Term. "Lease Year" means the twelve (12) month period beginning an the ---------- Commencement Date and on each anniversary of the Commencement Date throughout the Lease Term; provided, however, that if the Commencement Date occurs on a date other than the first day of a month, the first Lease Year shall consist of the portion of the calendar month in which the Commencement Date occurs and the next subsequent 12 calendar months, and the first day of each Lease Year thereafter shall be the first day of the month after the month in which the Commencement Date occurs. "Legal Requirements" means all applicable laws, statutes, rules, ------------------ regulations and requirements of governmental authorities, including, but not limited to, zoning laws and building codes. "Market Rent" has the meaning set forth in Section 4.1(b). ----------- "Negotiation Period" has the meaning set forth in Section 4.1(b). ------------------ "Office Space" has the meaning set forth in Item 3A of the Summary of Basic ------------ Terms. "Operating Cost Base" has the meaning set forth in Item 11E of the Summary ------------------- of Basic Terms. "Operating Costs" means all costs, expenses and disbursements of every kind --------------- and nature (except Taxes, Tenant's Electricity Costs and Insurance Costs) which Landlord shall pay or become obligated to pay in connection with owning, operating, managing, insuring, maintaining, repair or replacing Landlord's Property, all as determined by Landlord. Operating Costs shall include, by way of illustration, but not be limited to: all charges payable by Landlord in connection with the performance of Landlord's maintenance and repair obligations with respect to Landlord's Property; all charges payable by Landlord to provide janitorial service to Landlord's Property; all charges payable by Landlord to provide heating, ventilating and air conditioning services to the Building; all charges payable by Landlord to provide utility services to Landlord's Property, all costs related to the operation of any shuttle or other transportation service between Landlord's Property and public transportation stations (if required by applicable laws, rules, regulations or requirements of authorities with jurisdiction over the Landlord's Property); all costs related to any police details at any entrances to Landlord's Property; all costs related to trash, debris, and refuse removal, all costs related to removal of snow and ice; all costs of pest and vermin control; all costs of providing, maintaining, repairing and replacing of paving, curbs, walkways, landscaping, planters, roofs, walls, drainage, utility lines, security systems and other equipment; all costs of painting the exterior and/or interior of the Building; all costs of repaving, resurfacing, and restriping Parking Areas and drives; all costs of lighting, cleaning, waterproofing, repairing and maintaining the Building. Parking Areas and any other portions of Landlord's Property; all surcharges, costs and expenses that may result from any Environmental Laws provided that such surcharges, costs and expenses relate to or are directly associated with Tenant's or Tenant Invitee's use of the Landlord's Property (excluding costs related to Hazardous Materials which are located on Landlord's Property on the date hereof or which are placed on the Landlord's Property by a Person other than Tenant or a Tenant Invitee) or other laws, rules, regulations, guidelines or orders; all costs of licenses, permits and inspection fees; all legal, accounting, inspection and consulting fees; all costs of capital improvements to the Building, Parking Areas, or other portions of Landlord's Property amortized over their expected useful life based upon and including a market rate of interest; all costs of wages, salaries and benefits of operating personnel, including welfare, retirement, vacations and other compensation and fringe benefits and payroll taxes; management fees equal to five percent (5.0%) of gross rents (which management fees may be payable to an affiliate of Landlord); all materials and supplies, including charges for telephone, overnight courier, postage, stationery, supplies and other materials and expenses required for the routine operation or management of Landlord's Property. However, notwithstanding the above, the following specific items shall not be included: debt service and ground rent payments; any cost or expenditure for which Landlord has been reimbursed by insurance proceeds; costs which have been reimbursed under warranties provided to Landlord by contractors who have warranty obligations; leasing commissions, attorneys' fees and collection costs related to negotiation of tenant leases; expenses which are billed to, and paid directly by, the Tenant; advertising, marketing, promotional, public relations or brokerage fees, commissions or expenditures; financing and refinancing costs in respect of any mortgage or security interest placed upon the Landlord's Property or any portion thereof, including payments of principal, interest, finance or other charges, and any points and commissions in connection therewith; interest or penalties for any late or failed payments by Landlord under any contract or agreement unless resulting from Tenant's failure to pay any amount due under this Lease on or before the date when due; rent or other charges payable under any ground or underlying lease; costs of any additions to or expansions of the Landlord's Property; costs of repairs, restoration or replacements occasioned by fire or other casualty or caused by the exercise of the right of eminent domain; the cost to make improvements, alterations and additions to the Landlord's Property which are required in order to render the same in compliance with Legal Requirements existing on the date of this Lease; amounts paid to subsidiaries or affiliates of Landlord for services rendered to Landlord's Property (except management fees) to the extent such amounts exceed the competitive costs for delivery of such services were they not provided by such related parties; and management fees to the extent in excess of five percent (5.0%) of gross rents. "Other Additional Rent" has the meaning set forth in Item 11F of the --------------------- Summary of Basic Terms. "Parking Areas" means those portions of Landlord's Property which may be ------------- used for parking as depicted on the Site Plan, as such areas may be changed by Landlord from time to time. "Permitted Use" has the meaning set forth in Item 6 of the Summary of Basic ------------- Terms. "Person" means any individual, partnership, joint venture, trust, limited ------ liability company, business trust, joint stock company, unincorporated association, corporation, institution, or entity, including any governmental authority. "Premises" has the meaning set forth in Item 3A of the Summary of Basic -------- Terms. "Proceedings" has the meaning set forth in Section 4.4(b). ----------- "Proposed Change Order" has the meaning set forth in Section 3.1 (c). --------------------- "Refund" has the meaning set forth in Section 4.4(b). ------ "Rules and Regulations" means the rules and regulations promulgated by --------------------- Landlord with respect to Landlord's Property, a copy of which are attached hereto as Exhibit G, as the same may be reasonably modified by Landlord from --------- time to time upon notice to Tenant. "Security Deposit" has the meaning set forth Item 8 of the Summary of Basic ---------------- Terms. "Selection Period" has the meaning set forth in Section 4.1 (b). ---------------- "Storage Space" has the meaning set forth in Item 3A of the Summary of ------------- Basic Terms. "Substantial Completion Date" means the date, as reasonably determined in --------------------------- good faith by Landlord's Architect, on which (a) the Landlord's Work is substantially complete, except for incomplete or unsatisfactory items which do not unreasonably interfere with Tenant's use of the Premises for the Permitted Use or (b) the building inspector for the Town of Needham gives his final sign-off on the building permit, so that Tenant may legally occupy the Premises for the Permitted Use, whichever is later. "Summary of Basic Terms" means the Summary of Basic Terms which is affixed ---------------------- to this Lease immediately after the table of contents of this Lease. "Tax Base" has the meaning set forth in Item 11B of the Summary of Basic -------- Terms. "Tax Fiscal Year" shall mean July 1 through June 30 next following, or such --------------- other tax period as may be established by law for the payment of Taxes. "Taxes" shall mean (a) all taxes, assessments, betterments, water or sewer ----- entrance fees and charges including general, special, ordinary and extraordinary, environmental, or any other charges (including charges for the use of municipal services if billed separately from other taxes), levied, assessed or imposed at any time by any governmental authority upon or against the Land, the Building, or the fixtures, signs and other improvements thereon then comprising Landlord's Property and (b) all attorneys' fees, appraisal fees and other fees, charges, costs and/or expenses incur-red in connection with any Proceedings or other proceedings related to the amount of the Taxes and/or the tax classification and/or the assessed value of the Landlord's Property. This definition of Taxes is based upon the present system of real estate taxation in the Commonwealth of Massachusetts; if taxes upon rentals or any other basis shall be substituted, in whole or in part, for the present ad valorem real estate taxes, the term "Taxes" shall be deemed changed to the extent to which there is such a substitution for the present ad valorem real estate taxes. "Tenant" means SmarterKids.com, Inc., a Delaware corporation, its permitted ------ successors and permitted assigns. "Tenant Improvements Allowance" has the meaning set forth in Item 4D of the ----------------------------- Summary of Basic Terms. "Tenant Improvements Costs" means all costs of the Tenant Improvements ------------------------- Work, including, but not limited to (i) the fees of all architects and engineers for design and supervision services, the cost of all required permits, (ii) the charges of all contractors (including, but not limited to, overhead and profit of all contractors), subcontractors, material suppliers and laborers engaged in the performance of the Tenant Improvements Work, (iii) five percent (5%) profit for the contractor on all costs of the Tenant Improvements Work and (iv) a fee to the Landlord in the amount of two and one-half percent (2.5%) of all costs of the Tenant Improvements Work. "Tenant Improvements Plans and Specifications" has the meaning set forth in -------------------------------------------- Section 3.1. "Tenant Improvements Work" means the work to be performed by Landlord in ------------------------ accordance with the Tenant Improvements Plans and Specifications. "Tenant Invitees" means Tenant, its subtenants and assignees, together with --------------- their respective Invitees. "Tenants Contribution" has the meaning set forth in Item 4E of the Summary -------------------- of Basic Terms. "Tenant's Electricity Cost" has the meaning set forth in Item 11D of the ------------------------- Summary of Basic Terms. "Tenant's Insurance Escalation" means the excess, if any, of (a) the ----------------------------- Insurance Costs for any calendar year, minus (b) the Insurance Base. "Tenants Operating Cost Escalation" means the excess, if any, of (a) the --------------------------------- Operating Costs for any calendar year minus (b) the Operating Cost Base. "Tenant's Submission" has the meaning set forth in Section 3.1(c). ------------------- "Tenants Tax Escalation" means the excess, if any, of (a) the Taxes for any ---------------------- Tax Fiscal Year minus (b) the Tax Base. "Tenant's Work" means the work, if any, to be performed by Tenant with ------------- respect to the Premises, as set forth in the Tenant's Work Plans and Specifications. "Tenant's Work Plans and Specifications" means the plans and specifications -------------------------------------- for the Tenant's Work, as set forth in Exhibit F attached hereto, as the same may be modified from time to time in accordance with this Lease. ARTICLE II ---------- LEASE OF PREMISES ----------------- Section 2.1 Lease of The Premises. Landlord does hereby lease the ---------------------------------- Premises to Tenant, and Tenant hereby leases the Premises from Landlord, upon and subject to the terms and provisions of this Lease and all zoning ordinances, and easements, restrictions, and conditions of record. Subject to the rights of Landlord and applicable Legal Requirements; (a) Tenant shall have exclusive use of the Land and the Parking Areas located thereon and (b) Tenant shall have access to the Premises twenty-four hours a day, seven days a week, 365 days a year, subject to the terms of this Lease. Section 2.2 Communications Antenna; Backup Generator. Subject to ----------------------------------------------------- applicable Legal Requirements and the terms and conditions of this Lease (including, but not limited to, Section 3.2 and Article VII), Tenant shall have the right to install (a) a communications antenna on the roof of the Building (provided, however, that Tenant shall not be permitted to make any penetrations of the roof) and (b) a backup generator on the Land at a location on the Land to be agreed upon by Landlord and Tenant. The plans and specifications for the foregoing shall be subject to Landlord's review and approval, which approval shall not be unreasonably withheld. Section 2.3 Parking. Subject to the Rules and Regulations, Tenant -------------------- Invitees are authorized to park passenger automobiles in the Parking Areas at no cost to Tenant (except as otherwise provided in this Lease) in common with Landlord and Landlord's Invitees. Tenant shall not (a) permit any Tenant Invitees (other than visitors) to park in spaces designated as "visitor" spaces, (b) permit any Tenant Invitees to park in spaces designated as `reserved" spaces (unless reserved for Tenant), (c) permit the total number of passenger automobiles parked on Landlord's Property by Tenant Invitees, at any time, to exceed the number of spaces available to Tenant, and (d) except for delivery trucks using designated loading and unloading facilities, permit any Tenant Invitee to park any vehicle on Landlord's Property other than passenger automobiles. Landlord may, from time to time, designate one or more spaces as reserved for the exclusive use of Landlord and/or for Landlord's Invitees. Section 2.4 Commencement Date: Lease Term: Right to Extend. ----------------------------------------------------------- (a) The Lease Term shall commence at 12:01 A.M. on the Commencement Date and, unless Tenant timely and properly exercises its right to extend pursuant to Section 2.4(b) hereof, shall end at 11:59 P.M. on the last day of the Initial Term. At the request of Landlord or Tenant made after the Commencement Date, Landlord and Tenant will execute a written amendment to, and restatement of, the Summary of Basic Terms pursuant to Section 2.6, setting forth the Commencement Date. (b) Provided there does not then exist an Event of Default or circumstances which with the giving of notice, the passage of time, or both, would constitute an Event of Default, Tenant shall have the right to extend the Lease Term for one (1) period of five (5) years by giving Landlord written notice specifying such extension, which notice must be received by Landlord not more than eighteen (18) months nor less than twelve (12) months prior to the expiration date of the Initial Term. If such extension becomes effective, the Lease Term shall be automatically extended upon the same terms and conditions except that (i) Base Rent shall be payable for such Extension Term as set forth in Section 4.1(b) and (ii) there shall be no further right to extend or renew beyond the period expressly set forth herein. The right of extension is personal to SmarterKids.com, Inc. and is not exercisable by any subtenant or assignee permitted hereunder. Section 2.5 Security Deposit. ----------------------------- (a) Simultaneously with the execution and delivery of this Lease, Tenant shall deliver to Landlord a security deposit in the amount specified in Item 8 of the Summary of Basic Terms. The Security Deposit is security for the faithful performance and observance by Tenant of the terms, provisions and conditions of this Lease and is not an advance payment of rent. It is agreed that if an Event of Default occurs, Landlord may use, apply or retain the whole or any part of the Security Deposit to the extent required for payment of any Base Rent, Additional Rent, or any other sum as to which Tenant is in default or for any sum which Landlord may expend or may be required to expend by reason of the occurrence of an Event of Default in respect of any of the terms, covenants and conditions of this Lease, including, but not limited, to any damage or deficiency accrued before or after summary proceedings or other re-entry by Landlord, including the costs of such proceeding or re-entry and further including, without limitation, reasonable attorney's fees. It is agreed that Landlord shall always have the right to apply the Security Deposit, or any part thereof, as aforesaid, without notice and without prejudice to any other remedy or remedies which Landlord may have, or Landlord may pursue any other such remedy or remedies in lieu of applying the Security Deposit or any part thereof. No interest shall be payable on the Security Deposit and Landlord shall have the right to commingle the Security Deposit with other funds of Landlord. If Landlord shall apply the Security Deposit in whole or in part, Tenant shall immediately upon demand pay to Landlord the amount so applied to restore the Security Deposit to its original amount, Because Tenant's Operating Cost Escalation, Tenant's Tax Escalation, Tenant's Insurance Escalation, Tenant's Electricity Costs and other Additional Rent are subject to annual reconciliation based on actual amounts (collectively "Final Amounts Due") determined to be due, in addition to the ----------------- other rights provided herein to Landlord regarding the Security Deposit, Landlord shall have the right, in its discretion, upon the end of the Lease and delivery of the Premises in accordance with the terms hereof, to hold up to $50,000.00 of the Security Deposit until thirty (30) days after the determination of Final Amounts Due at which time Landlord has the right to deduct the Final Amounts Due from the remaining Security Deposit and return any balance of the Security Deposit to Tenant. Landlord shall determine the Final Amounts Due within ninety (90) days of expiration of the term or earlier termination of this Lease. If the remaining Security Deposit, if any, is not sufficient to pay Tenants obligations hereunder, Tenant shall pay the same within ten (10) days of billing from Landlord. In the event of a sale or other transfer of Landlord's Property, or leasing of the entire Landlord's Property including the Premises subject to Tenant's tenancy hereunder, Landlord shall transfer the Security Deposit then remaining to the vendee or lessee and, provided that such vendee or lessee acknowledges receipt of the same in writing, Landlord shall thereupon be released from all liability for the return of such Security Deposit to Tenant; and Tenant agrees to look solely to the new landlord for the return of the Security Deposit then remaining. The holder of any mortgage upon Landlord's Property shall never be responsible to Tenant for the Security Deposit or its application or return unless the Security Deposit shall actually have been received in hand by such holder. Tenant further covenants that it will not assign or encumber or attempt to assign or encumber the Security Deposit and that neither Landlord nor its successors or assigns shall be bound by any such assignment, encumbrance, attempted assignment or attempted encumbrance. Except as provided above, the Security Deposit or any remaining balance thereof after deduction for amounts due Landlord, shall be returned to Tenant within thirty (30) days after the expiration of the Lease Term. (b) If all or any portion of the Security Deposit is in the form of a letter of credit, such letter of credit must satisfy all of the following conditions: (i) the letter of credit must be in the exact form attached hereto as Exhibit I with an expiration date not less than one (1) year after the date the letter of credit is delivered to Landlord; (ii) the beneficiary of the letter of credit must be Landlord or Landlord's designee; (iii) the letter of credit must be irrevocable, unconditional and transferable one or more times without charge; (iv) the letter of credit must by issued by a U.S. bank with assets in excess of $10 billion, which bank is otherwise satisfactory to Landlord in its sole and absolute discretion; and (v) the letter of credit must provide that it may be drawn at a location in Boston, Massachusetts. If, at any time, the issuer of the letter of credit gives notice of its election not to renew, extend and/or reissue the letter of credit, then Tenant shall, on or before forty-five (45) days prior to the expiration of the term of the letter of credit, deliver to Landlord (1) a replacement letter of credit satisfying all of the above conditions or (2) cash in the full amount of the expiring letter of credit; and if Tenant fails to timely deliver to Landlord a replacement letter of credit as provided above or cash in the full amount of the expiring letter of credit, such failure shall constitute an Event of Default and, in addition to any other rights which Landlord might have by reason of such Event of Default, Landlord may draw on the letter of credit and hold the proceeds of such drawing as part of the Security Deposit. If (x) Landlord shall reasonably feel insecure with the creditworthiness of the bank issuing the letter of credit and Tenant shall fail, within ten (10) days after notice, to either provide a replacement letter of credit as provided above or cash in the full amount of the existing letter of credit, or (y) Tenant fails to provide Landlord with cash in the full amount of the letter of credit within ten (10) days after (I) any proceedings under the Bankruptcy Code or any insolvency law are instituted with the bank as debtor or (II) the bank issuing the letter of credit is taken over by the Federal Deposit Insurance Corporation, the Resolution Trust Corporation or a similar entity, then such failure by Tenant under clauses (x) or (y) of this sentence shall constitute an Event of Default and, in addition to any other rights which Landlord might have by reason of such Event of Default, Landlord may draw on the letter of credit and hold the proceeds of such drawing as part of the Security Deposit. Section 2.6 Lease Amendment. If, pursuant to any provision of this Lease, ---------------------------- there results a change in (or, in the case of the Commencement Date, the confirmation of any of the terms or amounts in the Summary of Basic Terms (including, without limitation, the Base Rent) then in effect, Landlord and Tenant will promptly execute a written amendment to, and restatement of, the Summary of Basic Terms, substituting the changed (or confirmed) terms and recomputed amounts in lieu of each of the applicable terms and amounts then in effect which have been changed. As of the effective date of the amendment to the Summary of Basic Terms, the changed terms (and recomputed amounts) will be effective for all purposes of this Lease, and the amended and restated Summary of Basic Terms will be a part of, and incorporated into, this Lease. ARTICLE III ----------- LANDLORD'S WORK; TENANT'S WORK ------------------------------ Section 3.1 Landlord's Work. ---------------------------- (a) Tenant Improvements Plan and Specifications. ------------------------------------------- (i) Landlord has retained Landlord's Architect to prepare the final, detailed working plans and specifications for the build-out of the Office Space (the "Tenant Improvements Plans and Specifications"), which Tenant -------------------------------------------- Improvements Plans and Specifications are identified in Exhibit E attached --------- hereto. On or before September 13, 1999, Landlord will give Tenant written notice (a "Construction Notice") specifying the amount of the Tenant ------------------- Improvements Costs on the basis of the Tenant Improvements Plans and Specifications. If a Construction Notice does not specify Tenant Improvements Costs which exceed the Tenant Improvements Allowance, then Tenant shall not respond to the Construction Notice and Tenant shall be deemed to have approved the Construction Notice upon delivery. However, if a Construction Notice specifies Tenant Improvements Costs which exceed the Tenant Improvements Allowance, then Tenant shall, within two (2) Business Days after receipt of the Construction Notice, give written notice to Landlord either approving or disapproving the Construction Notice, and the failure of Tenant to disapprove the Construction Notice within such time shall be deemed to constitute approval. If Tenant has the right to and does disapprove a Construction Notice, then Tenant shall, within two (2) Business Days after giving notice of disapproval, prepare, at its expense, and submit to Landlord revised Tenant Improvements Plans and Specifications. Tenant shall submit such revised Tenant Improvements Plans and Specifications to Landlord for Landlord's review and approval. Within two (2) Business Days after receipt of such revised Tenant Improvements Plans and Specifications, Landlord shall, by written notice to Tenant, approve or disapprove the revised Tenant Improvements Plans and Specifications. In any disapproval of revised Tenant Improvements Plans and Specifications, Landlord shall specify in reasonable detail the respects in which the revised Tenant Improvements Plans and Specifications are not satisfactory to Landlord and the changes which Landlord desires in order that such revised Tenant Improvements Plans and Specifications will be satisfactory to Landlord. Within two (2) Business Days after receiving any notice of disapproval from Landlord with respect to the revised Tenant Improvements Plans and Specifications, Tenant, at its expense, will further revise the revised Tenant Improvements Plans and Specifications as reasonably requested by Landlord and will resubmit the revised Tenant Improvements Plans and Specifications to Landlord for review and approval in accordance with the procedures set forth in this Section. If the Tenant Improvements Costs as specified in an approved Construction Notice exceed the Tenant Improvements Allowance, then Tenant shall pay to Landlord, within three (3) Business Days after receipt of the Construction Notice, the amount of such excess, as part of Tenant's Contribution. Tenant shall have the right to review all of Landlord's books and records with respect to the Tenant Improvements Costs and Landlord agrees that the Tenant Improvements Costs shall not exceed the actual costs of the Tenant Improvements Work plus the contractors fee of five percent (5%) and the Landlord's fee of two and one-half percent (2.5%) of all costs of the Tenant Improvements Work as provided in this Lease. (ii) The Completion Date specified in this Lease is based upon the assumption that the Construction Notice will be approved not later than September 16, 1999. If the approval of the Construction Notice is delayed beyond September 16, 1999, then, except to the extent that such delay is attributable to delay by Landlord beyond the period provided in Section 3.1(a)(i) in giving a Construction Notice, the Completion Date shall be extended by the period of such delay, and Tenant shall pay, as and when the same would have become due and payable but for such delay, an amount equal to the Base Rent for the period of such delay. (b) Landlord shall perform Landlord's Work in a good and workmanlike manner using materials of a quality consistent with the Tenant Improvements Plans and Specifications. Subject always to Excusable Delay, the Landlord's Work shall be substantially completed (as determined by Landlord's Architect) by the Completion Date. If any of Landlord's Work is not competed as a result of an Excusable Delay, the Completion Date shall be extended upon notice from Landlord to Tenant for a reasonable period of time under all of the circumstances. Landlord reserves the right to make changes in Landlord's Work from time to time as Landlord deems necessary and/or appropriate in order to complete the performance of Landlord's Work. Without limiting the generality of the foregoing, Landlord may substitute materials to minimize delays and Landlord may make such changes to the Tenant Improvements Plans and Specifications as Landlord deems necessary or appropriate in light of actual conditions, provided that no such changes shall materially and adversely affect the function or appearance of the Premises. Landlord shall obtain a certificate of occupancy for the Office Space. (c) In the event that Tenant requests any changes in Landlord's Work, the following procedures shall apply: (i) Tenant shall give Landlord written notice of the proposed change(s) with such details, plans and specifications as may be required by Landlord ("Tenant's Submission"). ------------------- (ii) Landlord shall review Tenant's Submission and, Landlord shall, within fifteen (15) days after receipt of Tenant's Submission, reject it, approve it or approve it with conditions. If Landlord rejects Tenant's Submission or fails to respond within the specified period, Landlord's Work shall not be changed. If Landlord approves Tenant's Submission, Landlord shall provide Tenant with a proposed change order (a "Proposed Change Order") setting forth (A) the increase in the Tenants --------------------- Contribution, if any, which will be required due to the work included in Tenant's Submission, (B) the expected delay, if any, in achieving substantial completion of Landlord's Work in connection therewith and (C) any conditions imposed by Landlord on the grant of its approval. (iii) If Landlord provides Tenant with a Proposed Change Order, Tenant shall, within five (5) days after receipt of such Proposed Change Order, either reject or accept it. If Tenant rejects such Proposed Change Order (or fails to respond within the specified period), Landlord's Work shall not be changed. If Tenant approves such Proposed Change Order, then (A) Tenant shall execute the Proposed Change Order and deliver a signed original thereof to Landlord within the specified five (5) day period, together with payment of (1) the full amount of the specified increases, if any, in the Tenants Contribution and (2) an amount equal to the Base Rent for the period of time set forth in clause (ii)(B) above, and (B) the Completion Date shall be extended for the time period specified in clause (ii)(B) above. (d) Tenant's taking possession of the Premises on or after the Commencement Date shall be conclusive evidence, as against Tenant, that the Premises were in good order and satisfactory condition in substantial accordance with the Tenant Improvements Plans and Specifications when Tenant took possession, except for punch list items on a list signed by both parties within thirty (30) days after the date on which Tenant takes possession of the Premises. (e) Warranties. For any construction or installation, Tenant shall ---------- receive, to the extent possible, the benefit of any and all warranties from contractors, subcontractors, material suppliers, equipment suppliers, architects, engineers or others in connection with the Premises; however, Landlord will not have any obligation to bring any action to enforce any warranty claim. Landlord shall be deemed to have warranted to Tenant, at the time of delivery to Tenant of the Premises upon Substantial Completion: (i) that Landlord's Work has been Substantially Completed in accordance with the Tenant Improvements Plans and Specifications, with such modifications as are permitted under the terms of this Lease or approved by Tenant; (ii) that the electrical, plumbing, HVAC and other mechanical systems in the Building and serving the Premises are in good working order and condition and conform to the requirements (where applicable to the Premises) contained in this Lease; (iii) that the Premises are served by water, electricity and other utilities; (iv) that the Premises are served by sewer, and such sewer system, as installed, is of sufficient capacity to serve the Building when fully occupied; and (v) the Landlord's Work is free of material defects in materials or workmanship. Notwithstanding the foregoing, Landlord's warranties shall exclude, and Landlord shall not be responsible for (1) any damage or defects arising out of (or aggravated by) the acts or omissions of Tenant, and/or any other Tenant Invitee, (2) ordinary wear and tear, and (3) except to the extent provided in Article VI, routine maintenance, repairs and/or replacements and/or any damage or defects due to neglect or failure to provide proper maintenance and repairs. Landlord's warranties as set forth herein shall be limited to items as to which Tenant gives Landlord written notice within twelve (12) months of the Substantial Completion Date and in any event with respect to the Building's HVAC system shall extend for not less than a full cooling and heating season following Substantial Completion of the Premises. Except for the express warranties set forth in this Section 3.1(e), Landlord disclaims all warranties (express or implied) with respect to the Landlord's Work, and Tenant hereby releases all warranties not expressly stated in this Section 3.1(e). Section 3.2 Tenant's Work; Pre-Term Occupancy. Tenant agrees to perform ---------------------------------------------- all of Tenant's Work as specified herein and on Exhibit F and to complete same --------- by the Completion Date, as the same may be extended as provided herein. The Tenant's Work Plans and Specifications and all modifications thereto shall be subject to Landlord's prior written approval, which approval shall not be unreasonably withheld. Except as hereinafter set forth, Tenant's Work shall commence as soon as the Tenant Improvements Work has progressed to the point at which Tenant's Work may reasonably begin. All of Tenant's Work shall be done in a good and workmanlike manner using new and high quality materials, in accordance with the provisions of all laws, rules, regulations and insurance requirements applicable thereto and in accordance with the requirements of Section 7.5 hereof. In the event that Tenant enters Landlord's Property prior to the Commencement Date, such entry shall be at Tenants own risk solely for the purpose of preparing for occupancy by Tenant and installing fixtures and equipment; provided, however, that in so entering Landlord's Property prior to the Commencement Date, Tenant shall not interfere with Landlord's construction activities: and provided, further, that Tenant may not so enter Landlord's Property prior to October 1, 1999 without the prior written approval of Landlord, which approval Landlord shall have no obligation to give. During the period of any entry by Tenant prior to the Commencement Date pursuant to the above provisions of this Section, Tenant shall be subject to the insurance obligations set forth in Sections 7.8 and 7.9 and to all other obligations of Tenant under this Lease, other than the obligations to pay Base Rent, Tenant's Tax Escalation, Tenant's Insurance Cost Escalation and Tenants Operating Cost Escalation, and, prior to any such entry by Tenant prior to the Commencement Date, Tenant shall furnish Landlord with a certificate of insurance confirming its procurement of the insurance required by Sections 7.8 and 7.9. In the event of any delay in the performance of Landlord's Work and/or increase in the cost thereof due to any entry by Tenant or any Tenant Invitee prior to the Commencement Date, Tenant shall pay to Landlord, within ten (10) days after demand, an amount equal to the Base Rent for the period of such delay plus any and all such cost increases. Section 3.3 Approval of Plans and Specifications. If Tenant's Work as set ------------------------------------------------- forth on Exhibit F does not refer to complete plans and specifications approved ---------- by Landlord, then Tenant shall promptly, following execution of this Lease, cause such plans and specifications to be prepared at Tenant's cost and submitted to Landlord for Landlord's prior written approval before Tenant's Work is commenced. Landlord shall not unreasonably withhold or delay such approval. Landlord's approval of any Plans and specifications pursuant to this Section or any other provisions of this Lease shall not, and shall not be deemed to, be a certification, representation, or warranty by Landlord that the plans and specifications are adequate, complete, or in compliance with applicable codes and legal requirements. Section 3.4 Signs. Tenant shall have the right, at Tenant's sole cost, to ----------------- erect one (1) sign on the exterior of the Building provided that such sign complies with the provisions of this Section 3.4 and other applicable provisions of this Lease. The sign's location, design, shape, size, materials, color and type and all other matters related to such sign (other than Tenant's right to erect a sign) shall be subject to Landlord's prior written approval (which approval shall be in Landlord's sole discretion), following submission by Tenant to Landlord of detailed plans and specifications therefor. Tenant shall provide such plans and specifications to Landlord within twenty (20) days after the date hereof. Except for the one sign permitted pursuant to this Section 3.4, Tenant shall not erect any signs which are visible from the exterior of the Building. Tenant shall not erect signs except in compliance with all applicable requirements of the Town of Needham and all other applicable Legal Requirements. Tenant shall be solely responsible for confirming that any proposed sign is in compliance with all such requirements. All costs of obtaining permits and approvals, creating, installing, illuminating, maintaining, repairing, and/or replacing such sign shall be paid by Tenant. Any signs located in the interior of the Building (i) shall comply with all applicable Legal Requirements and the sign criteria included in the Rules and Regulations, and (ii) and shall have been approved of in writing and in advance by Landlord following submission of detailed plans and specifications by Tenant to Landlord. Tenant shall maintain its signs, if any, in good repair and condition. Immediately upon the expiration of the Lease Term or other termination of this Lease, Tenant shall remove all signs from the exterior of the Building and shall make all repairs necessary to restore the exterior surfaces to the condition of the surrounding exterior surfaces of the Building. ARTICLE IV ---------- BASE RENT; ADDITIONAL RENT -------------------------- Section 4.1 Base Rent. --------------------- (a) In consideration of the lease of the Premises pursuant to this Lease, Tenant shall pay therefor Base Rent in the amounts set forth in Item 10 of the Summary of Basic Terms. (b) (i) The Base Rent during the Extension Term will be the greater of (A) the Base Rent in effect during the last Lease Year prior to the Extension Term or (B) ninety- five percent (95%) of the Market Rent, as determined by this Section 4.1(b). Within thirty (30) days after Tenant gives to Landlord written notice of exercise of the extension option pursuant to Section 2.4 hereof, Landlord and Tenant shall simultaneously exchange proposals setting forth their opinions as to the market rent for the Premises for the Extension Term "Market Rent"). ----------- Landlord and Tenant shall negotiate in good faith until the later of: (X) fifteen (15) days after the exchange of proposals or (Y) the date which is ten (10) months prior to the expiration of the Initial Term (such period being herein called the "Negotiation Period") to attempt to agree upon the Market ------------------ Rent, and, in the course of such negotiations, each party may from time to time submit modified proposals to the other. If the parties agree upon the Market Rent prior to the determination of the arbitrator pursuant to Section 4.1(b)(ii) hereof, whether such agreement is reached during or after the Negotiation Period, the Market Rent shall be so agreed. (ii) If the parties are unable to agree upon the Market Rent for the Extension Term within the Negotiation Period then each party shall, upon selection of an arbitrator pursuant to Section 4.1 (b)(iii) hereof, simultaneously exchange and submit to the arbitrator for binding arbitration a proposal as to Market Rent for the Extension Term. "Market Rent" shall be determined as of the commencement of the Extension Period at the then current arms-length negotiated rentals being charged to new (or renewal tenants for renewals and extensions which do not have pre-negotiated contract rents) for comparable space in comparable buildings located in the Needham area, taking into account and giving effect to, in determining comparability, without limitation, such considerations as lease term, Base Years and the age, size, location, condition, and amenities of the Building. For purposes of such determination, the Premises shall be considered to be vacant and to be rented as a whole for its highest and best use with the degree of finishes and level of leasehold improvements then generally afforded as "building standard" by landlords in the Needham area. The arbitrator shall also consider and incorporate into the computation, the existing improvements to the Premises. Neither party shall be deemed under any compulsion to rent or lease space. The arbitrator shall not have the right to modify any other provision of the Lease except Base Rent. Within thirty (30) days after both parties have submitted such proposals to the arbitrator, the arbitrator shall select one of the proposals as more closely approximating the Market Rent appropriate for the applicable Extension Term, and, unless the parties have then agreed upon the Market Rent, the proposed Market Rent set forth in such proposal selected by the arbitrator shall be deemed to be the Market Rent for the Extension Term. (iii) If the parties are unable to agree upon the Market Rent within the Negotiation Period, then the parties shall, within fifteen (15) days after the end of the Negotiation Period (such fifteen (15) day period being herein called the "Selection Period"), attempt to agree upon an arbitrator to whom to ---------------- submit the determination of Market Rent for binding arbitration pursuant to Section 4.1(b)(ii) hereof. If the parties are unable to agree upon an arbitrator within the Selection Period, then, at the end of the Selection Period, each party shall select an arbitrator and, within fifteen (15) days after the end of the Selection Period, the arbitrators shall agree upon an arbitrator to whom the determination of Market Rent shall be submitted for binding arbitration pursuant to Section 4.1(b)(ii) hereof. If such arbitrators are unable to agree promptly upon an arbitrator, an arbitrator shall be selected by the American Arbitration Association. Any arbitrator selected by either party, by the arbitrators selected by the parties or by the American Arbitration Association shall be independent of both parties and shall have such experience, either as a licensed real estate broker or salesperson or as an appraiser, as would qualify such arbitrator as an expert with respect to office leasing terms in Needham, Massachusetts. Such arbitrator shall make the determination required pursuant to Section 4.1(b)(ii) within thirty (30) days of selection. The parties shall share equally the fees and expenses of the arbitrator to whom the determination of Market Rent is submitted. Landlord and Tenant shall each pay the fee of the arbitrator selected by it. In making its determination of Market Rent, the arbitrator shall not make any downward adjustment to account for any savings to be realized by Landlord with respect to leasing commissions or tenant improvements. (c) Base Rent for each Lease Year shall be payable in equal monthly installments of one-twelfth of the annual Base Rent for such Lease Year and shall be paid without offset for any reason, in advance, on the first day of each calendar month during the Lease Term following the Commencement Date. If the Commencement Date is not on the first day of a calendar month, Tenant shall pay, on or before the Commencement Date, a proportionate part of the Base Rent for the month in which the Commencement Date occurs based upon the annual Base Rent applicable to the first Lease Year, divided by 360 and then multiplied by the number of days in such month (including the Commencement Date) included in the Lease Term. Base Rent and Additional Rent shall be paid at Landlord's option, by either (i) an "electronic funds transfer" system arranged by and among Tenant, Tenant's bank and Landlord, or (ii) a check sent to Landlord's office, c/o Robert A. Schlager, or at such other place as Landlord shall from time to time designate in writing. If Tenant is using checks, rent checks shall be made payable to BHX, LLC, as Trustee of Crawford Realty Trust or to such other entity or trade-style as Landlord may designate from time to time in writing. The parties hereto acknowledge and agree that the obligations owing by Tenant under this Section 4.1 are rent reserved under this Lease, for all purposes hereunder, and are rent reserved within the meaning of Section 502(b)(6) of the Bankruptcy Code or any successor provision thereto. Section 4.2 Certain Additional Rent. Tenant shall pay, without offset for ----------------------------------- any reason, all payments of Additional Rent payable by Tenant to Landlord hereunder. If Tenant fails to pay any Additional Rent, Landlord shall have all the rights and remedies for failure to pay Base Rent. The parties hereto acknowledge and agree that the obligations owing by Tenant under this Section 4.2 are rent reserved under this Lease, for all purposes hereunder, and are rent reserved within the meaning of Section 502(b)(6) of the Bankruptcy Code or any successor provision thereto. Section 4.3 Net Lease. Landlord and Tenant intend that the rent payable --------------------- under this Lease shall be net Base Rent and Additional Rent to Landlord as described herein during the Lease Term. Tenant shall pay all costs, expenses and obligations of every kind and nature whatsoever relating to the Premises and all expenses and obligations of every kind and nature whatsoever relating to the operation, maintenance, upkeep, replacement or repair of Landlord's Property in excess of the Operating Cost Base, Insurance Cost Base and Tax Base to the extent property includable in Operating Costs, Insurance Costs and Taxes as provided in this Lease, without any deduction or offset unless expressly provided otherwise herein. Section 4.4 Taxes. ----------------- (a) Tenant shall pay to Landlord, as Additional Rent, an amount equal to Tenant's Tax Escalation as provided in the following sentence. Tenant's Tax Escalation shall be estimated in good faith by Landlord at the end of each Tax Fiscal Year, and thereafter be payable to Landlord in equal estimated monthly installments together with the payment of Base Rent, subject to readjustment when the actual amount of Taxes is determined. After readjustment, any shortage shall be due and payable by Tenant within 30 days of demand by Landlord and any excess shall, unless an Event of Default has occurred, be credited against future Additional Rent obligations, or refunded if the Lease Term has ended and Tenant has no further obligations to Landlord. If the taxing authority provides an estimated tax bill, then monthly installments of Taxes shall be based thereon until the final tax bill is ascertained. Landlord shall furnish to Tenant, upon Tenant's request, but not more than once in any year, a copy of the tax bill or any estimated tax bill. (b) If, after Tenant shall have made any payment under this Section 4.4, Landlord shall receive a refund (the "Refund") of any portion of the Taxes --------- paid on account of any Tax Fiscal Year in which such payments shall have been made as a result of an abatement of such Taxes, by final determination of legal proceedings, settlement or otherwise ("Proceedings"), Landlord shall, within ----------- thirty (30) days after receiving the Refund, pay to Tenant (unless an Event of Default has occurred) an amount equal to (i) the lesser of (A) Tenant's Tax Escalation payments for such Tax Fiscal Year or (B) the Refund, which payment to Tenant shall be appropriately adjusted if Tenant's Tax Escalation covered a shorter period than covered by the Refund, less (ii) all expenses incurred by Landlord in connection with such Proceedings (including, but not limited to, attorneys' fees, costs and appraisers' fees). Landlord shall have sole control of all tax abatement proceedings. Tenant shall not receive any credit or refund in the event that the Taxes for any Tax Fiscal Year is less than the Tax Base. (c) If the Commencement Date of this Lease is not on July 1, or the expiration or termination of this Lease is not on June 30, Tenant's obligation in respect of Taxes shall be prorated. If the final tax bill for the Tax Fiscal Year in which such expiration or termination of this Lease occurs shall not have been received by Landlord, then within thirty (30) days after the receipt of the tax bill for such Tax Fiscal Year, Landlord and Tenant shall make appropriate adjustments of estimated payments. (d) Without limiting the generality of the foregoing, Tenant shall pay all rent and personal property taxes attributable to its signs or any other personal property including but not limited to its trade fixtures, the existing or any future floor coverings, wall treatments and light fixtures in the Premises. Section 4.5 Insurance Costs. Tenant shall pay to Landlord, as Additional --------------------------- Rent, an amount equal to Tenant's Insurance Cost Escalation. Tenant's Insurance Cost Escalation shall be estimated in good faith by Landlord at the end of each calendar year, and thereafter be payable in equal estimated monthly installments, together with the Base Rent, subject to readjustment from time to time as determined by Landlord and also when actual Insurance Costs are determined. After a readjustment, any shortage shall be due and payable by Tenant within 30 days of demand by Landlord and any excess shall, unless an Event of Default has occurred, be credited against future Additional Rent obligations, or refunded if the Lease Term has ended and Tenant has no further obligations to Landlord. Landlord shall provide Tenant upon request with reasonable supporting documentation for the Insurance Costs for the prior calendar year, provided that such request is received by Landlord within six (6) months after the end of the calendar year to which such Insurance Costs relate. Section 4.6 Operating Costs. Tenant shall pay to Landlord, as Additional --------------------------- Rent, an amount equal to Tenant's Operating Cost Escalation. Tenant's Operating Cost Escalation shall be estimated in good faith by Landlord at the end of each calendar year, and thereafter be payable in equal estimated monthly installments, together with the Base Rent, subject to readjustment from time to time as determined by Landlord and also when actual Operating Costs are determined. After a readjustment, any shortage shall be due and payable by Tenant within 30 days of demand by Landlord and any excess shall, unless an Event of Default has occurred, be credited against future Additional Rent obligations, or refunded if the Lease Term has ended and Tenant has no further obligations to Landlord. Landlord shall provide Tenant upon request with reasonable supporting documentation for the Operating Costs for the prior calendar year; provided that such request is received by Landlord within six (6) months after the end of the calendar year to which such Operating Costs relate. Section 4.7 Payment for Electricity. Landlord shall cause the Premises to ----------------------------------- be separately metered or submetered for electrical use including, without limitation, with respect to all variable air volume ("VAV") boxes and pre- --- heaters, lighting and outlets serving the Premises. Except to the extent of amounts collected by Landlord from Tenant on account of Tenant's Electricity Costs, Tenant shall promptly pay all charges related to its use of electricity to the appropriate public utility. Section 4.8 Annual Statement: Tenant's Audit. Subsequent to the Base Year --------------------------------------------- and Base Tax Fiscal Year, Landlord shall provide one or more statements to Tenant setting forth the Operating Cost Base, Insurance Cost Base, and/or the Tax Base (each such statement being referred to hereinafter as a "Base ---- Statement"). Thereafter, with respect to each year during the Lease Term, Landlord-shall provide an annual statement of Operating Costs, Insurance Costs, and Taxes. Tenant shall have the right to audit each annual statement and the books and records relating thereto, by delivering a notice of its intention to perform such audit to Landlord within sixty (60) gays after receipt of such statement. Such audit may be performed at any time prior to the sixtieth (60") day following the date that Tenant gives such notice of audit (the "Audit ----- Deadline"). If Tenant wishes to receive a refund of any of Tenant's Operating - ----------- Cost Escalation, Insurance Cost Escalation, and/or Tenants Tax Escalation as a result of such audit, Tenant shall deliver to Landlord, no later than forty-five (45) days after the Audit Deadline, a notice demanding such a refund, together with a statement of the grounds for each such demand and the amount of each proposed refund. The cost of any such audit shall be paid by Tenant, except that, if it is determined on the basis of any such audit that the amount of the Operating Costs, Insurance Costs, and Taxes was overstated in any such annual statement by more than five percent (5.0%), the reasonable cost of such audit, but in no event more than the amount by which Tenant was overcharged due to such overstatement, shall be paid or reimbursed to Tenant by Landlord. An overstatement shall not be deemed to exist due to a Refund. Any audit shall be performed by either (a) Tenant's regular employees or (b) a nationally recognized accounting firm whose compensation is not, directly or indirectly, contingent in whole or in part on the results of the audit. ARTICLE V --------- USE OF PREMISES --------------- Section 5.1 Permitted Use. Tenant shall use and occupy the Premises only ------------------------- for the Permitted Use. Section 5.2 Restrictions on Use. Tenant shall use the Premises in a --------------------------- careful, safe and proper manner, shall not commit or suffer any waste on or about Landlord's Property, and shall not make any use of Landlord's Property which is prohibited by or contrary to any laws, rules, regulations, orders or requirements of public authorities, or which would cause a public or private nuisance. Tenant shall comply with and obey all laws, rules, regulations, orders and requirements of public authorities which in any way affect the use of Landlord's Property. Tenant, at its own expense, shall obtain any and all permits, approvals and licenses necessary for use of the Premises, except that Landlord shall obtain all building permits, approvals and certificates of occupancy required for Landlord's Work. Tenant shall not overload the floors or other structural parts of the Building; and shall not commit or suffer any act or thing an Landlord's Property which is illegal, offensive, dangerous, or which unreasonably disturbs other tenants. Tenant shall not do or permit to be done any act or thing on Landlord's Property which will invalidate or be in conflict with any insurance policies, or which will increase the rate of any insurance, covering the Building. If, because of Tenants failure to comply with the provisions of this Section or due to any use of the Premises or activity of Tenant in or about Landlord's Property, the Insurance Costs are increased, Tenant shall pay Landlord the amount of such increase caused by the failure of Tenant to comply with the provisions of this Section. Tenant shall cause any fire lanes in the front, sides and rear of the Building to be kept free of all parking associated with its business or occupancy and in compliance with all applicable regulations. Tenant shall conduct its business at all times so as not to annoy or be offensive to other tenants and occupants in Landlord's Property. Tenant shall not permit the emission of any objectionable noise or odor from the Premises and shall at its own cost install such extra sound- proofing or noise control systems and odor control systems, as may be needed to eliminate noise, vibrations and odors, if any, emanating from the Premises being heard, felt or smelled outside the Premises. Tenant shall not place any file cabinets bookcases, partitions, shelves or other furnishings or equipment in a location which abuts or blocks any windows. Section 5.3 Hazardous Materials. Tenant in its use of the Premises will ------------------------------- not use, store, discharge, release, or permit the presence of any Hazardous Materials on Landlord's Property, except in minor quantities typically found in similar office buildings for typical office use in and in compliance with all applicable Environmental Laws. ARTICLE VI ---------- LANDLORD'S SERVICES ------------------- Section 6.1 Landlord's Services. Landlord shall furnish to the Building ------------------------------- the services set forth below in this Section 6.1. subject to the conditions stated in this Lease. The cost of certain of these services are to be (i) paid by Tenant, as provided in this Lease, or (ii) included in Operating Costs, Insurance Costs or Taxes, as applicable and to the extent permitted under this Lease. (a) Exterior of Building and Structure. Landlord shall keep in good ---------------------------------- condition and repair the exterior and structural elements of the Building, including the roof, the utility lines and systems outside the Building (except to the extent those utility lines or systems are the property or responsibility of the applicable utility company) and the Parking Areas, landscaping and sidewalks on the Land. (b) Systems. Subject to Tenant's obligations under Section 7.9, ------- Landlord shall operate, maintain and repair the heating, ventilating and air conditioning system, the plumbing system and the electrical system (excluding lamps and ballasts) of the Building so that the same are in good and operational condition. Landlord shall provide heating and air conditioning services to the Premises to heat and cool the Premises at temperatures in accordance with ASHRAE standards in effect as of the date of the Lease during Business Hours. If Tenant desires heating or air conditioning services at the Premises at any time other than Business Hours, Landlord shall use reasonable efforts to arrange for such "after hours" heating or air conditioning service, and Tenant shall pay for such service as Additional Rent at an hourly rate of $50.00 (such payments shall constitute Other Additional Rent and shall be due and payable within 30 days after Landlord bills Tenant therefor). (c) Water and Sewer. Cold and hot water at standard Building --------------- temperatures will be available for ordinary drinking, cleaning, sanitary and lavatory purposes. (d) Elevator. Landlord will provide one (1) automatic operatorless -------- elevator in the Building. Landlord shall operate, maintain and repair the elevator so that the same is in good and operational condition. (e) Waste Removal. Landlord shall provide or arrange for ordinary and ------------- reasonable waste removal services for the Building. In the event that Landlord reasonably determines that Tenant's quantity of waste is excessive, or, in the event that Landlord deter-mines that Tenant's waste is other than waste generated by typical office use, Landlord may require that Tenant be responsible for disposing of its own waste. (f) Janitorial Services and Window Cleaning. Landlord shall supply ---------------------------------------- routine janitorial services for the Office Space and window cleaning for the Building comparable to that provided by the owners of comparable buildings in the Greater Boston area. Such services may be revised from time to time by Landlord in its sole discretion, but janitorial services shall in all events be provided five days a week except for Building holidays. (g) Taxes. Landlord shall pay all Taxes levied upon or with respect ----- to Landlord's Property. (h) Snow Plowing and Ice Sanding. Landlord shall provide snow plowing ---------------------------- and ice sanding services with respect to the Parking Areas and sidewalks comparable to that provided by the owners of comparable buildings in the Greater Boston area. (i) Insurance. Landlord shall procure and maintain in full force and --------- effect fire, casualty and extended coverage insurance with respect to the Building, with vandalism and malicious mischief endorsements in an amount not less than the replacement value of the Building (excluding foundations and underground utilities), liability insurance with limits of not less than One Million Dollars per occurrence for bodily injury and property damage and Two Million Dollars annual aggregate, rent loss insurance and such other insurance upon or with respect to Landlord's Property as Landlord determines to be necessary, appropriate and/or desirable or is required by Landlord's lender, all with such limits of coverage as Landlord or Landlord's lender may deem necessary. appropriate and/or desirable. Section 6.2 Extraordinary Use. Tenant acknowledges that the services to be ----------------------------- supplied by Landlord will be sufficient only for general office purposes. Any additional capacity or structural support, as determined by Landlord, needed for uses beyond ordinary office uses, shall be subject to Landlord's prior written approval, which approval shall be in Landlord's sole discretion, and all necessary equipment shall be installed and maintained at Tenant's sole expense. Section 6.3 Interruption; Delay. Landlord shall have no responsibility or ------------------------------- liability for failure or interruption of any such repairs or services referred to in this Article VI, or for any interruption in utility services, caused by breakage, accident, strikes, repairs, inability after exercise of reasonable diligence to obtain supplies or otherwise furnish services, or for any cause or causes beyond the reasonable control of Landlord (but Landlord, in respect of those matters for which Landlord is responsible, will use reasonable efforts to restore such services or make such repairs as soon as possible), nor in any event for any indirect or consequential damages; and failure or omission on the part of Landlord to furnish such service or make such repair shall not be construed as an eviction of Tenant, nor, provided that Landlord is using reasonable efforts to restore such services or make such repairs in those circumstances where Landlord is obligated to do so, render Landlord liable in damages, nor entitle Tenant to an abatement of Base Rent or Additional Rent, nor release Tenant from the obligation to fulfill any of its covenants under this Lease, except as provided in Articles X and XI hereof with respect to eminent domain and damage by fire or other casualty. Section 6.4 Additional Services. Should Tenant request any additional ------------------------------- services, or services beyond the noted hours for such services (other than "after hours" HVAC which is covered in Section 6.1(b)), Tenant agrees to pay to Landlord as Additional Rent therefor Landlord's costs for providing such service, plus an additional fifteen (15%) percent as an administrative fee, within thirty (30) days of Landlord's billing Tenant therefor. Section 6.5 Tenant's Right to Cure. If Landlord shall be in material ---------------------------------- default under this Article VI, which default shall continue for thirty (30) days after the written notice thereof from Tenant to Landlord, then Tenant shall have the right, but not the obligation, to cure such default, in which event Landlord shall pay to Tenant within thirty (30) days after receipt of Tenant's demand therefor (accompanied by invoices and other information reasonably acceptable to Landlord documenting such costs), the reasonable out-of-pocket third party costs incurred by Tenant to cure such default, provided, however, if such fault is not reasonably susceptible of being cured within such thirty (30) day period, then, as long as Landlord shall commence the curing thereof within such thirty (30) day time period and is proceeding with due diligence to cure the same, Tenant shall not have the aforesaid right and provided further, that, in the event of an emergency, then the cure period shall be shortened to such time period after notice from Tenant to Landlord as may be reasonable under the circumstances. Notwithstanding anything to the contrary in this Lease. Tenant shall not be entitled to cure a default under Sections 9.5 and 12.1 (j). Section 6.6 Exoneration and Indemnification. Landlord will exonerate, ------------------------------------------- indemnify, defend, save and hold harmless Tenant (and any and all Persons claiming by, through or under Tenant, from and against all claims, damages, proceedings, defenses thereof, liabilities, costs, and expenses of any kind and nature, including reasonable legal fees, arising from: (a) any breach of this Lease by Landlord (but not any breach by a prior landlord) and/or (b) any act, wrongful omission or negligence of Landlord (but not any act, omission or negligence of any prior landlord). Under no circumstances shall Landlord be responsible to Tenant or any other Person for the acts or omissions of any tenant of Landlord's Property or any Invitee of any tenant. This exoneration, indemnification and hold harmless agreement shall survive the termination of this Lease. Under no circumstances shall any landlord have any liability or obligation under this Section for (i) any breach of this Lease by any predecessor or (ii) any act, omission or negligence of any predecessor. ARTICLE VII ----------- CERTAIN OBLIGATIONS OF TENANT ----------------------------- Section 7.1 Rent. Tenant will promptly pay the Base Rent and Additional ---------------- Rent, including without limitation any and all fees, charges, expenses, fines, assessments or other sums payable by Tenant to Landlord (or to the applicable provider of utilities) at the time and in the manner provided for in this Lease, all of which shall be deemed to be obligations to pay Base Rent or Additional Rent. Section 7.2 Utilities. Except for Tenant's Electricity Costs, Tenant shall --------------------- pay for all utility usage as a part of Tenant's Operating Cost Escalation. Tenant agrees that its use of electric current shall never exceed the capacity of existing feeders, risers and wiring installations in the Building. Without limiting the foregoing, Tenant shall not connect to the electrical distribution system anything other than normal office equipment (which includes computers, fax machines, printers and copiers). Tenant shall not make or perform any alterations to wiring, installations, lighting fixtures or other electrical facilities in any manner without the prior written consent of Landlord, which consent shall be in Landlord's sole discretion. Any risers or wiring to meet Tenant's excess electrical requirements, if requested by Tenant and approved by Landlord, will be installed by Landlord at Tenants expense. Section 7.3 No Waste. Tenant shall not overload, damage or deface the -------------------- Premises nor shall it suffer or permit the same to be done, nor shall it commit any waste. Tenant shall initiate and carry out a program of regular maintenance and repair of the Premises so as to impede, to the extent possible, deterioration by ordinary wear and tear. Section 7.4 Maintenance; Repairs, and Yield-Up. Subject to Landlord's ---------------------------------------------- obligations under Section 6.1, Tenant agrees that from the Commencement Date until the end of the Lease Term and during any holdover, it will keep the Premises and any improvements placed an Landlord's Property by Tenant neat and clean and maintain the same in substantially the same repair and condition as such were in on the Commencement Date (or the date on which installation of same was completed, as applicable), except for reasonable wear and tear, damage by fire or other casualty or taking by eminent domain. Tenants obligation to so maintain and repair the Premises and any improvements placed on Landlord's Property by Tenant shall apply to all interior areas of the Premises, including, without limitation, all doors, interior glass, fixtures, interior walls, floors and ceilings. Nothing contained in this Section 7.4 shall place any obligation an Tenant to maintain or repair the exterior of the Building, the systems serving the Building or the structure of the Building; provided, however, that Tenant may be responsible for the costs incurred by Landlord in connection therewith to the extent that such costs are properly included in Operating Costs. At the end of the Lease Term or sooner termination of this Lease, Tenant shall peaceably surrender and deliver up the Premises to Landlord (and (i) having first removed, at Tenant's sole cost and expense, any or all erections, alterations and additions made to or upon the Premises as may be designated by Landlord and restoring the Premises to the condition required above, and (ii) leaving all erections, alterations and additions to the Premises which Landlord designates to remain in good repair and condition, except for reasonable wear and tear, damage by fire or other casualty and taking by eminent domain), broom clean, with all utilities safely capped, and in good repair and condition, and removing all signs and lettering and all personal property, goods and effects belonging to Tenant or anyone claiming through or under Tenant. Nothing contained herein shall be deemed to require Tenant to remove Landlord's Work at the end of the Lease Term, it being agreed that Tenant shall have no right nor obligation to remove the same. Without limiting the generality of the foregoing, Tenant shall be responsible for the replacement of lamps and ballasts in the Building at Tenant's cost. Tenant shall cause all maintenance and repair work to conform to applicable governmental laws, rules, regulations, orders and requirements of public authorities. Subject to Landlord's performance of its obligations under Section 6.1(f), Tenant shall keep the Premises clear of all filth, trash and refuse. If Tenant fails to perform Tenant's obligations under the above provisions of this Section, then Landlord will have the right (but not the obligation), without waiving any default by Tenant, to cause such obligations to be performed upon not less than ten (10) days prior written notice to Tenant (or a shorter period of prior written notice, or a contemporaneous written notice, if appropriate in Landlord's judgment in light of the nature of Tenant's obligations to be performed), and if Landlord causes any of such obligations to be performed, the costs and expenses reasonably incurred by Landlord in connection therewith shall be due and payable by Tenant to Landlord as Additional Rent upon demand. Section 7.5 Alterations by Tenant. Tenant will not make any alteration in, --------------------------------- or addition to, the Premises without first obtaining, on each occasion, Landlord's consent in writing, which consent shall not be unreasonably withheld or delayed, and then only at Tenants expense and in a lawful manner and upon such terms and conditions as Landlord, by such writing, shall reasonably approve, which shall include, without limitation, (a) maintenance of insurance in form and substance reasonably satisfactory to Landlord and (b) compliance with Sections 7.9 and 7.11. Any such alteration or addition shall be consistent in appearance with the rest of the Building and Landlord's Property and shall be made only after duly obtaining (and providing to Landlord copies of) all required permits and licenses from all governmental authorities. Tenant will deliver to Landlord in writing a schedule setting forth the details and location of all such proposed alterations or additions and detailed plans and specifications. The contractor(s) performing the work shall be subject to Landlord's approval, which approval shall not be unreasonably withheld or delayed. If required by Landlord, Tenant shall provide a statutory lien bond with respect to such work. All approved repairs, installations, alterations, additions or other improvements made by Tenant shall be made in a good and workmanlike manner. Tenant Invitees shall be given such reasonable access to other portions of the Building and the mechanical systems as may be necessary or appropriate to perform such work. Both during and after the performance of any such work, Landlord shall have free access to any and all mechanical installations in the Premises, including, but not limited to, air conditioning, fans, ventilating systems, machine rooms and electrical closets; and Tenant agrees not to construct or permit the installation of partitions and/or other obstructions in the Premises which might interfere with Landlord's free access to the Premises or Building, or impede the free flow of air to and from air vents and other portions of the heating, ventilating and air conditioning systems in the Building. Unless Landlord elects otherwise, all installations, alterations, additions or improvements in or to the Premises shall be the property of Landlord and shall remain upon, and be surrendered with, the Premises at the end of the Lease Term or sooner termination of this Lease. Section 7.6 Trade Fixtures and Equipment. Any trade fixtures and equipment ---------------------------------------- installed in, or attached to, the Premises by, and at the expense of, Tenant, shall remain the property of Tenant. Tenant shall have the right, at any time and from time to time during the Lease Term, to remove any and all of its trade fixtures, which it may have installed in, or attached to, the Premises, during the Lease Term. In addition, at the end of the Lease Term or sooner termination of this Lease, Tenant shall remove all of Tenant's trade fixtures and all floor coverings and wait treatments installed by Tenant unless Landlord gives Tenant a written waiver for same. At any time that Tenant removes its trade fixtures, Tenant shall promptly repair Landlord's Property as a result of any damage to, or destruction of, Landlord's Property caused by the removal of its trade fixtures. Section 7.7 Compliance with Laws. Tenant, in its use of the Premises and -------------------------------- at its sole expense, shall comply with all laws, orders and regulations of Federal, State, County and Town authorities, and with any direction of any public officer or officers, pursuant to law, including, without limitation, all Legal Requirements related to the use, storage, discharge, release, removal or existence of Hazardous Materials. Tenant agrees that the Premises shall be kept in a sanitary and safe condition in accordance with all applicable Federal and State laws and the by-laws, rules, regulations and ordinances of the Town of Needham, and in accordance with all directions, rules and regulations of the Health Officer, Fire Marshall, Building Inspector and other proper officers of the governmental agencies having jurisdiction thereover. Notwithstanding the foregoing, Landlord shall be responsible for delivering Landlord's Property in compliance with applicable laws, orders and regulations and for maintaining Landlord's Property in compliance therewith, the cost of maintaining such compliance to be included as part of Operating Costs in accordance with the provisions of this Lease, including without limitation, Section 4.6. Section 7.8 Contents at Tenant's Risk. All inventory, equipment, goods, ------------------------------------- merchandise, furniture, fixtures and property of every kind which may be on or about the Premises shall be at the sole risk and hazard of Tenant, and if the whole or any part thereof shall be destroyed or damaged by fire, water or otherwise, or by the use or abuse of water or by the leaking or bursting of water pipes, or by rising water, or by roof or other structural leak, or in any other way or manner, no part of such loss or damage shall be charged to or borne by Landlord in any case whatsoever, except that to the extent required by applicable Massachusetts law, the foregoing shall not exculpate the Landlord from its own negligent acts or omissions or willful misconduct. Tenant agrees to maintain full and adequate insurance coverage on all of its property at the Premises and in the remainder of Landlord's Property, including physical damage, theft and business interruption insurance, or Tenant shall be a self-insurer thereof, in which case Tenant shall so advise Landlord in writing and shall be fully responsible for all such damage, and shall indemnify and save harmless Landlord from any loss, cost, expense, damage or liability resulting from Tenant's failure to have such insurance as required in this Lease. Such insurance an Tenant's property shall contain a waiver of subrogation cause in favor of Landlord, or shall name Landlord as an additional insured for the sole purpose of preventing a subrogation claim against Landlord. If Tenant is a self-insurer, in whole or in part, Landlord shall be entitled to the same benefits it would have enjoyed had insurance covering the loss in full with a waiver of subrogation clause been in effect, or as if the Landlord has been named on insurance covering the loss in full as an additional insured for the purpose of preventing a subrogation claim. Section 7.9 Exoneration: Indemnification and Insurance. Tenant will ------------------------------------------------------ exonerate, indemnify, defend, save and hold harmless Landlord (and any and all Persons claiming by, through or under Landlord) from and against all claims, proceedings, defenses thereof, liabilities, costs, and expenses of any kind and nature, including legal fees, arising from: (i) any breach of this Lease by Tenant or any Tenant invitee or other Person claiming by, through or under Tenant; and/or (ii) any act, omission or negligence of any Tenant invitee, or arising from any accident, injury or damage occurring in, on or about Landlord's Property, which such accident, damage or injury results or is claimed to have resulted from the negligence or misconduct on the part of any Tenant invitee. This exoneration, indemnification and hold harmless agreement shall survive the termination of this Lease. From and after any pre-term occupancy by Tenant, if any allowed by Landlord, and thereafter during the Lease Term and any period of holding over, Tenant shall maintain in full force and effect a policy of commercial general liability insurance under which Landlord (and its designees) and Landlord's mortgagee(s) (whose names are provided to Tenant) are named as additional insureds. Each such policy shall be non-cancelable with respect to Landlord without thirty (30) days prior written notice to Landlord (except for cancellation for non-payment of premiums, in which case notice shall be ten (10) days) and Tenant shall deliver to Landlord prior to any pre-term occupancy, prior to the Commencement Date and thereafter at least thirty (30) days prior to the expiration of any then effective coverage a satisfactory written certificate of insurance coverages or the renewal or replacement of such coverages. The minimum limits of liability of such insurance shall be One Million Dollars ($1,000,000.00) combined single limits for bodily injury and property damage, each occurrence, and One Million Dollars ($1,000,000.00) limits for personal injury, together with an overall umbrella coverage of an additional One Million Dollars ($1,000.000.00). Tenant shall not permit any contractor to do any work at or furnish any materials to be incorporated into the Premises without first delivering to Landlord satisfactory evidence of the Contractors commercial general liability insurance, worker's compensation insurance, automobile insurance and statutory lien bonds each reasonably acceptable to Landlord and complying with any insurance specifications provided by Landlord. All insurance requirements imposed upon Tenant or its contractors under this Lease shall be subject to the further requirement that the forms of coverage and the insurers providing the insurance be licensed in the Commonwealth of Massachusetts, be in sound financial condition, carry an A+ or better Best's rating, and be reasonably acceptable to Landlord. Tenant agrees that Landlord shall not be responsible or liable to Tenant, or to those Persons claiming by, through or under Tenant, for any loss or damage that may be occasioned by or through the acts or omissions of Persons occupying or using adjoining premises or any part of Landlord's Property, or otherwise, or for any loss or damage resulting to Tenant or those Persons claiming by, through or under Tenant, or its or their property, except that to the extent required by applicable Massachusetts law, the foregoing shall not exculpate the Landlord from acts of its own negligence or willful misconduct. Section 7.10 Landlord's Access. Upon reasonable advance notice (except in ------------------------------ case of emergency), Landlord and its representatives shall have the right without charge to it and without reduction in Base Rent or Additional Rent, at reasonable times and in such manner as shall not unreasonably interfere with Tenant's business, to enter the Premises for any reasonable purpose (including, without limitation, showing the Premises to prospective purchasers, tenants and lenders) and, if Landlord so elects, to make entry for the purpose of investigating repair or maintenance problems and to make such repairs or changes as Landlord deems advisable, and to maintain, use, repair, replace, relocate or introduce pipes, ducts, wires, meters and any other Landlord's fixtures serving or to serve the Premises or other parts of Landlord's Property, or to maintain or repair any portion of Landlord's Property, and, in case of an emergency, whether resulting from circumstances in the Premises or elsewhere in Landlord's Property, Landlord or its representatives may enter the Premises (forcibly, if necessary) at any time to take such measures as may be needed to cope with such emergency. Such access shall include, but not be limited to, the right to open floors, walls, ceilings, and building systems for the foregoing purposes. Landlord may place "For Lease", "For Rent" and/or "For Sale" signs on Landlord's Property. Any exercise of Landlord's rights under this Section 7.10 shall be conducted at such times and in such manner as to minimize, to the extent reasonable, any interference with Tenant's operations and shall be diligently pursued to completion. Any relocation or introduction of pipes, ducts, wires, meters and/or other fixtures shall, to the extent reasonably practical, be undertaken so as to minimize any loss of usable area in the Premises. Section 7.11 No Liens. Tenant shall not permit any mechanics', laborers' --------------------- or materialmen's liens to stand against Landlord's Property or Tenant's interest in the Premises, this Lease, or the estate created hereby for any labor or materials furnished to Tenant or claimed to have been furnished to Tenant in connection with work of any character performed or claimed to have been performed in or on the Premises by or at the direction or sufferance of Tenant. Landlord may condition the right of Tenant to do Tenant's work or to do any other work which could result in a lien upon Landlord's Property or Tenant's interests in the Premises, this Lease, or the estate created hereby on the delivery and recording of statutory lien bonds or indemnities satisfactory to Landlord. Section 7.12 Compliance with Rules and Regulations. Tenant covenants that -------------------------------------------------- all Tenant Invitees will comply with the Rules and Regulations and all other reasonable rules and regulations as Landlord may from time to time hereafter promulgate to regulate the conduct Generally of all the tenants of Landlord's Property. Landlord, however, shall have the reasonable right to change said rules and regulations and to waive any one or more of them in the case of any one or more tenants. ARTICLE VIII ------------ SUBLETTING AND ASSIGNMENT ------------------------- Section 8.1 Subletting and Assignment. ------------------------------------- (a) Except as hereinafter set forth, Tenant shall not assign, mortgage, pledge or encumber this Lease nor sublet all or any part of the Premises, nor permit or allow the use of all or any part of the Premises by third party users, such as concessionaires, without, on each occasion, obtaining Landlord's written consent thereto, which consent may be granted, conditionally granted or withheld at Landlord's discretion for any reason or no reason. As used herein, the term "assign' or `assignment' shall be deemed to include, without limitation: (i) any transfer of Tenants interest in this Lease by operation of law and/or the merger or consolidation of Tenant with or into any other firm or corporation; or (ii) the transfer or sale of a controlling interest in Tenant (whether in a single transaction or series of transactions) whether by sale of its capital stock or otherwise. (b) (i) Notwithstanding anything to the contrary in Section 8.1 (a), Landlord will not unreasonably withhold, condition or delay its consent to any sublease of all or any part of the Premises, so long as (A) the sublease will not violate the terms of (1) any lease affecting the Landlord's Property or (2) any agreement, instrument, law, rule, regulation or requirement which is binding upon Landlord and/or the Landlord's Property; (B) the subtenant and its proposed use is of a character consistent with the operation of a first class office building; (C) the subtenant's proposed use is as offices and is permitted under the terms of this Lease; (D) the subtenant is qualified to do business in the Commonwealth of Massachusetts and has all applicable permits and licenses to do business; (E) Tenant pays to Landlord all of Landlord's reasonable expenses arising out of such sublease: (F) there does not then exist an Event of Default and no Event of Default will be created as a result of the proposed sublease or, the proposed use by the subtenant,, (G) there are not more than a total of two (2) subtenants, including the proposed subtenant under the proposed sublease, in occupancy of the Premises or portions thereof; (H) the proposed sublease prohibits any assignment of the sublease or any sub-sublease of any portion of the Premises without the prior written consent of Landlord, which consent may be granted or denied in Landlord's sole discretion; and (1) each of Landlord's mortgagees has consented to such sublease if such mortgagee's consent is required pursuant to the terms of the applicable financing documents. (ii) Notwithstanding anything to the contrary in Section 8.1(a), but subject to the requirements set forth below in this paragraph, Landlord's consent shall not be required to an assignment of this Lease to (A) any entity which controls the legal and beneficial ownership of Tenant, (B) any entity controlled by, or under common control with, Tenant, (C) any corporation resulting from a merger or consolidation with Tenant, or (D) an entity acquiring all or substantially all of Tenant's assets, so long as, in each instance under any of clauses (A) through (D) above: (1) Tenant shall give Landlord at least thirty (30) days prior written notice of such proposed assignment together with the name and address of the proposed assignee, information concerning the terms and provisions upon which the proposed assignment is to be made, copies of all documents evidencing or setting forth the terms of the transaction and all other information as reasonably requested by Landlord, (2) there is no change in the use of the Premises; (3) Tenant is the surviving corporation in any merger or consolidation, or, if Tenant is not the surviving corporation, the surviving corporation assumes all of the obligations of Tenant under this Lease by executing an assignment and assumption agreement with respect to this Lease in form and substance satisfactory to Landlord; (4) the assignee has a tangible net worth (i.e., book value, determined in accordance with generally accepted accounting principles, consistently applied, less all intangible assets) on the date of such assignment not less than $5,000,000.00; (5) the assignee is qualified to do business in the Commonwealth of Massachusetts and has all applicable permits and licenses to do business from the Premises: (6) Tenant pays to Landlord all of Landlord's reasonable expenses arising out of such assignment-, and (7) there does not then exist an Event of Default and no Event of Default will be created as a result of the proposed assignment or the proposed use by the assignee. (c) In the event of an assignment of this Lease or sublease of all or any part of the Premises by Tenant, Tenant and any Guarantor shall remain primarily liable jointly and severally with the assignee or subtenant for the payment of any and all Base Rent and Additional Rent which may become due by the terms of this Lease and for the performance of all covenants, agreements and conditions on the part of Tenant to be performed hereunder and, if required by Landlord, Tenant and any Guarantor shall execute an instrument confirming the foregoing. No assignment of this Lease shall be effective unless and until the assignee (x) executes and delivers to Landlord an agreement, in form and substance satisfactory to Landlord, pursuant to which such assignee assumes all of the obligations of Tenant under this Lease and (y) delivers to Landlord evidence, in form and substance satisfactory to Landlord, of the insurance coverages required to be maintained by Tenant under this Lease. No sublease of all or any portion of the Premises shall be effective unless and until (i) the sublessee and the Tenant execute and deliver to Landlord an agreement, in Landlord's standard form, pursuant to which, inter alia, such sublessee (A) ----- ---- assumes all of the obligations of the Tenant under this Lease, (B) agrees to execute and deliver such estoppel certificates and subordination agreements as may be required by Landlord, (C) acknowledges that Landlord has no obligations to sublessee under this Lease, the sublease or otherwise and (D) agrees to maintain the same insurance coverages as the insurance coverages which Tenant is required to maintain under this Lease and to provide evidence thereof satisfactory to Landlord when requested,, and (ii) the sublessee delivers to Landlord evidence, in form and substance, satisfactory to Landlord, of the insurance coverages required to be maintained by such sublessee under the agreement referenced in clause (i) above. No modification of the terms of this Lease or any course of dealing between Landlord and any assignee or sublessee of Tenant's interest herein shall operate to release or impair Tenant's obligations under this Lease or the obligations of any Guarantor. (d) Tenant shall pay to Landlord fifty percent (50%) of any rent received as a result of any assignment or sublease which exceeds the rental payable hereunder for the same time period on a per square foot basis after deducting the actual direct out-of-pocket, third-party costs which are incurred by Tenant for leasing commissions and additional tenant improvements paid in connection with such assignment or sublease, and (ii) documented to Landlord's reasonable satisfaction by invoices, contracts, canceled checks and the like. (e) Notwithstanding anything to the contrary contained in this Section 8.1 or other provisions of this Lease, in the event that Tenant seeks Landlord's consent to an assignment of this Lease or a sublease of all or any part of the Premises other than pursuant to Section 8.1(b)(i), then, in any such event, Landlord, at its option, may, upon not less than ten (10) days notice from Tenant's request, terminate this Lease (or if the request is for a sublease of less than all of the Premises, at Landlord's option, Landlord may terminate this Lease as to the portion requested to be sublet and Landlord and Tenant shall execute an appropriate amendment to this Lease to modify the Premises and to adjust the Base Rent and other Lease terms) (the "Landlord's Termination Notice"). In such event, Landlord may enter into a new lease with the proposed assignee or sublessee or any other party an any terms and provisions acceptable to Landlord in Landlord's sole discretion for the Premises, and (provided that Tenant vacates the Premises or applicable portion thereof and leaves the Premises or said portion thereof in the condition required under this Lease), Tenant shall have no further liability under this Lease for the portion of the Premises released from this Lease except for any liability arising prior to such termination and those obligations which expressly survive termination (including, but not limited to, Tenant's obligations under Section 7.9). Notwithstanding the foregoing, if Landlord exercised its right to terminate with respect to all or a portion of the Premises, Tenant shall have the right to rescind its request for consent to an assignment of this Lease or a sublease of all or any part of the Premises by giving written notice to Landlord within ten (10) days of the date of Landlord's Termination Notice and such Landlord's Termination Notice shall be deemed void and this Lease shall remain in full force and effect in accordance with its terms. (f) Tenant shall not enter into any arrangements with any subtenant or assignee to circumvent, or which has the effect of circumventing, (i) its obligation to share rents received from a sublease or assignment, or (ii) any of the other provisions of this Section 8.1. ARTICLE IX ---------- RIGHTS OF MORTGAGEES AND GROUND LESSORS; ESTOPPEL CERTIFICATES -------------------------------------------------------------- Section 9.1 Subordination to Mortgages and Ground Leases. Tenant agrees -------------------------------------------------------- that this Lease is and shall be and remain subordinate to the lien of any present or future mortgage or mortgages, or ground lease, upon Landlord's Property, irrespective of the time of execution or time of recording of any such mortgage or mortgages, or ground lease, and to all renewals, extensions, and modifications therefor or amendments thereto, provided that the holder of such mortgage or ground lease enters into a non-disturbance agreement consistent with this Article IX. Tenant agrees that it will, upon ten (10) days' advance written request from Landlord or any holder of a mortgage on all or a portion of Landlord's Property or the ground lessor thereof, execute, acknowledge, and deliver any and all instruments reasonably deemed necessary or desirable by Landlord, or such holder to give effect to, or notice of, such subordination and non-disturbance agreement. Upon ten (10) days' written request from Landlord, any holder of a mortgage or ground lease an Landlord's Property or any successor in interest to Landlord, whether by purchase, foreclosure, deed in lieu of foreclosure or otherwise, Tenant and such holder shall enter into an attornment and non-disturbance agreement, in the form requested by such party, with such party. Section 9.2 Lease Superior at Mortgagee's or Ground Lessor's Election. --------------------------------------------------------------------- At the request in writing of any mortgagee, or ground lessor, of Landlord's Property, this Lease shall be deemed superior to such mortgage, or ground lease, whether this Lease was executed before or after such mortgage, or ground lease, and Tenant shall execute such documents to effect the foregoing in recordable form as such mortgagee, or ground lessor, shall reasonably request. Section 9.3 Notice to Mortgagee and Ground Lessor. Upon receipt of a ------------------------------------------------- written request from Landlord or any holder of a mortgage, on all or any part of Landlord's Property, or the ground lessor thereof, Tenant will thereafter send any such holder copies of all notices (including, but not limited to, notices of default or termination) given by Tenant to Landlord in accordance with any provision of this Lease. In the event of any failure by Landlord to perform, fulfill or observe any agreement by Landlord herein or any breach by Landlord of any representation or warranty of Landlord herein. any such holder may at its election cure such failure or breach for and on behalf of Landlord within twenty (20) business days after the time provided herein for Landlord to cure the same or such longer period as may be reasonably necessary to cure the default. Section 9.4 Limitations on Obligations of Mortgagees, around Lessors and ------------------------------------------------------------------------ Successors. Tenant agrees that the holder of a mortgage or ground lease or any - ---------- successor-in-interest to any of them or to Landlord shall not be: (a) bound by any payment of an installment of Base Rent or Additional Rent which may have been made more than 30 days before the due date of such installment; (b) bound by any amendment or modification to this Lease made without the consent of the holder of a mortgage or ground lease or such successor in interest, (c) liable for any previous act or omission of Landlord (or its predecessors in interest), (d) responsible for any monies owing by Landlord to the credit of Tenant or subject to any credits, offsets, claims, counterclaims, demands or defenses which Tenant may have against Landlord (or any of its predecessors in interest); (e) bound by any covenant to undertake or complete any construction of the Premises or any portion thereof; or (f) obligated to make any payment to Tenant other than any security deposit actually delivered to holder of a mortgage or ground lease or such successor in interest. Further, Tenant agrees that it will not seek to terminate this Lease by reason of any act or omission of Landlord until Tenant shall have given written notice of such act or omission to the holder of such mortgage or ground lease (at such holder's last address furnished to Tenant) and following the giving of such notice such holder shall have the right, but shall not be obligated, to remedy such act or omission within twenty (20) business days after the time period provided for in this Lease for Landlord to cure the same or such longer period as may be reasonably necessary to cure the same. Tenant shall enter into a written agreement confirming the foregoing from time to time upon written request from Landlord and/or the holder of a mortgage or ground lease on Landlord's Property. Section 9.5 Estoppel Certificate By Tenant and Information Concerning --------------------------------------------------------------------- Tenant. Tenant agrees, at any time and from time to time, within ten (10) days - ------ after written request by Landlord or any holder of a mortgage on all or a portion of Landlord's Property or the ground lessor thereof, (a) to execute, acknowledge and deliver to Landlord a statement in writing certifying that (except may be otherwise specified by Tenant): (i) this Lease is presently in full force and effect and unmodified; (ii) Tenant has accepted possession of the Premises; (iii) any improvements required by the terms of this Lease to be made by Landlord have been completed to the satisfaction of Tenant; (iv) no rent under this Lease has been paid more than 30 days in advance of its due date; (v) the addresses for notices to be sent to Tenant is as set forth in this Lease or as specified in such certificates (vi) Tenant as of the date of executing the certificate has no charge, lien or claim of offset under this Lease, or otherwise, against rents or other charges due or to become due hereunder, (vii) Tenant is not in default under this Lease; (viii) to the best of Tenant's knowledge, Landlord is not in default of this Lease; and (ix) such other information as Landlord may reasonably request about this Lease or Tenant's occupancy; and (b) to deliver information in form satisfactory to Landlord and such holder or ground lessor concerning Tenants operations, including but not limited to historic and current financial statements of Tenant, provided that, (i) at any time during which the shares of Tenants stock are publicly traded on a recognized stock exchange, such information shall be limited to information Tenant makes publicly available (including, without limitation, filings with the Securities and Exchange Commission); and (ii) during the pendency of any public offering of the shares of Tenant's stock, Tenant shall only be required to deliver information that can be made available by Tenant in accordance with applicable law. ARTICLE X --------- CASUALTY -------- Section 10.1 Damage From Casualty. In the event that the Premises are --------------------------------- damaged in whole or in part by fire or other casualty, Tenant shall promptly notify Landlord thereof. If following the execution hereof and prior to the expiration of the Lease Term the Premises shall be damaged or destroyed in whole or in part by fire or other casualty, this Lease shall, except as hereinafter provided in this Article X, remain in full force and effect and Landlord shall, upon notice of such damage from Tenant and proceeding with reasonable dispatch, repair or rebuild the Premises (exclusive of Tenants Work and any alterations or improvements, other than Landlord's Work, made by or on behalf of Tenant) to substantially their condition immediately prior to the time of such damage or destruction (subject, however, to zoning laws and building codes then in existence), but Landlord shall not be responsible for any Excusable Delay. including any delay which may result by reason of adjustment of insurance claims or collection of insurance proceeds, nor shall Landlord be obligated to commence repair or restoration work prior to receipt of sufficient insurance proceeds, nor shall Landlord be required to expend sums in excess of "net recovered insurance proceeds. The term "net recovered insurance proceeds" shall mean the ---------------------------- amount of any insurance proceeds actually recovered by Landlord, less the cost of obtaining the same (including attorneys' fees and appraisal fees) and less the amount thereof required to be paid to a mortgagee or ground lessor, plus the amount of any insurance deductible. Subject to the terms of this Lease, Tenant shall concurrently repair or restore so much of the Premises (a) as were constructed by Tenant or (b) are the responsibility of Tenant under this Lease and shall repair and restore its fixtures and personal property. Section 10.2 Abatement of Rent. In the event that the provisions of ------------------------------ Section 10.1 shall become applicable, the Base Rent, Tenant's Tax Escalation, Tenant's Insurance, Escalation and Tenant's Operating Cost Escalation shall be abated or reduced proportionately during any period in which, by reason of any such damage or destruction, there is interference, as reasonably determined by Landlord, with the operation of the business of Tenant in the Premises, having regard to the extent to which Tenant may be required to discontinue its business in the Premises, and such abatement or reduction shall continue (but may be adjusted from time to time based on the extent of the interference with Tenant's operations as reasonably determined by Landlord) for the period commencing with such destruction or damage and ending with the substantial completion by Landlord of such work, repair and/or reconstruction as Landlord may do. Section 10.3 Limitation on Landlord's and Tenant's Obligations. Landlord -------------------------------------------------------------- and Tenant shall not be obligated to do any repair or restoration work if Landlord or Tenant elects to terminate this Lease as provided for in this Article X. Section 10.4 Landlord's Right to Terminate. Notwithstanding the ------------------------------------------ foregoing, Landlord may terminate this Lease following: (a) damage or destruction to the Premises to the extent of thirty percent (30%) or more of the cost of replacement thereof; or (b) the refusal of the applicable insurance carrier to pay funds sufficient for the cost to repair or replace or the refusal of any applicable mortgagee or ground lessor to release the insurance proceeds for such purposes. Landlord may exercise the right to so terminate this Lease by written notice to Tenant given within sixty (60) days after the date of the damage or sixty (60) days after the date Landlord receives written notice of such damage, whichever is later. Such notice of termination shall be effective on the date thereof. Section 10.5 Tenant's Right to Terminate. If the Premises are damaged by ---------------------------------------- fire or other casualty and (a) Landlord does not elect, by notice to Tenant given within sixty (60) days after Tenant's written notice of such damage or destruction is received by Landlord, to substantially repair or restore the same to their former condition (excluding those portions which consist of the Tenant's Work or other alterations or improvements, other than Landlord's Work, made by or on behalf of Tenant), (b) the damage or destruction is such that restoration of the Premises cannot, in the opinion of Landlord upon consultation with Landlord's Architect, be completed within nine (9) months of the date of such damage or destruction or (c) Landlord, having elected to restore, fails to do so within said nine (9) month period, as the same may be extended due to Excusable Delay, then, in any of such events, Tenant may thereafter terminate this Lease upon sixty (60) days prior written notice to Landlord unless such repair or restoration is substantially completed within such 60-day period. ARTICLE XI ---------- EMINENT DOMAIN -------------- Section 11.1 Eminent Domain, Right to Terminate and Abatement in Rent. If --------------------------------------------------------------------- the Premises or any part thereof, or the whole or any substantial part of Landlord's Property, shall be taken, or if a conveyance shall be made in anticipation thereof, for any street or other public use, by action of the municipal, state, federal or other authorities, or shall receive any substantial direct or consequential damage for which Landlord or Tenant shall be entitled to compensation by reason of anything lawfully done in pursuance of any public authority, after the execution hereof and before the expiration of the Lease Term, then this Lease and the Lease Term shall terminate at the election of Landlord (such termination to be effective upon the date of taking), and such election may be made in case of any such taking notwithstanding the entire interest of Landlord may have been divested by such taking; and if Landlord does not so elect, then in case of any such taking or destruction of, or damage to, the Premises, rendering the same or any part thereof unfit for use and occupation, a just proportion of the Base Rent hereinbefore reserved according to the nature and extent of the injury sustained by the Premises as determined by Landlord, shall be suspended or abated until the Premises or, in case of such taking, what may remain thereof, shall have been put in proper condition for use and occupation. To the extent that the Premises, upon having been put in proper condition for use and occupation are smaller, the Base Rent hereinbefore reserved shall be reduced for the balance of the Lease Term in the same proportion which the reduction in space bears to the original Leasable Square Footage of the Premises. Section 11.2 Restoration. If this Lease is not terminated as provided in ------------------------ Section 11.1, Landlord shall apply so much of the available proceeds of the eminent domain award as are required to restore Landlord's Property and the Premises to a condition, to the extent practical, substantially the same as that immediately preceding the taking, but subject to zoning laws and building codes then in existence. If the available proceeds of the eminent domain award are insufficient, in Landlord's judgment, for that purpose, Landlord shall have no obligation to expend funds in excess of said proceeds and Landlord shall have the right to select which portions of Landlord's Property, if any, shall be restored. The term "available proceeds" shall mean the amount of the award paid ------------------ to Landlord, less cost of obtaining the same (including attorneys' fees and appraisal fees) and less the amount thereof required to be paid to a mortgagee or ground lessor. Section 11.3 Landlord to Control Eminent Domain Action. Landlord reserves ------------------------------------------------------ all rights to compensation for damage to the Premises or any part thereof, or the leasehold hereby created, heretofore accrued or hereafter to accrue, by reason of any taking for public use of said Premises or any portion thereof, or right appurtenant thereto, or privilege or easement in, through, under or over the same, and by way of confirmation of the foregoing Tenant hereby assigns all rights to such damages heretofore accrued or hereafter accruing during the Lease Term to Landlord. Provided, however, nothing herein contained shall limit Tenant's right to any separate award for the taking of personal property, moving expenses, or other items the payment of which shall not reduce the award payable to Landlord. ARTICLE XII ----------- DEFAULT AND REMEDIES -------------------- Section 12.1 Event of Default. As used herein, `Event of Default' shall ----------------------------- mean the occurrence and/or existence Of any one or more of the following: (a) Tenant shall neglect or fail to pay when first due Base Rent or any installment thereof, or Additional Rent or, as applicable, any installment thereof (and such failure is not solely due to an error by Landlord or Landlord's bank in collecting such installment by an electronic funds transfer when Tenant has adequate available funds in its account to pay such installment), or (b) Tenant shall neglect or fail to perform or observe any of the other covenants or undertakings herein on its part to be performed or observed and such neglect or failure shall continue for thirty (30) days after notice to Tenant; provided, however, that if the default is other than a default under clause (a) above, or clauses (c) through (j) below, and is such that it cannot be cured within thirty (30) days, but is capable of being cured, such thirty (30) day period shall be extended by up to thirty (30) additional days provided that Tenant commences to cure such default within said initial thirty (30) day period, continues to do so diligently, and thereafter completes such cure within not more than sixty (60) days following the notice of default; or (c) there is filed by Tenant or any Guarantor any case, petition, proceeding or other action under any Bankruptcy Law; or (d) any other proceedings shall be instituted against Tenant or any Guarantor under any Bankruptcy Law and not be dismissed within ninety (90) days; or (e) Tenant or any Guarantor shall execute an assignment of its property for the benefit of its creditors; or (f) a receiver, custodian or other similar officer for Tenant or any Guarantor shall be appointed and not be discharged within ninety (90) days; or (g) the estate hereby created shall be taken by execution or by other process of law and is not redeemed by Tenant within thirty (30) days thereafter, or (h) an assignment or sublease in violation of the terms of this Lease; or in an Event of Default shall occur under Section 2.5(b); or (j) Tenant shall fail to deliver any agreement, document or certificate required pursuant to Article IX within the time period provided therein and such failure is not cured within ten (10) days after notice to Tenant. Section 12.2 Landlord's Remedies. -------------------------------- (a) Upon the occurrence of an Event of Default and after the lapse of any applicable period of cure, Landlord may, provided such is done in accordance with applicable laws, immediately or at any time thereafter (notwithstanding any license or waiver of any former breach or waiver of the benefit hereof, or consent in a former instance), and without demand or notice, in person or by agent or attorney, enter the Premises or any part thereof and repossess the same as of its former estate, or terminate this Lease by written notice to Tenant, and in either event expel Tenant and those claiming through or under it and remove their effects (forcibly, if necessary) without being deemed guilty of any manner of trespass and without prejudice to any remedy which might otherwise be used for arrears of Base Rent or Additional Rent or breach of covenant, and upon entry or written notice of termination, or automatic termination, both as aforesaid, this Lease shall terminate and Landlord, in addition to all other remedies which it may have at law or equity, and not in limitation thereof, shall have the remedies provided in this Article XII. (b) If this Lease shall be terminated as provided in Section 12.2(a) hereof, Tenant shall forthwith pay to Landlord as damages, in addition to all sums which were due prior to the date of such termination, a sum equal to the amount by which the Base Rent and Additional Rent for the remainder of the Lease Term exceeds the fair rental value of the Premises for the remainder of the Lease Term. For the purposes of computing damages payable pursuant to this Section 12.2, it is agreed that there shall be payable to Landlord as part of such damages at the time of such termination the product of the Additional Rent due with respect to Taxes, Insurance Costs and Operating Costs for the most recently ended fiscal, calendar or lease year, as the case may be, times the number of years remaining of the Lease Term, it being assumed that the amount of such Additional Rent payments so payable for the most recently ended fiscal, calendar year or lease year would have remained constant for each subsequent year of the Lease Term. Tenant also (i) will indemnify and save Landlord harmless from and against all reasonable expenses which Landlord may incur, including, without limitation, legal expenses, reasonable attorneys' fees, brokerage fees, and the cost of putting the Premises in the condition required to be maintained hereunder or preparing the same for rental; and (ii) agrees that Landlord may re-let the Premises or any part or parts thereof, either in the name of Landlord or otherwise for a term or terms which may, at Landlord's option, be less than or exceed the period which would otherwise have constituted the balance of the Lease Term and may grant concessions or free rent. The good faith failure of Landlord to re-let the Premises or any part or parts thereof, or, if the Premises are re-let, for the good faith failure to collect the rents due under such re-letting, shall not release or affect Tenants liability for damage so long as Landlord does not act arbitrarily or capriciously. Any suit brought to collect the amount of deficiency for any month or other period shall not prejudice in any way the tight of Landlord to collect the deficiency for any subsequent month or period by a similar proceeding. Landlord, at Landlord's option, may make such alterations, repairs, replacements and decorations on the Premises as Landlord in Landlord's reasonable judgment considers advisable and necessary for the purpose of re-letting the Premises, and the making of such alterations or decorations shall not operate or be construed to release Tenant from liability hereunder. Landlord shall in no event be liable in any way for the good faith failure to re-let the Premises, or. if the Premises are re-let, for the good faith failure to collect the rents due under such re-letting, provided always that Landlord does not act arbitrarily or capriciously. Section 12.3 Reimbursement of Landlord. In the event of any default by -------------------------------------- Tenant in the payment of any Base Rent or Additional Rent, Tenant will, in addition to paying Landlord all amounts due under the terms and provisions of this Lease, including, without limitation, Section 12.9, reimburse Landlord for all reasonable expenses incurred by Landlord in collecting such rent or in obtaining possession of, or in re-letting the Premises, or in defending any action, including expenses for reasonable counsel fees and commissions. Tenant further agrees that, if on termination of this Lease by expiration or otherwise, Tenant shall fail to remove any of its property from the Premises as provided for herein, Landlord shall be authorized, in its sole option, and in Tenant's name and an its behalf, either (a) to cause such property to be removed and placed in storage for the account and at the expense of Tenant; or (b) to sell such property at public or private sale, with or without notice, and to apply the proceeds thereof, after the payment of all expenses of removal, storage and sale, to the indebtedness, if any, of Tenant to Landlord, the surplus, if any, to be paid to Tenant; prior to the removal of such property Landlord may charge Tenant a fair rental amount for the storage of such property. All sums payable by Tenant under this Article XII shall be deemed Additional Rent. Section 12.4 Landlord's Right to Perform Tenant's Covenants. Tenant ----------------------------------------------------------- covenants and agrees that, if it shall at any time fail to make any payment or perform any other act on its part to be made or performed as in this Lease provided beyond the cure period set forth below in this Section 12.4, Landlord, in its sole discretion may after due notice to, or demand upon, Tenant, make any payment or perform any other act on the part of Tenant to be made and performed as in this Lease provided, in such manner and to such extent as Landlord may reasonably deem desirable, and in exercising any such rights, Landlord may pay necessary and incidental costs and expenses, employ counsel, and incur and pay reasonable attorneys' fees. The making of any such payment or the performing of any other act by Landlord pursuant to this Article shall not waive, or release Tenant from, any obligations of Tenant in this Lease contained. All sums so paid by Landlord and all reasonably necessary and incidental costs and expenses in connection with the performance of any such act by Landlord shall, except as otherwise in this Lease expressly provided, be payable to Landlord on demand, and Tenant covenants to pay any such sum or sums promptly, and Landlord shall have (in addition to any other right or remedy of Landlord) the same rights and remedies in the event of the non-payment thereof by Tenant as in the case of default by Tenant in the payment of the Base Rent. Whenever practicable, Landlord, before proceeding as provided in this Section 12.4, shall give Tenant notice in writing of the failure of Tenant which Landlord proposes to remedy, and shall allow Tenant such length of time as may be reasonable in the circumstances, consistent with any grace periods contained herein, but not exceeding thirty (30) days from the giving of notice, to remedy the failure itself and, if Tenant shall not remedy the failure in the time so allowed, Landlord shall be deemed to have given "due notice" and may proceed as provided in this Section 12.4; provided, however, that nothing in this Section shall prevent Landlord from acting without notice to Tenant in case of any emergency wherein there is danger to property or person or where there may exist any violation of legal requirements including but not limited to the presence of Hazardous Materials, in which event no notice shall be required. Section 12.5 Cumulative Remedies. The specified remedies to which Landlord -------------------------------- may resort under the terms of this Lease, or under the provisions of applicable law, are cumulative and not intended to be exclusive of any other remedies or means of redress to which Landlord may be lawfully entitled in case of any breach or threatened breach by Tenant of any provisions of this Lease. The failure of Landlord to insist in any one or more cases upon the strict performance of any of the covenants of this Lease or to exercise any option contained herein shall not be construed as a waiver or a relinquishment for the future of such covenant or option. Receipt by Landlord of any Base Rent or Additional Rent payment with knowledge of the breach of any covenants hereof shall not be deemed a waiver of such breach. No waiver by either party of any provision of this Lease shall be deemed to have been made unless expressed in writing and signed by it. In addition to the other remedies provided in this Lease, Landlord shall be entitled to restraint by injunction of any violation or attempted or threatened violation of any of the covenants, conditions or provisions of this Lease. Section 12.6 Expenses of Enforcement. Tenant agrees to pay all reasonable ------------------------------------ expenses and reasonable attorneys' fees incurred by Landlord in enforcing any obligation or any remedies hereunder including, without limitation, in connection with collection of Base Rent or Additional Rent, recovery by Landlord of the Premises, or in any litigation in which Landlord shall become involved by reason of any act or negligence of Tenant Invitees or any breach of this Lease by Tenant. Section 12.7 Landlord's Default. Landlord shall not be deemed to be in -------------------------------- default hereunder unless such default shall remain uncured for more than thirty (30) days following written notice from Tenant to Landlord specifying the nature of such default, or such longer period as may be reasonably required to correct such default provided that Landlord is diligently pursuing cure of same. Landlord's liability to keep, maintain, and repair shall always be limited to the cost of making such repair or accomplishing such maintenance or repair. In no event whatsoever shall Landlord be liable for consequential or any indirect damages. The provisions of this Section 12.7 are further subject to the provisions of Articles X and XI dealing with eminent domain and fire and other casualty. Section 12.8 Limitation of Landlord's Liability. The obligations of ----------------------------------------------- Landlord hereunder shall be binding upon Landlord and each succeeding owner of Landlord's interest hereunder only during the period of such ownership, and Landlord and each succeeding owner shall have no liability whatsoever except for its obligations during each such respective period. Tenant hereby agrees for itself and each succeeding holder of Tenant's interest, or any portion thereof, hereunder, that any judgment, decree or award obtained against Landlord or any succeeding owner of Landlord's interest, which is in any manner related to this Lease, the Premises or Tenant's use and occupancy of the Premises or other portions of Landlord's Property, whether at law or in equity, shall be satisfied out of Landlord's equity in the land and buildings then comprising Landlord's Property owned by Landlord to the extent then owned by Landlord and such succeeding owner and available insurance proceeds, and further agrees to look only to such assets and to no other assets of Landlord, or such succeeding owner, for satisfaction. Neither Landlord nor any Person executing this Lease on behalf of Landlord, nor any partner, limited or general, or any officer, director, employee, member, trustee, beneficiary, or owner of Landlord, nor any subsequent Landlord, or any partner, limited or general, or any officer, director, employee, member, trustee, beneficiary, or owner of any subsequent Landlord shall have any personal liability hereunder. The remedies provided to Tenant in this Lease are exclusive, and Landlord will not be liable under any theory of recovery, whether based on contract, tort or otherwise. Section 12.9 Late Payment and Administrative Expense. If Tenant shall fail ---------------------------------------------------- to pay Base Rent, Additional Rent or other charges after the same become due and payable under this Lease, such unpaid amounts shall bear interest from the due date thereof to the date of payment at the Applicable Interest Rate ("Interest -------- Payment"). In addition, if Landlord is required to redeposit any check which is - ------- returned for insufficient funds or if Tenant shall fail to pay Base Rent, Additional Rent or other charges on or before the date on which the same become due and payable, then Tenant shall also pay to Landlord an administrative expense charge ("Administrative Expense") of five percent (5.0%) of the amount ---------------------- thereof for each calendar month or part thereof after the due date of such payment until such payment is received by Landlord. The provisions herein for Interest Payment and Administrative Expense shall not be construed to relieve Tenant of the obligation to pay Base Rent, Additional Rent and all other charges when due under this Lease and shall be in addition to and not in limitation of Landlord's other remedies as provided for in this Lease. ARTICLE XIII ------------ MISCELLANEOUS PROVISIONS ------------------------ Section 13.1 Brokers. Tenant and Landlord each represents to the other -------------------- that it has not dealt with any Person in connection with the Premises or the negotiation or execution of this Lease other than officers, employees and attorneys of Landlord and the Brokers. Each of Tenant and Landlord shall indemnify and save harmless the other from and against all claims, liabilities, costs and expenses incurred as a result of any breach of the foregoing representation by it. The broker's fees payable to Brokers for this Lease shall be payable by Landlord subject to and in accordance with the terms of separate agreements between Landlord and Brokers. Section 13.2 Quiet Enjoyment. Tenant shall, upon paying all Base Rent and ---------------------------- Additional Rent due hereunder and observing and performing all of the terms, covenants and conditions on Tenant's part to be observed and performed, peaceably and quietly have and hold the Premises without hindrance or molestation by any Person or Persons lawfully claiming by, through or under, Landlord, subject, however, to the terms of this Lease. Section 13.3. [intentionally omitted]. ------------ Section 13.4 Notices. Any notice, demand, request or statement required or -------------------- intended to be given or delivered under the terms of this Lease shall be in writing, shall be addressed to the party to be notified at the address or addresses set forth in the Summary of Basic Terms or at such other address in the continental United States as each party may designate for itself from time to time by notice hereunder, and shall be deemed to have been given, delivered or served upon the earliest of (a) three (3) days following deposit in the U.S. Mail, with proper postage prepaid, certified or registered, return receipt requested, (b) the next business day after delivery to a regularly scheduled overnight delivery carrier with delivery fees either prepaid or an arrangement, satisfactory with such carrier, made for the payment of such fees, or (c) receipt of notice given by telecopy or personal delivery. Section 13.5 Waiver of Subrogation. Landlord and Tenant hereby release ---------------------------------- each other, to the extent of their respective insurance coverages, from any and all liability for any loss or damage caused by fire, any of the extended coverage casualties, or other casualties insured against, even if such fire or other casualty shall be brought about by the fault or negligence of the party benefited by the release or its agents, provided, however, this release shall be in force and effect only with respect to loss or damage occurring during such time as the policies of fire, extended coverage and other insurance, maintained by the releasing party shall contain a clause, or be subject to a statutory provision to the effect that such release shall not affect said policies or the right of the releasing party to recover thereunder. Landlord and Tenant agree that their respective fire, extended coverage, and other insurance policies will include such a clause. To the extent that Tenant is a self-insurer with respect to personal property, the provisions of Section 7.8 hereof shall be applicable. The provisions in favor of Landlord under this Section 13.6 are in addition to, and not in lieu of, the other terms of this Lease. In the event that either party fails to maintain the insurance coverage required under this Lease, it shall be deemed, for purposes of this Section 13.5, to have received the amount which it would have received had such insurance coverage been in place. Section 13.6 Entire Agreement: Execution; Time of the Essence and Headings ----------------------------------------- -------------------------------- and Table of Contents. This Lease together with all Exhibits referred to herein - --------------------- and the Summary of Basic Terms, sets forth the entire agreement between the parties hereto and cannot be modified or amended, except in a writing duly executed by the respective parties. This Lease, together with all Exhibits referred to herein and the Summary of Basic Terms, supersedes all previous written and oral negotiations, understandings. and agreements regarding the subject matter of this Lease. Neither Landlord nor any Person acting on behalf of Landlord has made any representations to Tenant on which Tenant has relied in entering into this Lease except any representations expressly stated in this Lease. This Lease is executed as a sealed instrument and in multiple counterparts, all copies of which are identical, and any one of which is to be deemed to be complete in itself and may be introduced in evidence or used for any purpose without the production of any other copy. Time is of the essence of the obligations of each party to be performed within a specific time frame in this Lease. The headings throughout this Lease and the Table of Contents are for convenience of reference only, and shall in no way be held or deemed to define, limit, explain, describe, modify or add to the interpretation, construction or meaning of any provision of this Lease. Section 13.7 Partial Invalidity. If any term or condition of this Lease or ------------------------------- its application to any Person or circumstance shall to any extent be in violation of or unenforceable under any law, rule, regulation or order (including any court order) now existing or hereafter enacted or entered by any court or other governmental entity having competent jurisdiction (including after all appeals therefrom), the remainder of this Lease, or the application of such term or condition to Persons or circumstances other than those as to which it is invalid or unenforceable, shall not be affected thereby and shall be enforceable to the fullest extent not prohibited by law. Section 13.8 No Waiver. No assent, express or implied, by either party to ---------------------- any breach of any agreement or condition herein contained on the part of the other party to be performed or observed, and no waiver, express or implied, of any such agreement or condition shall be deemed to be a waiver of or an assent to any succeeding breach of the same or any other agreement or condition; the acceptance by Landlord of Base Rent or Additional Rent due hereunder (whether such payment is made by Tenant or another Person), or silence by either party as to any breach, shall not be construed as waiving any of its fights hereunder unless such waiver shall be in writing. No payment by Tenant or acceptance by Landlord of a lesser amount than shall be due Landlord from Tenant shall be deemed to be anything but payment on account, and the acceptance by Landlord of a check for a lesser amount with an endorsement or statement thereon, or upon a letter accompanying said check, that said lesser amount is payment in full shall not be deemed an accord and satisfaction, and Landlord may accept said check without prejudice to recover the balance due or pursue any other remedy. Section 13.9 Holdover. If Tenant remains in the Premises beyond the --------------------- expiration of this Lease at the end of the Lease Term, or sooner following an early termination as provided for herein, such holding over shall not be deemed to create any tenancy, but Tenant shall be a daily Tenant at sufferance only subject to all of Tenant's obligations set forth herein, but at a daily rate equal to one and one-half (1 1/2) times the Base Rent, then in effect, and Additional Rent and other charges provided for under this Lease. The acceptance of a purported rent check following termination shall not constitute the creation of a tenancy at will, it being agreed that Tenant's status shall remain that of a daily Tenant at sufferance, at the aforesaid daily rate. Tenant shall also pay to Landlord all damages, if any, sustained by reason of any such holding over. Otherwise. such holding over shall be on the terms and conditions set forth in this Lease as far as applicable. Section 13.10 When Lease Becomes Binding. The submission of this document ---------------------------------------- for examination and negotiation does not constitute an offer to lease or a reservation or an option for the Premises, and this document shall become effective and binding only upon the execution and delivery hereof by both Landlord and Tenant and the receipt by Landlord of the first month's installments of Tenant's Electricity Costs and Base Rent, along with the Security Deposit. All negotiations, considerations, representations and understandings between Landlord and Tenant are incorporated herein and may be modified or altered only by agreement in writing between Landlord and Tenant, and no act or omission of any employee or agent of Landlord shall alter, change or modify any of the provisions hereof. Section 13.11 No Recordation. Tenant shall not record this Lease with any ---------------------------- registry of deeds or land court, and any recordation of this Lease or any memorandum, short form or notice of this Lease will be void and constitute an Event of Default under this Lease. Section 13.12 As Is. Except for Landlord's Work, the Tenant represents to -------------------- Landlord that it has leased the Premises after a full and complete examination of the same, and by its execution and delivery of this Lease, Tenant hereby acknowledges that neither Landlord, nor Landlord's agents, has made any representation or promises with respect to the Premises, the Building, or the land upon which it stands, and no rights, easements or licenses are acquired by Tenant, by implication or otherwise, except as may be set forth expressly in this Lease. The execution and delivery of this Lease by Tenant shall be conclusive evidence, as against the Tenant, that Tenant accepts the Premises "AS IS", with all faults. Section 13.13 Financial Statements: Certain Representations and Warranties -------------------------------------------------------------------------- of Tenant. Subject to the restrictions set forth in Section 9.5 (b), from time - --------- to time as requested by Landlord, Tenant shall provide to Landlord, any actual or potential mortgagee and any actual or potential ground lessor or any representative of any of the foregoing, copies of Tenant's (and any Guarantor's) annual financial statements (audited or reviewed, if available) and quarterly financial statements, all certified as true and correct by the president or chief financial officer of Tenant (or any Guarantor, as applicable) and such other information regarding Tenant's (and, any Guarantors) financial condition as Landlord may reasonable request. Tenant represents and warrants to Landlord, its successors and assigns that: (a) all financial statements of Tenant and/or any Guarantor previously provided to Landlord have been prepared in accordance with GAAP, were true, complete and correct as of their respective dates and fairly and accurately reflect the financial condition of Tenant and any Guarantor, (b) there has been no material adverse change in the financial condition of Tenant and/or any Guarantor subsequent to the date(s) of such financial statements; (c) all financial statements of Tenant and/or any Guarantor provided to Landlord after the date hereof will be prepared in accordance with GAAP, will be true, complete and correct as of their respective dates and will fairly and accurately reflect the financial conditions of the Tenant and any Guarantor, (d) Tenant is a corporation duly organized, validly existing and in good standing under the laws of Delaware; (e) Tenant is qualified to do business in the Commonwealth of Massachusetts; (f) the execution, delivery and performance of this Lease by Tenant has been duly authorized by the shareholders and directors of Tenant; and (g) this Lease is valid and binding upon the Tenant and is enforceable against Tenant in accordance with the terms hereof. Section 13.14 Confidentiality. Tenant acknowledges that the terms under ----------------------------- which Landlord has leased the Premises to Tenant, (including, without limitation, the rental rate(s), term and other financial and business terms, constitute confidential information of Landlord "Confidential Information"). ------------------------ Tenant covenants and agrees to keep the Confidential Information completely confidential; provided, however, that (a) such Confidential Information may be disclosed by Tenant to those of its officers, employees, attorneys, accountants, lenders and financial advisors (collectively, "representatives") who need to know such information in connection with Tenant's use and occupancy of the Premises and for financial reporting and credit related activities (it being understood that Tenant shall inform its representatives of the confidential nature of such Confidential Information and that such representatives shall be directed by Tenant, and shall each expressly agree, to treat such Confidential Information confidentially in accordance with the terms of this Section), and (b) unless required by applicable law, any other disclosure of such information may only be made if Landlord consents in writing prior to any such disclosure. Section 13.15 Summary of Basic Terms. The Summary of Basic Terms which is ------------------------------------ affixed to this Lease sets forth certain basic terms and information which is thereafter referred to in the main text of this Lease. Every reference to the Summary of Basic Terms, or to a particular item thereon, shall have the effect of incorporating the Summary, or the particular item thereof, into the main text of this Lease. Section 13.16 [intentionally omitted]. ------------------------------------- Section 13.17 Year 2000 Compliance. The Building will be delivered with ---------------------------------- all systems compliant with Year 2000. [SIGNATURE PAGE FOLLOWS] Tenant and Landlord, each by its duly authorized officer, has signed this Lease as of the date first set forth above. TENANT: SmarterKids.com, Inc. By: /s/ David A. Blohm ----------------------------- Name: DAVID A. BLOHM ---------------------------- Title: PRES/CEO --------------------------- Duly authorized LANDLORD: BHX, LLC, as Trustee of Crawford Realty Trust By: /s/ Robert A. Schlager ----------------------------- Name: ROBERT A. SCHLAGER ---------------------------- Title: Illegible --------------------------- Duly authorized EXHIBIT A --------- PROPERTY DESCRIPTION -------------------- [To be attached] SCHEDULE A All that certain parcel of land situated in Needham, Norfolk County, Massachusetts, bounded and described as follows: Westerly by Hampton Avenue, two hundred forth eight and 44/100 (248.44) feet; Northwesterly by the junction of said Hampton Avenue, and Crawford Street, ninety five and 06/100 (95.06) feet; Northerly by said Crawford Street, two hundred nine and 41/100 (209.41) feet; Northeasterly by Parcel No. 42TB, shown on plan filed with Certificate No. 81403, five and 88/100 (5.88) feet; Northeasterly by the junction of said Crawford Street and Town Way, shown on plan filed with Certificate No. 49606, fifty nine and 90/100 (59.09) fee; Easterly by the Westerly line of said Town Way, one hundred eighty one and 28/100 (181.28) feet; and Southeasterly by lot numbered 7, shown on said plan filed with Certificate No. 49606, two hundred ninety nine and 51.100(299.51) feet. Said parcel comprises lots numbered 5 and 6 on a plan drawn by Frank L. Cheney, Civil Engineer, dated November 7, 1953, as approved by the Land Court, filed in the Land Registration Office as No. 21023C, a copy of a portion of which is filed in Norfolk Registry District with Certificate No. 49606, Book 249; and lot numbered 9 on a plan drawn by Mass. Dept. of Public Works, E.F. Sawyer, Officer Engineer, dated September 1, 1953, as approved by the said Court, filed in the Land Registration Office as No. 21023D, a copy of a portion of which is filed in Norfolk Registry District with Certificate No. 81403, Book 408. EXHIBIT B --------- SITE PLAN --------- [To be attached] [COPY OF SITE PLAN] EXHIBIT C --------- BUILDING FLOOR PLAN ------------------- [To be attached] [COPY OF BUILDING FLOOR PLAN] EXHIBIT D --------- BASE BUILDING WORK ------------------ I. Work per plans and specifications determined by Landlord's Architect (to be attached). II. Landlord shall perform the following work at Landlord's sole cost and expense and without charge against he Tenant Improvements Allowance. 1. Landlord shall make at least one set of restrooms on each floor of the building handicap accessible and ADA-compliant and install new finishes in all restrooms. 2. Remove all remaining plant material and clean the walls, windows and structural elements of the atrium. Clean vestibule lobby and rear garage area. Install new floor tiles in lobby. Garage area should be in good operational condition (lighting, HVAC, etc.). 3. Remove directory from wall and install sheetrock with wood panel wainscoat. 4. Replace those pieces of plan material in the lobby planter which are in poor condition with new plantings or remove completely at Tenant's election. 5. New lighting fixtures for lobby overhead, sidewalls and second floor balcony area. 6. Replace lobby-ceiling tiles (under balcony area) with new tiles. Convert acrylic fixture to downlights. 7. Landlord will remove "steel monuments" from the front of the Building and reconfigure front entrance of building to be ADA compliant. 8. Replace garage door (facing the parking lot) to a standard, which is mutually agreeable between Landlord and Tenant. EXHIBIT E --------- TENANT IMPROVEMENTS PLANS AND SPECIFICATIONS -------------------------------------------- [To be attached] [COPY OF TENANT IMPROVEMENT PLANS AND SPECIFICATIONS] EXHIBIT F --------- TENANT'S WORK ------------- 1. Tenant will perform any work necessary to equip and open its office in accordance with all applicable building codes and other laws. Work shall be performed as provided in Section 3.2 of this Lease. Work shall include but not be limited to any computer or telephone cables, wiring, jack locations and the like, and supplying and installation of such furnishings, trade fixtures and equipment as Tenant may elect which are necessary or desirable for the conduct by Tenant of its business in the Premises consistent with the terms and conditions of this Lease. 2. Tenant shall only use contractors approved by Landlord (such approval not to be unreasonably withheld or delayed) to perform Tenant's Work. In the event Tenant uses Landlord's contractors, Tenant shall pay Landlord, as Additional Rent, an administrative fee for such contractors in the amount of 15% of the estimated cost of Tenant's Work, payable within 30 days of Landlord's billing to Tenant therefor. [To be attached] EXHIBIT G --------- RULES AND REGULATIONS --------------------- BHX, LLC, a Massachusetts limited liability company, as Trustee of Crawford Realty Trust, under Declaration of Trust dated June 9, 1997 and filed with the Norfolk Registry District of the Land Court on June 9, 1997 as Document No. 764674 ("Landlord"), hereby promulgates the rules and regulations (the "Rules -------- ----- and Regulations") set forth below with respect to the use of the office building - --------------- (the "Building"), parking areas and related amenities located at and known as -------- 15-19 Crawford Street, Needham, Massachusetts (the "Property") by -------- SmarterKids,.com, a Delaware corporation (the "Tenant") of the Building. All ------ space within the Building leased by Tenant is called the "Premises." The Rules -------- and Regulations are as follows: 1. Sidewalks, doorways, vestibules, stairways, elevators, corridors, halls and other similar areas within the Property shall not be obstructed by Tenant or used for any purpose other than ingress and egress to and from the Premises and for going from one part of the Property to another part of the Property. 2. No sign, advertisement, notice or other lettering shall be exhibited, inscribed, painted or affixed by Tenant on or to any window, door, corridor or other part of the Building which is visible from outside of the Building without the prior written consent of Landlord. 3. Tenant shall be entitled to maintain a director in the lobby of the Building, the design and location of which is subject to Landlord's approval, identifying the names and locations of its employees. 4. Movement of furniture, office equipment or any bulky material shall be subject to such restrictions as Landlord may reasonably impose. 5. Landlord shall have the authority to limit the weight of, and to prescribe and restrict the positioning and manner of installation of, safes, file cabinets and other heavy equipment. 6. Tenant shall not use, or permit any person making or receiving any delivery to the Premises to use, any hand trucks except those equipped with rubber tires and side guards. 7. All locks for doors in the Premises shall be building standard and Tenant shall not place any additional lock or locks on any door without Landlord's prior written consent. All requests for duplicate keys shall be made through Landlord and charged to Tenant. Upon termination of Tenant's tenancy, the Tenant shall deliver to Landlord all keys to the Premises, to interior doors within the Premises and to exterior Building doors which have been furnished to or obtained by the Tenant. 8. Tenant shall lock all doors at the close of its working day. 9. No curtains, blinds, draperies or other window treatments shall be attached to or hung in any window of the Premises, on an exterior wall of the Building without the prior written consent of Landlord, which consent shall not be unreasonably withheld. 10. Plumbing fixtures and appliances shall be used only for the purposes for which they were designed and constructed, and no sweepings rubbish, rages or other material shall be thrown or placed therein. The cost of repairing any damage resulting from misuse of the plumbing fixtures or appliances by Tenant or its employees, agents or invitees shall be borne by Tenant. 11. Tenant shall not use or permit the use of Premises, or any part thereof, for lodging, for manufacturing, for any immoral, "adult" or illegal purpose, or for any other purpose which is not permitted by the terms of its lease. 12. Tenant shall, at its expense, provide artificial light and electric current for the employees of Landlord and/or Landlord's contractors while performing janitorial or other cleaning, maintenance or repair services in the Premises. 13. Tenant shall not cause any unnecessary janitorial labor or services by reason of the Tenant's willful misconduct or carelessness or indifference in the preservation of good order and cleanliness. 14. With the exception of so-called "seeing-eye" dogs necessary for the assistance of the visually-impaired, no animals of any kind shall be brought onto or kept on the Property. 15. Without the prior written consent of Landlord, Tenant shall not use the name of the Building or any picture of the Building in any materials promoting or advertising the business of the Tenant, except that each Tenant may use the address of the Building as the address of its business. 16. Tenant shall cooperate with Landlord to assure the effective operation of the heating and air conditioning systems serving the Building. Without limiting the generality of the immediately preceding sentence, Tenant will, at the request of Landlord, close its window treatments when the sun's rays fall directly on windows of the Premises. 17. Neither Landlord nor the Property manager will be responsible for lost or stolen money, jewelry or other personal property from any areas of the Property, regardless of whether the loss or theft occurs when the area in question is locked. 18. Landlord may, in its discretion, institute security measures in the operation of the Property, and Tenant will comply with all such security measures. Such security measures may include, but are not limited to, requiring persons entering the Building or the Property to identify themselves to a watchman or other person designated by Landlord and to sign in and sign out of the Property, denying access to persons who are not properly identified or appear suspicious, and conducting fire or other emergency drills. The exercise of such security measures by Landlord and any resulting interruption of Tenant's business shall not constitute an eviction or disturbance of Tenant's use and possession of the Premises, render Landlord liable to Tenant for damages, or relive Tenant from its obligations under its lease. 19. No bicycles or vehicles shall be brought into or kept in the Building (except bicycles and vehicles may be brought into the Storage Space). All bicycles and vehicles brought onto the Property shall be driven and parked only in designated, paved areas. 20. Parking on the Property shall be subject to the restrictions set forth in this paragraph and to any additional restrictions on parking set forth in Tenant's lease. Tenant, its employees, agents and invitees shall have the right, in connection with the conduct of Tenant's business at the Property, to park passenger automobiles on portions of the Property which have been striped for parking; provided, however that (a) Tenant, its employees or agents may not park in any space marked "visitor," and (b) Tenant, its employees, agents or invitees may not park in any space marked "reserved," unless reserved for such Tenant, and (c) persons parking their vehicles will do so exclusively within the marked parking space lines. Tenant, its employees, agents or invitees shall not have a right to park vehicles on the Property overnight or for purposes other than in connection with Tenant's business at the Property. Landlord shall have no responsibility to Tenant, its employees, agents or invitees for any theft, loss of or damage to any vehicle or its contents on the Property. 21. All vehicles brought onto the Property by Tenant, its employees, agents, customers and invitees shall be in good condition and appearance and shall be drivable. No such vehicles shall be leaking oil or other fluids. 22. Tenant will deposit its garbage, trash and refuse only in approved trash containers within the Premises and in designated trash receptacles placed on the Property by Landlord. Tenant shall not deposit any hazardous, flammable or explosive substances in any trash receptacle on the Property. 23. Landlord reserves the right to rescind, alter or waive any of the Rules and Regulations, and to adopt such additional rules and regulations as part of the Rules and Regulations, from time to time as Landlord reasonably deems it appropriate for the safety, protection, care and cleanliness of the Property, the operation thereof, the preservation of good order therein or the protection and comfort of Tenant, its employees, agents and invitees. In the event that during the tenancy of Tenant, the Building becomes a multi-tenant building, these Rules ad Regulations will be altered to provide for the protection and comfort of other tenants, their employees, agents and invitees. EXHIBIT H --------- SECRETARY'S CERTIFICATE ----------------------- [To be provided by Tenant's Counsel] EXHIBIT I --------- FORM OF LETTER OF CREDIT ------------------------ BANKBOSTON Irrevocable Letter of Credit Form Date: September 7, 1999 Amount: $500,000 USD Letter of Credit No. ________________ Beneficiary: BHX, LLC, as Trustee of Crawford Realty Trust c/o The Bulfinch Companies, Inc. First Needham Place 250 First Avenue, Suite 200 Needham, MA 02494 Attn: Robert A. Schlager Gentlemen: We hereby establish our unconditional, irrevocable Letter of Credit No. __________ in your favor and for the account of ____________________ whereby we irrevocably authorize you to draw on us from time to time at sight prior to the expiration hereof, and in the manner provided herein, up to __________________ and Five Hundred Thousand Dollars ($500,000 USD). Such drawing(s) will be unconditionally available to you upon your presentation of your draft(s) (which draft(s) shall have been signed by one purporting to be a duly authorized representative of the Beneficiary) on which shall be indicated "Drawn under(Name of Financial Institution) Letter of Credit No. _______," together with your certification to us that either (i) an "Event of Default" has occurred under a certain Lease between BHX, LLC, as Trustee of Crawford Realty Trust and _________________ or (ii) you are otherwise entitled to draw upon this Letter of Credit under the terms of said Lease. Multiple partial drawings are permitted. Each draft is to be accompanied by a copy of this Letter of Credit and shall be honored when presented between 9:00 a.m. and 5:00 p.m. on any Business Day (by which is meant any day other than Saturday, Sunday or any day (Name of Financial Institution) is prohibited from conducting commercial banking transactions) at (Name of Financial Institution) office at (Address of Financial Institution). This Letter of Credit sets forth in full the terms of our undertaking and such undertaking shall not in any way be modified, amended, or amplified by reference to any documents, instruments, or agreements referred to herein, or in which this Letter of Credit is referred, or to which this Letter of Credit relates. Any such reference shall not be deemed to incorporate herein the terms of any such referenced documents, instruments, or agreements. If a drawing by Beneficiary hereunder does not, in any instance, conform to the terms and conditions of this Letter of Credit, we shall give Beneficiary immediate notice that the attempted negotiation was not effected in accordance with the terms and conditions of this Letter of Credit, sating the reasons therefor, and that we are holding any documents at Beneficiary's disposal or are returning same to Beneficiary, as we may elect. Upon being notified that the attempted negotiation was not effected in accordance with this Letter of Credit, Beneficiary may attempt to correct any such non-conforming demand for payment if, and to the extent that, Beneficiary is entitled (without regard to the provisions of this sentence) and able to do so within the terms of this Letter of Credit. This Letter of Credit may be transferred, in whole, but not in part, without charge one or more times upon receipt of Beneficiary's written instructions. EX-10.10 11 0011.txt LEASE AGREEMENT DATED 4/7/2000 EXHIBIT 10.10 KEEP YOUR DAY JOB, LLC INDUSTRIAL MULTI-TENANT LEASE 1. BASIC PROVISIONS ("Basic Provisions"). 1.1 Parties: This Lease ("Lease") dated _____________, 2000, is made by and between KEEP YOUR DAY JOB, LLC, a Delaware limited liability company, ("Landlord") and SMARTERKIDS.COM, a Delaware corporation ("Tenant") (collectively the "Parties," or individually a "Party"). 1.2 Premises: A portion consisting of 139,500 square feet,, outlined on Exhibit A attached hereto ("Premises"), of the building ("Building") being constructed and located at 145 Plymouth Street, in the City of Mansfield, Commonwealth of Massachusetts. The Building is located in the industrial center commonly known as Cabot Business Park. Tenant shall have non-exclusive rights to the Common Areas (as defined in Paragraph 2.3 below), but shall not have any rights to the roof, exterior walls or utility raceways of the Building or to any other buildings in the Industrial Center. The Premises, the Building, the Common Areas, the land upon which they are located and all other buildings and improvements thereon are herein collectively referred to as the "Industrial Center." 1.3 Term: Five (5) years and zero (0) months ("Term") commencing on the Commencement Date, as set forth in the Commencement Date Addendum annexed hereto and made a part hereof ("Commencement Date"), and ending on the lst day of the month on which the fifth anniversary of the Commencement Date shall occur ("Expiration Date"). 1.4 Base Rent: $5.45 per square foot per annum, $760,275.00 per annum, payable in equal installments of $63,356.25 per month ("Base Rent"). $___________ payable on execution of this Lease for period _______________. 1.5 Tenant's Share of Operating Expenses ("Tenant's Share"): (a) Industrial Center 4% (b) Building 75% 1.6 Tenant's Estimated Monthly Rent Payment: Following is the estimated monthly Rent payment to Landlord pursuant to the provisions of this Lease. This estimate is made at the inception of the Lease and is subject to adjustment pursuant to the provisions of this Lease: (a) Base Rent (Paragraph 4.1) $63,356.25 (b) Operating Expenses (Paragraph 4.2; excluding Real Property Taxes, Landlord Insurance $ 4,650.00 (c) Landlord Insurance (Paragraph 8.3) $ 348.75 (d) Real Property Taxes (Paragraph 10) $ 7,323.75 Estimated Monthly Payment $75,678.75 1.7 Security Deposit: $850,000.00 ("Security Deposit") as of the date hereof and through June 30, 2000, and as of July 1, 2000, $500,000.00, subject to the provisions set forth in Section 5 below. 1.8 Permitted Use ("Permitted Use") Warehouse and distribution use, with office use(not to exceed 10% of the square footage of the Premises), as necessary and incidental to such warehouse and distribution use. 1.9 Guarantor: None 1.10 Addenda and Exhibits: Attached hereto are the following Addenda and Exhibits, all of which constitute a part of this Lease: (a) Addenda: Landlord's Remedies in Event of Tenant Default Option to Extend Early Possession and Inducement Recapture Commencement Date Addendum (b) Exhibits:Exhibit A: Diagram of Premises. Exhibit A-1: Legal Description of Lot Exhibit B: Commencement Date Certificate. Exhibit C: Tenant Move-In and Lease Renewal Environmental Questionnaire for Commercial and Industrial Properties. Exhibit D: Tenant Move-Out and Lease Renewal Environmental Questionnaire for Commercial and Industrial Properties. Exhibit E: Form of Estoppel Certificate. 1.11 Address for Rent Payments: All amounts payable by Tenant to Landlord shall until further notice from Landlord be paid to Landlord at the following address: c/o National Development 2310 Washington Street Newton, Massachusetts 02462 2. PREMISES, PARKING AND COMMON AREAS. 2.1 Letting. Landlord hereby leases to Tenant and Tenant hereby leases from Landlord the Premises upon all of the terms, covenants and conditions set forth in this Lease. Any statement of square footage set forth in this Lease or that may have been used in calculating Base Rent and/or Operating Expenses is an approximation which Landlord and Tenant agree is reasonable and the Base Rent and Tenant's Share based thereon is not subject to revision whether or not the actual square footage is more or less, except that Tenant's Share may be adjusted to reflect changes in square footage of the Common Areas pursuant to Section 2.5(d) below. The Premises are on a lot accessible directly from a public way and shall be accessible to Tenant twenty-four hours per day, seven days per week, subject to events beyond Landlord's control and subject to the Rules and Regulations of the Building and Industrial Center, as provided for herein. 2.2 Common Areas - Definition. "Common Areas" are all areas and facilities outside the Premises and within the exterior boundary line of the Industrial Center and interior utility raceways within the Premises that are provided and designated by the Landlord -2- from time to time for the general non-exclusive use of Landlord, Tenant and other tenants of the Industrial Center and their respective employees, suppliers, shippers, tenants, contractors and invitees. 2.3 Common Areas - Tenant's Rights. Landlord hereby grants to Tenant, for the benefit of Tenant and its employees, suppliers, shippers, contractors, customers and invitees, during the term of this Lease, the non-exclusive right to use, in common with others entitled to such use, the Common Areas at the Building and on the lot on which the Building is located, which lot is described on Exhibit A-1 attached hereto and made a part hereof as they exist from time to time, subject to any rights, powers, and privileges reserved by Landlord under the terms hereof or under the terms of any rules and regulations or covenants, conditions and restrictions governing the use of the Industrial Center. 2.4 Common Areas - Rules and Regulations. Landlord shall have the exclusive control and management of the Common Areas and shall have the right, from time to time, to establish, modify, amend and enforce reasonable Rules and Regulations with respect thereto in accordance with Paragraph 16.19. 2.5 Common Area Changes. Landlord shall have the right, in Landlord's sole discretion, from time to time: (a) To make changes to the Common Areas, including, without limitation, changes in the locations, size, shape and number of driveways, entrances, parking spaces, parking areas, loading and unloading areas, ingress, egress, direction of traffic, landscaped areas, walkways and utility raceways, provided that Landlord shall use reasonable efforts to minimize any adverse effect upon Tenant's use of and access to and from the Premises, subject to the provisions of Section 2.1; (b) To close temporarily any of the Common Areas for maintenance purposes so long as reasonable access to and use of the Premises remains available; (c) To designate other land outside the boundaries of the Industrial Center to be a part of the Common Areas; (d) To add additional buildings and improvements to the Common Areas, provided that Tenant's Share shall be adjusted if applicable to reflect any additional rentable square footage in the Building and/or Industrial Center; (e) To use the Common Areas while engaged in making additional improvements, repairs or alterations to the Industrial Center, or any portion thereof; and (f) To do and perform such other acts and make such other changes in, to or with respect to the Common Areas and Industrial Center as Landlord may, in the exercise of sound business judgment, deem to be appropriate. 2.6 Parking. Tenant shall be entitled to use one hundred thirty-nine (139) parking spaces, one hundred and five (105) of which shall be located in parking areas within Common Areas, and the remainder of which shall be created by Landlord within the area within the Common Areas which would otherwise be Tenant's loading area, at no extra cost to Tenant. All parking spaces which Tenant is permitted to use pursuant to this Section shall be on an unreserved, first-come, first-serve basis. Tenant shall, and shall cause its employees to, comply with all reasonable rules and regulations imposed from time to time by Landlord with respect to the such parking in accordance with Paragraph 16.19. Furthermore, Tenant shall -3- indemnify and hold Landlord harmless from and against all loss, cost, damage or expense arising out of the use by Tenant and its employees and invitees arising from the use of such parking spaces, unless any such loss, cost, damage or expense is due to the gross negligence or willful misconduct of Landlord, its agents, employees or contractors. 3. TERM. 3.1 Term. The Commencement Date, Expiration Date and Term of this Lease are as specified in Paragraph 1.3. 3.2 Delay in Possession. If for any reason Landlord cannot deliver possession of the Premises to Tenant by the Commencement Date, Landlord shall not be subject to any liability therefor, nor shall such failure affect the validity of this Lease or the obligations of Tenant hereunder. In such case, Tenant shall not, except as otherwise provided herein, be obligated to pay Rent or perform any other obligation of Tenant under the terms of this Lease until Landlord delivers possession of the Premises to Tenant 3.3 Preparation of the Premises. Landlord shall exercise all reasonable efforts to complete the work specified on the plans and specifications prepared by Newbury Design Associates and dated March 21, 2000 Revision 1 (the "Plans") by May 15, 2000, respecting the construction of approximately 4,000 square feet of office space (the "Office Space") within the Premises, and which shall also include warehouse lighting and power distribution (the "Warehouse Space") (such work to be performed by Landlord respecting the Office Space and the Warehouse Space are hereinafter collectively referred to as "Landlord's Work"), but Tenant shall have no claim against Landlord for failure so to complete Landlord's Work except the right to terminate this Lease in accordance with Section 3.2 above. Tenant agrees that Landlord may make any changes in Landlord's Work, upon prior written notice to Tenant for insubstantial changes and with the approval of Tenant (which approval may be withheld in Tenant's sole discretion) for substantial changes. Landlord shall provide Tenant with an allowance ("Landlord's Contribution") of up to a maximum total amount of $230,000 for the performance of Landlord's Work not more than $130,000 of which shall be for construction of the Office Space, and not more than $100,000 of which shall be for work related to the Warehouse Space, and Tenant shall not be liable for any cost of Landlord's Work to the extent that the total cost thereof is less than or equal to Landlord's Contribution. Landlord's contractor shall provide Tenant with an "open book" estimate of the cost of Landlord's Work. To the extent that the cost of Landlord's Work exceeds Landlord's Contribution, or to the extent that work related to the Office Space or the Warehouse Space exceeds the amounts of Landlord's Contribution allocated to the Office Space or Warehouse Space, as the case may be, Tenant shall pay the cost of such excess within thirty (30) days of Landlord's notice to Tenant of such excess cost, which notice shall be accompanied with copies of invoices respecting such additional costs, and a certification from Landlord's architect that the Landlord's Work has been completed substantially in accordance with the Plans. For purposes of this Section, "cost" shall be the actual cost to Landlord of performing Landlord's Work including, without limitation, all architectural and engineering fees and expenses and all contractor charges for the cost of work and materials, profit, general conditions and overhead and supervision and all filing fees and other permitting costs. Tenant shall, if requested by Landlord, execute an agreement (the "Excess Cost Agreement") confirming Landlord's estimate of such excess costs, and Tenant's obligation therefor, prior to the time Landlord shall be required to commence Landlord's Work. In addition to the specifications set forth in the Plans, Landlord -4- shall at its sole cost and expense (and not to be applied against Landlord Contribution) provide one (1) additional coat of curing compound to the floor within the Office Space. Landlord agrees to complete Landlord's Work in compliance with the Americans with Disabilities Act, and to deliver the Warehouse Space and the Office Space with all mechanical systems in good working order. Tenant shall be conclusively deemed to have accepted Landlord's Work unless, within sixty (60) days after the Commencement Date, Tenant gives Landlord written notice setting forth in detail those portions of Landlord's Work which Tenant does not accept, except for any defects which could not have reasonably been observed, despite reasonable investigation, prior to the sixtieth (60th) calendar day after the Commencement Date ("Latent Defects"). With respect to Latent Defects, Tenant may give written notice not later than the date which is six (6) months after the Commencement Date. Landlord shall correct either of the above referenced types of defects of which Landlord received such notice from Tenant, promptly following Landlord's receipt of such notice, except to the extent that shall dispute the accuracy of Tenant's characterization of such work as defective. 3.4 Condition of the Premises.Other than the Office Space and the Warehouse Space as the same are to be altered by Landlord's Work, Tenant accepts the Premises in "as is" condition without representation or warranty by Landlord. 3.5 Commencement Date Certificate. At the request of Landlord, Tenant shall execute and deliver to Landlord a completed certificate ("Commencement Date Certificate") in the form attached hereto as Exhibit B. 3.6 Compliance with Laws. The Building and parking areas shall be constructed to comply with all applicable material laws, codes, rules and ordinances. 4. RENT. 4.1 Base Rent. Tenant shall pay to Landlord Base Rent and other monetary obligations of Tenant to Landlord under the terms of this Lease (such other monetary obligations are herein referred to as "Additional Rent") in lawful money of the United States, without offset or deduction, except as specifically permitted hereunder, in advance on or before the first day of each month. Base Rent and Additional Rent for any period during the term hereof which is for less than one full month shall be prorated based upon the actual number of days of the month involved. Payment of Base Rent and Additional Rent shall be made to Landlord at its address stated herein or to such other persons or at such other addresses as Landlord may from time to time designate in writing to Tenant. Base Rent and Additional Rent are collectively referred to as "Rent". All monetary obligations of Tenant to Landlord under the terms of this Lease are deemed to be Rent. 4.2 Operating Expenses. Tenant shall pay to Landlord on the first day of each month during the term hereof, in addition to the Base Rent, Tenant's Share of all Operating Expenses in accordance with the following provisions: (a) "Operating Expenses" are all costs incurred by Landlord relating to the maintenance, repair and operation of the Industrial Center, Building and Premises including, but not limited to, the following: -5- (i) The operation, repair, maintenance and replacement in neat, clean, good order and condition of the Common Areas, including parking areas, loading and unloading areas, trash areas, roadways, sidewalks, walkways, parkways, driveways, landscaped areas, striping, bumpers, irrigation systems, drainage systems, lighting facilities, fences and gates, exterior signs and tenant directories. (ii) Water, gas, electricity, telephone and other utilities servicing the Common Areas. (iii) Trash disposal, janitorial services, snow removal, property management and security services. (iv) Real Property Taxes. (v) Premiums for the insurance policies maintained by Landlord under Paragraph 8 hereof. (vi) Environmental monitoring and insurance programs. (vii) Amortization (with interest at a commercially reasonable rate) over the useful life of the applicable item of any capital expenditure which is (a) made to comply with any law, rule, regulation, order, or ordinance with which the Premises had not been required to comply prior to the Commencement Date or with any amendment or change in interpretation by appropriate regulatory authority of any such law, rule, regulation, order or ordinance after the date of this Lease, (b) made to protect the health and safety of the occupants of the Industrial Center or Building, as applicable, (c) made to replace worn out or obsolete items or to keep the Premises in the condition the Premises was in as of the Commencement Date, reasonable wear and tear excepted, or (d) designed to reduce other Operating Expenses over the useful life of the item installed by at least the amount of the expenditure. (viii) Maintenance of the Building including, but not limited to, painting, caulking and repair and replacement of Building components, including, but not limited to, roof, elevators and fire detection and sprinkler systems, subject however to the amortization requirement above, if the expenditure is for a capital item. (ix) Management fees in an amount not to exceed four (4%) percent of the gross receipts from the Building. (b) Tenant's Share of Operating Expenses that are not specifically attributed to the Premises or Building ("Common Area Operating Expenses") shall be that percentage shown in Paragraph 1.5(a). Tenant's Share of Operating Expenses that are attributable to the Building ("Building Operating Expenses") shall be that percentage shown in Paragraph 1.5(b). Landlord in its reasonable discretion, consistently applied, shall determine which Operating Expenses are Common Area Operating Expenses, Building Operating Expenses or expenses to be entirely borne by Tenant. (c) The inclusion of the improvements, facilities and services set forth in Subparagraph 4.2(a) shall not be deemed to impose any obligation upon Landlord to either have said improvements or facilities or to provide those services unless required by this Lease. (d) Tenant shall pay monthly in advance on the same day as the Base Rent is due Tenant's Share of estimated Operating Expenses costs in the amount set forth in Paragraph 1.6. Landlord shall deliver to Tenant within 90 days after the expiration of each calendar year a -6- reasonably detailed statement showing Tenant's Share of the actual Operating Expenses incurred during the preceding year. If Tenant's estimated payments under this Paragraph 4(d) during the preceding year exceed Tenant's Share as indicated on said statement, Tenant shall be credited the amount of such overpayment against Tenant's Share of Operating Expenses next becoming due. If Tenant's estimated payments under this Paragraph 4.2(d) during said preceding year were less than Tenant's Share as indicated on said statement, Tenant shall pay to Landlord the amount of the deficiency within 10 days after delivery by Landlord to tenant of said statement. At any time Landlord may adjust the amount of the estimated Tenant's Share of Operating Expenses to reflect Landlord's estimate of such expenses for the year. (e) The following costs and expenses shall not be included in Operating Expenses: (i) costs of alterations of any tenant's premises for a particular tenant other than Tenant; (ii) the portion of any costs incurred in connection with the making of repairs or replacements which are the lease obligation of another tenant of the Industrial Center; (iii) costs associated with advertising, marketing, promotional and brokerage fees or expenditures; (iv) financing and refinancing costs respecting any mortgage or security interest placed upon the Industrial Center or any portion thereof, including payments of principal, interest, finance or other charges, and any points and commissions in connection therewith; (v) interest or penalties for any late or failed payments by Landlord under any contract or agreement unless resulting from Tenant's failure to pay when and as due Tenant's Share of Operating Expenses; (vi) costs (including, without limitation, attorneys' fees and disbursements) incurred in connection with any judgment, settlement or arbitration award resulting from any tort liability; (vii) rent or other charges payable under any ground lease or underlying lease; (viii) costs of electrical or other utilities services furnished directly to any premises of other tenants of the Industrial Center where such utility is separately metered to the premises of such other tenant, or for which Tenant pays a separate charge therefor; (ix) costs incurred in connection with Landlord's preparation, negotiation, dispute resolution and/or enforcement of leases, including court costs and attorneys' fees and disbursements in connection with any summary proceeding to dispossess any tenant, or incurred in connection with disputes with prospective tenants, employees, consultants, management agents, leasing agents, purchasers or mortgagees; (x) costs of any expansions of the Industrial Center; -7- (xi) costs of repairs, restoration or replacements occasioned by fire or other casualty or caused by the exercise of the right of eminent domain, provided, however, that the deductible proportion of any insurance carried for such losses shall be included in Operating Expenses; (xii) amounts paid to subsidiaries or affiliates of Landlord for services rendered to the Industrial Center to the extent such amounts exceed the competitive costs for delivery of such services had such services not been provided by such related parties; (xiii) depreciation; and (xiv) management fees to the extent in excess of four (4%) percent of gross receipts from the Building. (f) Landlord shall permit Tenant, at Tenant's sole expense and during normal business hours, to review Landlord's invoices and statements relating to Operating Expenses for the applicable period for the purpose of verifying the statement delivered by Landlord pursuant to Section 4.2(b) above, provided that notice of Tenant's desire to so review is given to Landlord not later than three (3) months after delivery of such statement by Landlord, and provided that such review is thereafter commenced and prosecuted by Tenant (and not by any third party compensated by Tenant on a contingency fee arrangement) with due diligence. Any such statement delivered to Tenant by Landlord shall be binding and conclusive upon Tenant unless within four (4) months after the giving by Landlord of such statement Tenant shall notify Landlord that Tenant disputes the correctness of such statement, specifying the particular respect in which the statement is claimed to be incorrect. If such dispute has not been settled by agreement within two (2) months after the expiration of the aforementioned four-month period, either party may submit the dispute to arbitration in accordance with the commercial arbitration rules of the American Arbitration Association within thirty (30) days after the expiration of the aforementioned two-month period. The decision of the arbitrators shall be final and binding on Landlord and Tenant and judgment thereon may be entered in any court of competent jurisdiction. All of the information obtained through Tenant's review of Operating Expenses as well as compromise, settlement or adjustment reached between Landlord and Tenant relative to the result thereof shall be held in strict confidence by Tenant. Tenant shall indemnify, defend upon request and hold Landlord harmless from and against all loss, cost, damage and expense suffered by Landlord based in whole or in part upon the breach of the covenants of Tenant contained in the preceding sentence. The obligations of Tenant hereunder shall survive the expiration or earlier termination of this Lease. If it should be agreed or decided that Operating Expenses were overstated by ten percent (10%) or more, then Landlord shall promptly reimburse Tenant for the reasonable costs incurred by Tenant in reviewing Landlord's invoices and statements, Tenant's reasonable arbitration costs plus any excess amount paid by Tenant on account of overstated Operating. If it should be agreed or decided that Operating Expenses were not overstated at all, then Tenant shall, as Additional Rent, promptly reimburse Landlord for its costs incurred in the arbitration plus the lesser of $500 or the costs incurred by Landlord in preparing for Tenant's review of invoices and statements; and if Operating Expenses shall have been understated or Tenant shall not have paid the Operating Expenses in full, Tenant shall, as Additional Rent, promptly pay any deficiency in -8- the payments theretofore made. In the event of an overstatement which is less than ten percent (10%), Landlord shall promptly reimburse Tenant any excess amount paid by Tenant on account of overstated Operating Expenses, and each party shall be responsible for its own costs incurred in connection with such dispute. Tenant keep confidential (and shall cause any third party assisting Tenant with any such audit to keep confidential) all information obtained during the audit process including any settlements or arbitration awards made. Landlord may require Tenant to execute and deliver a separate confidentiality agreement further specifying Tenant's obligations and Landlord's remedies for breach, as a condition to commencement of the audit. 5. SECURITY DEPOSIT. Tenant shall deposit with Landlord upon Tenant's execution hereof the Security Deposit set forth in Paragraph 1.7 as security for Tenant's faithful performance of Tenants obligations under this Lease. If Tenant fails to pay Base Rent or Additional Rent or otherwise defaults under this Lease (as defined in Paragraph 13.1), Landlord may use the Security Deposit for the payment of any amount due Landlord or to reimburse or compensate Landlord for any liability, cost, expense, loss or damage (including attorney's fees) which Landlord may suffer or incur by reason thereof. Tenant shall on demand pay Landlord the amount so used or applied so as to restore the Security Deposit to the amount set forth in Paragraph 1.7. Landlord shall not be required to keep all or any part of the Security Deposit separate from its general accounts. Landlord shall, at the expiration or earlier termination of the term hereof and after Tenant has vacated the Premises, return to Tenant that portion of the Security Deposit not used or applied by Landlord. No part of the Security Deposit shall be considered to be held in trust, to bear interest, or to be prepayment for any monies to be paid by Tenant under this Lease. Tenant shall have the right to post the Security Deposit (as the same may have been reduced in accordance with this Section 5) in the form of a letter of credit (the "Letter of Credit"), which shall (a) be unconditional and irrevocable and otherwise in form and substance reasonably satisfactory to Landlord; (b) be at all times in the amount of the Security Deposit, and shall permit multiple draws; (c) be issued by a commercial bank reasonably acceptable to Landlord; (d) be made payable to, and expressly transferable and assignable at no charge by, Landlord; (e) be payable at sight upon presentment to a branch of the issuer in the Route 495 area (a "495 Office") of a simple sight draft accompanied by a certificate of Landlord stating either that Tenant is in default under this Lease or that Landlord is otherwise permitted to draw upon such Letter of Credit under the express terms of this Lease, and the amount that Landlord is owed (or permitted to draw) in connection therewith; and (f) shall either expire thirty (30) days following the expiration of the term of this Lease, or be replaced not less than thirty (30) days prior to the expiration of the then current Letter of Credit so that the original Letter of Credit or a replacement thereof shall be in full force and effect throughout the term of this Lease and for a period of thirty (30) days thereafter. Tenant shall deliver to Landlord any replacement Letter of Credit not less than thirty (30) days prior to the expiration of the then current Letter of Credit. Notwithstanding anything in this Lease to the contrary, any grace period or cure periods which are otherwise applicable under Section 13.1 hereof, shall not apply if Tenant fails to comply with the requirements of subsection (f) above, in which event, Landlord shall have the immediate right to draw upon the Letter of Credit in full and hold the proceeds thereof as a cash security -9- deposit, provided, however, that Tenant shall have the right at any time during the Term to deliver a replacement Letter of Credit to Landlord meeting the requirements of this paragraph, and upon receipt of such replacement Letter of Credit, Landlord shall return promptly to Tenant the amount of cash security deposit then being held by Landlord. Each Letter of Credit shall be issued by a commercial bank that (i) has a credit rating with respect to certificates of deposit, short term deposits or commercial paper of at least P-2 (or equivalent) by Moody's Investor Service, Inc., or at least A-2 (or equivalent) by Standard & Poor's Corporation and (ii) maintains a 495 Office at which such Letter of Credit may be presented for payment. If the issuer's credit rating is reduced below P-2 (or equivalent) by Moody's Investor Service, Inc., or below A-2 (or equivalent) by Standard and Poor's Corporation, or if the financial condition of the issuer changes in any other materially adverse way or if the issuer ceases to maintain a 495 Office, then Landlord shall have the right to require that Tenant obtain from a different issuer a substitute Letter of Credit that complies in all respect with the requirements of this Section, and Tenant's failure to obtain such substitute Letter of Credit within ten (10) days after Landlord's written demand therefor (with no other notice, grace or cure period being applicable thereto) shall entitle Landlord immediately to draw upon the existing Letter of Credit in full, without any further notice to Tenant. As of July 1, 2000, the Security Deposit shall be reduced to $500,000.00, and as of second anniversary of the Commencement Date, the Security Deposit shall be reduced to $380,000.00, provided, however, that no reduction in the Security Deposit shall occur if (i) there shall have existed a Default of Tenant at any time prior to the date that such reduction would otherwise have occurred, or (ii) no reduction to $380,000 shall occur if Tenant does not have or does not give Landlord reasonably satisfactory evidence that Tenant has cash or cash equivalents in the amount of at least $50,000,000 at such time. Tenant may either deliver an amendment to the Letter of Credit or a new Letter of Credit in the amount of the applicable Security Deposit. 6. USE. 6.1 Permitted Use. Tenant shall use and occupy the Premises only for the Permitted Use set forth in Paragraph 1.8. Tenant shall not commit any nuisance, permit the emission of any objectionable noise or odor, suffer any waste, make any use of the Premises which is contrary to any law or ordinance or which will invalidate or increase the premiums for any of Landlord's insurance. Tenant shall not service, maintain or repair vehicles other than forklifts and other warehouse equipment on the Premises, Building or Common Areas. Tenant shall not store foods, pallets, drums or any other materials outside the Premises; but may keep pallets in front of one of Tenant's loading docks provided there shall be no interference with any other tenant and such pallets are kept neat, clean and orderly. 6.2 Hazardous Substances. (a) Reportable Uses Require Consent. The term "Hazardous Substance" as used in this Lease shall mean any product, substance, chemical, material or waste whose presence, nature, quantity and/or intensity of existence, use, manufacture, disposal, transportation, spill, release or effect, either by itself or in combination with other materials expected to be on the Premises, is either: (i) potentially injurious to the public health, safety or welfare, the environment, or the Premises; (ii) regulated or monitored by any governmental authority; or (iii) a basis for potential liability to any governmental agency or third party under any applicable -10- statute or common law theory. Hazardous Substance shall include, but not be limited to, hydrocarbons, petroleum, gasoline, crude oil or any products or by- products thereof. Tenant shall not engage in any activity in or about the Premises which constitutes a Reportable Use (as hereinafter defined) of Hazardous Substances without the express prior written consent of Landlord and compliance in a timely manner (at Tenant's sole cost and expense) with all Applicable Requirements (as defined in Paragraph 6.3). "Reportable Use" shall mean (i) the installation or use of any above or below ground storage tank, (ii) the generation, possession, storage, use, transportation, or disposal of a Hazardous Substance that requires a permit from, or with respect to which a report, notice, registration or business plan is required to be filed with, any governmental authority, and (iii) the presence in, on or about the Premises of a Hazardous Substance with respect to which any Applicable Requirements require that a notice be given to persons entering or occupying the Premises or neighboring properties. Notwithstanding the foregoing, Tenant may, without Landlord's prior consent, but upon notice to Landlord and in compliance with all Applicable Requirements, use any ordinary and customary materials reasonably required to be used by Tenant in the normal course of the Permitted Use, so long as such use is not a Reportable Use and does not expose the Premises, or neighboring properties to any meaningful risk of contamination or damage or expose Landlord to any liability therefor. In addition, Landlord may (but without any obligation to do so) condition its consent to any Reportable Use of any Hazardous Substance by Tenant upon Tenant's giving Landlord such additional assurances as Landlord, in its reasonable discretion, deems necessary to protect itself, the public, the Premises and the environment against damage, contamination or injury and/or liability therefor, including but not limited to the installation (and, at Landlord's option, removal on or before Lease expiration or earlier termination) of reasonably necessary protective modifications to the Premises (such as concrete encasements) and/or the deposit of an additional Security Deposit. (b) Duty to Inform Landlord. If Tenant knows, or has reasonable cause to believe, that a Hazardous Substance is located in, under or about the Premises or the Building, Tenant shall immediately give Landlord written notice thereof, together with a copy of any statement, report, notice, registration, application, permit, business plan, license, claim, action, or proceeding given to, or received from, any governmental authority or private party concerning the presence, spill, release, discharge of, or exposure to, such Hazardous Substance. Tenant shall not cause or permit any Hazardous Substance to be spilled or released in, on, under or about the Premises (including, without limitation, through the plumbing or sanitary sewer system). (c) Indemnification. Tenant shall indemnify, protect, defend and hold Landlord, Landlord's affiliates, Lenders, and the officers, directors, shareholders, partners, employees, managers, independent contractors, attorneys and agents of the foregoing ("Landlord Entities") and the Premises, harmless from and against any and all damages, liabilities, judgments, costs, claims, liens, expenses, penalties, loss of permits and attorneys' and consultants' fees arising out of or involving any Hazardous Substance brought onto the Premises by or for Tenant or by any of Tenant's employees, agents, contractors or invitees. Tenant's obligations under this Paragraph 6.2(c) shall include, but not be limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Tenant, and the cost of investigation (including consultants' and attorneys' fees and testing), removal, remediation, restoration and/or abatement thereof, or of any contamination therein involved. Tenant's obligations under this Paragraph 6.2(c) shall survive the expiration or earlier termination of this Lease. -11- 6.3 Tenant's Compliance with Requirements. Tenant shall, at Tenant's sole cost and expense, fully, diligently and in a timely manner, comply with all "Applicable Requirements," which term is used in this Lease to mean all laws, rules, regulations, ordinances, directives, covenants, easements and restrictions of record (so long as not unreasonably interfering with the use of the Premises for storage), permits, and the requirements of any applicable fire insurance underwriter or rating bureau, now in effect or which may hereafter come into effect relating in any manner to the Premises (including but not limited to matters pertaining to (i) environmental conditions on, in, under or about the Premises, including soil and groundwater conditions, and (ii) the use, generation, manufacture, production, installation, maintenance, removal, transportation, storage, spill or release of any Hazardous Substance), but with respect to (i) and (ii) only to the extent the need for compliance shall be due to the acts or failure to act of Tenant or any subtenant or assignee or any of its or their agents, employees, contractors or invitees (collectively each a "Tenant Entity"), Tenant shall, within 5 days after receipt of Landlord's written request, provide Landlord with copies of all documents and information evidencing Tenant's compliance with any Applicable Requirements and shall promptly upon receipt, notify Landlord in writing (with copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving failure by Tenant or the Premises to comply with any Applicable Requirements. Tenant shall execute and deliver to Landlord a completed questionnaire, in the form attached hereto as Exhibit C, immediately prior to the Commencement Date and, if applicable, immediately prior to the commencement of any Option Period; and Tenant shall execute and deliver to Landlord a completed questionnaire, in the form attached hereto as Exhibit D, immediately prior to the expiration of the term or Tenant's surrender of possession of the Premises, whichever is earlier. 6.4 Inspection; Compliance with Law. In addition to Landlord's environmental monitoring and insurance program, the cost of which is included in Operating Expenses, Landlord and the holders of any mortgages, deeds of trust or ground leases on the Premises ("Lenders") shall have the right to enter the Premises at any time in the case of an emergency, and otherwise at reasonable times, for the purpose of inspecting the condition of the Premises and for verifying compliance by Tenant with this Lease and all Applicable Requirements. Landlord shall be entitled to employ experts and/or consultants in connection therewith to advise Landlord with respect to Tenant's installation, operation, use, monitoring, maintenance, or removal of any Hazardous Substance on or from the Premises. The cost and expenses of any such inspections shall be paid by the party requesting same unless a violation of Applicable Requirements exists or is imminent or the inspection is requested or ordered by a governmental authority. In such case, Tenant shall upon request reimburse Landlord or Landlord's Lender, as the case may be, for the costs and expenses of such inspections. 7. MAINTENANCE, REPAIRS, TRADE FIXTURES AND ALTERATIONS. 7.1 Tenant's Obligations. Subject to the provisions of Paragraph 7.2 (Landlord's Obligations), Paragraph 9 (Damage or Destruction) and Paragraph 14 (Condemnation), Tenant shall, at Tenant's sole cost and expense and at all times, keep the Premises and every part thereof in good order, condition and repair including, without limiting the generality of the foregoing, all equipment or facilities specifically and exclusively serving the Premises, such as plumbing, heating, air conditioning, ventilating, electrical, lighting facilities, boilers, fired or unfired pressure vessels, fire hose connectors if within the Premises, fixtures, interior walls, interior surfaces of exterior walls, ceilings, floors, windows, doors, plate glass, and skylights, but -12- excluding any items which are the responsibility of Landlord pursuant to Paragraph 7.2 below. Tenant shall through the term maintain at Tenant's expense HVAC maintenance contracts reasonably acceptable to Landlord. Except as hereinafter provided, Tenant's obligations shall include restorations, replacements or renewals when necessary to keep the Premises and all improvements thereon or a part thereof in good order, condition and state of repair, reasonable wear and tear and (in the case of the Premises) damage by casualty or taking by eminent domain excepted . Notwithstanding the foregoing, Tenant's obligations hereunder shall not apply to any capital expenditure (including any replacement of a capital item) the need for which shall not have arisen due to (i) the failure by Tenant to perform ordinary repairs and maintenance (ii) the negligence or other wrongful acts of any Tenant Entity or (iii) any alterations or installations made by Tenant. 7.2 Landlord's Obligations. Subject to the provisions of Paragraph 6 (Use), Paragraph 7.1 (Tenant's Obligations), Paragraph 9 (Damage or Destruction) and Paragraph 14 (Condemnation), Landlord at its expense and not subject to reimbursement pursuant to Paragraph 4.2, shall keep in good order, condition and repair the foundations and structural supports and exterior walls of the Building and utility systems outside the Building. Landlord, subject to reimbursement pursuant to Paragraph 4.2, shall keep in good order, condition and repair the Building roof and Common Areas. 7.3 Alterations. Tenant shall not make nor cause to be made any alterations, installations in, on, under or about the Premises without on each occasion obtaining the prior consent of Landlord. Landlord's consent shall not be unreasonably withheld or delayed with respect to the installation of a mezzanine or to other alterations, additions or improvements which Tenant proposes to make at its sole cost provided such mezzanine and any other such alterations or installation are consistent with Building standards, do not adversely affect the plumbing, heating ventilating, air-conditioning, life safety, mechanical or electrical systems of the Building, do not adversely affect the structural elements of the Building, are not visible from the outside of the Premises, and shall not materially increases Real Estate Taxes or Operating Expenses, nor require Landlord to perform any work to the Premises, Building or Industrial Center. So long as any request by Tenant for comment hereunder shall expressly so state, the failure by Landlord to respond to any such request within five (5) business days of receipt of such request shall constitute deemed consent. 7.4 Surrender/Restoration. Tenant shall surrender the Premises by the end of the last day of the Lease term or any earlier termination date, clean and free of debris and in good operating order, condition and state of repair ordinary wear and tear excepted. Without limiting the generality of the above, Tenant shall remove all personal property, trade fixtures and floor bolts, patch all floors and cause all lights to be in good operating condition. Landlord may condition any consent on Tenant agreeing to remove any alteration or installation and to restore any damage caused by installation or removal, on or before the expiration or sooner termination of the term of this Lease. 8. INSURANCE; INDEMNITY. 8.1 Payment of Premiums. The cost of the premiums for the insurance policies maintained by Landlord under this Paragraph 8 shall be a Common Area Operating Expense pursuant to Paragraph 4.2 hereof. Premiums for policy periods commencing prior to, -13- or extending beyond, the term of this Lease shall be prorated to coincide with the corresponding Commencement Date or Expiration Date. 8.2 Tenant's Insurance. (i) At its sole cost and expense, Tenant shall maintain in full force and effect during the Term of the lease the following insurance coverages insuring against claims which may arise from or in connection with the Tenant's operation and use of the leased premises. (a) Commercial General Liability with minimum limits of $1,000,000 per occurrence; $3,000,000 general aggregate for bodily injury, personal injury and property damage. (b) Workers' Compensation insurance with statutory limits and Employers Liability with a $1,000,000 per accident limit for bodily injury or disease. (c) Automobile Liability covering all owned, non- owned and hired vehicles with a $1,000,000 per accident limit for bodily injury and property damage. (d) Property insurance against all risks of loss to any tenant improvements or betterments and business personal property on a full replacement cost basis with no coinsurance penalty provision; and Business Interruption Insurance with a limit of liability representing loss of at least approximately six months of income. (ii) Tenant shall deliver to Landlord certificates of all insurance reflecting evidence of required coverages prior to initial occupancy; and annually thereafter. (iii) If, in the opinion of Landlord's insurance advisor, the amount of scope of such coverage is deemed inadequate at any time during the Term, Tenant shall increase such coverage to such reasonable amounts or scope as Landlord's advisor deems adequate. (iv) All insurance required under Paragraph 8.2 (i) shall be primary and non-contributory (ii) shall provide for severability of interests, (iii) shall be issued by insurers, licensed to do business in the state in which the Premises are located and which are rated A:VII or better by Best's Key Rating Guide, (iv) shall be endorsed to include Landlord and such other persons or entities as Landlord may from time to time designate, as additional insureds (Commercial General Liability only), and (v) shall be endorsed to provide at least 30-days prior notification of cancellation or material change in coverage to said additional insureds. 8.3 Landlord's Insurance. Landlord may, but shall not be obligated to, maintain all risk, including earthquake and flood, insurance covering the buildings within the Industrial Center, Commercial General Liability and such other insurance in such amounts and covering such other liability or hazards as deemed appropriate by Landlord. The amount and scope of coverage of Landlord's insurance shall be determined by Landlord from time to time in its sole discretion and shall be subject to such deductible amounts as Landlord may elect. Landlord shall have the right to reduce or terminate any insurance or coverage. Premiums for any such insurance shall be a Common Area Operating Expense. 8.4 Waiver of Subrogation. To the extent permitted by law and without affecting the coverage provided by insurance required to be maintained hereunder, Landlord and Tenant each waive any right to recover against the other on account of any and all claims Landlord or Tenant may have against the other with respect to property insurance actually carried, or required to be carried hereunder, to the extent of the proceeds realized from such insurance coverage. -14- In addition, to the extent Landlord shall not have maintained at the time of damage all-risk, full replacement cost insurance on the Building subject to commercially reasonably deductibles, Landlord shall be deemed to have waived any claim against Tenant for property loss which would have been made available to Landlord had it maintained such insurance. 8.5 Indemnity. Except to the extent caused by or arising out of the gross negligence or willful misconduct of any of the Landlord Entities, Tenant shall protect, indemnify and hold the Landlord Entities harmless from and against any and all loss, claims, liability or costs (including court costs and attorney's fees) incurred by reason of: (i) any damage to any property (including but not limited to property of any Landlord Entity) or death or injury to any person occurring in or about the Premises, the Building or the Industrial Center to the extent that such injury or damage shall be caused by or arise from any actual or alleged act, neglect, fault or omission by or of Tenant, its agents, servants, employees, invitees, or visitors; (ii) the conduct or management of any work or anything whatsoever done by the Tenant on or about the Premises or from transactions of the Tenant concerning the Premises; (iii) Tenant's failure to comply with any and all governmental laws, ordinances and regulations applicable to the particular use of the Premises or its occupancy; or (iv) any breach or default of the part of Tenant in the performance of any covenant or agreement on the part of the Tenant to be performed pursuant to this Lease. The provisions of this Paragraph 8.5 shall survive the termination of this Lease with respect to any claims or liability accruing prior to such termination. 8.6 Exemption of Landlord from Liability. Except to the extent caused by the gross negligence or willful misconduct of Landlord, Landlord Entities shall not be liable for and Tenant waives any claims against Landlord Entities for injury or damage to the person or the property of Tenant, Tenant's employees, contractors, invitees, customers from any cause whatsoever, including, but not limited to, damage or injury which is caused by or results from (i) fire, steam, electricity, gas, water or rain, or from the breakage, leakage, obstruction or other defects of pipes, fire sprinklers, wires, appliances, plumbing, air conditioning or lighting fixtures or (ii) from the condition of the Premises, other portions of the Building or Industrial Center. Landlord shall not be liable for any damages arising from any act or neglect of any other tenant of Landlord nor from the failure by Landlord to enforce the provisions of any other lease in the Industrial Center. Notwithstanding Landlord's negligence or breach of this Lease, Landlord shall under no circumstances be liable for injury to Tenant's business, for any loss of income or profit therefrom or any indirect, consequential or punitive damages. 8.7 Landlord Indemnity. Subject to all limitations, waivers, exclusions and conditions contained in this Lease (each of which shall control in the event of any conflict or inconsistent with this Section 8.7), Landlord shall indemnify Tenant from and against any and all claims asserted by or on behalf of any third party on account of personal injury or death arising out of the negligence or other wrongful conduct of Landlord or its agents, contractors or employees during the term of this Lease. In respect of the foregoing, Landlord shall indemnify Tenant from and against all costs, expenses (including reasonable attorneys' fees), and liabilities incurred in or in connection with any such claim, action or proceeding brought thereon; and, in case of any action or proceeding brought against Tenant by reason of any such claim, Landlord, -15- upon notice from Tenant and at Landlord's expense, shall resist or defend such action or proceeding and employ counsel therefor reasonably satisfactory to Tenant. 9. DAMAGE OR DESTRUCTION. 9.1 Termination Right. To the extent that Landlord is not aware of any damage to the Premises, Tenant shall give Landlord immediate written notice of any damage to the Premises. Subject to the provisions of Paragraph 9.2, if the Premises or the Building shall be damaged to such an extent that in the good faith determination of Landlord's architect, the time needed to make restoration as required by Section 9.2 shall exceed 180 days from the date of casualty, Landlord shall give prompt notice thereof to Tenant. Tenant, at any time following such notice but prior to commencement of repair of the Premises and following 10 days written notice to Landlord, may terminate this Lease effective 30 days after delivery of such notice to Landlord. Such termination shall not excuse the performance by Tenant of those covenants which under the terms hereof survive termination. Rent shall be abated in proportion to the degree of interference during the period that there is such substantial interference with the conduct of Tenant's business at the Premises. Abatement of rent and Tenant's right of termination pursuant to this provision shall be Tenant's sole remedy for failure of Landlord to keep in good order, condition and repair the foundations structural supports and exterior walls of the Building, Building roof, utility systems outside the Building, the Common Areas. In the event that the Premises or the Building, or any material part thereof, shall be destroyed or damaged by fire or other casualty, to such an extent that the time needed to repair is likely to exceed 180 days from the date of casualty then this Lease may be terminated at the election of Landlord. Any such election shall be made by the giving of notice by Landlord to Tenant within sixty (60) days following Landlord's receipt of Tenant's notice of such fire or casualty. 9.2 Restoration. If neither Landlord nor Tenant shall elect to so terminate, this Lease shall continue in force and (so long as the damage is not caused by the negligence or other wrongful act of Tenant or its employees, agents, contractors or invitees) a just proportion of the Base Rent reserved, according to the nature and extent of the damages sustained by the Premises, shall be suspended or abated until the Premises (excluding any improvements to the Premises made at Tenant's expense but including Landlord's Work), or what may remain thereof, shall be restored substantially to their pre-existing condition, to the extent practical, which Landlord covenants to do with reasonable diligence to the extent permitted by the net proceeds of insurance recovered for such destruction and subject to zoning and building laws or ordinances then in existence. 9.3 Damage Caused by Tenant. Tenant's termination rights under Paragraph 9.1 shall not apply if the damage to the Premises or Building is the result of any act or omission of Tenant or of any of Tenant's agents, employees, customers, invitees or contractors ("Tenant Acts"). Any damage resulting from a Tenant Act shall be promptly repaired by Tenant. Landlord at its option may at Tenant's expense repair any damage caused by Tenant Acts. Tenant shall continue to pay all rent and other sums due hereunder and shall be liable to Landlord for all damages that Landlord may sustain resulting from a Tenant Act. -16- 10. REAL PROPERTY TAXES. 10.1 Payment of Real Property Taxes. Landlord shall pay prior to delinquency the Real Property Taxes due and payable during the term of this Lease and, except as otherwise provided in Paragraph 10.3, any such amounts shall be included in the calculation of Operating Expenses in accordance with the provisions of Paragraph 4.2. 10.2 Real Property Tax Definition. As used herein, the term "Real Property Taxes" is any form of tax or assessment, general, special, ordinary or extraordinary, imposed or levied upon the Building and/or the land upon which the Building is located (the "Land") and/or any interest of Landlord in the Building and/or the Land. Real Property Taxes include (i) any license fee, commercial rental tax, excise tax, improvement bond or bonds, levy or tax; (ii) any tax or charge which replaces or is in addition to any of such above-described "Real Property Taxes" and (iii) any fees, expenses or costs (including attorney's fees, expert fees and the like) incurred by Landlord in protesting or contesting any assessments levied or any tax rate. The term "Real Property Taxes" shall also include any increase resulting from a change in the ownership of the Land or Building, the execution of this Lease or any modification, amendment or transfer thereof. Real Property Taxes for tax years commencing prior to, or extending beyond, the term of this Lease shall be prorated to coincide with the corresponding Commencement Date or Expiration Date. 10.3 Additional Improvements. Operating Expenses shall not include Real Property Taxes attributable to improvements placed upon the Industrial Center by other tenants or by Landlord for the exclusive enjoyment of such other tenants. Notwithstanding Paragraph 10.1 hereof, Tenant shall, however, pay to Landlord at the time Operating Expenses are payable under Paragraph 4.2, the entirety of any increase in Real Property Taxes if assessed by reason of improvements placed upon the Premises by Tenant or at Tenant's request (other than Landlord's Work). 10.4 Joint Assessment. If the Building is at any time in the future no longer separately assessed, Real Property Taxes allocated to the Building shall be an equitable proportion of the Real Property Taxes for all of the land and improvements included within the tax parcel assessed. 10.5 Tenant's Property Taxes. Tenant shall pay prior to delinquency all taxes assessed against and levied upon Tenant's improvements, fixtures, furnishings, equipment and all personal property of Tenant contained in the Premises or stored within the Industrial Center. 11. UTILITIES. Tenant shall pay directly for all utilities and services supplied and separately metered to the Premises, including but not limited to electricity, telephone, security, gas and cleaning of the Premises, together with any taxes thereon. Landlord shall as part of Landlord's Work separately meter the utilities serving the Premises, other than water and sewer services, as part of Landlord's Work. The electrical systems shall be designed to provide 2000 amps at 277/480 Volts. 12. ASSIGNMENT AND SUBLETTING. (a) Tenant shall not assign, mortgage or otherwise transfer or encumber (collectively, "assign") or sublet all or any part of Tenant's interest in this Lease or in the Premises without Landlord's prior written consent which consent shall not be unreasonably withheld, conditioned or delayed. Relevant criteria in determining reasonability of consent include, but are not limited to, credit history of a proposed assignee or sublessee, references from prior landlords, -17- any change or intensification of use of the Premises or the Common Areas and any limitations imposed by the Internal Revenue Code and the Regulations promulgated thereunder relating to Real Estate Investment Trusts. Assignment or sublet shall not release Tenant from its obligations hereunder. Tenant shall not (i) sublet or assign or enter into other arrangements such that the amounts to be paid by the sublessee or assignee thereunder would be based, in whole or in part, on the income or profits derived by the business activities of the sublessee or assignee; (ii) sublet the Premises or assign this Lease to any person in which Landlord owns an interest, directly or indirectly (by applying constructive ownership rules set forth in Section 856(d)(5) of the Internal Revenue Code (the "Code"); or (iii) sublet the Premises or assign this Lease in any other manner which could cause any portion of the amounts received by Landlord pursuant to this Lease or any sublease to fail to qualify as "rents from real property" within the meaning of Section 856(d) of the Code, or which could cause any other income received by Landlord to fail to qualify as income described in Section 856(c)(2) of the Code. The requirements of this Section 12.1 shall apply to any further subleasing by any subtenant. (b) A change in the control of Tenant shall constitute an assignment requiring Landlord's consent. The transfer, on a cumulative basis, of 25% or more of the voting or management control of Tenant shall constitute a change in control for this purpose provided, however this subsection (b) shall not be applicable for so long as Tenant's stock is listed for trading or quotation on the New York Stock Exchange or Nasdaq, or other nationally recognized domestic securities exchange; and any transaction pursuant to which Tenant is merged or consolidated with another entity or pursuant to which all or substantially all of Tenant's assets are transferred shall not be deemed a prohibited assignment, if (w) after any such transaction or transfer, the successor to Tenant or the transferee of or successor to any of Tenant's rights hereunder has a tangible net worth computed in accordance with generally accepted accounting principles at least equal to the net worth of Tenant on the date of this Lease, (x) proof satisfactory to Landlord of such net worth shall have been delivered to Landlord (subject to any reasonable confidentiality obligation to be honored by Landlord) at least ten (10) days prior to the effective date of any such transaction, (y) in the case of a sale of assets, proof satisfactory to Landlord shall have been delivered to Landlord (subject to any reasonable confidentiality obligation to be honored by Landlord) at least ten (10) days prior to the effective date of any such transaction that substantially all of Tenant's assets shall be sold to such transferee, and (z) the assignee, transferee or successor agrees directly with Landlord, by written instrument in form satisfactory to Landlord, to be bound by all the terms of this Lease including, without limitation, the covenants contained herein. In addition, Tenant may, upon not less than ten (10) days prior notice to Landlord, sublease all or any portion of the Premises to any entity which controls, is controlled by or is under common control with the Tenant identified in Section 1.1 (such entity being an "Affiliate"). Any sublease to an Affiliate shall, at Landlord's election, be terminated if the subtenant shall cease to be an Affiliate, and any sublease shall so provide. The term "control" for this purpose shall mean the ownership, directly or indirectly, of more than seventy-five percent (75%) of the outstanding voting stock of a corporation or other equity interest if Tenant is not a corporation. (c) If the rent and other sums (including, without limitation, all monetary payments plus the reasonable value of any services performed or any other thing of value given by any assignee or subtenant in consideration of such assignment or sublease), either initially or over the term of any assignment or sublease, payable by any assignee or subtenant (other than an Affiliate or an assignee permitted pursuant to (b) above) to Tenant on account of an assignment -18- or sublease of all or any portion of the Premises exceed the sum of (i) Base Rent plus Additional Rent called for hereunder with respect to the space assigned or sublet plus (ii) all brokerage fees and legal fees paid by Tenant with respect to such assignment or sublease and any demising costs and any cost of alterations which are performed solely for the benefit of the assignee or subtenant (all such costs to be amortized over the term of such sublease or assignment), Tenant shall pay to Landlord as Additional Rent fifty percent (50%) of such excess payable monthly at the time for payment of Base Rent. (d) In the event that Tenant intends enter into any assignment or sublease other than to an Affiliate or an assignee permitted pursuant to (b) above, then Tenant shall, not sooner than one hundred twenty (120) days and not later than forty-five (45) days, prior to the proposed effective date of such sublease or assignment, give notice to Landlord of such intent, identifying the proposed subtenant or assignee, all of the terms and conditions of the proposed sublease or assignment, and such other information as Landlord may reasonably request. Landlord may elect (i) to terminate the term of this Lease in the case of an assignment or a sublease of more than fifty percent (50%) of the Premises or (ii) to exclude from the Premises, for the term of the proposed sublease, the portion thereof to be sublet by giving notice to Tenant of either such election not later than thirty (30) days after receiving notice of such intent from Tenant. If Landlord shall give such notice within such thirty (30) day period, upon the later to occur of (a) the proposed date of commencement of such proposed sublease or assignment, or (b) the date which is fifteen (15) days after Landlord's notice, the term of this Lease shall terminate or (as applicable), for the period expiring on the expiration date of such proposed sublease (if applicable), the Premises shall be reduced to exclude the portion of the Premises intended for subletting, in which case the Base Rent and Tenant's Share of Operating Expenses shall be correspondingly reduced. If Landlord shall give its consent, Tenant may enter into such sublease or assignment on the terms and conditions set forth in such notice from Tenant within the following thirty (30) days. If Tenant shall not enter into such sublease or assignment within such following thirty (30) day period and shall still desire to enter into any sublease, or if Tenant shall change the terms and conditions thereof following the date of Tenant's notice to Landlord, the first sentence of this paragraph shall again become applicable. 13. DEFAULT; REMEDIES. 13.1 Default. The occurrence of any one of the following events shall constitute an event of default on the part of Tenant ("Default"): (a) Failure to pay any installment of Base Rent, Additional Rent or any other monies due and payable hereunder, said failure continuing for a period of 7 days after notice from Landlord; (b) A general assignment by Tenant or any guarantor for the benefit of creditors; (c) The filing of a voluntary petition in bankruptcy by Tenant or any guarantor, the filing of a voluntary petition for an arrangement, the filing of a petition, voluntary or involuntary, for reorganization, or the filing of an involuntary petition by Tenant's creditors or guarantors, but with respect to involuntary petitions filed against Tenant, a Default shall not -19- occur unless such involuntary petition is not dismissed or stayed within ninety (90) days after the filing of such involuntary petition; (d) Receivership, attachment, of other judicial seizure of the Premises or all or substantially all of Tenant's assets on the Premises; (e) Failure of Tenant to maintain insurance as required by Paragraph 8.2; and (f) Failure in the performance of any of Tenant's covenants, agreements or obligations hereunder (except those failures specified as events of Default in other Paragraphs of this Paragraph 13.1 which shall be governed by such other Paragraphs), which failure continues for 30 days after written notice thereof from Landlord to Tenant provided that, if Tenant has exercised reasonable diligence to cure such failure and such failure cannot be cured within such 30 day period despite reasonable diligence, Tenant shall not be in default under this subparagraph unless Tenant fails thereafter diligently and continuously to prosecute the cure to completion; 13.2 Remedies. In the event of any Default by Tenant, Landlord shall have the remedies set forth in the Addendum attached hereto entitled "Landlord's Remedies in Event of Tenant Default". 13.3 Late Charges. Tenant hereby acknowledges that late payment by Tenant to Landlord of rent and other sums due hereunder will cause Landlord to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges. Accordingly, if any installment of rent or other sum due from Tenant shall not be received by Landlord or Landlord's designee within 10 days after such amount shall be due, then, without any requirement for notice to Tenant, Tenant shall pay to Landlord a late charge equal to 54% of such overdue amount. The parties hereby agree that such late charge represents a fair and reasonable estimate of the costs Landlord will incur by reason of late payment by Tenant. Acceptance of such late charge by Landlord shall in no event constitute a waiver of Tenant's Default with respect to such overdue amount, nor prevent Landlord from exercising any of the other rights and remedies granted hereunder. 14. CONDEMNATION. If the Premises or any portion thereof are taken under the power of eminent domain or sold under the threat of exercise of said power (all of which are herein called "condemnation"), this Lease shall terminate as to the part so taken as of the date the condemning authority takes title or possession, whichever first occurs, and as of such date the Base Rent and Tenant's Share shall be reduced in the same proportion as the rentable floor area of the Premises taken bears to the total rentable floor area of the Premises. Landlord's notice shall indicate whether the net severance damages will be expected to be sufficient to repair the damage to the Premises resulting from such condemnation. If more than 10% of the floor area of the Premises, or more than 25% of the portion of the Common Areas designated for Tenant's parking, is taken by condemnation, Tenant may, at Tenant's option, to be exercised in writing within 10 days after Landlord shall have given Tenant written notice of such taking (or in the absence of such notice, within 10 days after the condemning authority shall have taken possession) terminate this Lease as of the date the condemning authority takes such possession. If Tenant does not terminate this Lease in accordance with the foregoing, this Lease shall remain in full force and effect as to the portion of the Premises remaining, except that the Base Rent shall be reduced in the same proportion as the rentable floor area of the Premises taken bears to the total rentable floor area of -20- the Premises. No reduction of Base Rent shall occur if the condemnation does not apply to any portion of the Premises. Any award for the taking of all or any part of the Premises under the power of eminent domain or any payment made under threat of the exercise of such power shall be the property of Landlord, provided, however, that Tenant shall be entitled to any compensation, separately awarded to Tenant for Tenant's relocation expenses and/or loss of Tenants trade fixtures. In the event that this Lease is not terminated by reason of such condemnation, Landlord shall to the extent of its net severance damages in the condemnation matter, repair any damage to the Premises caused by such condemnation authority. 15. ESTOPPEL CERTIFICATE AND FINANCIAL STATEMENTS. 15.1 Estoppel Certificate. Each party (herein referred to as "Responding Party") shall within 10 days after written notice from the other Party (the "Requesting Party") execute, acknowledge and deliver to the Requesting Party, to the extent it can truthfully do so, an estoppel certificate in the form attached hereto as Exhibit E, plus such additional information, confirmation and/or statements as shall be reasonably requested by the Requesting Party. 15.2 Financial Statement. If Landlord desires to finance, refinance, or sell the Building, Industrial Center or any part thereof, Tenant and any Guarantors shall deliver to any potential lender or purchaser designated by Landlord such financial statements of Tenant as are publicly available, if and to the extent that Tenant is required to file reports with the Securities Exchange Commission pursuant to Sections 13 or 15(d) of the Securities Exchange Act of 1934, as amended, and has complied with such filing requirements, and, if Tenant is not required to file such reports or has not complied with such filing requirements, Tenant and such Guarantors shall deliver such financial statements of Tenant and any Guarantors and other financial information as may be reasonably required by such lender or purchaser, including but not limited to Tenant's financial statements for the past 3 years. All such financial statements shall be received by Landlord and such lender or purchaser in confidence and shall be used only for the purposes herein set forth. 16. ADDITIONAL COVENANTS AND PROVISIONS. 16.1 Severability. The invalidity of any provision of this Lease, as determined by a court of competent jurisdiction, shall not affect the validity of any other provision hereof. 16.2 Interest on Past-Due Obligations. Any monetary payment due Landlord hereunder not received by Landlord within 10 days following the date on which it was due shall bear interest from the date due at 12% per annum, but not exceeding the maximum rate allowed by law in addition to the late charge provided for in Paragraph 13.3. 16.3 Time of Essence. Time is of the essence with respect to the performance of all obligations to be performed or observed by the Parties under this Lease. 16.4 Landlord Liability. Tenant, its successors and assigns, shall not assert nor seek to enforce any claim for breach of this Lease against any of Landlord's assets other than Landlord's interest in the Industrial Center and the proceeds of any insurance policies carried by Landlord. Tenant agrees to look solely to such interest for the satisfaction of any liability or claim against Landlord under this Lease. In no event whatsoever shall Landlord (which term shall include, without limitation, any general or limited partner, trustees, beneficiaries, officers, directors, or stockholders of Landlord) ever be personally liable for any such liability. -21- 16.5 No Prior or Other Agreements. This Lease contains all agreements between the Parties with respect to any matter mentioned herein, and supersedes all oral, written prior or contemporaneous agreements or understandings. 16.6 Notice Requirements. All notices required or permitted by this Lease shall be in writing and may be delivered in person (by hand or by messenger or courier service) or may be sent by regular, certified or registered mail or U.S. Postal Service Express Mail, with postage prepaid, or by facsimile transmission during normal business hours, and shall be deemed sufficiently given if served in a manner specified in the Paragraph 16.6. The addresses noted adjacent to a Party's signature on this Lease shall be that Party's address for delivery or mailing of notice purposes and with respect to notices to Tenant, a copy shall be concurrently delivered to Testa, Hurwitz & Thibeault, LLP, 125 High Street, Boston, Massachusetts 02110, attention: Real Estate Department. Either Party may by written notice to the other specify a different address for notice purposes, except that upon Tenant's taking possessing of the Premises, the Premises shall constitute Tenant's address for the purpose of mailing or delivering notices to Tenant. A copy of all notices required or permitted to be given to Landlord hereunder shall be concurrently transmitted to such party or parties at such addresses as Landlord may from time to time hereafter designate by written notice to Tenant. 16.7 Date of Notice. Any notice sent by registered or certified mail, return receipt requested, shall be deemed given on the date of delivery shown on the receipt card, or if no delivery date is shown, 48 hours after the postmark thereon. If sent by regular mail, the notice shall be deemed given 48 hours after the same is addressed as required herein and mailed with postage prepaid. Notices delivered by United States Express Mail or overnight courier that guarantees next day delivery shall be deemed given 24 hours after delivery of the same to the United States Postal Service or courier. If any notice is transmitted by facsimile transmission or similar means, the same shall be deemed served or delivered upon telephone or facsimile confirmation of receipt of the transmission thereof, provided a copy is also delivered via hand or overnight delivery or certified mail. If notice is received on a Saturday or a Sunday or a legal holiday, it shall be deemed received on the next business day. 16.8 Waivers. No waiver by Landlord of a Default by Tenant shall be deemed a waiver of any other term, covenant or condition hereof, or of any subsequent Default by Tenant of the same or any other term, covenant or condition hereof. 16.9 Holdover. Tenant has no right to retain possession of the Premises or any part thereof beyond the expiration or earlier termination of this Lease. If Tenant holds over with the consent of Landlord: (i) the Base Rent payable shall be increased to 175% of the Base Rent applicable during the month immediately preceding such expiration or earlier termination; (ii) Tenant's right to possession shall terminate on 30 days notice from Landlord and (iii) all other terms and conditions of this Lease shall continue to apply. Nothing contained herein shall be construed as a consent by Landlord to any holding over by Tenant. Tenant shall indemnify, defend and hold Landlord harmless from and against any and all claims, demands, actions, losses, damages, obligations, costs and expenses, including, without limitation, attorneys' fees incurred or suffered by Landlord by reason of Tenant's failure to surrender the Premises on the expiration or earlier termination of this Lease in accordance with the provisions of this Lease. 16.10 Cumulative Remedies. No remedy or election hereunder shall be deemed exclusive but shall, wherever possible, be cumulative with all other remedies in law or in equity. -22- 16.11 Binding Effect: Choice of Law. This Lease shall be binding upon the Parties, their personal representatives, successors and assigns and be governed by the laws of the State in which the Premises are located. Any litigation between the Parties hereto concerning this Lease shall be initiated in the county in which the Premises are located. 16.12 Landlord. The covenants and obligations contained in this Lease on the part of Landlord are binding on Landlord, its successors and assigns, only during and in respect of their respective period of ownership of such interest in the Industrial Center. In the event of any transfer or transfers of such title to the Industrial Center, Landlord (and in case of any subsequent transfers or conveyances, the then grantor) shall be concurrently freed and relieved from and after the date of such transfer or conveyance, without any further instrument or agreement, of all liability with respect to the performance of any covenants or obligations on the part of Landlord contained in this Lease thereafter to be performed which obligations shall, subject to the terms of this Lease, be assumed by the transferee by virtue of its ownership of the Industrial Center or portion thereof. 16.13 Attorneys' Fees and Other Costs. If any Party brings an action or proceeding to enforce the terms hereof or declare rights hereunder, the Prevailing Party (as hereafter defined) in any such proceeding shall be entitled to reasonable attorneys' fees. The term "Prevailing Party" shall include, without limitation, a Party who substantially obtains or defeats the relief sought. Landlord shall be entitled to attorneys' fees, costs and expenses incurred in preparation and service of notices of Default and consultations in connection therewith, whether or not a legal action is subsequently commenced in connection with such Default or resulting breach. Tenant shall reimburse Landlord on demand for all reasonable legal, engineering and other professional services expenses incurred by Landlord in connection with all requests by Tenant for consent or approval hereunder. 16.14 Landlord's Access; Showing Premises; Repairs. Landlord and Landlord's agents shall have the right to enter the Premises at any time, in the case of an emergency, and otherwise at reasonable times upon reasonable notice for the purpose of showing the same to prospective purchasers, lenders, or tenants (but if such parties are prospective tenants, only during the last twelve (12) months of the Term), and making such alterations, repairs, improvements or additions to the Premises or to the Building, as Landlord may reasonably deem necessary. Landlord may at any time place on or about the Premises or Building any ordinary "For Sale" signs and Landlord may at any time during the last 180 days of the term hereof place on or about the Premises any ordinary "For Lease" signs. All such activities of Landlord shall be without abatement of rent or liability to Tenant. Except in instances posing an imminent threat to life or property, Landlord shall endeavor to comply with Tenant's reasonable security requirements of which Tenant shall have given Landlord prior notice and to give Tenant reasonable notice (not less than twenty-four hours in advance) prior to making entry onto the Premises, provided, however, notwithstanding anything to the contrary contained in this Lease, such notice may be made orally to any supervisor of Tenant; and Landlord shall, to the extent practical, use reasonable efforts to minimize interference with the conduct of Tenant's business in the Premises as a result of any entry. 16.15 Signs. Tenant shall not place any signs at or upon the exterior of the Premises or the Building, except that Tenant may, with Landlord's prior written consent, install (but not on -23- the roof) such signs as are reasonably required to advertise Tenant's own business so long as such signs are in a location designated by Landlord and comply with sign ordinances and the signage criteria established for the Industrial Center by Landlord. Notwithstanding the foregoing, Tenant shall have the right to install, at a location acceptable to Landlord and at Tenant's sole cost and expense, one (1) Building-mounted sign, subject to Landlord's approval, which approval shall not be unreasonably withheld, which shall be located on the side of the Building which is visible from Route 495. Landlord shall add Tenant's name to the Industrial Park and Building directories, the cost of which shall be borne by Landlord. Tenant shall be required to obtain at its expense all permits and approvals required for the installation of the Building-mounted sign (but shall not be permitted to seek any zoning or other similar relief for such signs without Landlord's consent) and shall at its expense keep all such permits and approvals in full force and effect. Tenant shall keep such signs in good condition through the term of this Lease and shall, if Landlord so requests, remove such exterior signs at the end of the term of this Lease and repair any damage caused by such removal. 16.16 Termination: Merger. Unless specifically stated otherwise in writing by Landlord, the voluntary or other surrender of this Lease by Tenant, the mutual termination or cancellation hereof, or a termination hereof by Landlord for Default by Tenant, shall automatically terminate any sublease or lesser estate in the Premises; provided, however, Landlord shall, in the event of any such surrender, termination or cancellation, have the option to continue any one or all of any existing subtenancies. Landlord's failure within 10 days following any such event to make a written election to the contrary by written notice to the holder of any such lesser interest, shall constitute Landlord's election to have such event constitute the termination of such interest. 16.17 Quiet Possession. Upon payment by Tenant of the Base Rent and Additional Rent for the Premises and the performance of all of the covenants, conditions and provisions on Tenant's part to be observed and performed under this Lease, Tenant shall have quiet possession of the Premises for the entire term hereof subject to all of the provisions of this Lease. 16.18 Subordination; Attornment; Non-Disturbance. (a) Subordination. This Lease shall be subject and subordinate to any ground lease, mortgage, deed of trust, or other hypothecation or mortgage (collectively, "Mortgage") now or hereafter placed by Landlord upon the real property of which the Premises are a part, to any and all advances made on the security thereof and to all renewals, modifications, consolidations, replacements and extensions thereof. Tenant agrees that any person holding any Mortgage shall have no duty, liability or obligation to perform any of the obligations of Landlord under this Lease. In the event of Landlord's default with respect to any such obligation, Tenant will give any Lender, whose name and address have previously in writing been furnished Tenant, notice of a default by Landlord. Tenant may not exercise any remedies for default by Landlord unless and until Landlord and the Lender shall have received written notice of such default and a reasonable time (not less than 30 days) shall thereafter have elapsed without the default having been cured. If any Lender shall elect to have this Lease superior to the lien of its Mortgage and shall give written notice thereof to Tenant, this Lease shall be deemed prior to such Mortgage. The provisions of a Mortgage relating to the disposition of condemnation and insurance proceeds shall prevail over any contrary provisions contained in this Lease. Landlord represents that as of -24- the date of this Lease there are no ground leases, superior leases, deeds of trusts or mortgages encumbering the Premises or the Building, or the lot on which the Building is located. (b) Attornment. Subject to the non-disturbance provisions of of this Paragraph 16.18, Tenant agrees to attorn to a Lender or any other party who acquires ownership of the Premises by reason of a foreclosure of a Mortgage or deed in lieu of foreclosure. In the event of such foreclosure, such owner shall perform Landlord's obligations hereunder but shall not: (i) be liable for any act or omission of any prior landlord or with respect to events occurring prior to acquisition of ownership, unless such act or omission is of a continuing nature, (ii) be subject to any offsets or defenses which Tenant might have against any prior Landlord, or (iii) be liable for security deposits (unless such security deposit is received by such party) or be bound by prepayment of more than one month's rent. (c) Non-Disturbance. With respect to any Mortgage entered into by Landlord after the execution of this Lease, Tenant's subordination of this Lease shall be subject to receiving assurance (a "non- disturbance agreement") from the Mortgage holder that Tenant's possession and this Lease will not be disturbed in the event of foreclosure or deed in lieu of foreclosure, so long as Tenant is not in Default and attorns to the record owner of the Premises. (d) Self-Executing. The agreements contained in this Paragraph 16.18 shall be effective without the execution of any further documents; provided, however, that upon written request from Landlord or a Lender in connection with a sale, financing or refinancing of Premises, Tenant and Landlord shall execute such further writings as may be reasonably required to separately document any such subordination or non-subordination, attornment and/or non-disturbance agreement as is provided for herein. 16.19 Rules and Regulations. Tenant agrees that it will abide by, and to cause its employees, suppliers, shippers, customers, tenants, contractors and invitees to abide by all reasonable rules and regulations ("Rules and Regulations") which Landlord may make from time to time for the management, safety, care, and cleanliness of the Common Areas, the parking and unloading of vehicles and the preservation of good order, as well as for the convenience of other occupants or tenants of the Building and the Industrial Center and their invitees, provided such rules and regulations are applicable generally to all tenants of the Industrial Center. Landlord shall not be responsible to Tenant for the non-compliance with said Rules and Regulations by other tenants of the Industrial Center, however, Landlord shall, to the extent permitted by applicable law and by the respective leases with such other tenants, use reasonable efforts to enforce the Rules and Regulations of general applicability against all tenants in a uniform fashion. 16.20 Security Measures. Tenant acknowledges that the rental payable to Landlord hereunder does not include the cost of guard service or other security measures. Landlord has no obligations to provide same. Tenant assumes all responsibility for the protection of the Premises, Tenant, its agents and invitees and their property from the acts of third parties. 16.21 Reservations. Landlord reserves the right to grant such easements that Landlord deems necessary and to cause the recordation of parcel maps, so long as such easements and maps do not unreasonably interfere with the use of the Premises by Tenant, or Tenant's use of such areas within the Common Areas on the lot on which the Building is located. Tenant agrees to sign any documents reasonable requested by Landlord to effectuate any such easements or maps. -25- 16.22 Conflict. Any conflict between the printed provisions of this Lease and the typewritten or handwritten provisions shall be controlled by the typewritten or handwritten provisions. 16.23 Offer. Preparation of this Lease by either Landlord or Tenant or Landlord's agent or Tenant's agent and submission of same to Tenant or Landlord shall not be deemed an offer to lease. This Lease is not intended to be binding until executed and delivered by all Parties hereto. 16.24 Brokerage. Tenant warrants and represents that it has dealt with no broker in connection with the execution of this Lease other than Cushman & Wakefield and Insignia/ESG, and agrees to indemnify and hold Landlord harmless from and against any and all brokerage claims, other than by Cushman & Wakefield and Insignia/ESG arising therefrom. Landlord shall be responsible for the payment of all fees and commissions due to Insignia/ESG pursuant to the terms of a separate agreement between such parties. Insignia/ESG shall be responsible for the payment of all fees and commissions due to Cushman & Wakefield, pursuant to a separate agreement between such parties. 16.25 Amendments. This Lease may be modified only in writing, signed by the parties in interest at the time of the modification. 16.26 Multiple Parties. Except as otherwise expressly provided herein, if more than one person or entity is named herein as Tenant, the obligations of such persons shall be the joint and several responsibility of all persons or entities named herein as such Tenant. 16.27 Authority. Each person signing on behalf of Landlord or Tenant warrants and represents that she or is authorized to execute and deliver this Lease and to make it a binding obligation of Landlord or Tenant. 16.28 Right of First Offer. So long as (i) there then exists no Default of Tenant, (ii) the initially named Tenant pursuant to Section 1.1 hereof (and any successor of Tenant by merger or any other entity which controls, is controlled by or is under common control with the Tenant set forth in Section 1.1 above) shall occupy the entire Premises, and (iii) this Lease is still in full force and effect, then if Landlord shall desire to lease all or any space within the Building for a period commencing on or after the Commencement Date, Landlord shall so notify Tenant, and shall identify the space available (the "Offered Space") together with the rental rate and other terms and conditions (collectively, the "Terms") under which in good faith it intends to offer such space to third parties and the date on which such Offered Space is expected to be available. Tenant may irrevocable elect to lease the Offered Space on the Terms by giving notice thereof to Landlord within five (5) days after Tenant's receipt of notice from Landlord of the Terms. If Tenant shall have so elected to lease the Offered Space, it shall enter into an amendment to this Lease within ten (10) days after it shall have received the same from Landlord, confirming the lease of such Offered Space to Tenant on the Terms, Tenant acknowledging, however, that the term applicable to such Offered Space may not coincide with the term applicable to the Premises initially demised hereunder. If Tenant shall fail to give notice of its election to lease the Offered Space within the aforesaid 5-day period, then Tenant shall have no further rights under this Section and Landlord shall thereafter be free to lease any or all of such Offered Space or any other space in the Building to a third party or parties from time to time on such terms and conditions as it may deem appropriate, it being agreed that time is of the essence with respect to the exercise of Tenant's rights under this Section. For purposes of the first sentence of this Section, the term "lease" shall not include (a) the leasing of any space then leased to or occupied -26- by, or the extension or renewal of a lease with, any then existing tenant or occupant, (b) the exercise of any expansion option, right of first offer, or right of first refusal by any tenant of the Industrial Center pursuant to a lease in effect prior to the date of this Lease, or (c) the lease of any space to any entity controlling, controlled by or under common control with, or otherwise affiliated with Landlord. The parties hereto have executed this Lease at the place and on the dates specified above their respective signatures. LANDLORD: TENANT: KEEP YOUR DAY JOB, LLC SMARTERKIDS.COM, a Delaware corporation a Delaware limited liability company Name: By: MANSFIELD LAND LLC Title: a Massachusetts limited liability company Its: Manager By: NDNE REALTY, INC. a Massachusetts corporation Its: Manager By:_____________________________ Name: Its: AMB PROPERTY, L.P. a Delaware limited partnership By: AMB PROPERTY CORPORATION a Maryland corporation By: ________________________ Name: Cynthia J. Sarver Its: Vice President Attention: Robert Cahill, CFO 15-19 Crawford Street Needham, MA 02192 Telephone: ( ) Telephone: ( ) Facsimile: ( ) Facsimile: ( ) Executed at: Executed at: -27- LANDLORD'S REMEDIES IN EVENT OF TENANT DEFAULT ADDENDUM This Remedies Addendum is part of the Lease dated ______________________ by and between KEEP YOUR DAY JOB LLC and SMARTERKIDS.COM for the premises known as 145 Plymouth Street, Mansfield, MA. (a) TERMINATION. In the event of any Default by Tenant, Landlord and the agents and servants of Landlord may, in addition to and not in derogation of any remedies for any preceding breach of covenant, immediately or at any time thereafter give notice to Tenant terminating this Lease and the term hereof, which notice shall specify the date of termination, whereupon on the date so specified the term of this Lease and all of Tenant's rights and privileges under this Lease shall expire and terminate, but Tenant shall remain liable as hereinafter provided. (b) REMEDIES. In the event of any termination due to a Default by Tenant, Tenant shall pay the Base Rent, Additional Rent and other charges payable hereunder up to the time of such termination, and thereafter, Tenant, until the end of what would have been the term of this Lease in the absence of such termination and whether or not the Premises shall have been relet, shall be liable to Landlord for, and shall pay to Landlord, as current damages, the Base Rent, Additional Rent and other charges which would be payable hereunder for the remainder of this Lease if such termination had not occurred, less the proceeds, if any, of any reletting of the Premises, after deducting all expenses in connection with such reletting, including, without limitation, all repossession costs, brokerage commissions, legal expenses, attorneys' fees, advertising, expenses of employees, alteration costs and expenses of preparation for such reletting. Tenant shall pay such current damages to Landlord monthly on the days on which the Base Rent would have been payable hereunder if this Lease had not been terminated. At any time after such termination, in lieu of all such current damages beyond the date of such demand, at Landlord's election Tenant shall pay to Landlord either (i) an amount equal to the excess, if any, of the Base Rent, Additional Rent and other charges as hereinbefore provided which would be payable hereunder from the date of such demand for what would be the then unexpired term of this Lease if the same remained in effect, over the then fair net rental value of the Premises for the same period or (ii) an amount equal to the lesser of (x) the Base Rent, Additional Rent and other charges that would have been payable for the balance of the term of this Lease had it not been terminated or (y) the aggregate of the Base Rent, Additional Rent and other charges accrued in the twelve (12) months ended next prior to such termination (without reduction for any free rent or other concession or abatement) except that in the event the term of this Lease is so terminated prior to the expiration of the first full year of the term of this Lease, the liquidated damages which Landlord may elect to recover pursuant to clause (ii) (y) of this paragraph shall be calculated as if such termination had occurred on the first anniversary of the Commencement Date and there had been no so-called free rent or other rental concession or any rental abatement. Nothing contained in this Lease shall, however, limit or prejudice the right of Landlord to prove for and obtain in proceedings for bankruptcy or insolvency by reason of the termination of this Lease, an amount equal to the maximum allowed by any statute or rule of law in effect at the time when, and governing the proceedings in which, the damages are to be proved, whether or not the amount be greater than, equal to, or less than the amount of the loss or damages referred to above. In case of any Default of Tenant, re-entry, expiration and dispossession by summary proceedings or otherwise, Landlord may (i) relet the Premises or any part or parts thereof, either in the name of Landlord or otherwise, for a term or terms which may at Landlord's option be equal to or less than or exceed the period which would otherwise have constituted the balance of the term of this Lease and may grant concessions or free rent to the extent that Landlord considers advisable and necessary to relet the same and (ii) may make such reasonable alterations, repairs and decorations in the Premises as Landlord in its sole judgment considers advisable and necessary for the purpose of reletting the Premises; and the making of such alterations, repairs and decorations shall not operate or be construed to release Tenant from liability hereunder as aforesaid. Landlord shall in no event be liable in any way whatsoever for failure to relet the Premises, or, in the event that the Premises are relet, for failure to collect the rent under such reletting. To the fullest extent permitted by law, Tenant hereby expressly waives any and all rights of redemption granted under any present or future laws in the event of Tenant being evicted or dispossessed, or in the event of Landlord obtaining possession of the Premises, by reason of the violation by Tenant of any of the covenants and conditions of this Lease. (c) REMEDIES CUMULATIVE. Except as expressly provided above, any and all rights and remedies which Landlord may have under this Lease, and at law and equity (including without limitation actions at law for direct, indirect, special and consequential (foreseeable and unforeseeable) damages, for Tenant's failure to comply with its obligations under this Lease shall be cumulative and shall not be deemed inconsistent with each other, and any two or more of all such rights and remedies may be exercised at the same time insofar as permitted by law. (d) NO SURRENDER. No act or conduct of Landlord, whether consisting of the acceptance of the keys to the Premises, or otherwise, shall be deemed to be or constitute an acceptance of the surrender of the Premises by Tenant prior to the expiration of the Term, and such acceptance by Landlord of surrender by Tenant shall only flow from and must be evidenced by a written acknowledgment of acceptance of surrender signed by Landlord. The surrender of this Lease by Tenant, voluntarily or otherwise, shall not work a merger unless Landlord elects in writing that such merger take place, but shall operate as an assignment to Landlord of any and all existing subleases, or Landlord may, at its option, elect in writing to treat such surrender as a merger terminating Tenant's estate under this Lease, and thereupon Landlord may terminate any or all such subleases by notifying the sublessee of its election so to do within five (5) days after such surrender. (e) LANDLORD'S CURE RIGHTS. Landlord shall have the right, but shall not be required, to pay such sums or do any act which requires the expenditure of monies which may be necessary or appropriate by reason of the failure or neglect of Tenant to comply with any of its obligations under this Lease, and in the event of the exercise of such right by Landlord, Tenant agrees to pay to Landlord forthwith upon demand all such sums including reasonable attorneys fees, together with interest thereon at a rate equal to the lesser of 6% over the Prime Rate or the maximum rate allowed by law. Landlord shall not exercise such right unless either a Default (as defined in Section 13) has occurred or the breach by Tenant has resulted in an imminent threat to life or property or exposure of Landlord to actual or potential liability. "Prime Rate" shall mean the annual floating rate of interest, determined daily and expressed as a percentage from time to time announced by the largest national or state-chartered banking institution in the state or district in which the Building is located as its "prime" or "base" rate. -2- TENANT INITIALS LANDLORD INITIALS - ---------------------- --------------------- -3- KEEP YOUR DAY JOB, LLC, A DELAWARE LIMITED LIABILITY COMPANY INDUSTRIAL MULTI-TENANT LEASE OPTION TO EXTEND This Option to Extend is a part of the Lease dated ______________________, by and between KEEP YOUR DAY JOB, LLC ("Landlord") and ____________________________ ("Tenant") for the premises commonly known as ________________________________. 1. OPTION TO EXTEND. Landlord hereby grants to Tenant the option to extend the term of this Lease for the one (1) additional period of five (5) years, commencing on the date immediately following the Expiration Date. 2. Exercise Dates: For purposes of Paragraph 5 of this Addendum, the Last Exercise Date is twelve (12) months prior to the date that the Option Period would commence. 3. Monthly Base Rent. The monthly Base Rent for each month of the Option Period shall be the amount calculated in accordance with the alternative selected below ("Rent Adjustment Alternative"), but in no event shall the monthly Base Rent for the Option Period be less than the highest monthly Base Rent payable during the term immediately preceding the Option Period. [ ] Fixed rent adjustment ("Fixed Rent Adjustment") $ shall be the monthly Base Rent for Period One. $ shall be the monthly Base Rent for Period Two. $ shall be the monthly Base Rent for Period Three. $ shall be the monthly Base Rent for Period Four. $ shall be the monthly Base Rent for Period Five. [ ] Cost of living adjustment ("CPI Adjustment") Monthly Base Rent shall be calculated using the following CPI index ("Index") [ ] Urban Wage Earners and Clerical Workers [ ] All Urban Consumers [ ] The Comparison Month is: [ ] the first month of the term of this Lease; or [ ] [X] Market rent ("Market Rent Adjustment") 4. Conditions to Exercise of Option. Tenant's right to extend is conditioned upon and subject to each of the following: A. In order to exercise the option to extend, Tenant must give written notice of such election to Landlord and Landlord must receive the same by the Last Exercise Date and not sooner than three (3) months prior thereto. If proper notification of the exercise of the option is not given and/or received, such option shall automatically expire. Tenant acknowledges that because of the importance to Landlord of knowing no later than the Last Exercise Date whether or not Tenant will exercise the option, the failure of Tenant to notify Landlord by the Last Exercise Date will conclusively be presumed an election by Tenant not to exercise the option. B. Landlord may elect to revoke Landlord's rights hereunder (i) if Tenant is in Default at the time of the exercise of the option or (ii) in the event that Landlord has given to Tenant 3 or more notices of separate Defaults during the 12 month period immediately preceding the exercise of the option, whether or not the Defaults are cured. The period of time within which the option may be exercised shall not be extended or enlarged by reason of Tenant's inability to exercise the option because of the provisions of this paragraph. C. All of the terms and conditions of this Lease except where specifically modified by this Addendum shall apply, except that there shall be no further right to extend the term hereof. D. The option is personal to the named Tenant as set forth in Section 1.1 above (or any successor of the Tenant named in Section 1.1 hereof by merger or consolidation or any assignee permitted by Section 12(b), and cannot be assigned or exercised by anyone other than the Tenant named in Section 1.1 or any successor by merger or consolidation, and only while the Tenant or such successor, Section 12(b) permitted assignee or any Affiliate is in full possession of the Premises and without the intention of thereafter assigning or subletting. 5 3. CALCULATION OF RENT ADJUSTMENT A. Market Rent Adjustment. Four months prior to the commencement of the Option Period, if the selected Rent Adjustment Alternative is the Market Rent Adjustment, the Parties shall negotiate in good faith to determine the Base Rent for the Option Period. If agreement cannot be reached within thirty days, then Landlord and Tenant shall each, no later then 90 days prior to the commencement of the Option Period, make a reasonable determination of the fair market rental for the Premises for the Option Period and submit such determination, in writing, to arbitration in accordance with the following provisions: (i) No later then 90 days prior to the commencement of the Option Period, Landlord and Tenant shall each select an industrial leasing broker to act as an arbitrator. The two arbitrators so appointed shall, no later then 75 days prior to the commencement of the Option Period, select a third mutually acceptable industrial leasing broker to act as a third arbitrator. (ii) The three arbitrators, acting by a majority, shall no later then 75 days prior to the commencement of the Option Period, determine the actual fair market rental for the Premises for the Option Period. The decision of a majority of the arbitrators shall be binding on the Parties. The fair market rental determination of Landlord or Tenant which is closest to the fair market rental as determined by the arbitrators shall be the Base Rent for the Option Period. (iii) If either of the Parties fails to appoint an arbitrator within the period required by this Addendum, the arbitrator timely appointed shall determine the Base Rent for the Option Period. -5- (iv) The entire cost of such arbitration shall be paid by the party whose fair market rental submission is not selected. LANDLORD: TENANT: KEEP YOUR DAY JOB, LLC SMARTERKIDS.COM By: MANSFIELD LAND LLC Name: a Massachusetts limited liability company Title: Its: Manager By: NDNE REALTY, INC. a Massachusetts corporation Its: Manager By: ___________________ Name: Its: AMB PROPERTY, L.P. a Delaware limited partnership By: AMB PROPERTY CORPORATION a Maryland corporation By: _________________________ Name: Cynthia J. Sarver Its: Vice President -6- KEEP YOUR DAY JOB, LLC, A DELAWARE LIMITED LIABILITY COMPANY INDUSTRIAL MULTI-TENANT LEASE EARLY POSSESSION AND INDUCEMENT RECAPTURE ADDENDUM This Early Possession and Inducement Recapture Addendum is a part of the Lease dated _______________________________, by and between KEEP YOUR DAY JOB, LLC ("Landlord") and SMARTERKIDS.COM ("Tenant") for the premises commonly known as - ------------------------------. EARLY POSSESSION. For the purpose of installation of Tenant's office furniture, equipment and warehouse equipment, Tenant may enter the Premises from and after April 3,2000 ("Early Possession Date") even though the Early Possession Date is prior to the Commencement Date of the Lease ("Early Possession"), but only to the extent that such Early Possession does not interfere with Landlord's construction at the Industrial Center. The obligation to pay Base Rent and Tenant's Share of Operating Expenses shall be abated for the Early Possession Period. All other terms of this Lease, however, including but not limited to the obligations to carry the insurance required by Paragraph 8 shall be in effect during the Early Possession period. Such Early Possession shall not change the Expiration Date of the Original Term. If possession is not tendered to Tenant on the Early Possession Date, the Early Possession period shall run from the date of delivery of possession and continue for a period equal to the period during which the Tenant would have otherwise enjoyed under the terms hereof possession of the Premises with abated Base Rent, but minus any days of delay caused by the acts, failure to act, or omissions of Tenant. LANDLORD: TENANT: KEEP YOUR DAY JOB, LLC SMARTERKIDS.COM By:___________________________ a Delaware limited liability company Name: By: MANSFIELD LAND LLC Title: a Massachusetts limited liability company Its: Manager By: NDNE REALTY, INC. a Massachusetts corporation Its: Manager By: _________________________ Name: Its: AMB PROPERTY, L.P. a Delaware limited partnership By: AMB PROPERTY CORPORATION a Maryland corporation By: _______________________ Name: Cynthia J. Sarver Its: Vice President -8- EXHIBIT A [Diagram of Premises] EXHIBIT B COMMENCEMENT DATE MEMORANDUM LANDLORD: KEEP YOUR DAY JOB, LLC TENANT: ___________________________________ LEASE DATE: _________________, ____ PREMISES: ___________________________________ ___________________________________ Tenant hereby accepts the Premises as being in the condition required under the Lease. The Commencement Date of the Lease is _______________________, ____. The Expiration Date of the Lease is _______________________, ____. LANDLORD: TENANT: KEEP YOUR DAY JOB, LLC SMARTERKIDS.COM, a Delaware corporation a Delaware limited liability company By: MANSFIELD LAND LLC a Massachusetts limited liability company Its: Manager By: NDNE REALTY, INC. a Massachusetts corporation Its: Manager By: _____________________________ Name: Its: AMB PROPERTY, L.P. a Delaware limited partnership By: AMB PROPERTY CORPORATION a Maryland corporation By: __________________________ Name: Cynthia J. Sarver Its: Vice President By:______________________________ Name: Title: Telephone: ( ) Telephone: ( ) Facsimile: ( ) Facsimile: ( ) Executed at: Executed at: on: on: -11- EXHIBIT C TENANT MOVE-IN AND LEASE RENEWAL ENVIRONMENTAL QUESTIONNAIRE FOR COMMERCIAL AND INDUSTRIAL PROPERTIES PROPERTY NAME: ______________________________________________________________ PROPERTY ADDRESS: ___________________________________________________________ EXHIBIT ________ TO THE LEASE DATED __________________ BETWEEN --------------------------------------- ("LESSEE") AND --------------------------------------- ("LESSOR") Instructions: The following questionnaire is to be completed by the Tenant Representative with knowledge of the planned/existing operations for the specified building/location. A copy of the completed form must be attached to all new leases and renewals, and forwarded to the Owner's Risk Management Department. Please print clearly and attach additional sheets as necessary. 1.0 PROCESS INFORMATION Describe planned use (new Lease) or existing operations (lease renewal), and include brief description of manufacturing processes employed. 2.0 HAZARDOUS MATERIALS Are hazardous materials used or stored? If so, continue with the next question. If not, go to Section 3.0. 2.1 Are any of the following materials handled on the property? Yes____ No____ (A material is handled if it is used, generated, processed, produced, packaged, treated, stored, emitted, discharged, or disposed.) If so, complete this section. If this question is not applicable, skip this section and go on to Section 5.0. : Explosives : Fuels : Oils : Solvents : Oxidizers : Organics/Inorganics : Acids : Bases : Pesticides : Gases : PCBs : Radioactive Materials : Other (please specify) 2-2. If any of the groups of materials checked in Section 2.1, please list the specific material(s), use(s), and quantity of each chemical used or stored on the site in the Table below. If convenient, you may substitute a chemical inventory and list the uses of each of the chemicals in each category separately. - ------------------------------------------------------------------------------- MATERIAL PHYSICAL STATE USAGE CONTAINER SIZE NUMBER OF TOTAL QUANTITY (SOLID, LIQUID, CONTAINERS OR GAS) - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- MATERIAL PHYSICAL STATE USAGE CONTAINER SIZE NUMBER OF TOTAL QUANTITY (SOLID, LIQUID, CONTAINERS OR GAS) - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 2-3. Describe the planned storage area location(s) for these materials. Please include site maps and drawings as appropriate. 3.0 HAZARDOUS WASTES Are hazardous wastes generated? Yes____ No____ If yes, continue with the next question. If not, skip this section and go to section 4.0. -2- TENANT MOVE-IN AND LEASE RENEWAL QUESTIONNAIRE 3.1 Are any of the following wastes generated, handled, or disposed of (where applicable) on the property? : Hazardous Wastes : Industrial Wastewater : Waste Oils : PCBs : Air Emissions : Sludges : Regulated Wastes : Other (please specify) 3-2. List and quantify the materials identified in Question 3-1 of this section. - ------------------------------------------------------------------------------- WASTE RCRA SOURCE APPROXIMATE WASTE DISPOSITION GENERATED LISTED MONTHLY CHARACTERIZATION WASTE? QUANTITY - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 3-3. Please include name, location, and permit number (e.g., EPA ID No.) for transporter and disposal facility, if applicable). Attach separate pages as necessary. - ------------------------------------------------------------------------------- TRANSPORTER/DISPOSAL FACILITY LOCATION TRANSPORTER (T) OR PERMIT NUMBER FACILITY NAME DISPOSAL (D) FACILITY - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 3-4. Are pollution controls or monitoring employed in the process to prevent or minimize the release of wastes into the environment? Yes ____ No____ If so, please describe. 4.0 USTS/ASTS 4.1 Are underground storage tanks (USTs), aboveground storage tanks (ASTs), or associated pipelines used for the storage of petroleum products, chemicals, or liquid wastes present on site (lease renewals) or required for planned operations (new tenants)? Yes____ No____ If not, continue with section 5.0. If yes, please describe capacity, contents, age, type of the USTs or ASTs, as well any associated leak detection/spill prevention measures. Please attach additional pages if necessary. - ------------------------------------------------------------------------------- CAPACITY CONTENTS YEAR TYPE (STEEL, ASSOCIATED LEAK DETECTION INSTALLED FIBERGLASS, ETC.) /SPILL PREVENTION MEASURES* - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- *Note: The following are examples of leak detection/spill prevention measures: Integrity testing Inventory reconciliation Leak detection system Overfill spill protection Secondary containment Cathodic protection - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 4-2. Please provide copies of written tank integrity test results and/or monitoring documentation, if available. 4-3. Is the UST/AST registered and permitted with the appropriate regulatory agencies? Yes____ No____ If so, please attach a copy of the required permits. -3- 4-4. If this Questionnaire is being completed for a lease renewal, and if any of the USTs/ASTs have leaked, please state the substance released, the media(s) impacted (e.g., soil, water, asphalt, etc.), the actions taken, and al remedial responses to the incident. -4- TENANT MOVE-IN AND LEASE RENEWAL QUESTIONNAIRE 4-4. If this Questionnaire is being completed for a lease renewal, have USTs/ASTs been removed from the property? Yes____ No____ If yes, please provide any official closure letters or reports and supporting documentation (e.g., analytical test results, remediation report results, etc.). 4-6. For Lease renewals, are there any above or below ground pipelines on site used to transfer chemicals or wastes? Yes____ No____ For new tenants, are installations of this type required for the planned operations? Yes____ No____ If yes to either question, please describe. 5.0 ASBESTOS CONTAINING BUILDING MATERIALS Please be advised that this property participates in an Asbestos Operations and Maintenance Program, and that an asbestos survey may have been performed at the Property. If provided, please review the information that identifies the locations of known asbestos containing material or presumed asbestos containing material. All personnel and appropriate subcontractors should be notified of the presence of these materials, and informed not to disturb these materials. Any activity that involves the disturbance or removal of these materials must be done by an appropriately trained individual/contractor. 6.0 REGULATORY 6-1. For Lease Renewals, are there any past, current, or pending regulatory actions by federal, state, or local environmental agencies alleging noncompliance with regulations? Yes____ No____ If so, please describe. 6-2. For lease renewals, are there any past, current, or pending lawsuits or administrative proceedings for alleged environmental damages involving the property, you, or any owner or tenant of the property? Yes____ No____ If so, please describe. 6-3. Does the operation have or require a National Pollutant Discharge Elimination System (NPDES) or equivalent permit? Yes____ No____ If so, please attach a copy of this permit. 6-4. For Lease renewals, have there been any complaints from the surrounding community regarding facility operations? Yes____ No____ Have there been any worker complaints or regulatory investigations regarding hazardous material exposure at the facility? Yes____ No____ If so, please describe status and any corrective actions taken. Please attach additional pages as necessary. 6-5. Has a Hazardous Materials Business Plan been developed for the site? Yes____ No____ If so, please attach a copy. CERTIFICATION I am familiar with the real property described in this questionnaire. By signing below, I represent and warrant that the answers to the above questions are complete and accurate to the best of my knowledge. I also understand that the Owner -5- will rely on the completeness and accuracy of my answers in assessing any environmental liability risks associated with the property. Signature: Name:_______________________________ Title:______________________________ Date:_______________________________ Telephone:__________________________ PLEASE PROVIDE A COPY OF THE COMPLETED QUESTIONNAIRE TO: Mr. Steve Campbell KEEP YOUR DAY JOB, LLC 505 Montgomery Street, Fifth Floor San Francisco, CA 94111 -6- EXHIBIT D TENANT MOVE-OUT ENVIRONMENTAL QUESTIONNAIRE FOR COMMERCIAL AND INDUSTRIAL PROPERTIES PROPERTY NAME: _______________________________________________________ PROPERTY ADDRESS: ____________________________________________________ BUILDING / SUITE NUMBER(S): __________________________________________ Instructions: The following questionnaire is to be completed by the Property Manager prior to/after the Tenant vacates a building/suite or location. A copy of the completed form must be forwarded to the Owner's Risk Management Department. Please print clearly and attach additional sheets as necessary. 1.0 GENERAL INFORMATION Property Manager: Property Management Company: Regional Manager: 2.0 TENANT INFORMATION Name of Former Tenant: Lease Date: ___________________ Move-out Date: ________________ 3.0 INDOOR INSPECTION The Property Manager is expected to inspect the vacant building/suite of the tenant. A pre-vacate "inspection" should be performed in advance of the tenant moving out to ensure that potential environmental issues requiring tenant response are addressed. Areas that are inaccessible should be noted. The Property Manager should check the interior of all closets and storage cabinets for items left by the vacated tenant. 3.1 Upon entering the vacated building(s)/suite(s), did you note any unusual odors? Yes____ No____ If yes, please provide a brief description of the odor (rotten eggs, chemical, etc.), and note possible sources of the odor: ---------------------------------------------------------------------- ---------------------------------------------------------------------- ---------------------------------------------------------------------- 3.2 Were any chemicals, including janitorial supplies left in the building/suite(s)? Yes____ No____ If yes, please provide a list of the items, note their location and note whether any leakage or staining is apparent (please attach additional sheets as necessary): ---------------------------------------------------------------------- ---------------------------------------------------------------------- ---------------------------------------------------------------------- 3.3 Are there any known or suspect environmental conditions associated with the tenant's former activities at the building/suite? If yes, please identify the location and nature of the environmental conditions: ---------------------------------------------------------------------- ---------------------------------------------------------------------- ---------------------------------------------------------------------- 4.0 OUTDOOR INSPECTION The Property Manager is expected to inspect the exterior and perimeter of the vacant building/suite of the former tenant. 4.1 Please check each of the applicable items, if observed outside the former tenant's building/suite: : Drums or Other Containers : Leakage from Transformers : Dumping of Trash/Debris/Wastes : Leakage from Trash Compactor Oil Reservoir : Stained Soils/Pavement : Other (Specify):__________________________ : Stressed or Stained Vegetation
For each item checked above, please describe the location, provide a brief description and estimate the approximate quantity or amount (Attach additional sheets as necessary.): - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 4.2 Are underground storage tanks (USTs), aboveground storage tanks (ASTs), or associated pipelines used for the storage of--either petroleum products, chemicals, or liquid wastes present at the vacating tenant's building/suite? Yes____ No____ If yes, please describe capacity, contents, age, type of the USTs or ASTs, as well any associated leak detection/spill prevention measures. Please attach additional pages if necessary. -2- TENANT MOVE-OUT ENVIRONMENTAL QUESTIONNAIRE - ------------------------------------------------------------------------------- CAPACITY CONTENTS YEAR TYPE (STEEL, ASSOCIATED LEAK DETECTION INSTALLED FIBERGLASS, ETC.) /SPILL PREVENTION MEASURES* - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- *Note: The following are examples of leak detection/spill prevention measures: Integrity testing Inventory reconciliation Leak detection system Overfill spill protection Secondary containment Cathodic protection
4.2.1 Please provide copies of the most recent written tank integrity test results and/or monitoring documentation, if available. 4.2.2 Are there any documented releases associated with the USTs/ASTs? Yes____ No____ If so, please state the substance released, the media(s) impacted (e.g., soil, water, asphalt, etc.), the actions taken, and all remedial responses to the incident (Please attach additional sheets as necessary.): ------------------------------------------------------------- ------------------------------------------------------------- ------------------------------------------------------------- ------------------------------------------------------------- 4.3 Have USTs/ASTs been removed from the vacated tenant's building/suite? Yes____ No____ If yes, please provide any official closure letters or reports and supporting documentation (e.g., analytical test results, remediation report results, etc.) unless previously provided. 5.0 ASBESTOS CONTAINING BUILDING MATERIALS If an asbestos survey is available for the property, please review the information that identifies the locations of known asbestos containing material or presumed asbestos containing material. Please note that any tenant activity that may have involved the disturbance or removal of these materials must be done by an appropriately trained individual/contractor. If the available asbestos survey results indicate that asbestos containing materials (ACMs), and/or presumed asbestos containing materials (PACMs) have been identified in the building/suite, please inspect those materials and note those that are damaged in the space below: ---------------------------------------------------------------------- ---------------------------------------------------------------------- ---------------------------------------------------------------------- 6.0 REGULATORY 6.1 Are there any past, current, or pending regulatory actions by federal, state, or local environmental agencies alleging that the vacated tenant is in noncompliance with regulations? Yes____ No____ If so, please describe. ---------------------------------------------------------------------- ---------------------------------------------------------------------- ---------------------------------------------------------------------- PREPARED BY: PLEASE FORWARD THE COMPLETED QUESTIONNAIRE TO: Signature: ____________________________ Mr. Steve Campbell KEEP YOUR DAY JOB, LLC Name: ____________________________ 505 Montgomery Street, Fifth Floor San Francisco, CA 94111 Date: ____________________________ -3- Title: ____________________________ Company: ____________________________ Telephone: ____________________________ Fax: ____________________________ -4- EXHIBIT E Form of Estoppel Certificate TO: DATE: Reference is made to that certain Commercial Multi-Tenant Lease (the "Lease") dated ___________________- by and between ___________________________, as Landlord, ______________________________________, as Tenant, covering certain premises known as ___________________________________________________, as further described in the Lease. Tenant hereby certifies to and agrees with ____________________________ that: 1. The Lease is in full force and effect, and has not been modified, amended, terminated or superseded in any manner, except as follows: ___________________________; 2. The Lease was executed on __________________ and will expire ______ years from the Commencement Date, to wit, on or about __________________ (not including ____ option periods of ____ years each which, if all exercised, would extend the Term until - -------------------); 3. Tenant has no offsets or defenses to its performance of the terms and conditions of the Lease, including the payment of Rent, and there are no modifications or agreements with regard to the Rent set forth in the Lease except (insert "NONE" if there are no modifications or other agreements): _____________________________________________________________________________ _____________________________________________________________________________ _____________________________________________________________________________ 4. Tenant has accepted possession of the Premises subject to the terms of the Lease; 5. Tenant has not and will not pay Rent more than one (1) month in advance to Landlord; 6. Tenant will not look to __________________________________________ for any security deposits paid to Landlord under the Lease unless such deposits have been received in cash by _______________________________________________; 7. Tenant agrees that, without the written consent of ________________________, Tenant will not modify or alter the terms of the Lease; 8. None of the following events have occurred: (a) the filing by or against Tenant of a petition in bankruptcy, insolvency, reorganization, or an action for the appointment of a receiver or trustee; or (b) the making of an assignment for the benefit of creditors. KEEP YOUR DAY JOB, LLC, A DELAWARE LIMITED LIABILITY COMPANY INDUSTRIAL MULTI-TENANT LEASE COMMENCEMENT DATE ADDENDUM The "Commencement Date" shall be the date upon which Landlord receives a temporary certificate of occupancy the Premises (excluding, to the extent applicable, the Office Space) and all of Landlord's Work except that relating to the Office Space (if applicable) has been substantially completed, i.e., completed except for items of work (and, if applicable, adjustment of equipment and fixtures), which can be completed after occupancy has been taken without causing undue interference with Tenant's use (i.e., so-called "punch list" items). Landlord agrees to complete as soon as conditions permit all "punch list" items and Tenant agrees to afford Landlord access to the Premises for such purposes. In the event that a temporary certificate of occupancy (as opposed to a permanent certificate of occupancy) is issued for the Premises, then Landlord shall diligently pursue to completion all conditions precedent to the issuance of a permanent certificate of occupancy imposed by the Town of Mansfield for the issuance of the same. If Landlord fails to diligently pursue and obtain a permanent certificate of occupancy for the Premises and, as a result thereof, Tenant is ordered to cease and desist its use and occupancy of the Premises, then the Base Rent, Additional Rent and all other charges due under the Lease shall abate until a permanent certificate of occupancy is issued or Tenant is permitted to occupy the Premises. The provisions of this paragraph shall not apply if and to the extent the failure of Landlord to obtain any occupancy permit is due to the acts of Tenant or any Tenant Entity. Landlord: Tenant: KEEP YOUR DAY JOB, LLC SMARTERKIDS.COM, a Delaware corporation a Delaware limited liability company ________________________________________ By:______________________________ By: MANSFIELD LAND LLC Name: a Massachusetts limited Title: liability company Its: Manager By: NDNE REALTY, INC. a Massachusetts corporation Its: Manager By: ________________________ Name: Its: AMB PROPERTY, L.P. a Delaware limited partnership By: AMB PROPERTY CORPORATION a Maryland corporation By: _________________________ Name: Cynthia J. Sarver Its: Vice President -2- GLOSSARY The following terms in the Lease are defined in the paragraphs opposite the terms. TERM DEFINED IN PARAGRAPH Additional Rent 4.1 Applicable Requirements 6.3 Assign 12.1 Base Rent 1.4 Basic Provisions 1.1 Building 1.2 Building Operating Expenses 4.2(b) Code 12.1 Commencement Date 1.3 Commencement Date Certified 3.3 Common Areas 2.2 Common Area Operating Expenses 4.2(b) Condemnation 14 Default 13.1 Expiration Date 1.3 Hazardous Substance 6.2 Indemnity 8.5 Industrial Center 1.2 Landlord 1.1 Landlord Entities 6.2(c) Lease 1.1 Lenders 6.4 Mortgage 16.18 Operating Expenses 4.2 Party/Parties 1.1 Permitted Use 1.8 Premises 1.2 Prevailing Party 16.13 Real Property Taxes 10.2 Rent 4.1 Reportable Use 6.2 Requesting Party 15 Responding Party 15 Rules and Regulations 2.4 Security Deposit 1.7, 5 Taxes 10.2 Tenant 1.1 Tenant Acts 9.2 Tenant's Share 1.5 Term 1.3 Use 6.1 EX-10.11 12 0012.txt BUSINESS AGREEMENT EXHIBIT 10.11 ------------- SmarterKids.com(TM) NCS and SmarterKids.com Business Agreement Version 1.0 March 9, 1999 Overview 1.1 NCS: National Computer Systems, a global information services company providing software, services and systems for the collection, management and interpretation of data. NCS http://www.ncs.com serves important segments of the education, ------------------ testing, assessment and complex data management markets. NCS is the world's largest commercial processor of educational measurement instruments, processing and scoring over 30 million student assessment tests. Additionally, National Computer Systems is the nation's single largest provider of financial management, student information, and instructional management software and services to the K-12 education market. Across all of these markets, NCS supports its customers by providing service solutions that include consulting, training, network administration, system support and outsourcing. 1.2 SmarterKids.com: SmarterKids.com is an Internet reseller of children's educational products, and is the fastest growing publisher of children's educational software in the US. SmarterKids.com features a comprehensive database of 1000 plus educational products including books, software, and games for children in Preschool through Ninth Grade. Each product is characterized using a unique combination of over 100 educational attributes, making it easy to select products based on the individual education goals of parents/teachers. SmarterKids.com's mission is to empower parents, teachers and educational professionals to play a more productive role in the education of children. The Company's approach is to understand a child's academic strengths and weaknesses, using assessment tools and technology, and to apply that understanding in identifying products and services to enhance a child's learning and to use the Internet to enable customers to purchase those products and services conveniently at http://www.smarterkids.com. -------------------------- 2 Goals and Objectives 2.1 General: The business relationship between NCS and SmarterKids.com is a focused priority on providing value-added electronic testing and educational products and services to our clients and their constituents in the K-12 market. The theme of the business proposition is to augment state assessment programs by offering a variety of HelpTests for users to access on-line. These tests will provide feedback on student skill proficiency and performance. Using this skill data, NCS will refer parents/teachers to recommended web sites where they may find educationally relevant information, services, and products (SmarterKids.com). 2.2 On-line HelpTests: The purpose of the NCS web site is to provide HelpTests aligned specifically to individual state assessment standards and curriculum requirements. Additionally off-grade tests and national tests (e.g., NAEP items) will also be provided online. These tests will promote confidence in test taking skills, provide an early assessment of student strengths and areas for improvement, an electronic workbook for repeat test takers working to pass state matriculation standards, and provide educational product recommendations for skill proficiency improvement (SmarterKids.com). Additionally, the site will accommodate direct entry of individual student report data for parents/teachers whose children have already taken a state assessment test. It is not planned that a paper-based HelpTest would be provided as part of this project. [CONFIDENTIAL TREATMENT REQUESTED]** 2.3 Link To SmarterKids.com: At the completion of a HelpTest, the student scores and results are provided on- line. The user will be referred to options, including "Would You Like To See Products and Services Tailored To: 1) Concentration On Strengths 2) Concentration On Areas For Improvement." After a selection, a Notice page will advise the user of linking to SmarterKids.com for product recommendations. The user will arrive at the SmarterKids.com web site, with special co-site branding of NCS and SmarterKids.com and navigation button(s) back to NCS. This will promote intersite navigation and will build the brand recognition, confidence, and quality of our relationship. [CONFIDENTIAL TREATMENT REQUESTED]** **[CONFIDENTIAL TREATMENT REQUESTED] INDICATES MATERIAL THAT HAS BEEN OMITTED AND FOR WHICH CONFIDENTIAL TREATMENT HAS BEEN REQUESTED. ALL SUCH OMITTED MATERIAL HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 406 PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. 3 Project Plans 3.1 Pilot Projects: NCS has identified two state pilot projects to kickoff the initiative. One pilot will be a statewide initiative for Michigan and the [CONFIDENTIAL TREATMENT REQUESTED]**. For participating in the pilot projects, NCS will provide a special promotional offer of [CONFIDENTIAL TREATMENT REQUESTED]** and a [CONFIDENTIAL TREATMENT REQUESTED]** merchandise credit at the SmarterKids.com web store. This discount could be applied to teacher accounts and/or Title I district funds. Participation by states in the pilot projects is subject to their approval. 3.2 Project Phases: This project will be divided into three phases. Phase 1 will involve the generation of a PC based demonstration tool and marketing materials to initiate discussions with customers to promote support for hosting a pilot project. This system will include an alpha release of the WeHelpKids.com web site including menus and links, (1) 30Q Math Grade 4 HelpTest, test skill results mapping to SmarterKids.com skill sets, and the process of linking to the SmarterKids.com web site for product recommendations. Phase 2 will involve the active deployment of a beta WeHelpKids.com web site to support both the Michigan and [CONFIDENTIAL TREATMENT REQUESTED]** pilots. NCS will provide a subset of HelpTests and ReportCard entry forms for inputting state test results. Skill results from the HelpTest and ReportCard will be completely mapped to SmarterKids.com skill sets. The user will then be windowed to the SmarterKids.com site for product recommendations. Phase 3 will involve a postmortem analysis of the pilot projects and their contribution to the NCS/SmarterKids.com value proposition. Collected information such as demographics, purchasing profile, adoption rates, revenue models, customer reactions, and other meaningful market data will be assessed to help refine the parameters of the business relationship. At the conclusion of this phase, a Go/No Go decision will be made on a nationwide deployment of this initiative. 3.3 Project Tasks and Schedule: The project tasks and planned schedule associated with completion of the Phases 1 through 3 are shown in the attached project schedule: Picture of ICON ** [CONFIDENTIAL TREATMENT REQUESTED] INDICATES MATERIAL THAT HAS BEEN OMITTED AND FOR WHICH CONFIDENTIAL TREATMENT HAS BEEN REQUESTED. ALL SUCH OMITTED MATERIAL HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 406 PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. 4 Business Agreement NCS/SmarterKids.com Schedule - ------------------------ ------------- --------------------------------- [CONFIDENTIAL TREATMENT [CONFIDENTIAL [CONFIDENTIAL TREATMENT REQUESTED]** TREATMENT REQUESTED]** - ------------------------ REQUESTED]** WeHelpKids.com Site Development - ------------------------ [CONFIDENTIAL TREATMENT REQUESTED]** - ------------------------ Marketing and Promotion - ------------------------ [CONFIDENTIAL TREATMENT REQUESTED]** - ------------------------ Business Development - ------------------------ [CONFIDENTIAL TREATMENT REQUESTED]** - ------------------------ Live Pilot - ------------------------ [CONFIDENTIAL TREATMENT REQUESTED]** - ------------------------ ------------- --------------------------------- **[CONFIDENTIAL TREATMENT REQUESTED] indicates material that has been omitted and for which confidential treatment has been requested. All such omitted material has been filed with the Securities and Exchange Commission pursuant to Rule 406 promulgated under the Securities Act of 1933, as amended. Terms and Conditions 4.1 General: This is the entire agreement between the parties and it, together with the Non- Disclosure Agreement referred to herein, replaces and supersedes all other agreements written or oral. This Agreement may only be modified by a written instrument signed by authorized representatives of both parties. This Agreement and the performance and relationship provided for herein shall be governed by the laws of and subject to the exclusive jurisdictions of the courts of and Federal courts in, the State of Minnesota. 4.2 Exclusivity: SmarterKids.com and NCS agree to work on an exclusive basis for the Term of this Agreement. This means that NCS will be SmarterKids.com's exclusive partner for the purpose of establishing the state initiatives. SmarterKids.com would be precluded from a similar relationship with a book/test publisher or NCS competitor in assessment administration and processing. NCS would be precluded from a similar relationship with another PreK-9 children's educational products company reseller (not precluded are companies marketing their own products and any products offered by National Computer Systems) who competes with Smarterkids.com. 4.3 Term: The term of this Agreement ("Term") shall be [CONFIDENTIAL TREATMENT REQUESTED]** years from the date set forth above. This agreement shall expire at the end of the last day of the Term unless extended by mutual agreement of the parties. 4.4 Database And Rights: There are three databases that are anticipated to result from these state initiatives. [CONFIDENTIAL TREATMENT REQUESTED]** ** [CONFIDENTIAL TREATMENT REQUESTED] INDICATES MATERIAL THAT HAS BEEN OMITTED AND FOR WHICH CONFIDENTIAL TREATMENT HAS BEEN REQUESTED. ALL SUCH OMITTED MATERIAL HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 406 PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. Terms and Conditions (Cont.) 4.5 Mutual Responsibilities: The parties will contribute the following assets and responsibilities to this initiative: NCS will provide: . Knowledge of state assessment practices; institutional marketing . Test item bank development; build on-line HelpTests . Web site for hosting, administering, scoring HelpTests SmarterKids.com will provide: . Expertise in consumer and on-line marketing . Knowledge of leading edge computer-based assessment technology . E-commerce, order processing, and fulfillment . Web site for product recommendations and expert reviews 4.6 Assignment: Neither party shall assign this business agreement in whole or in part without the prior written approval of the other party, which shall not be unreasonably withheld. 4.7 Liability: Each party will, at its expense but subject to the limitations set forth in this paragraph, defend, indemnify and hold harmless the other (the party from whom indemnification is sought hereinafter the "Indemnifying Party") against, and pay any costs, expenses and damages in connection therewith, an action or claim, based upon material on the Indemnifying Party's web site, or based on material (including, without limitation intellectual property) owned or provided by the indemnifying party, including without limitation an action or claim for infringement or misappropriation of a third party's trademark, trade secret or copyrighted material, or based upon the products or operation of the Indemnifying Party or the negligence or willful misconduct of Indemnifying Party or its employees or agents or anyone acting on its behalf or under its direction or control; provided that: (a) the party seeking indemnification promptly notifies the Indemnifying Party of the claim; and (b) subject to evidence reasonably satisfactory to the party seeking indemnification of the financial responsibility of the Indemnifying party and selection of reputable and appropriate counsel by the Indemnifying Party, the Indemnifying Party may, in full satisfaction of its obligations under this section, assume the defense and/or settlement of any such action or claim and payment of any award or settlement amount, all at its own expense. The party seeking indemnification may be represented in such action by counsel of its selection at its own expense. The Indemnifying Party shall not have liability to the other party regarding any claim to the extent arising from the negligence or willful misconduct of the party seeking indemnification or its employees or agents or anyone acting on its behalf or under its direction or control or arising from web site content provided by the party seeking indemnification. Terms and Conditions (Cont.) EXCLUDING LIABILITY ARISING UNDER OBLIGATIONS OF NON-DISCLOSURE (AS SET FORTH IN SECTION 4.8 BELOW), OR ARISING FROM THE INDEMNITY SET FORTH ABOVE: NEITHER PARTY SHALL BE LIABLE TO THE OTHER FOR ANY INDIRECT, CONSEQUENTIAL, OR INCIDENTAL DAMAGES (INCLUDING DAMAGES FOR LOSS OF BUSINESS PROFITS, BUSINESS INTERRUPTION, LOSS OF BUSINESS INFORMATION, AND THE LIKE) ARISING OUT OF THIS AGREEMENT, EVEN IF SUCH PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES, NOR SHALL EITHER PARTY'S AGGREGATE LIABILITY (EXCLUDING LIABILITY TO MAKE PAYMENTS DUE HEREUNDER) FOR MATTERS ARISING OUT OF THE SUBJECT MATTER OF THIS AGREEMENT, WHETHER IN CONTRACT, TORT OR OTHERWISE, EXCEED THE AMOUNT PAID OR PAYABLE TO NCS BY SMARTERKIDS.COM DURING THE 12 MONTHS PRECEDING THE OCCURRENCE GIVING RISE TO THE CLAIM OF LIABILITY. 4.8 Confidentiality: The parties acknowledge and agree that performance of this Agreement shall from time to time require disclosure of confidential information by each party to the other. The exchange and disclosure of such information shall be governed by the terms of that certain Non-Disclosure Agreement entered into by and between the parties and executed on September 9, 1998. 4.9 Warranty: UNLESS EXPRESSLY SET FORTH AND PROVIDED FOR IN THIS AGREEMENT OR AN AMENDMENT HERETO, BOTH PARTIES DISCLAIM ALL WARRANTIES, EXPRESS AND IMPLIED, INCLUDING BUT NOT LIMITED TO THE IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. NO ORAL OR WRITTEN INFORMATION OR ADVICE GIVEN BY EITHER PARTY, THEIR AGENTS OR EMPLOYEES SHALL CREATE A WARRANTY OR IN ANY WAY INCREASE THE SCOPE OF THE WARRANTIES IN THIS AGREEMENT. Neither party shall make any warranty or representation concerning the products or services of the other party or other material information concerning the other party, unless with the express, prior written consent of that party. Value Proposition 5.1 Revenue Model: The revenue from this initiative will result from the purchase of products and services at SmarterKids.com by parents/teachers. For state participation in the pilot projects, NCS will provide a special promotional offer of [CONFIDENTIAL TREATMENT REQUESTED]**, and a [CONFIDENTIAL TREATMENT REQUESTED]** merchandise credit at the SmarterKids.com web store. This discount will be applied to special teacher accounts and/or donations to Title/district funds, as applicable. It is envisioned that providing the HelpTest service for free will maximize traffic to the NCS web site, and ultimately maximize the exposure and adoption rate of products on the SmarterKids.com site. However, these pilot projects may validate the possibility of ultimately charging a registration fee for the HelpTest on the NCS web site. 5.2 Financial Model: 1. Standard Affiliate Program: Revenue generated from clients linking from the NCS web site to the SmarterKids.com store. Each and every time a client links from NCS to SmarterKids.com and purchases products, NCS will receives [CONFIDENTIAL TREATMENT REQUESTED]** of the gross margin of all SmarterKids.com sales to that client. 2. Special Affiliate Program: Revenue generated from clients returning directly to the SmarterKids.com store through a special SmarterKids.com homepage especially designed for NCS and its customers. (e.g., http://www.smarterkids. com/whk). Each and every time a client enters this homepage and subsequently purchases products, NCS receives [CONFIDENTIAL TREATMENT REQUESTED]** of the gross margin of all SmarterKids.com sales to that client. 3. Special Coupon Program: Revenue generated from clients returning directly to the SmarterKids.com store and purchasing products using special NCS incentive codes. Each and every time a client purchases products and enters a special NCS code, NCS receives [CONFIDENTIAL TREATMENT REQUESTED]** of the gross margin of all SmarterKids.com sales to that client. **[CONFIDENTIAL TREATMENT REQUESTED] INDICATES MATERIAL THAT HAS BEEN OMITTED AND FOR WHICH CONFIDENTIAL TREATMENT HAS BEEN REQUESTED. ALL SUCH OMITTED MATERIAL HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 406 PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. Value Proposition (Cont.) 5.3 Margin Calculation: Gross margin will be defined as the net revenue of the sale of products less the cost of goods sold for those products: Net revenue shall be defined as the gross revenue on the sale of all products less any discounts, applicable promotions, merchandise incentive program discounts or other programs that reduce the cost of the product to the customer. Shipping and sales tax are excluded from the calculation. Cost of Goods shall be defined as the cost of the product to SmarterKids.com, as charged by our 3/rd/ party fulfillment partner. These costs consist of the purchase cost from the product manufacturer plus handling and fulfillment fees incurred by our fulfillment partner. Additionally, royalties to the content providers of proprietary SmarterKids.com products (the Children's Skills Test line) shall be an additional cost of goods on those items only. Freight-out costs are excluded from the calculation. 5.4 Terms of Payment: Payment to NCS under this agreement shall occur quarterly, 30 days following the close of each calendar quarter. 5.5 Audit: NCS shall have the right to perform (or have performed on its behalf) an audit of the books and records (including business records and web site activity records regardless of media) of SmarterKids.com, relating to the performance of SmarterKids.com's obligations under this Agreement and the calculation of all payments due to be paid to NCS hereunder. Such audits shall be conducted at reasonable times and frequencies, with a minimum advanced notice of 10 business days, during regular business hours and subject to the terms and condition of the Non-Disclosure Agreement referred to in Section 4.8. 5.6 Purchase Incentives: SmarterKids.com offers NCS, on a nonexclusive basis, a merchandise incentive program. This incentive program allows NCS to offer merchandise credits to its clients for purchasing products at the SmarterKids.com web store using methods described in Section 5.2. These credits may be applied to teacher or other special accounts at the rate of [CONFIDENTIAL TREATMENT REQUESTED]** of sales price. NCS and SmarterKids.com shall equally share the cost burden of a client exercising a merchandise credit. **[CONFIDENTIAL TREATMENT REQUESTED] INDICATES MATERIAL THAT HAS BEEN OMITTED AND FOR WHICH CONFIDENTIAL TREATMENT HAS BEEN REQUESTED. ALL SUCH OMITTED MATERIAL HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 406 PROMULGATED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. Value Proposition (Cont.) 5.7 Stock Warrants: Smarterkids.com will grant to NCS, with the approval of the SmarterKids.com Board Of Directors, warrants to purchase 75,000 shares (approximately 1.00% of the company post financing) of the Company's common stock at an exercise price of $2.00/share. These shares would be exercisable in four equal increments based on completion of the planned rollout to states (to be mutually agreed upon). One fourth would be immediately exercisable upon completion of phase three and a "Go" decision on large scale deployment of the state initiatives. The remaining warrants would be exercisable as completion of the rollout occurs. This agreement ("Agreement") is entered into effective March 9, 1999 between SmarterKids.com, Inc., a Delaware Corporation, with offices at 200 Highland Avenue, Needham, Massachusetts and National Computer Systems, Inc. a Minnesota Corporation with offices at 2510 N. Dodge Street, Iowa City, Iowa 52245. The abbreviation "NCS" as used herein refers to the State Assessment business unit of the Measurement Services Division of National Computer Systems, Inc. In consideration of the mutual promises, obligations and rights set forth in this Agreement, the sufficiency of which is hereby acknowledged by both parties, and intending to be bound by this Agreement, the parties agree as follows: National Computer Systems, Inc. By: /s/ Gary A. Mainor --------------------------- Authorized Signature Name: Gary A. Mainor ------------------------ Title: General Manager ------------------------ Date: 3/10/99 ------------------------ SmarterKids.com, Inc. By: /s/ David A. Blohm -------------------------- Authorized Signature Name: David A. Blohm ------------------------ Title: President/CEO ------------------------ Date: 3/15/99 ------------------------ EX-10.12 13 0013.txt LOAN AND SECURITY AGREEMENT EXHIBIT 10.12 LOAN AND SECURITY AGREEMENT THIS LOAN AND SECURITY AGREEMENT (this "Agreement") dated as of November 24, 1999, between SILICON VALLEY BANK, a California-chartered bank, with its principal place of business at 3003 Tasman Drive, Santa Clara, California 95054 and with a loan production office located at Wellesley Office Park, 40 William Street, Suite 350, Wellesley, Massachusetts 02481, doing business under the name "Silicon Valley East" ("Bank") and SMARTERKIDS.COM, INC. ("Borrower"), provides the terms on which Bank shall lend to Borrower and Borrower shall repay Bank. The parties agree as follows: 1 ACCOUNTING AND OTHER TERMS Accounting terms not defined in this Agreement shall be construed following GAAP. Calculations and determinations must be made following GAAP. The term "financial statements" includes the notes and schedules. The terms "including" and "includes" always mean "including (or includes) without limitation" in this or any Loan Document. Capitalized terms in this Agreement shall have the meanings set forth in Section 13. This Agreement shall be construed to impart upon Bank a duty to act reasonably at all times. 2 LOAN AND TERMS OF PAYMENT 2.1 CREDIT EXTENSIONS. Borrower shall pay Bank the unpaid principal amount of all Credit Extensions and interest on the unpaid principal amount of the Credit Extensions as and when due in accordance with this Agreement. 2.1.1 EQUIPMENT FACILITY. (a) Subject to the terms and conditions of this Agreement, Bank agrees to lend to Borrower, from time to time prior to the Commitment Termination Date, equipment advances (each an "Equipment Advance" and collectively the "Equipment Advances") in an aggregate amount not to exceed the Committed Equipment Line. When repaid, the Equipment Advances may not be re-borrowed. The proceeds of the Equipment Advances shall be used solely to reimburse Borrower for the purchase of Eligible Equipment purchased within ninety (90) days (determined based upon the applicable invoice date of such Eligible Equipment) of the Equipment Advance and to purchase new Eligible Equipment. Not withstanding the foregoing, the proceeds of the first Equipment Advance shall be used to reimburse the Borrower for the purchase of Eligible Equipment purchased within one hundred twenty (120) days (determined based upon the applicable invoice date of such Eligible Equipment) of the Equipment Advance. Bank's obligation to lend hereunder shall terminate on the earlier of (i) the occurrence and continuance of an Event of Default, or (ii) the Commitment Termination Date. For purposes of this Section, the minimum amount of each Equipment Advance is One Hundred Thousand Dollars ($100,000.00). The Borrower may only request a total of ten (10) Equipment Advances. (b) To obtain an Equipment Advance, Borrower shall deliver to Bank a completed loan supplement in substantially the form attached as Exhibit B ("Loan Supplement"), together with a UCC Financing Statement covering the Financed Equipment described on Annex A to the applicable Loan Supplement and such additional information as Bank may reasonably request at least five (5) Business Days before the proposed funding date (the "Funding Date"). On each Funding Date, Bank shall specify in the Loan Supplement for each Equipment Advance, the Basic Rate, the Loan Factor, and the Payment Dates. If Borrower satisfies the conditions of each Equipment Advance, Bank shall disburse such Equipment Advance by internal transfer to Borrower's deposit account with Bank. Each Equipment Advance may not exceed 100% of the Original Stated Cost of the Financed Equipment. (c) Bank's obligation to lend the undisbursed portion of the Committed Equipment Line shall terminate if there has been a material adverse change in the general affairs, management, results of operation, condition (financial or otherwise) of Borrower, whether or not arising from transactions in the ordinary course of business, or there has been any material adverse deviation by Borrower from the most recent business plan of Borrower presented to and accepted by Bank prior to the execution of this Agreement. 2.2 INTEREST RATE; PAYMENTS. (1) Principal and Interest Payments On Payment Dates. Borrower shall repay each Equipment Advance pursuant to the terms set forth in the corresponding Loan Supplement. For each Equipment Advance, Borrower shall make equal monthly payments of principal and interest, in advance, calculated by the Bank based upon: (1) the amount of the Equipment Advance, (2) the Basic Rate, and (3) an amortization schedule equal to the Repayment Period (individually, the "Scheduled Payment", and collectively, "Scheduled Payments"), on the first Business Day of the month following the month in which the Funding Date occurs (or commencing on the Funding Date if the Funding Date is the first Business Day of the month) with respect to such Equipment Advance and continuing thereafter during the Repayment Period on the first Business Day of each successive calendar month (each a "Payment Date"). All unpaid principal and accrued interest is due and payable in full on the last Payment Date with respect to such Equipment Advance. Payments received after 12:00 noon Eastern time are considered received at the opening of business on the next Business Day. An Equipment Advance may only be prepaid in accordance with Sections 2.2(e) and 2.2(g). (b) Interest Rate. Borrower shall pay interest on the unpaid principal amount of each Equipment Advance from the first Payment Date after the Funding Date of such Equipment Advance until the Equipment Advance has been paid in full, at the per annum rate of interest equal to the Basic Rate determined by Bank as of the Funding Date for each Equipment Advance in accordance with the definition of the Basic Rate. Any amounts outstanding during the continuance of an Event of Default shall bear interest at a per annum rate equal to the Basic Rate plus five percent (5%)(the "Default Rate"). If any change in the law increases Bank's expenses or decreases its return from the Equipment Advances, Borrower shall pay Bank upon request the amount of such increase or decrease. (c) Interim Payment. In addition to the Scheduled Payments, on the Funding Date for each 2 Equipment Advance (unless the Funding Date is the first Business Day of the month, in which event no Interim Payment shall be due or owing), Borrower shall pay to Bank, on behalf of Bank, an amount (the "Interim Payment") equal to the initial Equipment Advance multiplied by the product of (i) the quotient derived from dividing the initial Loan Factor with respect to such Equipment Advance by 30, and (ii) the number of days from the Funding Date of the Equipment Advance until the first Payment Date with respect to such Equipment Advance. (d) Final Payment. On the Maturity Date with respect to each Equipment Advance, Borrower shall pay, in addition to the unpaid principal and accrued interest and all other amounts due on such date with respect to such Equipment Advance, an amount equal to the Final Payment. (e) Prepayment Upon an Event of Loss. If any Financed Equipment is subject to an Event of Loss and Borrower is required to or elects to prepay the Equipment Advance with respect to such Financed Equipment pursuant to Section 6.7 then such Equipment Advance shall be prepaid to the extent and in the manner provided in such section. (f) Mandatory Prepayment Upon an Acceleration. If the Equipment Advances are accelerated following the occurrence of an Event of Default or otherwise (other than following an Event of Loss), then Borrower shall immediately pay to Bank (i) all unpaid Scheduled Payments with respect to each Equipment Advance due prior to the date of prepayment, (ii) all accrued unpaid interest, including interest at the Default Rate, to the date of the prepayment, (iii) the Final Payment, and (iv) all other sums, if any, that shall have become due and payable with respect to any Equipment Advance. (g) Permitted Prepayment of Loans. With Bank's prior written consent, which shall not be unreasonably withheld, delayed or conditioned, Borrower shall have the option to prepay all, but not less than all, of the Equipment Advances advanced by Bank under this Agreement, provided Borrower (i) provides written notice to Bank of its election to prepay the Equipment Advances at least thirty (30) days prior to such prepayment, and (ii) pays, on the date of such prepayment (A) all outstanding principal; (B) all unpaid accrued interest to the date of the prepayment; (C) the Final Payment in respect of each Equipment Advance ; and (D) all other sums, if any, that shall have become due and payable hereunder with respect to this Agreement. 2.3 FEES. Borrower shall pay to Bank all Bank Expenses (including reasonable attorneys' fees and expenses incurred through and after the Closing Date when due. 2.4 REQUEST TO DEBIT. Bank may debit any of Borrower's deposit accounts including Account Number ______________________ for principal and interest payments or any amounts Borrower owes Bank when due. Bank shall notify Borrower when it debits Borrower's accounts. These debits are not a set-off. 3 3 CONDITIONS OF LOANS 3.1 CONDITIONS PRECEDENT TO INITIAL CREDIT EXTENSION. The obligation of Bank to make the initial Credit Extension is subject to the condition precedent that Bank shall have received, in form and substance satisfactory to Bank, the following: (1) this Agreement; (2) a certificate of the Secretary of Borrower with respect to articles, bylaws, incumbency and resolutions authorizing the execution and delivery of this Agreement; (3) an opinion of Borrower's counsel; (4) financing statements (Forms UCC-1); (5) insurance certificate; (6) payment of the fees and Bank Expenses then due specified in Section 2.3 hereof; (7) Certificate of Good Standing/Legal Existence; (8) Certificate of Foreign Qualification (if applicable); and (9) such other documents, and completion of such other matters, as Bank may reasonably deem necessary or appropriate. 3.2 CONDITIONS PRECEDENT TO ALL CREDIT EXTENSIONS. Bank's obligations to make each Credit Extension, including the initial Credit Extension, is subject to the following: (1) timely receipt of a completed Loan Supplement and UCC financing statement covering the Financed Equipment described on Annex A to the Loan Supplement; and (2) the representations and warranties in Section 5 must be materially true on the date of the Loan Supplement and on the effective date of each Credit Extension and no Event of Default may have occurred and be continuing, or result from the Credit Extension. Each Credit Extension is Borrower's representation and warranty on that date that the representations and warranties in Section 5 remain true. (3) the Bank shall have the opportunity to confirm that upon filing the UCC-1 financing statement covering the Equipment described on the Loan Supplement, that the Bank shall have a first perfected security interest in such Equipment. 4 4 CREATION OF SECURITY INTEREST 4.1 GRANT OF SECURITY INTEREST. Borrower grants Bank a continuing security interest in all presently existing and later acquired Collateral to secure all Obligations and performance of each of Borrower's duties under the Loan Documents. Any security interest shall be a first priority security interest in the Collateral. If the Agreement is terminated, Bank's lien and security interest in the Collateral shall continue until Borrower fully satisfies its Obligations. Upon termination of this Agreement and satisfaction of the Obligations, Bank shall release its security interest in all Collateral, and shall execute all documents and take all actions reasonably requested by Borrower in connection therewith. 5 REPRESENTATIONS AND WARRANTIES Borrower represents and warrants as follows: 5.1 DUE ORGANIZATION AND AUTHORIZATION. Borrower and each Subsidiary is duly existing and in good standing in its state of formation and qualified and licensed to do business in, and in good standing in, any state in which the conduct of its business or its ownership of property requires that it be qualified. The execution, delivery and performance of the Loan Documents have been duly authorized, and do not conflict with Borrower's organizational documents, nor constitute an event of default under any material agreement by which Borrower is bound. Borrower is not in default under any agreement to which or by which it is bound in which the default could reasonably be expected to cause a Material Adverse Change. 5.2 COLLATERAL. Borrower has good title to the Collateral, free of Liens. 5.3 LITIGATION. Except as shown in the Schedule, there are no actions or proceedings pending or, to Borrower's knowledge, threatened by or against Borrower or any Subsidiary in which an adverse decision could could reasonably be expected to cause a Material Adverse Change. 5.4 NO MATERIAL ADVERSE CHANGE IN FINANCIAL STATEMENTS. All consolidated financial statements for Borrower and any Subsidiary delivered to Bank fairly present in all material respects Borrower's consolidated financial condition and Borrower's consolidated results of operations. There has not been any material deterioration in Borrower's consolidated financial condition since the date of the most recent financial statements submitted to Bank. 5.5 SOLVENCY. Borrower is able to pay its debts (including trade debts) as they mature. 5.6 REGULATORY COMPLIANCE. Borrower is not an "investment company" or a company "controlled" by an "investment company" under the Investment Company Act. Borrower is not engaged as one of its important activities in extending credit for margin stock (under Regulations T and U of the Federal Reserve Board of Governors). Borrower has complied with the Federal Fair 5 Labor Standards Act. Borrower has not violated any laws, ordinances or rules, the violation of which could reasonably be expected to cause a Material Adverse Change. None of Borrower's or any Subsidiary's properties or assets has been used by Borrower or any Subsidiary or, to the best of Borrower's knowledge, by previous Persons, in disposing, producing, storing, treating, or transporting any hazardous substance other than legally. Borrower and each Subsidiary has timely filed all required tax returns and paid, or made adequate provision to pay, all material taxes. Borrower and each Subsidiary has obtained all consents, approvals and authorizations of, made all declarations or filings with, and given all notices to, all government authorities that are necessary to continue its business as currently conducted. 5.7 SUBSIDIARIES. Borrower does not own any stock, partnership interest or other equity securities. 5.8 FULL DISCLOSURE. No representation, warranty or other statement of Borrower in any certificate or written statement given to Bank contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements contained in the certificates or statements, in light of the circumstances in which they were made, not misleading. 6 AFFIRMATIVE COVENANTS Borrower shall do all of the following: 6.1 GOVERNMENT COMPLIANCE. Borrower shall maintain its and all Subsidiaries' corporate existence and good standing in its jurisdiction of incorporation and maintain qualification in each jurisdiction in which the failure to so qualify could have a material adverse effect on Borrower's business or operations. Borrower shall comply, and have each Subsidiary comply, with all laws, ordinances and regulations to which it is subject, noncompliance with which could have a material adverse effect on Borrower's business or operations or cause a Material Adverse Change. 6.2 FINANCIAL STATEMENTS, REPORTS, CERTIFICATES. (1) Borrower shall deliver to Bank: (i) a company prepared consolidated balance sheet and income statement covering Borrower's consolidated operations during the period, in a form acceptable to Bank and certified by a Responsible Officer (a) prior to the occurrence of the Capitalization Event, as soon as available, but no later than thirty (30) days after the last day of each month, and (b) upon and after the occurrence of the Capitalization Event, as soon as available, but no later than forty five (45) days after the last day of each quarter; (ii) as soon as available, but no later than ninety (90) days after the end of Borrower's fiscal year, audited consolidated financial statements prepared under GAAP, consistently applied, together with an unqualified opinion on the financial statements from an independent certified public accounting firm acceptable to Bank; (iii) within five (5) days of filing, copies of all statements, reports and notices made available to Borrower's security holders or to any holders of Subordinated Debt and all reports on Form 10-K, 10-Q and 8-K filed with the Securities and Exchange Commission; (iv) a prompt report of any legal actions pending or threatened against Borrower or any Subsidiary that could result in damages or 6 costs to Borrower or any Subsidiary of Two Hundred Thousand Dollars ($200,000.00) or more; and (v) other financial information Bank reasonably requests. (2) Borrower shall deliver to Bank with the financial statements, a Compliance Certificate signed by a Responsible Officer in the form of Exhibit C as follows: (i) if prior to the occurrence of the Capitalization Event, within thirty (30) days after the last day of each month, and (ii) upon and after the occurrence of the Capitalization Event, within forty five (45) days after the last day of each quarter. 6.3 TAXES. Borrower shall make, and cause each Subsidiary to make, timely payment of all material federal, state, and local taxes or assessments owing by Borrower and shall deliver to Bank, on demand, appropriate certificates attesting to such payments. 6.4 INSURANCE. Borrower shall keep its business and the Collateral insured for risks and in amounts, as Bank requests. Insurance policies shall be in a form, with companies, and in amounts that are reasonably satisfactory to Bank. All property policies shall have a lender's loss payable endorsement showing Bank as an additional loss payee and all liability policies shall show the Bank as an additional insured and all policies shall provide that the insurer must give Bank at least twenty (20) days notice before canceling its policy. At Bank's request, Borrower shall deliver certified copies of policies and evidence of all premium payments. Proceeds payable under any policy shall, at Bank's option, be payable to Bank on account of the Obligations. Notwithstanding the foregoing and subject to Section 6.7 below, so long as no Event of Default has occurred and is continuing, Borrower shall have the option of applying the proceeds of any casualty policy up to Five Thousand Dollars ($5,000.00) toward the replacement or repair of destroyed or damaged property; provided that (i) any such replaced or repaired property (a) shall be of equal or like value as the replaced or repaired Collateral and (b) shall be deemed Collateral in which Bank has been granted a first priority security interest and (ii) after the occurrence and during the continuation of an Event of Default all proceeds payable under such casualty policy shall, at the option of the Bank, be payable to Bank on account of the Obligations. 6.5 PRIMARY ACCOUNTS. Borrower shall maintain an operating account with Bank. On the Closing Date, Borrower shall deposit at least Two Million Five Hundred Thousand Dollars ($2,500,000.00) with the Bank. Upon the occurrence of the Capitalization Event, Borrower shall deposit with Bank an additional Five Million Dollars ($5,000,000.00). 6.6 FURTHER ASSURANCES. Borrower shall execute any further instruments and take further action as Bank requests to perfect or continue Bank's security interest in the Collateral or to effect the purposes of this Agreement. 6.7 LOSS; DESTRUCTION; OR DAMAGE. Borrower shall bear the risk of the Financed Equipment being lost, stolen, destroyed, or damaged. If during the term of this Agreement any item of Financed Equipment becomes obsolete or is lost, stolen, destroyed, damaged beyond repair, rendered permanently unfit for use, or seized by a governmental authority for any reason for a period 7 equal to at least the remainder of the term of this Agreement (an "Event of Loss"), then in each case, Borrower: (1) prior to the occurrence of an Event of Default, at Borrower's option, shall (i) pay to Bank on account of the Obligations all accrued interest to the date of the prepayment, plus all outstanding principal, plus the Final Payment; or (ii) repair or replace any Financed Equipment subject to an Event of Loss provided the repaired or replaced Financed Equipment is of equal or like value to the Financed Equipment subject to an Event of Loss and provided further that Bank has a first priority perfected security interest in such repaired or replaced Financed Equipment. (2) during the continuance of an Event of Default, on or before the next Payment Date following such Event of Loss, for each such item of Financed Equipment subject to such Event of Loss, Borrower shall, at Bank's option, pay to Bank an amount equal to the sum of: (i) all accrued and unpaid Scheduled Payments (with respect to such Equipment Advance related to the Event of Loss) due prior to the next such Payment Date, (ii) all outstanding principal plus unpaid accrued interest), (iii) the Final Payment plus (iv) all other sums, if any, that shall have become due and payable, including interest at the Default Rate with respect to any past due amounts. (3) On the date of receipt by Bank of the amount specified above with respect to each such item of Financed Equipment subject to an Event of Loss, this Agreement shall terminate as to such Financed Equipment. If any proceeds of insurance or awards received from governmental authorities are in excess of the amount owed under this Section, Bank shall promptly remit to Borrower the amount in excess of the amount owed to Bank. 7 NEGATIVE COVENANTS Borrower shall not do any of the following without the Bank's written consent, which shall not be unreasonably withheld: 7.1 DISPOSITIONS. Convey, sell, lease, transfer or otherwise dispose of (collectively a "Transfer"), or permit any of its Subsidiaries to Transfer, all or any material part of the Collateral, other than a Transfer (i) of inventory in the ordinary course of business; (ii) of non-exclusive licenses and similar arrangements for the use of the property of Borrower or its Subsidiaries in the ordinary course of business; or (iii) of worn-out or obsolete Equipment. 7.2 CHANGES IN BUSINESS, OWNERSHIP, MANAGEMENT OR BUSINESS LOCATIONS. Engage in or permit any of its Subsidiaries to engage in any business other than the businesses currently engaged in by Borrower or if either the Chief Financial Officer or the Chief Executive Officer leaves office and a replacement acceptable to the Bank is not made within thirty (30) days. Borrower shall not, without at least thirty (30) days prior written notice to Bank, relocate its principal executive office or add any new offices or business locations. 7.3 COMPLIANCE. Undertake as one of its important activities extending credit to purchase or carry margin stock, or use the proceeds of any Equipment Advance for that purpose; fail to meet 8 the minimum funding requirements of ERISA, permit a Reportable Event or Prohibited Transaction, as defined in ERISA, to occur; fail to comply with the Federal Fair Labor Standards Act or violate any other law or regulation, if the violation could reasonably be expected to have a material adverse effect on Borrower's business or operations or cause a Material Adverse Change, or permit any of its Subsidiaries to do so. 8 EVENTS OF DEFAULT Any one of the following is an Event of Default: 8.1 PAYMENT DEFAULT. Borrower fails to pay any of the Obligations within three (3) days after their due date. During the additional period the failure to cure the default is not an Event of Default (but no Credit Extensions shall be made during the cure period); 8.2 COVENANT DEFAULT. Borrower does not perform any obligation in Section 6 or violates any covenant in Section 7 or does not perform or observe any other material term, condition or covenant in this Agreement, any Loan Documents, or in any agreement between Borrower and Bank and as to any default under a term, condition or covenant that can be cured, has not cured the default within ten (10) days after it occurs, or if the default cannot be cured within ten (10) days or cannot be cured after Borrower's attempts in the ten (10) day period, and the default may be cured within a reasonable time, then Borrower shall have additional time, (of not more than thirty (30) days) to attempt to cure the default. During the additional period the failure to cure the default is not an Event of Default (but no Credit Extensions shall be made during the cure period); 8.3 MATERIAL ADVERSE CHANGE. (i) A material impairment in the perfection or priority of Bank's security interest in the Collateral or in the value of such Collateral which is not covered by adequate insurance occurs; or (ii) Bank determines, based upon information available to it and in its reasonable judgment, that there is a reasonable likelihood that Borrower shall fail to comply with one or more of the financial covenants in Section 6 during the next succeeding financial reporting period; 8.4 ATTACHMENT. (i) Any material portion of Borrower's assets is attached, seized, levied on, or comes into possession of a trustee or receiver and the attachment, seizure or levy is not removed in thirty (30) days; (ii) Borrower is enjoined, restrained, or prevented by court order from conducting a material part of its business; (iii) a judgment or other claim becomes a Lien on a material portion of Borrower's assets; or (iv) a notice of lien, levy, or assessment is filed against any of Borrower's assets by any government agency and not paid within ten (10) days after Borrower receives notice. These are not Events of Default if stayed or if a bond is posted pending contest by Borrower (but no Credit Extensions shall be made during the cure period); 8.5 INSOLVENCY. (i) Borrower becomes insolvent; (ii) Borrower begins an Insolvency Proceeding; or (iii) an Insolvency Proceeding is begun against Borrower and not dismissed or stayed within forty-five (45) days (but no Credit Extensions shall be made before any Insolvency Proceeding is dismissed); 9 8.6 OTHER AGREEMENTS. If there is a default in any agreement to which Borrower is a party with a third party or parties resulting in a right by such third party or parties, whether or not exercised, to accelerate the maturity of any Indebtedness in an amount in excess of Two Hundred Fifty Thousand Dollars ($250,000) or that could have a Material Adverse Effect; 8.7 JUDGMENTS. If a judgment or judgments for the payment of money in an amount, individually or in the aggregate, of at least Two Hundred Fifty Thousand Dollars ($250,000) shall be rendered against Borrower and shall remain unsatisfied and unstayed for a period of thirty (30) days (provided that no Credit Extensions will be made prior to the satisfaction or stay of such judgment); 8.8 MISREPRESENTATIONS. If Borrower or any Person acting for Borrower makes any material misrepresentation or material misstatement now or later in any warranty or representation in this Agreement or in any communication delivered to Bank or to induce Bank to enter this Agreement or any Loan Document. 9 BANK'S RIGHTS AND REMEDIES 9.1 RIGHTS AND REMEDIES. When an Event of Default occurs and continues Bank may, without notice or demand, do any or all of the following in accordance with applicable law: (1) Declare all Obligations immediately due and payable (but if an Event of Default described in Section 8.5 occurs all Obligations are immediately due and payable without any action by Bank); (2) Stop advancing money or extending credit for Borrower's benefit under this Agreement or under any other agreement between Borrower and Bank; (3) Make any payments and do any acts it considers necessary or reasonable to protect its security interest in the Collateral. Borrower shall assemble the Collateral if Bank requests and make it available as Bank designates. Bank may enter premises where the Collateral is located, take and maintain possession of any part of the Collateral, and pay, purchase, contest, or compromise any Lien which appears to be prior or superior to its security interest and pay all expenses incurred. Borrower grants Bank a license to enter and occupy any of its premises, without charge, to exercise any of Bank's rights or remedies; (4) Apply to the Obligations any (i) balances and deposits of Borrower it holds, or (ii) any amount held by Bank owing to or for the credit or the account of Borrower; (5) Ship, reclaim, recover, store, finish, maintain, repair, prepare for sale, advertise for sale, and sell the Collateral; and (6) Dispose of the Collateral according to the Code. 10 9.2 POWER OF ATTORNEY. Borrower hereby irrevocably appoints Bank as its lawful attorney-in-fact, to be effective upon the occurrence and during the continuance of an Event of Default, to: (i) endorse Borrower's name on any checks or other forms of payment or security; (ii) make, settle, and adjust all claims under Borrower's insurance policies; and (iii) transfer the Collateral into the name of Bank or a third party as the Code permits. Borrower hereby appoints Bank its power of attorney to sign Borrower's name on any documents necessary to perfect or continue the perfection of any security interest regardless of whether an Event of Default has occurred until all Obligations have been satisfied in full and Bank is under no further obligation to make Credit Extensions hereunder. Bank's foregoing appointment as Borrower's attorney in fact, and all of Bank's rights and powers, coupled with an interest, are irrevocable until all Obligations have been fully repaid and performed and Bank's obligation to provide Credit Extensions terminates. 9.3 BANK EXPENSES. If Borrower fails to obtain insurance as required under Section 6.4 or to pay any amount or furnish any required proof of payment to third persons and the Bank, Bank may make all or part of the payment or obtain such insurance policies required in Section 6.4, and take any action under the policies Bank deems prudent. Any amounts paid by Bank as provided herein are Bank Expenses and are immediately due and payable, bearing interest at the then applicable rate and secured by the Collateral. No payments by Bank are deemed an agreement to make similar payments in the future or Bank's waiver of any Event of Default. 9.4 BANK'S LIABILITY FOR COLLATERAL. So long as the Bank complies with reasonable banking practices and applicable law regarding the safekeeping of collateral, the Bank shall not be liable or responsible for: (a) the safekeeping of the Collateral; (b) any loss or damage to the Collateral; (c) any diminution in the value of the Collateral; or (d) any act or default of any carrier, warehouseman, bailee, or other person. Borrower bears all risk of loss, damage or destruction of the Collateral. 9.5 REMEDIES CUMULATIVE. Bank's rights and remedies under this Agreement, the Loan Documents, and all other agreements are cumulative. Bank has all rights and remedies provided under the Code, by law, or in equity. Bank's exercise of one right or remedy is not an election, and Bank's waiver of any Event of Default is not a continuing waiver. Bank's delay is not a waiver, election, or acquiescence. No waiver is effective unless signed by Bank and then is only effective for the specific instance and purpose for which it was given. 9.6 DEMAND WAIVER. Borrower waives demand, notice of default or dishonor, notice of payment and nonpayment, notice of any default, nonpayment at maturity, release, compromise, settlement, extension, or renewal of accounts, documents, instruments, chattel paper, and guaranties held by Bank on which Borrower is liable. 10 NOTICES All notices or demands by any party to this Agreement or any other related agreement must be in writing and be personally delivered or sent by an overnight delivery service, by certified mail, 11 postage prepaid, return receipt requested, or by telefacsimile at the addresses listed at the beginning of this Agreement. Either Bank or Borrower may change its notice address by giving the other written notice. If to Borrower: Smarterkids.com, Inc. 15 Crawford Street Needham, Massachusetts 02494 Attn: Robert Cahill FAX: (781) 449-4887 with a copy to: Testa, Hurwitz & Thibeault, LLP High Street Tower 125 High Street Boston, Massachusetts 02110 Attn: Gordon H. Hayes, Esq. If to Bank: Silicon Valley Bank 40 William Street Wellesley, Massachusetts 02481 Attn: Douglas W. Marshall FAX: (781) 431-9906 with a copy to: Riemer & Braunstein LLP Three Center Plaza Boston, Massachusetts 02108 Attn: David A. Ephraim, Esquire FAX: (617) 880-3456 11 CHOICE OF LAW, VENUE AND JURY TRIAL WAIVER Massachusetts law governs the Loan Documents without regard to principles of conflicts of law. Borrower and Bank each submit to the exclusive jurisdiction of the State and Federal courts in Suffolk County, Massachusetts; provided, however, that if for any reason Bank cannot avail itself of such courts in the Commonwealth of Massachusetts, Borrower accepts jurisdiction of the courts and venue in Santa Clara County, California. BORROWER AND BANK EACH WAIVE THEIR RIGHT TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION ARISING OUT OF OR BASED UPON THIS AGREEMENT, THE LOAN DOCUMENTS OR ANY CONTEMPLATED TRANSACTION, INCLUDING CONTRACT, TORT, BREACH OF DUTY AND ALL OTHER CLAIMS. THIS WAIVER IS A MATERIAL INDUCEMENT FOR BOTH PARTIES TO ENTER INTO THIS AGREEMENT. EACH PARTY HAS REVIEWED THIS WAIVER WITH ITS COUNSEL. 12 GENERAL PROVISIONS 12.1 SUCCESSORS AND ASSIGNS. This Agreement binds and is for the benefit of the successors and permitted assigns of each party. Borrower may not assign this Agreement or any 12 rights or Obligations under it without Bank's prior written consent which may be granted or withheld in Bank's discretion. Bank has the right, without the consent of or notice to Borrower, to sell, transfer, negotiate, or grant participation in all or any part of, or any interest in, Bank's obligations, rights and benefits under this Agreement, the Loan Documents or any related agreement. 12.2 INDEMNIFICATION. Borrower hereby indemnifies, defends and holds the Bank and its officers, employees and agents harmless against: (a) all obligations, demands, claims, and liabilities asserted by any other party in connection with the transactions contemplated by the Loan Documents; and (b) all losses or Bank Expenses incurred, or paid by Bank from, following, or consequential to transactions between Bank and Borrower (including reasonable attorneys' fees and expenses), except for losses caused by Bank's gross negligence or willful misconduct. 12.3 TIME OF ESSENCE. Time is of the essence for the performance of all Obligations in this Agreement. 12.4 SEVERABILITY OF PROVISION. Each provision of this Agreement is severable from every other provision in determining the enforceability of any provision. 12.5 AMENDMENTS IN WRITING, INTEGRATION. All amendments to this Agreement must be in writing signed by both Bank and Borrower. This Agreement and the Loan Documents represent the entire agreement about this subject matter, and supersedes prior or contemporaneous negotiations or agreements. All prior or contemporaneous agreements, understandings, representations, warranties, and negotiations between the parties about the subject matter of this Agreement and the Loan Documents merge into this Agreement and the Loan Documents. 12.6 COUNTERPARTS. This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which, when executed and delivered, are an original, and all taken together, are one Agreement. 12.7 SURVIVAL. All covenants, representations and warranties made in this Agreement continue in full force while any Obligations remain outstanding. The obligations of Borrower in Section 12.2 to indemnify Bank shall survive until all statutes of limitations for actions that may be brought against Bank have run. 12.8 CONFIDENTIALITY. In handling any confidential information, Bank shall exercise the same degree of care that it exercises for its own proprietary information, but disclosure of information may be made: (i) to Bank's subsidiaries or affiliates in connection with their present or prospective business relations with Borrower; (ii) to prospective transferees or purchasers of any interest in the Loans; (iii) as required by law, regulation, subpoena, or other order, (iv) as required in connection with Bank's examination or audit; and (v) as Bank considers appropriate in exercising remedies under this Agreement. Confidential information does not include information that either: (a) is in the public domain or in Bank's possession when disclosed to Bank, or becomes part of the public domain after disclosure to Bank; or (b) is disclosed to Bank by a third party, if Bank does not know that the third party is prohibited from disclosing the information. 13 12.9 ATTORNEYS' FEES, COSTS AND EXPENSES. In any action or proceeding between Borrower and Bank arising out of the Loan Documents, the prevailing party shall be entitled to recover its reasonable attorneys' fees and other costs and expenses incurred, in addition to any other relief to which it may be entitled, whether or not a lawsuit is filed. 13 DEFINITIONS 13.1 DEFINITIONS. "AFFILIATE" of a Person is a Person that owns or controls directly or indirectly the Person, any Person that controls or is controlled by or is under common control with the Person, and each of that Person's senior executive officers, directors, partners and, for any Person that is a limited liability company, that Person's managers and members. "BANK EXPENSES" are all audit fees and expenses and reasonable costs or expenses (including reasonable attorneys' fees and expenses) for preparing, negotiating, administering, defending and enforcing the Loan Documents (including appeals or Insolvency Proceedings). "BASIC RATE" is, as of the Funding Date the per annum rate of interest (based on a year of 360 days) equal to the sum of (a) U.S. Treasury note yield to maturity for a term equal to the Treasury Note Maturity as quoted in the Wall Street Journal on the day the Loan Supplement is prepared, plus (b) the Loan Margin. "BUSINESS DAY" is any day that is not a Saturday, Sunday or a day on which the Bank is closed. "CAPITALIZATION EVENT" is the making and completion by the Borrower of an initial public offering. "CHIEF EXECUTIVE OFFICER" is David Blohm. "CHIEF FINANCIAL OFFICER" is Robert Cahill. "CLOSING DATE" is the date of this Agreement. "CODE" is the Massachusetts Uniform Commercial Code. "COLLATERAL" is the property described on Exhibit A. --------- "COMMITTED EQUIPMENT LINE" is an Equipment Advance or Equipment Advances of up to One Million Five Hundred Thousand Dollars ($1,500,000.00). 14 "COMMITMENT TERMINATION DATE" shall be the date which is the one year anniversary of the Closing Date. "CONTINGENT OBLIGATION" is, for any Person, any direct or indirect liability, contingent or not, of that Person for (i) any indebtedness, lease, dividend, letter of credit or other obligation of another such as an obligation directly or indirectly guaranteed, endorsed, co-made, discounted or sold with recourse by that Person, or for which that Person is directly or indirectly liable; (ii) any obligations for undrawn letters of credit for the account of that Person; and (iii) all obligations from any interest rate, currency or commodity swap agreement, interest rate cap or collar agreement, or other agreement or arrangement designated to protect a Person against fluctuation in interest rates, currency exchange rates or commodity prices; but "Contingent Obligation" does not include endorsements in the ordinary course of business. The amount of a Contingent Obligation is the stated or determined amount of the primary obligation for which the Contingent Obligation is made or, if not determinable, the maximum reasonably anticipated liability for it determined by the Person in good faith; but the amount may not exceed the maximum of the obligations under the guarantee or other support arrangement. "CREDIT EXTENSION" is each Equipment Advance or any other extension of credit by Bank for Borrower's benefit. "ELIGIBLE EQUIPMENT" is (a) general purpose computer equipment, office equipment, test and laboratory equipment, furnishings, and (b) Other Equipment that complies with all of Borrower's representations and warranties to Bank and which is reasonably acceptable to Bank in all respects. "EQUIPMENT" is all present and future machinery, equipment, tenant improvements, furniture, fixtures, vehicles, tools, parts and attachments in which Borrower has any interest. "EQUIPMENT ADVANCE" is defined in Section 2.1.1. "ERISA" is the Employment Retirement Income Security Act of 1974, and its regulations. "EVENT OF LOSS" is defined in Section 6.7. "FINAL PAYMENT" is a payment (in addition to and not a substitution for the regular monthly payments of principal plus accrued interest) due on the Maturity Date for such Equipment Advance equal to the Loan Amount for such Equipment Advance at such time multiplied by the Final Payment Percentage. "FINAL PAYMENT PERCENTAGE" is, for each Equipment Advance, five percent (5.0%). "FINANCED EQUIPMENT" is all present and future Eligible Equipment in which Borrower has any interest, the purchase of which is financed by an Equipment Advance. 15 "FUNDING DATE" is any date on which an Equipment Advance is made to or on account of Borrower. "GAAP" is generally accepted accounting principles. "INDEBTEDNESS" is (a) indebtedness for borrowed money or the deferred price of property or services, such as reimbursement and other obligations for surety bonds and letters of credit, (b) obligations evidenced by notes, bonds, debentures or similar instruments, (c) capital lease obligations and (d) Contingent Obligations. "INSOLVENCY PROCEEDING" is any proceeding by or against any Person under the United States Bankruptcy Code, or any other bankruptcy or insolvency law, including assignments for the benefit of creditors, compositions, extensions generally with its creditors, or proceedings seeking reorganization, arrangement, or other relief. "LIEN" is a mortgage, lien, deed of trust, charge, pledge, security interest or other encumbrance. "LOAN AMOUNT" in respect of each Equipment Advance is the aggregate amount of such Equipment Advance. "LOAN DOCUMENTS" are, collectively, this Agreement, any note executed by Borrower, and any other present or future agreement between Borrower and/or for the benefit of Bank in connection with this Agreement, all as amended, extended or restated. "LOAN FACTOR" is the percentage which results from dividing (i) the monthly Scheduled Payment with respect to the applicable Equipment Advance by (ii) the original principal amount of such Equipment Advance. "LOAN MARGIN" is three hundred fifty (350) basis points. "LOAN SUPPLEMENT" is defined in Section 2.1.1(b) and attached as Exhibit B. --------- "MATERIAL ADVERSE CHANGE " is defined in Section 8.3. "MATURITY DATE" is, with respect to each Equipment Advance, the last day of the Repayment Period for such Equipment Advance, or if earlier, the date of acceleration of such Equipment Advance by Bank following an Event of Default. "OBLIGATIONS" are debts, principal, interest, Bank Expenses and other amounts Borrower owes Bank now or later, including letters of credit and foreign exchange contracts, if any, and including interest accruing after Insolvency Proceedings begin and debts, liabilities, or obligations of Borrower assigned to Bank. 16 "ORIGINAL STATED COST" is: (i) the original cost to the Borrower of the item of new Equipment net of any and all freight, installation, tax, or (ii) the fair market value assigned to such item of used Equipment by mutual agreement of Borrower and Bank at the time of making of the Equipment Advance. "OTHER EQUIPMENT" is leasehold improvements, intangible property such as computer software and software licenses, equipment specifically designed or manufactured for Borrower, other intangible property, limited use property and other similar property and soft costs approved by the Bank, including sales tax, freight and installation expenses. Unless otherwise agreed to by Bank, not more than 25% of the aggregate Equipment Advances shall consist of Other Equipment. "PAYMENT DATE" is defined in Section 2.2(a). "PERSON" is any individual, sole proprietorship, partnership, limited liability company, joint venture, company, trust, unincorporated organization, association, corporation, institution, public benefit corporation, firm, joint stock company, estate, entity or government agency. "REPAYMENT PERIOD," as to each Equipment Advance, is thirty six (36) months from the Funding Date of such Equipment Advance. "RESPONSIBLE OFFICER" is each of the Chief Executive Officer, President, Chief Financial Officer and Controller of Borrower. "SCHEDULE" is any attached schedule of exceptions. "SCHEDULED PAYMENT" is defined in Section 2.2(a). "SUBORDINATED DEBT" is debt incurred by Borrower subordinated to Borrower's debt to Bank (pursuant to a subordination agreement entered into between the Bank, the Borrower and the subordinated creditor). "SUBSIDIARY" is for any Person, joint venture, or any other business entity of which more than 50% of the voting stock or other equity interests is owned or controlled, directly or indirectly, by the Person or one or more Affiliates of the Person. "TREASURY NOTE MATURITY" is thirty six (36) months. 17 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as a sealed instrument under the laws of the Commonwealth of Massachusetts as of the date first above written. BORROWER: SMARTERKIDS.COM, INC. By_________________________________________ Name:______________________________________ Title:_____________________________________ BANK: SILICON VALLEY BANK, d/b/a SILICON VALLEY EAST By_________________________________________ Name:______________________________________ Title:_____________________________________ SILICON VALLEY BANK By_________________________________________ Name:______________________________________ Title:_____________________________________ (Signed in Santa Clara County, California) 525425.4 (56120/232) 18 EXHIBIT A --------- The Collateral consists of all of Borrower's right, title and interest in and to the following: Each item of equipment, or personal property financed with a "Equipment Advance" pursuant to that certain Loan and Security Agreement, dated as of _______________________________, 1999 (the "Loan Agreement"), by and between Borrower and Bank, including, without limitation, the property described in Annex A hereto, whether now owned or hereafter acquired, together with all substitutions, renewals or replacements of and additions, improvements, and accessions to any and all of the foregoing, and all proceeds from sales, renewals, releases or other dispositions thereof. 19 ANNEX A TO EXHIBIT A -------------------- The Financed Equipment being financed with the Equipment Advance is listed below. Upon the funding of such Equipment Advance, this schedule automatically shall be deemed to be a part of the Collateral. Description of Equipment Make Model Serial # Invoice# 20 EXHIBIT B --------- FORM OF LOAN AGREEMENT SUPPLEMENT LOAN AGREEMENT SUPPLEMENT No. [ ] LOAN AGREEMENT SUPPLEMENT No. [ ], dated ______________, ______ ("Supplement"), to the Loan and Security Agreement dated as of ______________, 1999 (the "Loan Agreement) by and between the undersigned Smarterkids.com, Inc. ("Borrower"), and Silicon Valley Bank ("Bank"). Capitalized terms used herein but not otherwise defined herein are used with the respective meanings given to such terms in the Loan Agreement. To secure the prompt payment by Borrower of all amounts from time to time outstanding under the Loan Agreement, and the performance by Borrower of all the terms contained in the Loan Agreement, Borrower grants Bank, a first priority security interest in each item of equipment and other property described in Annex A hereto, which equipment and other property shall be deemed to be additional Financed Equipment and Collateral. The Loan Agreement is hereby incorporated by reference herein and is hereby ratified, approved and confirmed. Annex A (Equipment Schedule) and Annex B (Loan Terms Schedule) are attached hereto. The proceeds of the Loan should be transferred to Borrower's account with Bank set forth below: Bank Name: Silicon Valley Bank Account No.: ____________________________ Borrower hereby certifies that (a) the foregoing information is true and correct and authorizes Bank to endorse in its respective books and records, the Basic Rate applicable to the Funding Date of the Loan contemplated in this Loan Agreement Supplement and the principal amount set forth in the Loan Terms Schedule; (b) the representations and warranties made by Borrower in the Loan Agreement are true and correct on the date hereof and shall be true and correct on such Funding Date. No Event of Default has occurred and is continuing under the Loan Agreement. This Supplement may be executed by Borrower and Bank in separate counterparts, each of which when so executed and delivered shall be an original, but all such counterparts shall together constitute but one and the same instrument. This Supplement is delivered as of this day and year first above written. SILICON VALLEY BANK SMARTERKIDS.COM, INC. By: By: ------------------------------ ------------------------------ Name: Name: ---------------------------- ---------------------------- Title: Title: --------------------------- --------------------------- Annex A - Description of Financed Equipment Annex B - Loan Terms Schedule 21 ANNEX A TO EXHIBIT B -------------------- The Financed Equipment being financed with the Equipment Advance which this Loan Agreement Supplement is being executed is listed below. Upon the funding of such Equipment Advance, this schedule automatically shall be deemed to be a part of the Collateral. Description of Equipment Make Model Serial # Invoice# 22 ANNEX B TO EXHIBIT B LOAN TERMS SCHEDULE #______ Loan Funding Date: _____________, ____ Original Loan Amount: $____________ Basic Rate: ______% Loan Factor: ______% Scheduled Payment Dates and Amounts*: One (1) payment of $_______ due ______________ ______ payment of $_______ due monthly in advance from _____ through_____. One (1) payment of $_______ due ______________ Maturity Date: ____________ Final Payment: An additional amount equal to the Final Payment Percentage multiplied by the Loan Amount then in effect, shall be paid on the Maturity Date with respect to such Loan. Payment No. Payment Date 1 2 3 4 . . . 35 [36] . . . */ The amount of each Scheduled Payment shall change as the Loan Amount changes. 23 EXHIBIT C COMPLIANCE CERTIFICATE TO: SILICON VALLEY BANK FROM: SMARTERKIDS.COM, INC. The undersigned authorized officer of SMARTERKIDS.COM, INC. certifies that under the terms and conditions of the Loan and Security Agreement between Borrower and Bank (the "Agreement"), (i) Borrower is in complete compliance for the period ending _______________ with all required covenants except as noted below and (ii) all representations and warranties in the Agreement are true and correct in all material respects on this date. Attached are the required documents supporting the certification. The Officer certifies that these are prepared in accordance with Generally Accepted Accounting Principles (GAAP) consistently applied from one period to the next except as explained in an accompanying letter or footnotes. The Officer acknowledges that no borrowings may be requested at any time or date of determination that Borrower is not in compliance with any of the terms of the Agreement, and that compliance is determined not just at the date this certificate is delivered. PLEASE INDICATE COMPLIANCE STATUS BY CIRCLING YES/NO UNDER "COMPLIES" COLUMN.
REPORTING COVENANT REQUIRED COMPLIES - ------------------ -------- -------- Financial statements with Compliance Certificate (a) Prior to Capitalization Event: Monthly within 30 days Yes No (b) After Capitalization Event: Quarterly within 45 days Yes No Annual (CPA Audited) FYE within 90 days Yes No 10-Q, 10-K and 8-K Within 5 days after filing with SEC Yes No COVENANTS REQUIRED ACTUAL COMPLIES - --------- -------- ------ -------- Deposit at Closing $2,500,000.00 $_______ Yes No Deposit at Occurrence of Capitalization Event $5,000,000.00 $_______ Yes No
COMMENTS REGARDING EXCEPTIONS: See Attached. --------------------------------------- Sincerely, BANK USE ONLY _____________________________ Received by: _____________________ Signature AUTHORIZED SIGNER _____________________________ Date: _________________________ Title Verified: ________________________ _____________________________ AUTHORIZED SIGNER Date Date: ______________________ 525425.4 (56120/232) Compliance Status: Yes No 3 --------------------------------------- 24 EX-10.13 14 0014.txt FORM OF EXECUTIVE OPTION AGREEMENT OF SMARTERKIDS.COM, INC. EXHIBIT 10.13 SMARTERKIDS.COM,INC. 1999 Incentive Stock Option Agreement ------------------------------------- SmarterKids.com, Inc. (the "Company") hereby grants the following stock option pursuant to its 1999 Stock Option and Incentive Plan. The terms and conditions attached hereto are also a part hereof. Name of Employee (the "Employee"): - ------------------------------------------------------------------------------ Date of this option grant: - ------------------------------------------------------------------------------ Number of shares of the Company's Common Stock subject to this option ("Option Shares"): - ------------------------------------------------------------------------------ Option exercise price per share: - ------------------------------------------------------------------------------ Number, if any, of Option Shares that may be purchased on or after grant date: - ------------------------------------------------------------------------------ Number of Option Shares subject to vesting schedule: - ------------------------------------------------------------------------------ Vesting Start Date: - ------------------------------------------------------------------------------
Vesting Schedule: - ------------------------------------------------------------------------------------------- One year anniversary date (the "One Year Anniversary shares Date") from Vesting Start Date: - ------------------------------------------------------------------------------------------- End of Yearly Calendar Quarter (the "First Calendar shares Quarter Vesting Period") containing the One Year Anniversary Date: - ------------------------------------------------------------------------------------------- End of Each Calendar Quarter following the First Calendar shares Quarter Vesting Period: - ------------------------------------------------------------------------------------------- Four Years from Vesting Start Date: All remaining shares - ------------------------------------------------------------------------------------------- Payment alternatives (specify any or all of Section Section 7(a) (i) through (iii) 7(a)(i) though (iii): - -------------------------------------------------------------------------------------------
=========================================================================================== SmarterKids.com, Inc. - ------------------------------------ Signature of Employee By: --------------------------------- - ------------------------------------ Name of Officer: Street Address Title: - ------------------------------------ City/State/Zip Code
SMARTERKIDS.COM, INC. 1999 INCENTIVE STOCK OPTION AGREEMENT -- INCORPORATED TERMS AND CONDITIONS -------------------------------------------------------------------------- 1. Grant Under Plan. This option is granted pursuant to and is governed by the Company's 1999 Stock Option and Incentive Plan (the "Plan") and, unless the context otherwise requires, terms used herein shall have the same meaning as in the Plan. 2. Grant as Incentive Stock Option. This option is intended to qualify as an incentive stock option under Section 422 of the Internal Revenue Code of 1986, as amended, and the regulations thereunder (the "Code"). 3. Vesting of Option if Employment Continues. The Employee may exercise this option on or after the date of this option grant for the number of shares of Common Stock, if any, indicated on the cover page hereof. If the Employee has remained continuously employed by the Company through the dates listed on the vesting schedule set forth on the cover page hereof, the Employee may exercise this option for the additional number of shares of Common Stock set opposite the applicable vesting date. In the event of an Acquisition, the final four calendar quarter vesting installments (or such lesser number which may not be vested at such time) of the Vesting Schedule shall become immediately vested immediately prior to the closing of such Acquisition. Notwithstanding the foregoing, the Board may, in its discretion, accelerate the date that any installment of this option becomes exercisable. The foregoing rights are cumulative and (subject to Sections 4 or 5 hereof if the Employee ceases to be employed by the Company) may be exercised only before the date which is [ten] years from the date of this option grant. 4. Termination of Employment. (a) Termination Other Than for Cause. If the Employee ceases to be employed by the Company, other than by reason of death or disability as defined in Section 5 or termination for Cause as defined in Section 4(c), no further installments of this option shall become exercisable, and this option may no longer be exercised after the passage of three months from the Employee's last day of employment, but in no event later than the scheduled expiration date. For purposes hereof, employment shall not be considered as having terminated during any leave of absence if such leave of absence has been approved in writing by the Company and if such written approval contractually obligates the Company to continue the employment of the Employee after the approved period of absence; in the event of such an approved leave of absence, vesting of this option shall be suspended (and the period of the leave of absence shall be added to all vesting dates) unless otherwise provided in the Company's written approval of the leave of absence. For purposes hereof, employment shall include a consulting arrangement between the Employee and the Company that immediately follows termination of employment, but only if so stated in a written consulting agreement executed by the Company that specifically refers to this option. This option shall not be affected by any change of employment within or among the Company and its Subsidiaries so long as the Employee continuously remains an employee of the Company or any Subsidiary. -2- (b) Termination for Cause. If the employment of the Employee is terminated for Cause (as defined in Section 4(c)), this option shall no longer be exercised from and after the Employee's receipt of written notice of such termination and shall thereafter not be exercisable to any extent whatsoever. (c) Definition of Cause. "Cause" shall mean conduct involving one or more of the following: (i) the substantial and continuing failure of the Employee, after notice thereof, to render services to the Company in accordance with the terms or requirements of his or her employment; (ii) disloyalty, gross negligence, willful misconduct, dishonesty, fraud or breach of fiduciary duty to the Company; (iii) deliberate disregard of the rules or policies of the Company, or breach of an employment or other agreement with the Company, which results in direct or indirect loss, damage or injury to the Company; (iv) the unauthorized disclosure of any trade secret or confidential information of the Company; or (v) the commission of an act which constitutes unfair competition with the Company or which induces any customer or supplier to breach a contract with the Company. 5. Death; Disability. (a) Death. If the Employee dies while in the employ of the Company, this option may be exercised, to the extent otherwise exercisable on the date of his or her death, by the Employee's estate, personal representative or beneficiary to whom this option has been transferred pursuant to Section 10, only at any time within 180 days after the date of death, but not later than the scheduled expiration date. (b) Disability. If the Employee ceases to be employed by the Company by reason of his or her disability, this option may be exercised, to the extent otherwise exercisable on the date of cessation of employment, only at any time within 180 days after such cessation of employment, but not later than the scheduled expiration date. For purposes hereof, "disability" means "permanent and total disability" as defined in Section 22(e)(3) of the Code. 6. Partial Exercise. This option may be exercised in part at any time and from time to time within the above limits, except that this option may not be exercised for a fraction of a share. 7. Payment of Exercise Price. (a) Payment Options. The exercise price shall be paid by one or any combination of the following forms of payment that are applicable to this option, as indicated on the cover page hereof: (i) by check payable to the order of the Company; or - 3 - (ii) if the Common Stock is then traded on a national securities exchange or on the Nasdaq National Market (or successor trading system), delivery of an irrevocable and unconditional undertaking, satisfactory in form and substance to the Company, by a creditworthy broker to deliver promptly to the Company sufficient funds to pay the exercise price, or delivery by the Employee to the Company of a copy of irrevocable and unconditional instructions, satisfactory in form and substance to the Company, to a creditworthy broker to deliver promptly to the Company cash or a check sufficient to pay the exercise price; or (iii) subject to Section 7(b) below, if the Common Stock is then traded on a national securities exchange or on the Nasdaq National Market (or successor trading system), by delivery of shares of Common Stock having a fair market value equal as of the date of exercise to the option price. In the case of (iii) above, fair market value as of the date of exercise shall be determined as of the last business day for which such prices or quotes are available prior to the date of exercise and shall mean (i) the last reported sale price (on that date) of the Common Stock on the principal national securities exchange on which the Common Stock is traded, if the Common Stock is then traded on a national securities exchange; or (ii) the last reported sale price (on that date) of the Common Stock on the Nasdaq National Market (or successor trading system), if the Common Stock is not then traded on a national securities exchange. (b) Limitations on Payment by Delivery of Common Stock. If Section 7(a)(iii) is applicable, and if the Employee delivers Common Stock held by the Employee ("Old Stock") to the Company in full or partial payment of the exercise price and the Old Stock so delivered is subject to restrictions or limitations imposed by agreement between the Employee and the Company, an equivalent number of Option Shares shall be subject to all restrictions and limitations applicable to the Old Stock to the extent that the Employee paid for the Option Shares by delivery of Old Stock, in addition to any restrictions or limitations imposed by this Agreement. Notwithstanding the foregoing, the Employee may not pay any part of the exercise price hereof by transferring Common Stock to the Company unless such Common Stock has been owned by the Employee free of any substantial risk of forfeiture for at least six months. 8. Securities Laws Restrictions on Resale. Until registered under the Securities Act of 1933, as amended, or any successor statute (the "Securities Act"), the Option Shares will be of an illiquid nature and will be deemed to be "restricted securities" for purposes of the Securities Act. Accordingly, such shares must be sold in compliance with the registration requirements of the Securities Act or an exemption therefrom. Unless the Option Shares have been registered under the Securities Act, each certificate evidencing any of the Option Shares shall bear a legend substantially as follows: "The shares represented by this certificate are subject to restrictions on transfer and may not be sold, exchanged, transferred, pledged, hypothecated or otherwise - 4 - disposed of except in accordance with and subject to all the terms and conditions of a certain Incentive Stock Option Agreement, a copy of which the Company will furnish to the holder of this certificate upon request and without charge." 9. Method of Exercising Option. Subject to the terms and conditions of this Agreement, this option may be exercised by written notice to the Company at its principal executive office, or to such transfer agent as the Company shall designate. Such notice shall state the election to exercise this option and the number of Option Shares for which it is being exercised and shall be signed by the person or persons so exercising this option. Such notice shall be accompanied by payment of the full purchase price of such shares, and the Company shall deliver a certificate or certificates representing such shares as soon as practicable after the notice shall be received. Such certificate or certificates shall be registered in the name of the person or persons so exercising this option (or, if this option shall be exercised by the Employee and if the Employee shall so request in the notice exercising this option, shall be registered in the name of the Employee and another person jointly, with right of survivorship). In the event this option shall be exercised, pursuant to Section 5 hereof, by any person or persons other than the Employee, such notice shall be accompanied by appropriate proof of the right of such person or persons to exercise this option. 10. Option Not Transferable. This option is not transferable or assignable except by will or by the laws of descent and distribution. During the Employee's lifetime only the Employee can exercise this option. 11. No Obligation to Exercise Option. The grant and acceptance of this option imposes no obligation on the Employee to exercise it. 12. No Obligation to Continue Employment. Neither the Plan, this Agreement, nor the grant of this option imposes any obligation on the Company to continue the Employee in employment. 13. Adjustments. Except as is expressly provided in the Plan with respect to certain changes in the capitalization of the Company, no adjustment shall be made for dividends or similar rights for which the record date is prior to such date of exercise. 14. Withholding Taxes. If the Company in its discretion determines that it is obligated to withhold any tax in connection with the exercise of this option, or in connection with the transfer of, or the lapse of restrictions on, any Common Stock or other property acquired pursuant to this option, the Employee hereby agrees that the Company may withhold from the Employee's wages or other remuneration the appropriate amount of tax. At the discretion of the Company, the amount required to be withheld may be withheld in cash from such wages or other remuneration or in kind from the Common Stock or other property otherwise deliverable to the Employee on exercise of this option. The Employee further agrees that, if the Company does not withhold an amount from the Employee's wages or other remuneration sufficient to satisfy the withholding obligation of the Company, the Employee will make reimbursement on demand, in cash, for the amount underwithheld. - 5 - 15. Restrictions on Transfer; Company's Right of First Refusal. (a) Exercise of Right. Option Shares may not be transferred without the Company's written consent except by will, by the laws of descent and distribution or in accordance with the further provisions of this Section 15. If the Employee desires to transfer all or any part of the Option Shares to any person other than the Company (an "Offeror"), the Employee shall: (i) obtain in writing an irrevocable and unconditional bona fide offer (the "Offer") for the purchase thereof from the Offeror; and (ii) give written notice (the "Option Notice") to the Company setting forth the Employee's desire to transfer such shares, which Option Notice shall be accompanied by a photocopy of the Offer and shall set forth at least the name and address of the Offeror and the price and terms of the Offer. Upon receipt of the Option Notice, the Company shall have an assignable option to purchase any or all of such Option Shares (the "Company Option Shares") specified in the Option Notice, such option to be exercisable by giving, within 15 days after receipt of the Option Notice, a written counter-notice to the Employee. If the Company elects to purchase any or all of such Company Option Shares, it shall be obligated to purchase, and the Employee shall be obligated to sell to the Company, such Company Option Shares at the price and terms indicated in the Offer within 30 days from the date of delivery by the Company of such counter-notice. (b) Sale of Option Shares to Offeror. The Employee may, for 60 days after the expiration of the 15-day option period as set forth in Section 15(a), sell to the Offeror, pursuant to the terms of the Offer, any or all of such Company Option Shares not purchased or agreed to be purchased by the Company or its assignee; provided, however, that the Employee shall not sell such Option Shares to such Offeror if such Offeror is a competitor of the Company and the Company gives written notice to the Employee, within 15 days of its receipt of the Option Notice, stating that the Employee shall not sell his or her Option Shares to such Offeror; and provided, further, that prior to the sale of such Option Shares to an Offeror, such Offeror shall execute an agreement with the Company pursuant to which such Offeror agrees to be subject to the restrictions set forth in this Section 15. If any or all of such Option Shares are not sold pursuant to an Offer within the time permitted above, the unsold Option Shares shall remain subject to the terms of this Section 15. (c) Failure to Deliver Option Shares. If the Employee fails or refuses to deliver on a timely basis duly endorsed certificates representing Company Option Shares to be sold to the Company or its assignee pursuant to this Section 15, the Company or its assignee shall have the right to deposit the purchase price for such Company Option Shares in a special account with any bank or trust company, giving notice of such deposit to the Employee, whereupon such Company Option Shares shall be deemed to have been purchased by the Company or its assignee, as the case may be. All such monies shall be held by the bank or trust company for the benefit of the Employee. All monies deposited with the bank or trust company but remaining unclaimed for two years after the date of deposit shall be repaid by the bank or trust company to the Company on demand, and the Employee shall thereafter look only to the Company for payment. - 6 - (d) Expiration of Company's Right of First Refusal and Transfer Restrictions. The first refusal rights of the Company and the transfer restrictions set forth in this Section 15 shall expire as to Option Shares on the earliest to occur of (i) the tenth anniversary of the date of this Agreement, (ii) immediately prior to the closing of a public offering of Common Stock by the Company pursuant to an effective registration statement filed under the Securities Act, or (iii) the occurrence of an Acquisition. 16. Early Disposition. The Employee agrees to notify the Company in writing immediately after the Employee transfers any Option Shares, if such transfer occurs on or before the later of (a) the date that is two years after the date of this Agreement or (b) the date that is one year after the date on which the Employee acquired such Option Shares. The Employee also agrees to provide the Company with any information concerning any such transfer required by the Company for tax purposes. 17. Lock-up Agreement. The Employee agrees that in the event that the Company effects an initial underwritten public offering of Common Stock registered under the Securities Act, the Option Shares may not be sold, offered for sale or otherwise disposed of, directly or indirectly, without the prior written consent of the managing underwriter(s) of the offering, for such period of time after the execution of an underwriting agreement in connection with such offering that all of the Company's then directors and executive officers agree to be similarly bound. 18. Arbitration. Any dispute, controversy, or claim arising out of, in connection with, or relating to the performance of this Agreement or its termination shall be settled by arbitration in Massachusetts, pursuant to the rules then obtaining of the American Arbitration Association. Any award shall be final, binding and conclusive upon the parties and a judgment rendered thereon may be entered in any court having jurisdiction thereof. 19. Provision of Documentation to Employee. By signing this Agreement the Employee acknowledges receipt of a copy of this Agreement and a copy of the Plan. 20. Miscellaneous. (a) Notices. All notices hereunder shall be in writing and shall be deemed given when sent by certified or registered mail, postage prepaid, return receipt requested, if to the Employee, to the address set forth below or at the address shown on the records of the Company, and if to the Company, to the Company's principal executive offices, attention of the Corporate Secretary. (b) Entire Agreement; Modification. This Agreement constitutes the entire agreement between the parties relative to the subject matter hereof, and supersedes all proposals, written or oral, and all other communications between the parties relating to the subject matter of this Agreement. This Agreement may be modified, amended or rescinded only by a written agreement executed by both parties. - 7 - (c) Fractional Shares. If this option becomes exercisable for a fraction of a share because of the adjustment provisions contained in the Plan, such fraction shall be rounded down. (d) Issuances of Securities; Changes in Capital Structure. Except as expressly provided herein or in the Plan, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares subject to this option. No adjustments need be made for dividends paid in cash or in property other than securities of the Company. If there shall be any change in the Common Stock of the Company through merger, consolidation, reorganization, recapitalization, stock dividend, stock split, combination or exchange of shares, liquidation, spin-off, split-up or other similar change in capitalization or event, the restrictions contained in this Agreement shall apply with equal force to additional and/or substitute securities, if any, received by the Employee in exchange for, or by virtue of his or her ownership of, Option Shares, except as otherwise determined by the Board. (e) Definition of Good Reason. "Good reason" means, with respect to any Employee, any of the following actions taken without the Employee's consent: (i) a reduction by the Company in the Employee's annual base salary as in effect on the date of the consummation of the Acquisition or as the same may be increased from time to time; or (ii) the failure by the Company to pay to the Employee any portion of the Employee's current compensation within seven (7) days of the date such compensation is due; or (iii) a substantial reduction in the value of the Employee's benefit package from the value of the Employee's benefit package on the date of the consummation of the Acquisition. (f) Severability. The invalidity, illegality or unenforceability of any provision of this Agreement shall in no way affect the validity, legality or enforceability of any other provision. (g) Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, subject to the limitations set forth in Section 10 hereof. (h) Governing Law. This Agreement shall be governed by and interpreted in accordance with the laws of Massachusetts, without giving effect to the principles of the conflicts of laws thereof. EX-10.14 15 0015.txt CHANGE OF CONTROL AGREEMENT FOR EXECUTIVE OFFICERS Exhibit 10.14 CHANGE OF CONTROL AGREEMENT --------------------------- CHANGE OF CONTROL AGREEMENT, dated as of September 7, 2000, by and between SmarterKids.com. (the "Company") and __________ (the "Executive"). This Agreement supercedes any other agreement between the parties. WHEREAS, the Company believes it to be to its advantage to employ the Executive to render services to the Company as hereinafter provided; WHEREAS, the Company desires continuity of management; and WHEREAS, the Executive is willing to continue to render services to the Company subject to the conditions set forth in this Agreement. NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the Company and the Executive agree as follows: 1. TERMINATION FOLLOWING A CHANGE OF CONTROL. ----------------------------------------- (a) If, at any time after a Change in Control (as such term is defined in Section 3(b)), but prior to the date three (3) years from the date of a Change in Control, the Company terminates the Executive's employment, the Company shall: (i) continue to pay to the Executive, in accordance with the Company's normal payroll practices and policies in effect from time to time (including any required withholding), the Executive's base salary (at the monthly base salary rate in effect for such Executive immediately prior to the termination of his employment) until the earlier of (i) six (6) months following the termination of the Executive's employment, or (ii) the date the Executive is employed by a subsequent employer or is engaged as a consultant (note: in the event of consulting income of less than base salary, the Company will compensate the difference) (the "Severance Payments"); provided, however, that the Company shall not be obligated to make any Severance Payments pursuant to this Section 1(a) during any period in which the Executive is in violation of the terms of his/her Employee Noncompetition, Nondisclosure and Developments Agreement with the Company; (ii) the date of the Executive's termination shall be the date of the "qualifying event" under the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA"). If the Executive elects to continue medical insurance coverage after termination in accordance with the provisions of COBRA, the Company shall pay the Executive's monthly premium payments until the earlier of (i) the date which is six (6) months following the termination of the Executive's employment; (ii) the date the Executive obtains other employment, or (iii) the date the Executive's COBRA continuation coverage would terminate in accordance with the provisions A-2 of COBRA. Thereafter, if the payment of monthly premiums by the Company has ceased due to a reason in (i) or (ii) above, the Executive will be responsible for any and all payments for the remaining period of elected continued health insurance coverage under COBRA. (iii) In addition to any other vesting provisions that the Executive may be entitled to in accordance with other agreements with the Company, accelerate the vesting of all of the Executive's incentive and non- qualified stock options by six (6) months from the date of the termination; (b) For purposes of Section 1, "Good Reason" shall mean the occurrence of one or more of the following events following a Change of Control: (i) the assignment to the Executive of any duties substantially inconsistent with his position, authority, duties or responsibilities immediately prior to the Change of Control or any other action by the Company which results in a substantial limitation in such position, authority, duties or responsibilities; (ii) a substantial reduction in the aggregate of the Executive's base or incentive compensation of the termination of the Executive's rights or any employee benefits immediately prior to the Change of Control, except to the extent any such benefit is replaced with a substantially similar benefit, or a reduction in scope of value thereof; or (iii) a relocation of the Executive's place of business which results in the one-way commuting distance for the Executive increasing by more than 50 miles from the location thereof immediately prior to the Change of Control (provided, however, that travel consistent with past practices for business purposes shall not be considered "commuting" for purposes of this clause (iii)); or (iv) a failure by the Company to obtain the agreement referenced in Section 3(f). 2. TERM. If a Change of Control has not occurred within three (3) years ---- from the date hereof, this Agreement shall terminate and be of no further force and effect. 3. GENERAL. ------- (a) Notwithstanding anything else to the contrary herein: (i) the Company's obligation to provide any of the amounts and benefits set forth in this Agreement shall be subject to, and conditioned upon, the Executive's execution of a full release of claims satisfactory to the Company releasing the Company and its affiliates, subsidiaries, divisions, directors, employees and agents from any claims arising from or related to the Executive's employment or severance from employment with the Company, including any claims arising from this Agreement (the "Release"); (ii) the Company shall not be obligated to provide any of the amounts and benefits set forth in this Agreement until any applicable period within which the Executive may revoke the Release has expired; and (iii) any amounts and benefits set forth in this Agreement shall be reduced by any and all other severance or other amounts or benefits paid or payable to the Executive as a result of the termination of his employment. (b) In the event the Executive's employment with the Company is terminated by the Company for any reason other than without Cause, or the Executive terminates his employment with the Company for any reason other than Good Reason, the Executive shall not be entitled to any severance benefits or other considerations described herein. A-3 (c) For purposes of this Agreement, "Change of Control" shall mean the closing of: (i) a merger, consolidation, liquidation or reorganization of the Company into or with another Company or other legal person, after which merger, consolidation, liquidation or reorganization the capital stock of the Company outstanding prior to consummation of the transaction is not converted into or exchanged for or does not represent more than 50% of the aggregate voting power of the surviving or resulting entity; or (ii) the direct or indirect acquisition by any person (as the term "person" is used in Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended) of more than 50% of the voting capital stock of the Company, in a single or series of related transactions. (d) For purposes of this Agreement, "Cause" shall mean: (i) the commission of the Executive of a felony, either in connection with the performance of his obligations to the Company or which adversely affects the Executive's ability to perform such obligations; (ii) gross negligence, dishonesty or breach of fiduciary duty; or (iii) the commission by the Executive of an act of fraud or embezzlement which results in loss, damage or injury to the Company, whether directly or indirectly. (e) Notwithstanding anything to the contrary in this Agreement, if the Company determines in its sole discretion after consultation with its tax and accounting advisors that the Executive is a Disqualified Individual (as defined in Section 280G of the Internal Revenue Code of 1986, as amended (the "Code")) and that any portion of any payment or distribution by the Company to or for the benefit of the Executive, whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise (a "Payment") would be an Excess Parachute Payment (as defined in Section 280G of the Code) but for the application of this sentence, then the amount of all such Payments otherwise payable to the Executive pursuant to this Agreement shall be reduced to the minimum extent necessary (but in no event to less than zero) so that no portion of any Payment, as so reduced, constitutes an Excess Parachute Payment. For purposes of this reduction, no portion of any Payment shall be taken into account to the extent that such Payment, in the opinion of the Company, after consultation with its tax and accounting advisors, does not constitute a "parachute payment" within the meaning of Section 280G(b)(2) of the Code. (f) Except as otherwise provided herein, this Agreement shall be binding upon and inure to the benefit of the Company and any successor (whether direct or indirect, by purchase, merger, consolidation, reorganization or otherwise) of the Company; provided, however, that the Company shall obtain the written agreement of any successor (whether direct or indirect, by purchase, merger, consolidation, reorganization or otherwise) of the Company to be bound by the provisions of this Agreement as if such successor were the Company and for purposes of this Agreement, any such successor of the Company shall be deemed to be the "Company" for all purposes. (g) Nothing in this Agreement shall create any obligation on the part of the Company or any other person to continue the employment of the Executive or to employ the Executive for A-4 any specific or definite term or length of employment. If the Executive elects to receive the severance and benefits set forth in this Agreement by executing the Release, the Executive shall not be entitled to any other salary continuation, severance or other termination benefits in the event of his cessation of employment with the Company. (h) Nothing herein shall affect the Executive's obligations under any key employee, non-competition, confidentiality, option or similar agreement between the Company and the Executive currently in effect or which may be entered into in the future. 4. REPRESENTATIONS AND GOVERNING LAW --------------------------------- (a) This Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Massachusetts. (b) This Agreement represents the complete and sole understanding between the parties, supersedes any and all other agreements and understandings, whether oral or written. This Agreement may not be modified, amended or rescinded except upon the written consent of the Company and the Executive. The invalidity or unenforceability of any provision of this Agreement shall not affect the other provisions of this Agreement and this Agreement shall be construed and reformed to the fullest extent possible. (c) The Executive may not assign any of his rights or obligations under this Agreement; the rights and obligations of the Company under this Agreement shall inure to the benefit of, and shall be binding upon, the successors and assigns of the Company. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument. (d) The Executive represents that he has read the foregoing Agreement, fully understands the terms and conditions of such Agreement, and is voluntarily executing the same. In entering into this Agreement, the Executive does not rely on any representation, promise or inducement made by the company, with the consideration described herein. [Remainder of page intentionally left blank] IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first written above. The Company: ----------- SMARTERKIDS.COM By: ----------------------------- Name: --------------------------- Title: -------------------------- The Executive: ------------- --------------------------------- EX-10.15 16 0016.txt CHANGE OF CONTORL AGREEMENT FOR SENIOR EXECUTIVES Exhibit 10.15 CHANGE OF CONTROL AGREEMENT --------------------------- CHANGE OF CONTROL AGREEMENT, dated as of September 7, 2000, by and between SmarterKids.com. (the "Company") and __________ (the "Senior Executive"). This Agreement supercedes any other agreement between the parties. WHEREAS, the Company believes it to be to its advantage to employ the Senior Executive to render services to the Company as hereinafter provided; WHEREAS, the Company desires continuity of management; and WHEREAS, the Senior Executive is willing to continue to render services to the Company subject to the conditions set forth in this Agreement. NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the Company and the Senior Executive agree as follows: 1. TERMINATION FOLLOWING A CHANGE OF CONTROL. ----------------------------------------- (a) If, at any time after a Change in Control (as such term is defined in Section 3(b)), but prior to the date three (3) years from the date of a Change in Control, the Company terminates the Senior Executive's employment, the Company shall: (i) continue to pay to the Senior Executive, in accordance with the Company's normal payroll practices and policies in effect from time to time (including any required withholding), the Senior Executive's base salary (at the monthly base salary rate in effect for such Senior Executive immediately prior to the termination of his employment) until the earlier of (i) twelve (12) months following the termination of the Senior Executive's employment, or (ii) the date the Senior Executive is employed by a subsequent employer or is engaged as a consultant (note: in the event of consulting income of less than base salary, the Company will compensate the difference) (the "Severance Payments"); provided, however, that the Company shall not be obligated to make any Severance Payments pursuant to this Section 1(a) during any period in which the Senior Executive is in violation of the terms of his/her Employee Noncompetition, Nondisclosure and Developments Agreement with the Company; (ii) the date of the Senior Executive's termination shall be the date of the "qualifying event" under the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA"). If the Senior Executive elects to continue medical insurance coverage after termination in accordance with the provisions of COBRA, the Company shall pay the Senior Executive's monthly premium payments until the earlier of (i) the date which is twelve (12) months following the termination of the Senior Executive's employment; (ii) the date the Senior Executive obtains other A-2 employment, or (iii) the date the Senior Executive's COBRA continuation coverage would terminate in accordance with the provisions of COBRA. Thereafter, if the payment of monthly premiums by the Company has ceased due to a reason in (i) or (ii) above, the Senior Executive will be responsible for any and all payments for the remaining period of elected continued health insurance coverage under COBRA. (iii) In addition to any other vesting provisions that the Senior Executive may be entitled to in accordance with other agreements with the Company, accelerate the vesting of all of the Senior Executive's incentive and non-qualified stock options by twelve (12) months from the date of the termination; (b) For purposes of Section 1, "Good Reason" shall mean the occurrence of one or more of the following events following a Change of Control: (i) the assignment to the Senior Executive of any duties substantially inconsistent with his position, authority, duties or responsibilities immediately prior to the Change of Control or any other action by the Company which results in a substantial limitation in such position, authority, duties or responsibilities; (ii) a substantial reduction in the aggregate of the Senior Executive's base or incentive compensation of the termination of the Senior Executive's rights or any employee benefits immediately prior to the Change of Control, except to the extent any such benefit is replaced with a substantially similar benefit, or a reduction in scope of value thereof; or (iii) a relocation of the Senior Executive's place of business which results in the one-way commuting distance for the Senior Executive increasing by more than 50 miles from the location thereof immediately prior to the Change of Control (provided, however, that travel consistent with past practices for business purposes shall not be considered "commuting" for purposes of this clause (iii)); or (iv) a failure by the Company to obtain the agreement referenced in Section 3(f). 2. TERM. If a Change of Control has not occurred within three (3) years ---- from the date hereof, this Agreement shall terminate and be of no further force and effect. 3. GENERAL. ------- (a) Notwithstanding anything else to the contrary herein: (i) the Company's obligation to provide any of the amounts and benefits set forth in this Agreement shall be subject to, and conditioned upon, the Senior Executive's execution of a full release of claims satisfactory to the Company releasing the Company and its affiliates, subsidiaries, divisions, directors, employees and agents from any claims arising from or related to the Senior Executive's employment or severance from employment with the Company, including any claims arising from this Agreement (the "Release"); (ii) the Company shall not be obligated to provide any of the amounts and benefits set forth in this Agreement until any applicable period within which the Senior Executive may revoke the Release has expired; and (iii) any amounts and benefits set forth in this Agreement shall be reduced by any and all other severance or other amounts or benefits paid or payable to the Senior Executive as a result of the termination of his employment. A-3 (b) In the event the Senior Executive's employment with the Company is terminated by the Company for any reason other than without Cause, or the Senior Executive terminates his employment with the Company for any reason other than Good Reason, the Senior Executive shall not be entitled to any severance benefits or other considerations described herein. (c) For purposes of this Agreement, "Change of Control" shall mean the closing of: (i) a merger, consolidation, liquidation or reorganization of the Company into or with another Company or other legal person, after which merger, consolidation, liquidation or reorganization the capital stock of the Company outstanding prior to consummation of the transaction is not converted into or exchanged for or does not represent more than 50% of the aggregate voting power of the surviving or resulting entity; or (ii) the direct or indirect acquisition by any person (as the term "person" is used in Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended) of more than 50% of the voting capital stock of the Company, in a single or series of related transactions. (d) For purposes of this Agreement, "Cause" shall mean: (i) the commission of the Senior Executive of a felony, either in connection with the performance of his obligations to the Company or which adversely affects the Senior Executive's ability to perform such obligations; (ii) gross negligence, dishonesty or breach of fiduciary duty; or (iii) the commission by the Senior Executive of an act of fraud or embezzlement which results in loss, damage or injury to the Company, whether directly or indirectly. (e) Notwithstanding anything to the contrary in this Agreement, if the Company determines in its sole discretion after consultation with its tax and accounting advisors that the Senior Executive is a Disqualified Individual (as defined in Section 280G of the Internal Revenue Code of 1986, as amended (the "Code")) and that any portion of any payment or distribution by the Company to or for the benefit of the Senior Executive, whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise (a "Payment") would be an Excess Parachute Payment (as defined in Section 280G of the Code) but for the application of this sentence, then the amount of all such Payments otherwise payable to the Senior Executive pursuant to this Agreement shall be reduced to the minimum extent necessary (but in no event to less than zero) so that no portion of any Payment, as so reduced, constitutes an Excess Parachute Payment. For purposes of this reduction, no portion of any Payment shall be taken into account to the extent that such Payment, in the opinion of the Company, after consultation with its tax and accounting advisors, does not constitute a "parachute payment" within the meaning of Section 280G(b)(2) of the Code. (f) Except as otherwise provided herein, this Agreement shall be binding upon and inure to the benefit of the Company and any successor (whether direct or indirect, by purchase, merger, consolidation, reorganization or otherwise) of the Company; provided, however, that the Company shall obtain the written agreement of any successor (whether direct or indirect, by purchase, merger, consolidation, reorganization or otherwise) of the Company to be bound by the provisions of this Agreement as if such successor were the Company and for purposes of this Agreement, any such successor of the Company shall be deemed to be the "Company" for all purposes. A-4 (g) Nothing in this Agreement shall create any obligation on the part of the Company or any other person to continue the employment of the Senior Executive or to employ the Senior Executive for any specific or definite term or length of employment. If the Senior Executive elects to receive the severance and benefits set forth in this Agreement by executing the Release, the Senior Executive shall not be entitled to any other salary continuation, severance or other termination benefits in the event of his cessation of employment with the Company. (h) Nothing herein shall affect the Senior Executive's obligations under any key employee, non-competition, confidentiality, option or similar agreement between the Company and the Senior Executive currently in effect or which may be entered into in the future. 4. REPRESENTATIONS AND GOVERNING LAW --------------------------------- (a) This Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Massachusetts. (b) This Agreement represents the complete and sole understanding between the parties, supersedes any and all other agreements and understandings, whether oral or written. This Agreement may not be modified, amended or rescinded except upon the written consent of the Company and the Senior Executive. The invalidity or unenforceability of any provision of this Agreement shall not affect the other provisions of this Agreement and this Agreement shall be construed and reformed to the fullest extent possible. (c) The Senior Executive may not assign any of his rights or obligations under this Agreement; the rights and obligations of the Company under this Agreement shall inure to the benefit of, and shall be binding upon, the successors and assigns of the Company. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument. (d) The Senior Executive represents that he has read the foregoing Agreement, fully understands the terms and conditions of such Agreement, and is voluntarily executing the same. In entering into this Agreement, the Senior Executive does not rely on any representation, promise or inducement made by the company, with the consideration described herein. [Remainder of page intentionally left blank] A-5 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first written above. The Company: ----------- SMARTERKIDS.COM By: ---------------------------------------- Name: -------------------------------------- Title: ------------------------------------- The Senior Executive: -------------------- -------------------------------------------- EX-10.16 17 0017.txt EXECUTIVE MANAGEMENT AGREEMENT Exhibit 10.16 EXECUTIVE MANAGEMENT AGREEMENT ------------------------------ THIS EXECUTIVE MANAGEMENT AGREEMENT (this "Agreement"), is made and entered into as of May 5, 1999, by and among William E. Simon & Sons, L.L.C., a Delaware limited liability company ("WES&Sons") and Earlychildhood.com LLC, a California limited liability company (the "Company"). Capitalized terms used but not otherwise defined herein shall have the meaning ascribed to them in that certain Purchase Agreement, dated as of May 5, 1999, by and among Educational Simon, L.L.C., Elliott-Mair LLC, QTL Corporation, Ronald Elliott, Jeffrey R. Mair, Gloria June Mair, and certain trusts named therein. RECITALS -------- A. The Company desires to enter into a management agreement with WES&Sons for the provision of certain executive management services. B. WES&Sons is willing and able to provide the Company with certain executive management services, upon the terms and subject to the conditions set forth in this Agreement. AGREEMENT --------- NOW THEREFORE, in consideration of the mutual promises and of other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereby agree as follows: SECTION 1. SERVICES - ---------- -------- 1.1 Retention. The Company hereby retains WES&Sons to provide the Company with executive management services as provided herein. Such services shall include consultation and advice services to the Company with respect to operations, strategic planning, material financings, mergers and acquisitions, corporate development and other similar aspects of the business of the Company. WES&Sons shall provide such services as may be requested by the Company, at such times, as may be mutually agreeable to WES&Sons and the Company. WES&Sons shall devote such time as is reasonably necessary to provide such services. 1.2 Acceptance of Appointment. WES&Sons accepts the appointment provided in Section 1.1 above and agrees to provide executive management services to the Company in accordance with the terms hereof. 1 SECTION 2. CONSIDERATION - ---------- ------------- 2.1 Initial Fee and Base Fee. In consideration of the executive management services to be provided by WES&Sons to the Company under this Agreement, the Company shall pay and WES&Sons shall be entitled to receive (i) an initial fee of Four Hundred Thousand Dollars ($400,000), which shall be paid at the Closing (the "Initial Fee"), and (ii) an aggregate management fee of Three Hundred Thousand Dollars ($300,000) per year (the "Base Fee") which shall be payable in arrears on a pro rata basis upon the completion of fifteen (15) days following the end of each fiscal quarter. The Initial Fee and the Base Fee shall be paid by wire transfer of immediately available funds, to such account or accounts as shall be designated from time to time by WES&Sons. The Base Fee shall be reviewed by the Management Committee of the Company (the "Management Committee") and may be adjusted from time to time in the sole discretion of a Supermajority of Representatives (as defined in the Restated Operating Agreement); provided, however, that the Base Fee shall not exceed Six Hundred Thousand Dollars ($600,000) at any time. 2.2 Acquisition Fee. In addition to the Initial Fee and the Base Fee, if mutually agreed upon by WES&Sons and a Supermajority of Representatives of the Management Committee, WES&Sons shall also be entitled to receive additional fees (the "Acquisition Fee") for services provided in connection with any acquisition by the Company, of assets, capital stock or other ownership interests of an individual, corporation, partnership, limited liability company, joint venture, or other entity. The aggregate amount of the Acquisition Fee, if any, shall be determined on a case-by-case basis by the mutual agreement of WES&Sons and the Company. 2.3 Expenses. In addition to the Initial Fee, the Base Fee and the Acquisition Fee, if any, WES&Sons shall also be entitled to reimbursement for all reasonable out-of-pocket expenses incurred by WES&Sons or its personnel in connection with the performance of their duties hereunder, which amounts shall be so reimbursed when invoices with respect thereto are submitted by WES&Sons to the Company. SECTION 3. TERM - ---------- ---- This Agreement shall take effect from the date hereof and shall remain in effect until the seventh (7th) anniversary of the date of this Agreement (the "Base Term"); provided, however, that this Agreement shall automatically terminate upon the earlier to occur of (i) the consummation of an underwritten public offering of equity securities of the Company or any corporation or other entity which is a successor to the Company (other than an offering made in connection with a compensatory benefit plan), resulting in such equity securities being listed on a national securities exchange or the Nasdaq National Market (or any successor thereto), (ii) the merger or consolidation of the Company with or into another corporation or other Person or the acquisition by another corporation or Person of all or substantially all of the Company's assets or eighty percent (80%) or more of the Company's then outstanding voting ownership interests or voting stock, or (iii) the liquidation or dissolution of the Company (each such event constituting an "Early Termination" of this Agreement). Upon such Early Termination prior to the expiration 2 of the Base Term, the fees and expenses provided for in Section 2 shall be paid through the end of the month during which such Early Termination occurs. SECTION 4. INDEMNIFICATION - ---------- --------------- 4.1 Indemnification. The Company shall indemnify, save and hold harmless WES&Sons and its Affiliates, to the full extent lawful, from and against any losses, costs, expenses, liabilities, obligations, damages, claims, lawsuits, demands or proceedings (collectively, "Losses") arising out of, in connection with, resulting from or based upon the engagement of, or services provided by, WES&Sons hereunder, and any transactions or conduct of WES&Sons in connection therewith; provided, however, that this indemnity shall not apply with respect to any Losses that are finally judicially determined to have resulted primarily from WES&Sons' bad faith, willful misconduct or gross negligence. The Company agrees that it will not, without the prior written consent of WES&Sons, settle any pending or threatened claim or proceeding related to the engagement of WES&Sons or services rendered, or transactions or conduct of WES&Sons in connection therewith (whether or not WES&Sons is a party to such claim or proceeding) unless such settlement includes a provision unconditionally releasing WES&Sons and its Affiliates and holding it and them harmless from and against any and all liability and other Losses in respect of claims by any releasing party arising out of, in connection with, resulting from or based upon the engagement of WES&Sons hereunder or services rendered, or transactions or conduct of WES&Sons in connection therewith; provided, that it is not otherwise finally judicially determined that WES&Sons acted in bad faith, willful misconduct or gross negligence. The Company will promptly reimburse WES&Sons for all out-of-pocket expenses (including reasonable legal fees) as they are incurred by WES&Sons in connection with investigating, preparing or defending, or providing evidence in, any pending or threatened claim or proceeding in respect of which indemnification is required hereunder (whether or not WES&Sons is a party to such claim or proceeding) or in enforcing this Agreement. The foregoing indemnification shall be in addition to any rights that WES&Sons may have at common law or otherwise. The provisions of this Section 4.1 shall remain in full force and effect following the expiration or termination of this Agreement. 4.2 Contribution. If the indemnification provided for in Section 4.1 is unavailable to WES&Sons for any reason (except for the limitations and exclusions set forth in Section 4.1), then the Company, in lieu of indemnifying WES&Sons, shall have an obligation to contribute to the amount paid or payable by WES&Sons as a result of such Losses in such proportion as is appropriate to reflect the relative fault of the Company and WES&Sons in connection with the actions which resulted in such Losses as well as any other relevant equitable considerations. Relative fault shall be determined by reference to, among other things, whether any alleged untrue statement or omission or any other alleged conduct relates to information provided by WES&Sons or other conduct by WES&Sons on the one hand or by the Company on the other hand. The amount paid or payable by the Company as a result of the Losses referred to above shall be deemed to include any out-of-pocket expenses (including reasonable legal fees) in connection with investigating, preparing or defending, or providing evidence in, any pending or threatened claim or proceeding (whether or not WES&Sons is a party to such claim or proceeding) or in enforcing this Agreement. The Company and WES&Sons agree that it would 3 not be just and equitable if contribution pursuant to this Section 4.2 were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to above. SECTION 5. SUBORDINATION - ---------- ------------- 5.1 WES&Sons hereby (a) acknowledges the Obligations (as defined in the Credit Agreement) of the Company under that certain Credit Agreement dated as of May 5, 1999, by and among Paribas, Chicago Branch, as Agent ("Agent"), the lending institutions named therein (the "Banks") and the Company (as the same may be amended or otherwise modified, the "Credit Agreement") and the other Loan Documents (as defined in the Credit Agreement); and (b) agrees that, subject to the remaining terms of this Section 5.1, so long as any of the Obligations are outstanding, or Agent or any Bank has any commitment under the Loan Documents, the Fees (as hereinafter defined) shall be subordinate and junior in right of payment as provided herein to the prior payment in full of all Obligations as provided in the Credit Agreement and the other Loan Documents. The Fees shall not be payable, and no payment thereof shall be made or given, and no property or guarantee of any nature to secure or pay the Fees shall be made or given, directly or indirectly by the Company or any Debtor (as hereinafter defined) or received, accepted, retained or applied by WES&Sons unless and until the Obligations shall have been paid in full in cash or the Agent shall otherwise have consented in writing, except that so long as no Event of Default (as defined in the Credit Agreement) has occurred and is continuing, WES&Sons shall, notwithstanding anything to the contrary set forth herein, have the right to receive payments of the Fees made in the Ordinary Course of Business or as otherwise permitted pursuant to the Credit Agreement. After the occurrence and during the continuance of an Event of Default, all payments of the Fees required to be made hereunder shall accrue (without interest thereon) and such Fees shall be payable and paid in full on the earliest date on which such payment is no longer restricted as a result of either, the payment and performance in full of all Obligations or, if earlier, the date the applicable Event of Default is cured or waived. If any portion of the Fee shall be paid to WES&Sons by any Debtor when such payment is not permitted hereunder, such sums shall be held in trust by WES&Sons for the benefit of Agent for the benefit of the Banks and shall forthwith be paid to Agent and may be applied by Agent against the Obligations in accordance with the Credit Agreement. For purposes of this Agreement, the term "Fees" means any and all amounts payable to WES&Sons in accordance with the provisions of Sections 2.1 and 2.2 of this Agreement. For purposes of this Agreement, the term "Debtor" means the Company and the Obligated Parties (as defined in the Credit Agreement). Notwithstanding the foregoing, nothing contained in this Section 5 is intended to or will impair, as between the Company and WES&Sons, the obligation of the Company to pay to WES&Sons the Fees as and when the same become due and payable in accordance with the terms hereof. SECTION 6. MISCELLANEOUS - ---------- ------------- 6.1 Notice. Any notice required or desired to be given hereunder shall be in writing and shall be personally served or shall be deemed given three (3) business days after deposit in the United States mail, registered or certified, postage and fee prepaid, one (1) 4 business day after being deposited with a reputable overnight delivery courier (e.g., Federal Express) with shipping charges prepaid, or on the day sent by telecopy, electronic or digital transmission method (if appropriate confirmation is received) and addressed as follows: If to the Company: Earlychildhood.com LLC 1353 Dayton Street Salinas, California 93901 Attn: Ronald Elliott Telephone: (831) 771-9000 Telecopy: (831) 771-5587 If to WES&Sons: William E. Simon & Sons, L.L.C. 10990 Wilshire Boulevard Suite 500 Los Angeles, California 90024 Attn: Robert P. Healy Telephone: (310) 914-2410 Telecopy: (310) 575-4220 6.2 Independent Contractor. The relationship between the parties hereto (including that of individuals performing the contemplated services) which is created hereunder is that of an independent contractor. This Agreement is not intended to create and shall not be construed as creating between the parties hereto (or such individuals) the relationship of employee, principal and agent, joint venture, partnership, or any other similar relationship, the existence of which is hereby expressly denied. 6.3 Successors and Assigns. Subject to the Early Termination provisions contained in Section 3, this Agreement shall be binding upon the successors and assigns of the parties hereto, including but not limited to any corporation or other entity into which the Company is merged, liquidated or otherwise combined. Section 5 hereof shall inure to the benefit of and be binding upon Agent and the Bank and their respective successors and assigns. This Agreement shall not be assignable without the prior written consent of the other party hereto, by either party by operation of law or otherwise; provided, however, that WES&Sons shall have the right to assign this Agreement to those permitted assignees of Simon under the Restated Operating Agreement. 6.4 Amendment. This Agreement shall not be amended or modified except by a written instrument executed by the parties; provided that Section 5 hereof shall not be amended or modified without the written consent of Agent and the Banks. 5 6.5 Prior Agreement. This Agreement shall supersede any prior management agreement, if any, entered into by WES&Sons with the Company or any of its subsidiaries, and any such management agreement shall be null and void and of no further force and effect. 6.6 Governing Law. This Agreement is made under and shall be construed in accordance with the laws of the State of California, without regard to the conflicts of law provisions thereof. 6.7 Headings. The headings or captions of the Sections herein are inserted for convenience of reference only and are not intended to be a part of or to affect the meaning or interpretation of this Agreement. 6.8 Authorization. The Company represents and warrants that this Agreement has been duly authorized by all necessary corporate action of the Company and, upon execution by the parties, shall be a legal, valid and enforceable obligation of the Company, enforceable in accordance with its terms. 6.9 Attorneys' Fees. In the event of any dispute among the parties hereto regarding this Agreement, the prevailing party shall be entitled to recover as an element of damages the reasonable costs actually incurred to enforce this Agreement, including the reasonable fees and disbursements of counsel. 6.10 Counterparts. This Agreement may be executed in one or more counterparts, any of which may be executed and transmitted by facsimile, and each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. [Signature Page Follows] 6 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date first above written. EARLYCHILDHOOD.COM LLC, a California limited liability company By: /s/ Ronald Elliott ------------------------------ Name: Ronald Elliott Title: President and Chief Executive Officer WILLIAM E. SIMON & SONS, L.L.C., a Delaware limited liability company By: /s/ Robert P. Healy ------------------------------ Name: Robert P. Healy Title: Vice President 7 EX-10.18 18 0018.txt EMPLOYMENT AGREEMENT Exhibit 10.18 EMPLOYMENT AGREEMENT -------------------- THIS EMPLOYMENT AGREEMENT (this "Agreement") is made and entered into effective May 5, 1999 (the "Effective Date"), by and between Earlychildhood.com LLC, a California limited liability company (hereinafter referred to as, the "Company"), and Ronald Elliott (hereinafter referred to as, "Employee"). 1. TERM OF AGREEMENT ----------------- Except as may otherwise be provided herein, the term of this Agreement shall commence on the Effective Date and terminate on the third (3rd) anniversary of the Effective Date (such date, giving effect to any extensions thereof, the "Expiration Date"), unless sooner terminated as hereinafter provided (such period of employment, the "Employment Period"). Notwithstanding the foregoing, on May 5, 2002 and on each annual anniversary thereof, the Expiration Date shall be extended for twelve (12) additional full calendar months, unless, prior to March 1st of each such year, the Company shall deliver to Employee or Employee shall deliver to the Company, written notice that the term of employment hereunder shall end on the then-existing Expiration Date (including any and all previous extensions thereof), in which case this Agreement shall not thereafter be further extended without the agreement of the Company and Employee. 2. DUTIES AND PERFORMANCE ---------------------- (a) During the term of this Agreement, Employee shall be employed by the Company on a full-time basis as its President and Chief Executive Officer and shall have such authority and shall perform such duties consistent with his position as may be reasonably assigned to him and shall report to the Management Committee of the Company (the "Management Committee") or any other person designated by the Management Committee. The Management Committee shall retain full direction and control of the means and methods by which Employee performs the above services. Employee shall use all reasonable efforts to further the interests of the Company and shall devote substantially all of his business time and attention to his duties hereunder. (b) Except with the prior written approval of the Management Committee (which the Management Committee may grant or withhold in its sole discretion), Employee, during the term of this Agreement or any renewal thereof, will not (i) accept any other employment, (ii) serve on the board of directors or similar body of any other business entity, (iii) engage, directly or indirectly, in any other business activity (whether or not pursued for pecuniary advantage) that is or may be competitive with, or that might place him in a competing position to, that of the Company or any of its Affiliates (as hereinafter defined) or (iv) engage in any venture presented to him by virtue of his position with the Company wherein the profits of such venture are not made available to the Company. (c) Employee shall be entitled to be reimbursed in accordance with the policies of the Company, as adopted and amended from time to time, for all reasonable 1 and necessary expenses incurred by him in connection with the performance of his duties of employment hereunder; provided that Employee shall, as a condition of such reimbursement, submit verification of the nature and amount of such expenses in accordance with the reimbursement policies from time to time adopted by the Company. 3. BASE SALARY AND OTHER COMPENSATION ---------------------------------- (a) Base Salary. The Company shall pay to Employee a base salary at the rate of Two Hundred Fifty-Six Thousand Dollars ($256,000.00) per annum (the "Base Salary") through the term of this Agreement as specified in Section 1 hereof, payable every two (2) weeks as per the normal pay practices of the Company (e.g., standard employee deductions such as income tax withholdings, social security, etc.). The Base Salary shall be reviewed in connection with Employee's annual performance review and may be adjusted in the sole discretion of the Management Committee. (b) Automobile Allowance. In addition to the Base Salary, as an executive benefit, the Company shall provide Employee with an automobile allowance of an amount up to Eight Hundred Dollars ($800.00) per month payable in accordance with the Company's normal pay procedures. (c) Bonus Compensation. In addition to the Base Salary, Employee shall be eligible during the term of this Agreement, upon the terms and subject to the conditions set forth herein, to receive a bonus for each year in an amount to be determined in the sole discretion of the Management Committee (the "Bonus"). Employee's Bonus each year shall be determined and, if appropriate, awarded, based upon meeting certain performance objectives which will be set by the mutual agreement of the Management Committee and Employee. Such performance objectives each year shall be fixed at the beginning of each calendar year (or another date agreed upon by Employee and the Management Committee) and shall be subject to any adjustments thereof from time to time as agreed upon by Employee and the Management Committee. 4. BENEFITS -------- Employee shall be entitled to participate, in any group medical and hospitalization, profit sharing, retirement, life insurance or other employee benefit plan maintained by the Company for its full time employees (collectively referred to herein as, "Benefits"). Nothing herein, however, is intended or shall be construed to require the Company to institute or continue all, or any particular, plan or Benefits. Employee shall be entitled to six (6) weeks of vacation per year and leave in accordance with the Company's policies in effect from time to time. 5. TERMINATION OF AGREEMENT ------------------------ (a) Termination. Employee's employment hereunder shall or may be terminated, as the case may be, under the following circumstances: 2 (i) Cause. The Company may terminate Employee's employment hereunder for "cause" by delivery of a written notice to Employee concerning the same. "Cause" shall mean by reason of any of the following: (A) a material breach by Employee of the provisions of this Agreement; (B) Employee's conviction of, or plea of nolo contendere to, any felony or to any crime causing substantial harm to the Company or any of its Affiliates (whether or not for personal gain) or involving acts of theft, fraud, embezzlement, moral turpitude or similar conduct; (C) misuse or diversion of the Company's or any of its Affiliate's funds, embezzlement, or fraudulent misrepresentations or concealments on any written reports submitted by Employee to the Company or any of its Affiliates; (D) misconduct, failure to perform the duties of Employee's employment or his habitual neglect thereof; or (E) failure to follow or comply with the lawful directives of the Management Committee of the Company; provided, however, that in the case of the foregoing clauses (A), (D) and (E), if any such breach, misconduct or failure is capable of cure, as determined in the Management Committee's reasonable discretion, "Cause" shall mean any continuation of such breach, misconduct or failure after a period of (x) in the case of the foregoing clauses (A) and (D), thirty (30) calendar days, and (y) in the case of the foregoing clause (E), ten (10) calendar days, in each case, from the date on which Employee shall first have been informed, in writing, thereof. (ii) Disability. Employee's employment hereunder shall terminate if, because of a mental or physical disability or infirmity, Employee is unable to perform the essential functions of his duties, with or without reasonable accommodation, for a consecutive period of one hundred twenty (120) days or a non-consecutive period of one hundred twenty (120) days during any twelve (12) month period, or such other greater period as may be required by applicable employment laws. (iii) Death. Employee's employment hereunder shall terminate upon the death of Employee. (iv) Employment-At-Will; Termination For Any Reason. Notwithstanding anything to the contrary contained herein, including in Section 1 of this Agreement, Employee's employment with the Company is not for any specified term and may be terminated by the Company at any time, for any reason, with or without cause, and without liability except with respect to the payments provided for by Section 5(b) hereof. In particular, and not by way of limitation, Employee understands and acknowledges and hereby agrees that the Company may terminate Employee's employment by delivery from the Company to Employee of written notice of such termination, without regard (A) to any general or specific policies (whether written or oral) of the Company relating to the employment or termination of its employees, or (B) to any statements made to Employee, whether made orally or contained in any document, pertaining to Employee's relationship with the Company. 3 (v) Voluntary Resignation. Employee may voluntarily resign his position and terminate his employment with the Company at any time by delivery of a written notice of resignation to the Company (the "Notice of Resignation"). The Notice of Resignation shall set forth the date such resignation shall become effective (the "Date of Resignation"), which date shall, in any event, be no more than thirty (30) days from the date the Notice of Resignation is delivered to the Company; provided that the Company shall, in its discretion and by sending written notice to Employee, be entitled to deem Employee's resignation effective at any time within such thirty (30) day period, and such date specified by the Company shall then become the Date of Resignation. Notwithstanding any such action by the Company, Employee's severance and his rights thereunder shall be set as if Employee voluntarily resigned on the Date of Resignation. (vi) Resignation For Good Reason. Employee may terminate his employment pursuant to this Agreement "for good reason" by delivery of a Notice of Resignation to the Company at least thirty (30) days prior to the Date of Resignation. For purposes of this Agreement the phrase "for good reason" and variations of it shall mean any of the following: (A) the assignment of Employee without his consent to a position, responsibilities or duties of a materially lesser status or degree of responsibility than his position, responsibilities or duties at the Effective Date; (B) the failure to pay Employee the Base Salary at a rate or in an amount at least equal to the amount or rate paid to him at the Effective Date; (C) any material diminution in Employee's aggregate Benefits; or (D) the relocation of Employee's place of business at least thirty (30) miles from Employee's business location as of the Effective Date; or (vii) Expiration Date. If not terminated sooner pursuant to any of Sections 5(a)(i) through 5(a)(vi) above, then Employee's employment hereunder shall terminate on the Expiration Date. (b) Compensation Upon Termination. In the event of the termination ----------------------------- of Employee's employment: (i) Cause. If Employee's employment shall be terminated for Cause pursuant to Section 5(a)(i) hereof, then the Company shall pay Employee the Base Salary through the Date of Termination (as hereinafter defined), together with reimbursable business expenses actually and reasonably incurred by Employee prior to the Date of Termination and accrued but unpaid vacation compensation up to an aggregate maximum amount equal to six (6) weeks of the Base Salary (such amount being referred to herein as, the "Accrued Vacation Payment") (each of which shall be paid consistent with the policies of the Company in effect at such time). Employee and his dependents shall also be entitled to any continuation of coverage rights required by COBRA (as hereinafter defined). (ii) Death or Disability. If Employee's employment shall be terminated pursuant to Section 5(a)(ii) or 5(a)(iii) hereof, then the Company shall 4 pay Employee or his estate, as applicable, (A) the Base Salary through the Date of Termination, (B) a bonus in an amount equal to a pro rata portion of Employee's Bonus for the immediately preceding year, and (C) reimbursable business expenses actually and reasonably incurred by Employee prior to the Date of Termination and the Accrued Vacation Payment (each of which shall be paid consistent with the policies of the Company in effect at such time). By way of illustration, if, in the immediately preceding year, Employee had received (or, in the case where his employment is terminated prior to the end of one year, had been eligible to receive) a Bonus of Fifty Thousand Dollars ($50,000), and Employee's Date of Termination pursuant to Section 5(a)(ii) or 5(a)(iii) above occurs on the two hundredth (200th) day of the year, Employee would be entitled to receive a pro rata bonus equal to Fifty Thousand Dollars ($50,000) multiplied by a fraction, the numerator of which is two hundred (200) and the denominator of which is three hundred sixty-five (365). Notwithstanding the foregoing, if Employee's employment is terminated prior to the end of Employee's first year of employment, the Company shall pay Employee or his estate, as applicable, in lieu of the pro rata bonus referenced in clause (B) above, within sixty (60) days after completion of the Company's then current fiscal year, a pro rata portion of any Bonus Employee would actually have received for such year pursuant to Section 3(b) above. In addition, the Company shall keep in force existing Benefits covering Employee and his dependents for a period of eighteen (18) months from the Date of Termination on the basis in effect at the Date of Termination, subject to the Company's right to amend, modify or terminate any such plan; provided, however, that such amendment, modification or termination applies generally to all of the Company's employees. Employee and his dependents shall also be entitled to any continuation of coverage rights required by COBRA. (iii) Other Terminations by the Company or Resignation for Good Reason. If the Company shall terminate Employee's employment without cause pursuant to Section 5(a)(iv) hereof or Employee resigns for good reason pursuant to Section 5(a)(vi) hereof, then the Company shall pay Employee (A) the Base Salary payable semi-monthly and in accordance with the Company's normal pay practices for a period equal to the lesser of two (2) years after the Date of Termination or the remaining term hereunder, (B) a bonus in an amount equal to a pro rata portion of Employee's Bonus for the immediately preceding year, and (C) reimbursable business expenses actually and reasonably incurred by Employee prior to the Date of Termination and the Accrued Vacation Payment (each of which shall be paid consistent with the policies of the Company in effect at such time). (See illustration of Bonus calculation in Section 5(b)(ii) above). Notwithstanding the foregoing, if Employee's employment is terminated prior to the end of Employee's first year of employment, the Company shall pay Employee or his estate (as applicable) in lieu of the pro rata bonus referenced in clause (B) above, within sixty (60) days after completion of the Company's then current fiscal year, a pro rata portion of any Bonus Employee would actually have received for such year pursuant to Section 3(b) above. In addition, the Company 5 shall keep in force existing Benefits covering Employee and his dependents for a period of eighteen (18) months from the Date of Termination on the basis in effect at the Date of Termination, subject to the Company's right to amend, modify or terminate any such plan; provided, however, that such amendment, modification or termination applies generally to all of the Company's employees. Employee and his dependents shall also be entitled to any continuation of coverage rights required by COBRA. (iv) Voluntary Resignation. If Employee terminates his employment with the Company pursuant to Section 5(a)(v) hereof, then the Company shall pay Employee the Base Salary through the Date of Termination together with reimbursable business expenses actually and reasonably incurred by Employee prior to the Date of Termination and the Accrued Vacation Payment (each of which shall be paid consistent with the policies of the Company in effect at such time). Employee and his dependents shall also be entitled to any continuation of coverage rights required by COBRA. (v) Expiration Date. If Employee's employment terminates pursuant to Section 5(a)(vii) hereof, then the Company shall pay Employee (A) the Base Salary through the Date of Termination, (B) a bonus in an amount equal to a pro rata portion of Employee's Bonus for the immediately preceding year, and (C) reimbursable business expenses actually and reasonably incurred by Employee prior to the Date of Termination and the Accrued Vacation Payment (each of which shall be paid consistent with the policies of the Company in effect at such time). Employee and his dependents shall also be entitled to any continuation of coverage rights required by COBRA. As used herein, "COBRA" shall mean Section 4980B of the Internal Revenue Code of 1986, as amended, and Sections 601 through 608 of the Employee Retirement Income Security Act of 1974, as amended, and any applicable state law establishing employer requirements for continuation of health care, life insurance or other welfare plan benefits for the benefit of certain current and former employees or dependents thereof. (c) The payments to Employee described in the foregoing Section 5(b) shall sometimes be referred to herein as "Severance Payments" and the period during which any Severance Payments are being made shall be referred to herein as the "Severance Period." (d) "Date of Termination" shall mean (i) if Employee's employment is terminated pursuant to Section 5(a)(i), the date specified in the written notice of termination delivered to Employee by the Company, (ii) if Employee's employment is terminated pursuant to Section 5(a)(ii), the date which is (A) the one hundred twentieth (120th) consecutive day of such inability or (B) the one hundred and twentieth (120th) day in any twelve (12) month period of such inability, (iii) if Employee's employment is terminated pursuant to Section 5(a)(iii), the date of Employee's death, (iv) if Employee's employment is terminated pursuant to Section 5(a)(iv), the date specified in the written 6 notice of termination delivered to Employee by the Company, (v) if Employee's employment is terminated pursuant to Section 5(a)(v) or (vi), the Date of Resignation and (vi) if Employee's employment is terminated pursuant to Section 5(a)(vii), the Expiration Date. (e) Termination Obligations. Employee hereby acknowledges and agrees that all Personal Property (as hereinafter defined) and equipment furnished to or prepared by Employee in the course of or incident to his employment, belongs to the Company and shall be promptly returned to the Company upon termination of Employee's employment hereunder. "Personal Property" includes, without limitation, all books, manuals, records, reports, notes, contracts, lists, encoded media, and other documents or materials, or copies thereof (including computer files), and all other proprietary information relating to the business of the Company. Following termination, Employee will not retain any written or other tangible material containing any proprietary information of the Company. Upon termination of Employee's employment hereunder, Employee shall be deemed to have resigned from all offices, directorships and management committee positions then held with the Company or any Affiliate. 6. CONFIDENTIALITY; COVENANT NOT TO COMPETE ---------------------------------------- (a) Confidentiality. Except as consented to by the Company and as and to the extent required by law, Employee hereby agrees that Employee will not, either during the Employment Period or any period thereafter, directly, indirectly or otherwise, disclose, publish, make available to, or use for his own benefit or the benefit of any person, firm, corporation, association or other entity for any reason or purpose whatsoever, any Confidential Information (as hereinafter defined). Employee agrees that, upon termination of his employment hereunder, all Confidential Information in his possession that is in written or other tangible form (together with all copies or duplicates thereof, including computer files) shall be returned to the Company and shall not be retained by Employee or furnished to any third party, in any form, including, without limitation, any document, record, notebook, computer program or similar repository of or containing any such Confidential Information, except as provided herein; provided, however, that Employee shall not be obligated to treat as confidential, or return to the Company copies of any Confidential Information that (i) was publicly known at the time of disclosure to Employee, (ii) becomes publicly known or available thereafter other than by any means in violation of this Agreement or any other duty owed to the Company by any person or entity or (iii) is lawfully disclosed to Employee by a third party. As used in this Agreement, the term "Confidential Information" means information disclosed to Employee or known by Employee as a consequence of, or through his relationship with, the Company, about the customers, employees (including compensation paid to employees or other terms of employment), operations, processes, products, inventions, business methods, principals, marketing methods, costs, prices, contractual relationships, regulatory status, trade secrets, public relations methods, organization, procedures or finances, including, without limitation, information of or relating to customer lists of the Company and its Affiliates. The parties hereto stipulate and agree that the foregoing 7 matters are important, material and confidential proprietary information and trade secrets that affect the successful conduct of the business of the Company (and any successor or assignee of the Company). (b) Non-Solicitation. In addition, Employee hereby agrees that during (i) the Employment Period and any Severance Period or (ii) the Employment Period and for one (1) year thereafter, whichever is longer, Employee will not, either on his own account or jointly with or as an advisor, director, agent, representative, officer, manager, employee, principal, partner, joint venturer, owner or security holder, consultant or otherwise on behalf of any other person, firm, corporation, partnership, profit or non-profit business or organization ("Person"), (A) in competition with the Company, directly or indirectly carry on or be engaged or interested in, or solicit, the manufacture or sale of goods or provision of services to any Person which, at any time during the term hereof has been, is a customer of, is a potential customer of, or is in the habit of dealing with the Company in its business, (B) endeavor directly or indirectly to canvas or solicit in competition with the Company or to interfere with the supply of orders for goods or services from or by any Person which during the term hereof has been or is a supplier of goods or services to the Company or (C) directly or indirectly solicit or attempt to solicit away from the Company, or otherwise interfere with the employment relationship with, any officer, employee, representative, consultant or other agent of the Company or offer employment to any person who, on or during the six (6) months immediately preceding the date of such solicitation or offer, is or was an officer, employee, representative, consultant or other agent of the Company; provided, however, that Employee may own, directly or indirectly, solely as a passive investment, equity securities of any entity which is required to file periodic reports with the U.S. Securities and Exchange Commission under Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the securities of which corporation are listed on any securities exchange, quoted on the National Association of Securities Dealers Automated Quotation System or traded in the over-the-counter market, if such Employee is not a controlling person of, or a member of a group which controls, such entity and does not, directly or indirectly, own five percent (5%) or more of any class of securities of such entity. (c) Covenant Not to Compete. Employee agrees that during (i) the Employment Period and any Severance Period or (ii) the Employment Period and for one (1) year thereafter, whichever is longer, Employee will not directly or indirectly engage in, have any interest in, own, manage, operate, join, control or otherwise participate in any activity with any Person (whether as an advisor, director, officer, employee, agent, representative, principal, partner, joint venturer, owner, security holder, consultant or otherwise) which, directly or indirectly, competes with, or in any way interferes with, the business of the Company or any of its Affiliates (that engages or otherwise is in the business of selling wholesale and retail school supplies or educational products), in any part of the counties listed on Schedule 1 attached hereto or in the counties or subdivision of any geographic area in which the Company now or shall then be doing business; provided, however, that Employee may own, directly or indirectly, solely as a passive investment, equity securities of any entity which is required to file periodic reports with 8 the U.S. Securities and Exchange Commission under Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the securities of which corporation are listed on any securities exchange, quoted on the National Association of Securities Dealers Automated Quotation System or traded in the over-the-counter market, if such Employee is not a controlling person of, or a member of a group which controls, such entity and does not, directly or indirectly, own five percent (5%) or more of any class of securities of such entity. (d) Injunctive Relief and Enforcement. In the event of breach by Employee of the terms of this Section 6, the Company shall be entitled to institute legal proceedings to obtain damages for any such breach, or to enforce the specific performance of this Agreement by Employee and to enjoin Employee from any further violation of this Section 6, and to exercise such remedies cumulatively or in conjunction with all other rights and remedies provided by law. Employee expressly agrees and acknowledges that the Company will or would suffer irreparable injury if Employee were to compete with the Company or any Affiliate in violation of this Agreement, that the remedies at law for any violation of this Section 6 would be inadequate and that the Company would by reason of such competition be entitled to injunctive relief. In addition, in the event that any provision of this Section 6 shall be determined by any court of competent jurisdiction to be unenforceable by reason of extending for too great a period of time or over too great a geographical area or by reason of being too extensive in any other respect, it shall be interpreted to extend over the maximum period of time for which it may be enforceable and to the maximum extent in all other respects as to which it may be enforceable, and enforced as so interpreted, all as determined by such court in such action. 7. THE COMPANY'S RIGHT TO REPURCHASE MEMBERSHIP INTERESTS IN CERTAIN ----------------------------------------------------------------- EVENTS ------ (a) The provisions of this Section 7 supersede Section 9.6 of that certain Amended and Restated Operating Agreement of the Company (as may be further amended from time to time, the "Operating Agreement") relating to Employee, it being understood and agreed that the provisions of Section 9.6 of the Operating Agreement shall not be applicable to Employee. If Employee's employment with the Company is terminated pursuant to Sections 5(a)(i) through 5(a)(vi) hereof, the Company or its designee(s) (which designee(s) may be any person or entity which shall have been approved by the Management Committee pursuant to the Operating Agreement) shall have the exclusive and irrevocable option (a "Call"), exercisable in its sole discretion, to repurchase any or all of that portion of the ownership interest of QTL Corporation, a California corporation ("QTL"), or its successors and assigns in the Company that is proportionate to Employee's ownership interest in QTL (the "Membership Interest"). The Call may be exercised for all or any portion of the Membership Interest by delivering written notice (a "Repurchase Notice") to QTL within one hundred twenty (120) days of Employee's Date of Termination. The Repurchase Notice will set forth the percentage of the total Membership Interest to be acquired from QTL, the aggregate consideration to be paid for such Membership Interest and the time and place for the closing of the 9 repurchase. QTL and each transferee shall be obligated to resell the Membership Interest as provided in this Section 7 in response to an exercise by the Company of its Call under this Section 7. The Membership Interest to be repurchased by the Company shall first be satisfied to the extent possible from the Membership Interest held by QTL. If the Membership Interest held by QTL is less than the total Membership Interest the Company has elected to Call, the Company shall purchase the remaining Membership Interest from QTL's transferees, pro rata according to the Membership Interest held by such transferees as of the Date of Termination. The consummation of the purchase or purchases of such Membership Interest pursuant to the Company's exercise of its Call shall take place on the date and in the manner designated by the Company in the Repurchase Notice, which date shall not be more than thirty (30) days after the delivery of the Repurchase Notice; provided, however, that the Company may consummate such purchase of the Membership Interest by delivering payment for such Membership Interest along with the Repurchase Notice. The Company will pay for the Membership Interest by delivery of a check in an amount equal to the applicable repurchase price, as discussed below, for the Membership Interest. The Company will, in connection with such repurchase, be entitled to receive customary representations and warranties from the seller(s) regarding such sale and to require that all such seller(s)' signatures be guaranteed. Notwithstanding anything to the contrary contained in this Section 7, all repurchases of all or any portion of the Membership Interest by the Company shall be subject to applicable restrictions contained in the California Corporations Code, the Company's and its Affiliates' debt and equity financing agreements, if any, and the Operating Agreement. If any such restrictions prohibit the repurchase of the Membership Interest hereunder which the Company is otherwise entitled to make, the Company may designate a third party to make such repurchase and QTL and each transferee shall be obligated to resell the Membership Interest to such third party on the same terms and conditions as it is obligated to resell the Membership Interest to the Company pursuant to this Section 7. If the Company does not designate a third party to repurchase the Membership Interest, the Company may make such repurchases as soon as it is permitted to do so (but in any case, within one hundred fifty (150) days after the Date of Termination). Under such circumstances, the Company shall pay interest on any portion of the Membership Interest being repurchased subject to the restrictions set forth in this paragraph, which interest shall accrue at an annual rate of eight percent (8%) (beginning on the latest date that the Company would otherwise be entitled to repurchase such Membership Interest were it not for the restrictions set forth in this paragraph) and be paid on the date such Membership Interest is repurchased. (b) If Employee's employment with the Company is terminated pursuant to Section 5(a)(i) or Section 5(a)(v) hereof, then the purchase price of the Membership Interest (or a portion thereof) purchased pursuant to this Section 7 shall be equal to the 10 lesser of (i) the Original Cost (as hereinafter defined) of such Membership Interest (or a portion thereof), or (ii) the Fair Market Value (as hereinafter defined) of such Membership Interest (or a portion thereof) on the Date of Termination as determined in good faith by the Management Committee. "Original Cost" shall mean the fair market value of the consideration paid or surrendered by Employee in exchange for the Membership Interest, at the time Employee acquired the Membership Interest. (c) If Employee's employment with the Company is terminated pursuant to Section 5(a)(ii), 5(a)(iii), 5(a)(iv) or 5(a)(vi) hereof, then the purchase for the Membership Interest (or a portion thereof) shall be equal to the Fair Market Value on the Date of Termination. If Employee's employment with the Company is terminated pursuant to Section 5(a)(vii), then the Company shall not have the right to purchase any Membership Interests pursuant to this Section 7. (d) For purposes of this Section 7, "Fair Market Value" shall mean the market value of the Membership Interest to be valued, as determined in good faith by the Management Committee, based upon the fair market value of one hundred percent (100%) of the Company if sold as a going concern and without regard to any discount for the lack of liquidity or on the basis that the relevant Membership Interest does not constitute a majority or controlling interest in the Company and assuming, if applicable, the exercise or conversion of all in the money warrants, options or other rights to subscribe for or purchase any additional ownership interests of the Company or securities convertible or exchangeable into such ownership interests; provided, however, that if Employee disputes the Fair Market Value as determined by the Management Committee, Employee may undertake to have Employee, on the one hand, and the Company, on the other hand, retain an Independent Expert (as hereinafter defined). The determination of Fair Market Value by the Independent Expert shall be final, binding and conclusive on the Company, QTL and Employee. All costs and expenses of the Independent Expert shall be borne by Employee unless the determination of Fair Market Value by the Independent Expert is more than five percent (5%) higher than the Fair Market Value determined by the Management Committee, in which event the cost of the Independent Expert shall be shared equally by Employee, on the one hand, and the Company, on the other hand, or more than ten percent (10%) higher than the Fair Market Value determined by the Management Committee, in which event the cost of the Independent Expert shall be borne solely by the Company. "Independent Expert" means a consultant reasonably agreeable to Employee, on the one hand, and the Company, on the other hand, who does not (and whose affiliates do not) have a financial interest in the Company or any of its Affiliates. (e) Notwithstanding anything in this Agreement to the contrary, if at any time it is determined that the termination of Employee pursuant to Section 5(a)(i) was not in accordance with the definition of Cause contained therein, and if the Company has repurchased the Membership Interest pursuant to the terms of Section 7(b) hereof, the Company shall, as its sole obligation under this Agreement, pay to QTL the excess, if any, of the Fair Market Value of such Membership Interest at the applicable Date of 11 Termination over the Original Cost of such Membership Interest. If the Company has not repurchased the Membership Interest pursuant to Section 7(b) above, the Company's repurchase obligation shall thereafter be as set forth in Section 7(c). (f) The right of the Company to repurchase the Membership Interests as described in this Section 7 shall terminate upon the completion of both (i) the conversion of the Company into a corporation or other entity for the purposes of an initial public offering and (ii) the completion of the initial public offering and the sale of the Company's ownership interests therein. 8. AFFILIATES ---------- As used in this Agreement, "Affiliate" or "Affiliates" shall mean any partnership, joint venture, limited liability company or corporation that, directly or indirectly through one or more intermediaries Controls, or is Controlled by, or is under common Control with, the Company. The term "Control" includes, without limitation, the possession, directly or indirectly, of the power to direct the management and policies of a partnership, joint venture, limited liability company or corporation, whether through the ownership of voting securities, by contract or otherwise. 9. NOTICE ------ For the purposes of this Agreement, notices, demands and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when personally delivered, when transmitted by telecopy with receipt confirmed, or one day after delivery to an overnight air courier guaranteeing next day delivery, addressed as follows: If to Employee: Ronald Elliott -------------- Chief Executive Officer c/o Earlychildhood.com LLC 1353 Dayton Street Salinas, California 93901 Telephone: (831) 771-9000 Telecopy: (831) 771-5587 If to the Company: Earlychildhood.com ----------------- 1353 Dayton Street Salinas, California 93901 Attn: Management Committee Telephone: (831) 771-9000 Telecopy: (831) 771-5587 12 With copies to: William E. Simon & Sons, L.L.C. -------------- 10990 Wilshire Boulevard, Suite 500 Los Angeles, California 90024 Attn: Robert P. Healy Telephone: (310) 914-2410 Telecopy: (310) 575-4220 Latham & Watkins 633 W. Fifth Street, Suite 4000 Los Angeles, California 90071-2007 Attn: Paul D. Tosetti, Esq. Telephone: (213) 485-1234 Telecopy: (213) 891-8763 or to such other address as any party may have furnished to the others in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 10. DIVISIBILITY OF AGREEMENT ------------------------- In the event that any term, condition or provision of this Agreement is for any reason rendered void, all remaining terms, conditions and provisions shall remain and continue as valid and enforceable obligations of the parties hereto. 11. CHOICE OF LAW ------------- This Agreement shall be construed, interpreted and the rights of the parties determined in accordance with the laws of the State of California (without giving effect to the choice of law provisions thereof), except with respect to matters of law concerning the internal corporate affairs of any corporate entity which is a party to or the subject of this Agreement, and as to those matters the law of the jurisdiction under which the respective entity derives its powers shall govern. 12. ARBITRATION ----------- Notwithstanding anything herein to the contrary, in the event that there shall be a dispute among the parties arising out of or relating to this Agreement or the breach thereof, other than Section 6 or Section 14 hereof, the parties agree that such dispute shall be resolved by final and binding arbitration before a sole arbitrator in San Francisco, California administered by the American Arbitration Association ("AAA"), in accordance with AAA's Labor Arbitration Rules then in effect. Depositions may be taken and other discovery may be obtained during such arbitration proceedings to the same extent as authorized in civil judicial proceedings. Any award issued as a result of such arbitration shall be final and binding between the parties thereto, and shall be enforceable by any court having jurisdiction over the party against whom enforcement is sought. The fees and expenses of such arbitration (including reasonable attorneys' fees) or any action to enforce an arbitration award shall be paid as may be awarded by the arbitrator. 13 13. SERVICE OF PROCESS; CONSENT TO JURISDICTION ------------------------------------------- (a) Service of Process. Each of the parties hereto irrevocably consents to the service of any process, pleading, notices or other papers by the mailing of copies thereof by registered, certified or first class mail, postage prepaid, to such party at such party's address set forth herein, or by any other method provided or permitted under California law. (b) Consent to Jurisdiction. Each party hereto irrevocably and unconditionally (i) agrees that any suit, action or other legal proceeding arising out of this Agreement shall be brought in the United States District Court for the Northern District of California or, if such court does not have jurisdiction or will not accept jurisdiction, in any court of general jurisdiction in the County of San Francisco, California, (ii) consents to the jurisdiction of any such court in any such suit, action or proceeding, and (iii) waives any objection which such party may have to the laying of venue of any such suit, action or proceeding in any such court. 14. LIMITATION ON LIABILITIES ------------------------- If Employee is awarded any damages as compensation for any breach or action related to this Agreement, a breach of any covenant contained in this Agreement (whether express or implied by either law or fact), or any other cause of action based in whole or in part on any breach of any provision of this Agreement, such damages shall be limited to contractual damages and shall exclude (a) punitive damages, and (b) consequential and/or incidental damages (e.g., lost profits and other indirect or speculative damages). The maximum amount of damages that Employee may recover for any reason shall be the amount equal to all amounts owed (but not yet paid) to Employee pursuant to this Agreement through its natural term or through any period for which severance is due pursuant to Section 5(b) hereof (including any amounts due to QTL in accordance with this Agreement upon exercise of the Call pursuant to Section 7 hereof). 15. COMPLETE AGREEMENT ------------------ This Agreement contains the entire understanding of the parties with respect to the employment of Employee and supersedes all prior arrangements or understandings with respect thereto and all oral or written employment agreements or arrangements between the Company (and any of its Affiliates) and Employee. This Agreement may not be altered or amended except by a writing, duly executed by the party against whom such alteration or amendment is sought to be enforced. 16. ASSIGNMENT ---------- This Agreement is personal and non-assignable by Employee. It shall inure to the benefit of any corporation or other entity with which the Company shall merge or consolidate or to which the Company shall lease or sell all or substantially all of its assets and may be assigned by the Company to any Affiliate of the Company or to any corporation or entity with which such Affiliate shall merge or consolidate or which shall lease or acquire all or substantially all of the 14 assets of such Affiliate; provided that as a condition to such sale of assets or merger, the purchaser or surviving company, as the case may be, shall have assumed all of the obligations and duties of the Company under this Agreement. 17. COUNTERPARTS ------------ This Agreement may be executed in counterparts, each of which shall be an original and all of which together shall constitute one and the same instrument. 18. EMPLOYEE'S ACKNOWLEDGMENT ------------------------- Employee acknowledges (a) that he has consulted with or has had the opportunity to consult with independent counsel of his own choice concerning this Agreement and has been advised to do so by the Company, and (b) that he has read and understands the Agreement, is fully aware of its legal effect, and has entered into it freely based on his own judgment. [Signature Page Follows] 15 IN WITNESS WHEREOF, each of the parties hereto has executed this Agreement as of the day and year first above written. "EMPLOYEE" /s/ Ronald Elliott ------------------------------ Ronald Elliott "COMPANY" EARLYCHILDHOOD.COM LLC, a California limited liability company /s/ Robert P. Healy ------------------------------ By: Robert P. Healy Title: Vice President 16 SCHEDULE 1 ---------- PROHIBITED COUNTIES California ----------
Alameda Madera San Luis Obispo Alpine Marin San Mateo Amador Mariposa Santa Barbara Butte Mendocino Santa Clara Calaveras Merced Santa Cruz Colusa Modoc Shasta Contra Costa Mono Sierra Del Norte Monterey Siskiyou El Dorado Napa Solano Fresno Nevada Sonoma Glenn Orange Stanislaus Humboldt Placer Sutter Imperial Plumas Tehama Inyo Riverside Trinity Kern Sacramento Tulare Kings San Benito Tuolumne Lake San Bernardino Ventura Lassen San Diego Yolo Los Angeles San Francisco Yuba
17 EX-10.19 19 0019.txt EMPLOYMENT AGREEMENT Exhibit 10.19 EMPLOYMENT AGREEMENT This employment agreement (the "Agreement") is effective December 6, 1999, between EARLYCHILDHOOD.COM LLC ("Employer") and JUDITH MCGUINN ("Employee"). RECITALS Employer desires the services of Employee in order to retain Employee's experience, abilities, and knowledge, and is therefore willing to engage her services on the terms and conditions set forth. Employee desires to be employed by Employer and is willing to do so on the terms and conditions set forth below. THEREFORE, in consideration of the above recitals and of the mutual promises and conditions set forth in this Agreement, it is agreed as follows: 1. DURATION: Subject to earlier termination as provided in this Agreement, Employee shall be employed for a term beginning December 6, 1999, and continuing through December 5, 2002. If Employer intends to employ Employee after the termination of this Agreement, the parties will meet at least sixty (60) days prior to the expiration of this Agreement to make a good faith attempt to negotiate a new agreement. 2. PLACE OF EMPLOYMENT: Unless the parties agree otherwise in writing, during the employment term Employee shall perform the services Employee is required to perform under this Agreement at Employer's headquarters (which are currently located at 2 Lower Ragsdale Drive, Suite 200, Monterey, California 93940); provided, however, that Employer may from time to time require Employee to travel temporarily to other locations on Employer's business. 3. DUTIES AND AUTHORITY: Employer shall employ Employee as Vice-President E- Content and Publishing or in such other capacity or capacities as Employer may from time to time prescribe. Employee shall have the full power and authority to manage and conduct business for the Employer, subject to the directions and policies of Employer as they may be, from time to time, stated either orally or in writing. 4. REASONABLE TIME AND EFFORT: During Employee's employment, Employee shall devote such time, interest, and effort to the performance of this Agreement as may be fairly and reasonably necessary. 5. SALARY: During the term of this Agreement, Employer agrees to pay Employee a base salary of $150,000 per year. The base salary shall be payable as a current salary on a semi-monthly basis. Employer, in its sole discretion, may increase Employee's base salary or any other benefits but may not decrease Employee's salary during the term of this Agreement. At Employee's request, Employee will receive a salary review at or near the end of each twelve (12) month period during the term. If during the term of this Agreement Employee's position is eliminated for any reason and/or Employee's employment with Employer is otherwise involuntarily terminated because 1) Employee's title is lowered, 2) Employee's reporting assignment is changed, without Employee's consent, to anyone other than Ronald Elliott while Ronald Elliott remains employed by Employer, 3) if Employee resigns (which shall, for purposes of this provision 3) only, be considered to be an "involuntary termination") because Ronald Elliott ceases to be President of Employer, 4) if Employee's place of business is relocated at least thirty (30) miles from Employer's headquarters on the effective date of this Agreement, or 5) any reason apart from the reasons set forth in the sections below titled "Termination," "Termination Because of Death," and/or "Termination Because of Disability," Employer shall continue to pay Employee's base salary in effect at the time of Employee's termination of employment through December 5, 2002. In such case, Employee will have no obligation to mitigate her lost compensation. In such case, Employer will also reimburse Employee's insurance premiums incurred as a result of the continuation of Employee's benefits coverage required by COBRA. Whenever compensation is payable to Employee during a time when Employee is partially or totally disabled and such disability would entitle Employee to disability income or to salary continuation payments from Employer according to the terms of any plan now or hereafter provided by Employer or according to any policy of Employer in effect at the time of such disability, Employee shall apply for such disability income or salary continuation, and the compensation payable to Employee under this Agreement shall be inclusive of any such disability income or salary continuation and shall not be in addition to such disability income or salary continuation. If disability income is payable to Employee by an insurance company under an insurance policy paid for by Employer, the compensation payable to Employee under this Agreement shall be inclusive of the amounts paid to Employee by that insurance company and shall not be in addition to the amounts paid to Employee by that insurance company. 6. RELOCATION EXPENSES: Employer shall be responsible for payment of all reasonable moving expenses incurred by Employee as a result of her relocation from New York, New York to Monterey, California. 7. RENTAL EXPENSES: Employer shall reimburse Employee, up to a maximum of $5000, for the cost of rental housing for Employee in or near Monterey. Such reimbursement shall be limited to the time Employee is paying rental expenses at her apartment in New York while at the same time paying for temporary rental housing in or near Monterey. 8. ADDITIONAL RELOCATION EXPENSES: Employer shall be responsible for payment of all reasonable moving expenses incurred by Employee as a result of her relocation, within one year from the effective date of this agreement, from temporary housing in or near Monterey to permanent housing in or near Monterey. 9. SIGNING BONUS: Employee shall be entitled to a "signing bonus" of $9,000 "net" (after normal withholding). Such "signing bonus" shall be paid to Employee during the first month following her first day of employment with Employer. 10. REIMBURSEMENT OF FOREGONE BONUS: Employer shall reimburse Employee, up to a maximum of $14,000, for any bonus Employee would otherwise have received from her former employer, Time Warner Trade Publishing, but for Employer's hiring of Employee to begin work prior to December 31, 1999. 11. ADDITIONAL BENEFITS: During the employment term, Employee shall be entitled to receive all other benefits of employment generally available to Employer's other managerial employees as she becomes eligible for them, including medical, dental, life and disability insurance benefits, and participation in Employer's Management Incentive Plan, pension plan, quarterly bonus plan and/or profit-sharing plan. Employer reserves the right to modify, suspend or discontinue any and all of the above benefit plans, policies and practices at any time without notice to or recourse to Employee so long as such action is taken generally with respect to other similarly situated persons and does not single out Employee. 12. VACATION: Employee shall be entitled to four weeks (20 business days) of paid vacation each calendar year, which shall accrue on a prorata basis from the date employment commences under this Agreement. Vacation time will continue to accrue so long as Employee's total accrued vacation does not exceed four weeks (20 business days). In the event Employee's accrued vacation should reach four weeks (20 business days), Employee will cease to accrue further vacation until Employee's accrued vacation time falls below that level. Employee agrees to inform Employer of her vacation schedule as soon as reasonably possible but not later than 30 days in advance of taking such vacation. Employee further agrees to schedule Employee's vacation at a time that is not disruptive to the company's business. 13. PAID TIME OFF: In addition to vacation accrual as set forth in the "Vacation" section above, Employee shall be entitled to nine (9) business days of Paid Time Off ("PTO") each calendar year. PTO will continue to accrue so long as Employee's total accrued PTO does not exceed fourteen (14) business days. In the event Employee's accrued PTO should reach fourteen (14) business days, Employee will cease to accrue further PTO until Employee's accrued PTO falls below that level. Other than the accrual and maximum accrual of PTO as set forth in this section of the Agreement, Employee's PTO shall be governed by the PTO provisions of the Earlychildhood.com Employee Manual. 14. EXPENSE REIMBURSEMENT: During the employment term, to the extent that such expenditures satisfy the criteria under the Internal Revenue Code for deductibility by Employer (whether or not fully deductible) for federal income tax purposes as 3 ordinary and necessary business expenses, Employer shall reimburse Employee promptly for reasonable business expenses, including travel, entertainment, parking, business meetings, and professional dues, made and substantiated in accordance with the policies and procedures established from time to time by Employer with respect to Employer's other similarly situated employees. 15. TERMINATION: Employer may terminate this Agreement at any time for cause. Under this Agreement, the term "cause" shall mean (i) misappropriation of any material funds or property of Employer or of any of its related companies; (ii) unjustifiable neglect of duties under this Agreement; (iii) conviction of a felony involving moral turpitude; (iv) gross misconduct and/or the failure to act in good faith to the material detriment of Employer, or (v) willful and bad faith failure to obey reasonable and material orders given by Employer; provided that in each such case (other than (i) or (iii)) prompt written notice of such cause is given to Employee specifying in reasonable detail the facts giving rise to the notice and that continuation of such cause will result in termination of employment, and such cause is not cured within three (3) business days after receipt by Employee of such notice. If Employee is terminated as set forth in this paragraph, then payment of the specified salary earned and benefits accrued as of the date of the termination shall be payment in full of all compensation payable under this Agreement. Employer may, at Employer's election, suspend the operation of this Agreement both as to the rendition of Employee's services and as to Employee's compensation for and during the continuance of any period(s) during which Employer shall be materially hampered, interrupted or interfered with in the normal conduct of Employer's business by reason of any epidemic, fire, action of the elements, strike, walkout, labor dispute, governmental order, court order or order of any other legally constituted authority, act of God or public enemy, riot, civil commotion, inability to procure materials and equipment or any other cause or causes beyond Employer's control, whether of the same or any other nature. If any suspension by reason of the preceding sentence shall continue for more than eight (8) consecutive weeks, then Employer may terminate this Agreement for the then-remaining portion of the Term. If Employer suspends Employee's services and compensation pursuant to this paragraph for a period of eight (8) consecutive weeks or longer, Employee shall have the right to terminate the Agreement on five (5) days written notice unless Employer resumes payment of Employee's compensation hereunder within five (5) days of receipt of such notice. If Employee is terminated as set forth in this paragraph, Employer shall be released and discharged of and from all further obligations under this Agreement, except for any monies due and owing to Employee and then unpaid which shall have vested prior to such termination. Notwithstanding the foregoing, Employer shall not suspend or terminate the operation of this Agreement pursuant to this paragraph (which shall be known as the "Force Majeure" paragraph) unless the agreements of employees based at Employer's headquarters, of a status of vice president or higher are simultaneously suspended or terminated. 4 16. TERMINATION BECAUSE OF DEATH: In the event that Employee dies during the term of this Agreement, this Agreement shall be terminated on the last day of the calendar month of her death and Employer shall be required to pay to Employee's estate the specified salary and any additional benefits accrued by Employee at the time of her death. 17. TERMINATION BECAUSE OF DISABILITY: If, at the end of any calendar month during the initial term or any renewal term of this Agreement, Employee is and has been for the three (3) consecutive full calendar months then ending, or for 80% or more of the normal working days during the six (6) consecutive full calendar months then ending, unable due to mental or physical illness or injury to perform Employee's duties under this Agreement, Employer shall have the right to, subject to applicable federal and state law, terminate Employee's employment, and Employer shall only be obligated to pay Employee the specified compensation earned and benefits accrued by Employee at the time of her termination by Employer. 18. AGREEMENT SURVIVES COMBINATION OR DISSOLUTION: This Agreement shall not be terminated by Employer's voluntary or involuntary dissolution or by any merger in which Employer is not the surviving or resulting corporation, or on any transfer of all or substantially all of Employer's assets. In the event of any such merger or transfer of assets, the provisions of this Agreement shall be binding on and inure to the benefit of the surviving business entity or the business entity to which such assets shall be transferred. 19. NOTICES: All notices that either party is required or may desire to serve upon the other may be served either personally or sent Certified Mail/Return Receipt Requested addressed to the other party to be served as follows: To Employer: Ron Elliott, 2 Lower Ragsdale Dr., #200, Monterey, CA 93940. To Employee: Judith McGuinn, 1121 Roosevelt Street, Monterey, CA 93940. 20. EMPLOYEE MANUAL: Employee acknowledges that Employee has been provided a copy of the Earlychildhood.com Employee Manual, attached hereto as Exhibit A. It is agreed and understood that the Employee Manual represents guidelines that the Company may change from time to time in its sole discretion. It is not intended to be a contract. To the extent that this Agreement conflicts with the Employee Manual, the terms of this Agreement pertain to Employee's employment. 21. NONDISCLOSURE OF CONFIDENTIAL INFORMATION OR TRADE SECRETS: In the course of Employee's employment with Employer, Employee will have access to confidential records and data pertaining to Employer's customers and its operations. Such information is considered secret and is disclosed to Employee in confidence. Furthermore, all memoranda, notes, records, computer files, and other documents or tangible material made or compiled by Employee, or made available to Employee during the term of this Agreement concerning the business of Employer, shall be the sole property of Employer and shall be delivered to Employer on the expiration or 5 termination of this Agreement, or at another time on request. During Employee's employment with Employer and thereafter, Employee shall keep in confidence and shall not directly or indirectly disclose any secret or confidential information belonging to Employer or any of its related companies except as required in the course of Employee's employment by Employer and/or authorized in writing by Employer, or required by law. 22. GOVERNING LAW: This Agreement shall be governed by, and construed in accordance with, the laws of the State of California. 23. WAIVER: The failure by either party to exercise or enforce any terms or conditions under this Agreement shall not be deemed to be a waiver of that party's right to exercise or enforce any such term or condition in the future. The waiver by either party of any breach, default, or omission in the performance of any of the terms or conditions of this Agreement by the other party shall not be deemed to be a waiver of any other breach, default, or omission. 24. SEVERABILITY: If any part of this Agreement is invalided or rendered unenforceable by any court of competent jurisdiction or by any regulation or legislation to which it is subject, the remaining provisions and that provision found invalid or unenforceable as it may apply to other circumstances, shall remain in full force and effect. In such event, the parties shall promptly negotiate in good faith to amend this Agreement by replacing such stricken provision with a valid and enforceable provision that fulfills the original intention of the invalid or unenforceable provision. 25. ENTIRE AGREEMENT: This Agreement constitutes the entire Agreement of the parties with respect to the subject matter hereof and cancels and supersedes all previous agreements or understandings relating thereto, whether written or oral, between the parties. 26. ARBITRATION: In the event that there shall be a dispute between the parties arising out of or relating to this Agreement or the breach thereof, other than Section 22 hereof, the parties agree that such dispute shall be resolved by final and binding arbitration before a sole arbitrator in Monterey, California administered by the American Arbitration Association ("AAA") in accordance with AAA's Labor Arbitration Rules then in effect. Depositions may be taken and other discovery may be obtained during such arbitration proceedings to the same extent as authorized in civil judicial proceedings. Any award issued as a result of such arbitration shall be final and binding between the parties thereto, and shall be enforceable by any court having jurisdiction over the party against whom enforcement is sought. The prevailing party in any legal action (including arbitration) shall be entitled to recover any and all reasonable attorneys' fees and other costs reasonably incurred in connection therewith. 27. AMENDMENT: This agreement shall only be amended or waived by a writing that explicitly refers to this Agreement and that is signed by both parties. 6 28. EXECUTION: The parties, having carefully read this Agreement and having consulted or having been given an opportunity to consult legal counsel, hereby acknowledge their agreement to all of the foregoing terms and conditions by executing this Agreement. Each signatory hereto represents and warrants that it is authorized to sign this Agreement on behalf of the respective party. This Agreement may be executed in any number of counterparts, and each such counterpart shall be an original and together they shall constitute one agreement. EMPLOYER EMPLOYEE By: By: /s/ Ronald Elliott /s/ Judith McGuinn - ------------------ ------------------ Ronald Elliott Judith McGuinn President - Earlychildhood.com LLC Date: Jan. 3, 2000 Date: Jan. 3, 2000 ------ ------ 7 EX-10.28 20 0020.txt LEASE AGREEMENT Exhibit 10.28 INDUSTRIAL REAL ESTATE LEASE --------------------------------- SINGLE-TENANT NET FORM ---------------------- TABLE OF CONTENTS
Article One Basic Terms.......................... 1 Article Two Premises and Property................ 2 Article Three Lease Term........................... 2 Article Four Rent................................. 4 Article Five Property Taxes....................... 4 Article Six Utilities............................ 4 Article Seven Insurance............................ 4 Article Eight Outside Areas........................ 7 Article Nine Use of Premises...................... 7 Article Ten Condition and Maintenance of Premises 9 Article Eleven Damage or Destruction................ 11 Article Twelve Condemnation......................... 12 Article Thirteen Assignment and Subletting............ 13 Article Fourteen Defaults; Remedies................... 14 Article Fifteen Protection of Lenders................ 16 Article Sixteen Legal Costs.......................... 17 Article Seventeen Miscellaneous Provisions............. 18 Exhibit A The Premises......................... A-1 Exhibit B Rules and Regulations................ B-1
ARTICLE ONE - BASIC TERMS The following terms used in this Lease shall have the meanings set forth below. 1.01 Date Of Lease: August 9, 2000 1.02 Landlord (legal entity): Elliott-Mair Salinas LLC, a California limited liability company 1.03 Tenant (legal entity): Earlychildhood.com LLC, a California limited liability company 1.04 Tenant's Guarantor: None 1.05 Address of Property: 1353 Dayton Street, Salinas, California 93901 1.06 Intentionally Omitted 1.07 Premises Rentable Area: Approximately 39,600 rentable square feet (including approximately 33,000 rsf of warehouse space and 6,600 rsf of office space) 1.08 Intentionally Deleted 1.09 Lease Term: The period beginning on the Lease Commencement Date and expiring on August 8, 2005 1.10 Lease Commencement Date: August 9, 2000 1.11 Permitted Uses: Warehousing, distribution and office uses 1.12 Broker(s): None 1.13 Initial Security Deposit: None 1.14 Intentionally Omitted 1.15 Base Rent: Base Rent shall be $22,110/month ($1.10psf for 6,600 sf of office space and $.45psf for 33,000 sf of warehouse space) for the first year of the Lease, and shall be increased in an amount equal to the CPI Increase or three percent (3%), whichever is greater, for each successive year of the Lease Term. For purposes of this Lease, "CPI Increase" shall mean (as a percentage increase): (i) the Cost of Living Index (as defined below) published for the month 3 months prior to expiration of the then current Lease year, over (ii) the Cost of Living Index published for the first month of the commencement of the then current Lease year. The "Cost of Living Index" means the Consumer Price Index for All Urban Consumers, U.S. City Average (1982-1984 = 100), published by the Department of Labor. NNN 1 1.16 Other Charges Payable by Tenant: (i) Real Property Taxes (Article Five); (ii) Utilities (Article Six); (iii) Insurance Premiums (Article Seven); (iv) OAM Expenses (Article Eight); 1.17 Address of Landlord for Notices: Elliott-Mair Salinas LLC 2 Lower Ragsdale Drive, Suite 200 Monterey, California 93940 Attn: Ron Elliott 2 1.18 Address of Tenant for Notices: Earlychildhood.com LLC 2 Lower Ragsdale Drive, Suite 200 Monterey, California 93940 1.19 Intentionally Omitted 1.20 Exhibits: Exhibit A: The Premises Exhibit B: Rules & Regulations ARTICLE TWO - PREMISES AND PROPERTY 2.01 Premises and Property. The Premises are described in Exhibit A and consists of all the land, building(s), and all other improvements located on the land including, without limitation, the landscaping, utility services, signage and paved areas. The term "Property" shall have the same meaning as Premises within this lease. ARTICLE THREE - LEASE TERM 3.01 Lease of Premises for Lease Term. Landlord leases the Premises to Tenant and Tenant leases the Premises from Landlord for the Lease Term. The Lease Term shall begin on the Lease Commencement Date. Provided that no "event of default" (as set forth in Section 14.02), has occurred and is continuing, then Lessee shall have the right to renew this Lease for one (1) additional five (5) year renewal term (the "Extended Term"), upon giving written notice to Lessor of such renewal not less than two (2) months prior to the expiration of the then current Lease Term. During the Extended Term, all of the terms and conditions of this Lease shall continue in full force and effect, including increases in the Base Rent equal to the CPI increase or 3%, whichever is greater. 3.02 Delay in Commencement. Landlord shall not be liable to Tenant if Landlord shall not deliver possession of the Premises to Tenant on the Lease Commencement Date. The Lease Commencement Date shall be postponed to the date possession of the Premises shall be delivered to Tenant. 3.03 Early Occupancy. If Tenant shall occupy the Premises prior to the Lease Commencement Date, Tenant's occupancy of the Premises shall be subject to all of the provisions of this Lease. Early occupancy of the Premises shall not advance the expiration date of this Lease. Tenant shall pay Base Rent and all charges specified in this Lease during the early occupancy period. 3.04 Holding Over. Tenant shall vacate the Premises upon the expiration or earlier termination of this Lease. Tenant shall reimburse Landlord for and 3 indemnify Landlord against all damages, costs, liabilities and expenses, including attorneys' fees, which Landlord shall incur on account of Tenant's delay in so vacating the Premises. If Tenant shall not vacate the Premises upon the expiration or earlier termination of this Lease, the Base Rent shall be increased to 125% of the Base Rent then in effect and Tenant's obligation to pay Additional Rent shall continue, but nothing herein shall limit any of Landlord's rights or Tenant's obligations arising from Tenant's failure to vacate the Premises, including, without limitation, Landlord's right to repossess the Premises and remove Tenant therefrom at any time after the expiration or earlier termination of this Lease and Tenant's obligation to reimburse and indemnify Landlord as provided in the preceding sentence. ARTICLE FOUR - RENT 4.01 Base Rent. On the first day of each month during the Lease Term, Tenant shall pay to Landlord the Base Rent in lawful money of the United States, in advance, without offset, deduction, or prior demand. The Base Rent shall be payable at Landlord's address or at such other place or to such other person as Landlord may designate in writing from time to time. 4.02 Additional Rent. All sums payable by Tenant under this Lease other than Base Rent shall be deemed "Additional Rent;" the term "Rent" shall mean Base Rent and Additional Rent. Landlord shall estimate in advance and charge to Tenant the following costs, to be paid with the Base Rent on a monthly basis throughout the Lease Term: (i) all Real Property Taxes for which Tenant is liable under Section 5.01 and 5.02 of the Lease, (ii) all utility costs (if utilities are not separately metered) for which Tenant is liable under Section 6.01 of the Lease, (iii) all insurance premiums for which Tenant is liable under Sections 7.01 and 7.06 of the Lease and (iv) all OAM Expenses for which Tenant is liable under Section 8.04 of the Lease. Collectively, the aforementioned Real Property Tax, insurance, utility, and OAM Expenses (if not paid by Tenant directly) shall be the "Total Operating Costs." Landlord may adjust its estimates of Total Operating Costs at any time based upon Landlord's experience and reasonable anticipation of costs. Such adjustments shall be effective as of the next Rent payment date after notice to Tenant. Within one hundred twenty (120) days after the end of each fiscal year during the Lease Term, Landlord shall deliver to Tenant a statement prepared in accordance with generally accepted accounting principles setting forth, in reasonable detail, the Total Operating Costs paid or incurred by Landlord during the preceding fiscal year. Within thirty (30) days after Tenant's receipt of such statement, there shall be an adjustment between Landlord and Tenant, with payment to or credit given by Landlord (as the case may be) in order that Landlord shall receive the entire amount of Tenant's share of such costs and expenses for such period. In addition to its obligation to pay Base Rent and Total Operating Expenses, Tenant is required hereunder to pay directly to suppliers, vendors, carriers, contractors, etc. certain insurance premiums, utility costs, personal property taxes, maintenance and repair and other expenses collectively "Additional Expenses." If Landlord pays for any Additional Expenses in accordance with the terms of this Lease, Tenant's obligation to reimburse such costs shall be an Additional Rent obligation payable in full with the next monthly Rent payment. Unless this Lease provides otherwise, Tenant shall pay all Additional Rent then due with the next monthly installment of Base Rent. 4 4.03 Late Charge. Tenant hereby acknowledges that late payment by Tenant to Landlord of Rent and other amounts due hereunder will cause Landlord to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed on Landlord by the terms of any loan secured by the Building. Accordingly, if any installment of Rent or any other sums due from Tenant shall not be received by Landlord within five (5) days following the due date, Tenant shall pay to Landlord a late charge equal to five (5%) percent of such overdue amount. The parties hereby agree that such late charge represents a fair and reasonable estimate of the costs Landlord will incur by reason of late payment by Tenant. Acceptance of such late charge by Landlord shall in no event constitute a waiver of Tenant's default with respect to such overdue amount, nor prevent Landlord from exercising any of the other rights and remedies granted hereunder. 4.04 Interest. Any amount due to Landlord, if not paid when due, shall bear interest from the date due until paid at the rate of fifteen percent (15%) per annum or, if a higher rate is legally permissible, at the highest rate legally permitted, provided that interest shall not be payable on late charges incurred by Tenant nor on any amounts upon which late charges are paid by Tenant to the extent such interest would cause the total interest to be in excess of that legally permitted. Payment of interest shall not excuse or cure any default hereunder by Tenant. ARTICLE FIVE - PROPERTY TAXES 5.01 Real Property Taxes. Tenant shall pay Real Property Taxes on the Property attributable to the Lease Term. Tenant shall make such payments in accordance with Section 4.02. If Landlord shall receive a refund of any real property taxes with respect to which Tenant shall have paid to, or on behalf of, Landlord, Landlord shall pay to Tenant the amount of such refund after deducting therefrom the costs and expenses incurred in connection therewith. 5.02 Definition of "Real Property Tax". "Real Property Tax" shall mean taxes, assessments (special, betterment, or otherwise), levies, fees, rent taxes, impositions, excises, charges, water and sewer rents and charges, and all other government levies and charges, general and special, ordinary and extraordinary, foreseen and unforeseen, which are imposed or levied upon or assessed against the Property or any Rent or other sums payable by any tenants or occupants thereof. If at any time during the term the present system of ad valorem taxation of real property shall be changed so that in lieu of the whole or any part of the ad valorem tax on real property, or in lieu of increases therein, there shall be assessed on Landlord a capital levy or other tax on the gross rents received with respect to the Property or a federal, state, county, municipal, or other local income, franchise, excise or similar tax, assessment, levy, or charge (distinct from any now in effect) measured by or based, in whole or in part, upon gross rents, then all of such taxes, assessments, levies, or charges, to the extent so measured or based, shall be deemed to be a Real Property Tax. 5.03 Personal Property Taxes. Tenant shall pay directly all taxes charged against trade fixtures, furnishings, equipment, inventory, or any other personal property belonging to Tenant. Tenant shall use its best efforts to have personal property taxed separately from the Property. If any of Tenant's personal property shall be taxed with the Property, Tenant shall pay Landlord the taxes for such personal property within fifteen (15) days after Tenant receives a written statement from Landlord for such personal property taxes. 5 ARTICLE SIX - UTILITIES 6.01 Utilities. Tenant shall promptly pay, directly to the appropriate supplier, the cost of all natural gas, heat, cooling, energy, light, power, sewer service, telephone, water, refuse disposal and other utilities and services supplied to the Premises allocable to the period from the time Tenant shall first enter the Premises, throughout the Lease Term and thereafter as long as Tenant shall remain in the Premises (collectively, the "Occupancy Period"), together with any related installation or connection charges or deposits (collectively "Utility Costs"). Landlord shall not be liable for damages, consequential or otherwise, nor shall there be any Rent abatement arising out of any curtailment or interruption whatsoever in utility services. ARTICLE SEVEN - INSURANCE 7.01 Liability Insurance. During the Occupancy Period, Tenant shall maintain in effect commercial general liability insurance insuring Tenant against liability for bodily injury, property damage (including loss of use of property) and personal injury at the Premises. Such insurance shall name Landlord, its property manager, and any mortgagee, as additional insureds. The initial amount of such insurance shall be Five Million Dollars ($5,000,000) per occurrence and shall be subject to periodic increases specified by Landlord based upon inflation, increased liability awards, recommendation of Landlord's professional insurance advisers, and other relevant factors. The liability insurance obtained by Tenant under this Section 7.01 shall (i) be primary and (ii) insure Tenant's obligations to Landlord under Section 7.09. The amount and coverage of such insurance shall not limit Tenant's liability nor relieve Tenant of any other obligation under this Lease. Landlord may also obtain commercial general liability insurance in an amount and with coverage determined by Landlord insuring Landlord against liability with respect to the Premises and the Property. The policy obtained by Landlord shall not be contributory, shall not provide primary insurance, and shall be excess over any insurance maintained by Tenant. 7.02 Worker's Compensation Insurance. During the Occupancy Period, Tenant shall maintain in effect Worker's Compensation Insurance (including Employees' Liability Insurance) in the statutory amount covering all employees of Tenant employed or performing services at the Premises, in order to provide the statutory benefits required by the laws of the state in which the Premises are located. 7.03 Automobile Liability Insurance. During the Occupancy Period, Tenant shall maintain in effect Automobile Liability Insurance, including but not limited to, passenger liability, on all owned, non-owned, and hired vehicles used in connection with the Premises, with a combined single limit per occurrence of not less than One Million Dollars ($1,000,000 for injuries or death of one or more persons or loss or damage to property. 6 7.04 Personal Property Insurance. During the Occupancy Period, Tenant shall maintain in effect Personal Property Insurance covering leasehold improvements paid for by Tenant and Tenant's personal property and fixtures from time to time in, on, or at the premises, in an amount not less than 100% of the full replacement cost, without deduction for depreciation, providing protection against events protected under "All Risk Coverage," as well as against sprinkler damage, vandalism, and malicious mischief. Any proceeds from the Personal Property Insurance shall be used for the repair or replacement of the property damaged or destroyed, unless this Lease is terminated under an applicable provision herein. If the premises are not repaired or restored following damage or destruction in accordance with other provisions herein, Landlord shall receive any proceeds from the Personal Property Insurance allocable to Tenant's leasehold improvements. 7.05 Business Interruption Insurance. During the Occupancy Period, Tenant shall maintain in effect Business Interruption Insurance, providing in the event of damage or destruction of the Premises an amount sufficient to sustain Tenant for a period of not less than one (1) year for: (i) the net profit that would have been realized had Tenant's business continued; and (ii) such fixed charges and expenses as must necessarily continue during a total or partial suspension of business to the extent to which they would have been incurred had no business interruption occurred, including, but not limited to, interest on indebtedness of Tenant, salaries of executives, foremen, and other employees under contract, charges under noncancelable contracts, charges for advertising, legal or other professional services, taxes and rents that may still continue, trade association dues, insurance premiums, and depreciation. 7.06 Landlord's Property and Rental Income Insurance. During the Lease Term, Landlord shall maintain in effect all risk insurance covering loss of or damage to the Property in the amount of its replacement value with such endorsements and deductibles as Landlord shall determine from time to time. Landlord shall have the right to obtain flood, earthquake, and such other insurance as Landlord shall determine from time to time or shall be required by any lender holding a security interest in the Property. Landlord shall not obtain insurance for Tenant's fixtures or equipment or building improvements installed by Tenant. During the Lease Term, Landlord shall also maintain a rental income insurance policy, with loss payable to Landlord, in an amount equal to one year's Base Rent, plus estimated real property taxes, operating expenses, and insurance premiums. Tenant shall be liable for the payment of any deductible amount under Landlord's insurance maintained pursuant to this Article Seven, in an amount not to exceed Twenty-Five Thousand Dollars ($25,000). Tenant shall not do or permit anything to be done which shall invalidate any such insurance. Any increase in the cost of Landlord's insurance due to Tenant's use or activities at the Premises shall be paid by Tenant to Landlord as Additional Rent hereunder. 7.07 Payment of Insurance Premiums. Landlord shall pay the premiums of the insurance policies maintained by Landlord under Section 7.06 and 7.01 (if applicable), and, Tenant shall reimburse Landlord for such premiums in accordance with Section 4.02. Tenant shall pay directly the premiums of the insurance policies maintained by Tenant under Sections 7.01, 7.02, 7.03, 7.04, and 7.05. 7 7.08 General Insurance Provisions. ---------------------------- 7.08(a) Any insurance which Tenant shall be required to maintain under this Lease shall include a provision which requires the insurance carrier to give Landlord not less than thirty (30) days' written notice prior to any cancellation or modification of such coverage. 7.08(b) Prior to the earlier of Tenant's entry into the Premises or the Commencement Date, Tenant shall deliver to Landlord an insurance company certificate that Tenant maintains the insurance required by Sections 7.01, 7.02, 7.03, 7.04 and 7.05 and not less than thirty (30) days prior to the expiration or termination of any such insurance, Tenant shall deliver to Landlord renewal certificates therefor. Tenant shall provide Landlord with copies of the policies promptly upon request from time to time. If Tenant shall fail to deliver any certificate or renewal certificate to Landlord required under this Lease within the prescribed time period or if any such policy shall be canceled or modified during the Lease Term without Landlord's consent, Landlord may obtain such insurance, in which case Tenant shall reimburse Landlord, as additional Rent, for 110% of the cost of such insurance within ten (10) days after receipt of a statement of the cost of such insurance. 7.08(c) Tenant shall maintain all insurance required under this Lease with companies having a "General Policy Rating" of A-;X or better, as set forth in the most current issue of the Best Key Rating Guide. Landlord and Tenant, on behalf of themselves and their insurers, each hereby waive any and all rights of recovery against the other, or against the officers, partners, employees, agents, or representatives of the other, for loss of or damage to its property or the property of others under its control, if such loss or damage shall be covered by any insurance policy in force (whether or not described in this Lease) at the time of such loss or damage. All property insurance carried by either party shall contain a waiver of subrogation against the other party to the extent such right shall have been waived by the insured party prior to the occurrence of loss or injury. 7.09 Indemnity. To the fullest extent permitted by law, Tenant hereby waives all claims against Landlord, its agents, advisors, employees, members, officers, directors, partners, trustees, beneficiaries and shareholders (each a "Landlord Party"), and the agents, advisors, employees, members, officers, directors, partners, trustees, beneficiaries and shareholders of each Landlord Party (collectively "the Indemnitees") for damage to any property or injury to or death of any person in, upon or about the Premises or the Property arising at any time and from any cause, except to the extent caused by the negligence or willful misconduct of Landlord, its agents, employees or contractors, and Tenant shall hold Indemnitees harmless from and defend Indemnitees from and against all claims, liabilities, judgements, demands, causes of action, losses, damages, costs and expenses including reasonable attorney's fees for damage to any property or injury to or death of any person arising in or from (i) the use or occupancy of the Premises by Tenant or persons claiming under Tenant, except to the extent caused by the negligence or willful misconduct of Landlord, its agents, employees or contractors, or (ii) arising from the negligence or willful misconduct of Tenant, its employees, agents, contractors, or invitees in, upon or about the Property, or (iii) arising out of any breach or default by Tenant under this Lease. The provisions of this Section 7.09 shall survive the expiration or termination of this Lease with respect to any damage, injury, or death occurring prior to such time. 8 ARTICLE EIGHT - OUTSIDE AREAS 8.01 Outside Areas. As used in this Lease, "Outside Areas" shall mean all areas within the Property which are outside the building envelope, including, but not limited to, parking areas, driveways, sidewalks, access roads, landscaping, and planted areas. So long as any changes do not materially impact Tenant's access to the Premises or availability of parking spaces to Tenant on the Premises, Landlord, from time to time, may change the size, location, nature, and use of any of the Outside Areas, convert Outside Areas into leaseable areas, construct additional parking facilities (including parking structures) in the Outside areas, and increase or decrease Outside Area land or facilities.. Tenant acknowledges that such activities may result in inconvenience to Tenant. Such activities and changes are permitted if Landlord provides written notification to Tenant of such activities and changes at least thirty (30) days prior to the activities and changes, and the activities and changes do not materially affect Tenant's use of the Premises. 8.02 Use of Outside Areas. Tenant shall have the nonexclusive right to use the Outside Areas for the purposes intended, subject to such reasonable rules and regulations ("Rules and Regulations") as Landlord may establish or modify from time to time and as initially set forth in Exhibit B. Tenant shall abide by all such Rules and Regulations and shall use its best efforts to cause others who use the Outside Areas with Tenant's express or implied permission to abide by Landlord's Rules and Regulations. At any time, Landlord may close any Outside Areas to perform any acts in the Outside Areas as, in Landlord's reasonable judgement, are desirable to maintain or improve the Property as long as such closure or performance of any acts does not materially affect Tenant's use of the Property. Tenant shall not interfere with the rights of Landlord, other tenants, or any other person entitled to use the Outside Areas. 8.03 Outside Area Maintenance. Tenant, at its sole cost and expense, shall maintain the Outside Areas in good order, condition, and repair. Outside Area Maintenance expenses ("OAM Expenses") are all costs and expenses associated with the operation and maintenance of the Outside Areas and the repair and maintenance of the heating, ventilation, air conditioning, plumbing, electrical, utility, and safety systems, including, but not limited to, the following: gardening and landscaping; snow removal; utility, water and sewage services for the Outside Area; maintenance of signs; worker's compensation insurance; personal property taxes; rental or lease payments for rented or leased personal property used in the operation or maintenance of the Outside Areas; fees for required licenses and permits; routine maintenance and repair of roof membrane, flashings, gutters, downspouts, roof drains, skylights and waterproofing; maintenance of paving (including sweeping, striping, repairing, resurfacing, and repaving); general maintenance; painting; lighting; cleaning; refuse removal; security and similar items; and reserves for roof replacement, exterior painting and other appropriate reserves. Tenant shall pay all OAM Expenses in accordance with Section 4.02. 9 ARTICLE NINE - USE OF PREMISES 9.01 Permitted Uses. Tenant may use the Premises only for the Permitted Uses. 9.02 Manner of Use. Tenant shall not cause or permit the Premises to be used in any way which shall constitute a violation of any law, ordinance, or governmental regulation, order, or restrictive covenant, or which shall annoy or interfere with the rights of tenants of the Property, or which shall constitute a nuisance or waste. Tenant shall obtain and pay for all permits, including a certificate of occupancy and shall promptly take all actions necessary to comply with all applicable statutes, ordinances, notes, regulations, orders covenants and requirements regulating the use by Tenant of the Premises, including the Occupational Safety and Health Act and the Americans With Disabilities Act. 9.03 Hazardous Materials. As used in this Lease, the term "Hazardous Material" shall mean any flammable items, explosives, radioactive materials, oil, hazardous or toxic substances, material or waste or related materials, including any substances defined as or included in the definition of "hazardous substances", "hazardous wastes", "hazardous materials" or "toxic substances" now or subsequently regulated under any applicable federal, state or local laws or regulations, including without limitation petroleum-based products, paints, solvents, lead, cyanide, DDT, printing inks, acids, pesticides, ammonia compounds and other chemical products, asbestos, PCBs and similar compounds, and including any different products and materials which are subsequently found to have adverse effects on the environment or the health and safety of persons. Tenant shall not cause or permit any Hazardous Material to be generated, produced, brought upon, used, stored, treated or disposed of in or about the Property in any reportable amount, and all Hazardous Material to be generated, produced, brought upon, used, stored, treated or disposed of in or about the Property shall be in compliance with all applicable laws, rules, and regulations. If the transportation, storage, use or disposal of Hazardous Materials on the Premises results in the contamination of the soil or surface or ground water or loss or damage to person(s) or property, then Tenant agrees to: (a) notify Landlord immediately of any contamination, claim of contamination, loss or damage, (b) after consultation with the Landlord, clean up the contamination in full compliance with all applicable statutes, regulations and standards and (c) indemnify, defend and hold Landlord harmless from and against any claims, suits, causes of action, costs and fees, including attorney's fees and costs, arising from or connected with any such contamination, claim of contamination, loss or damage. Tenant shall not be responsible for any Hazardous Materials generated, produced, brought upon, used, stored, treated or disposed of in or about the Property in any reportable amount prior to Tenant taking possession of the Premises. Tenant agrees to fully cooperate with Landlord and provide such documents, affidavits and information as may be requested by Landlord (i) to comply with any environmental law, (ii) to comply with the request of any lender, purchaser or tenant, and/or (iii) for any other reason deemed necessary by Landlord in its sole discretion. Tenant shall notify Landlord promptly in the event of any spill or other release of any Hazardous Material at, in, on, under or about the Premises which is required to be reported to a governmental authority under any environmental law, will promptly forward to Landlord copies of any notices received by Tenant relating to alleged violations of any environmental law and will promptly pay when due any fine or assessment against 10 Landlord, Tenant or the Premises relating to any violation of an environmental law during the term of this Lease. If a lien is filed against the Premises by any governmental authority resulting from the need to expend or the actual expending of monies arising from an act or omission, whether intentional or unintentional, of Tenant, its agents, employees or invitees, or for which Tenant is responsible, resulting in the releasing, spilling, leaking, leaching, pumping, emitting, pouring, emptying or dumping of any Hazardous Material into the waters or onto land located within or without the State where the Premises is located, then Tenant shall, within thirty (30) days from the date that Tenant is first given notice that such lien has been placed against the Premises (or within such shorter period of time as may be specified by Landlord if such governmental authority has commenced steps to cause the Premises to be sold pursuant to such lien) either (i) pay the claim and remove the lien, or (ii) furnish a cash deposit, bond, or such other security with respect thereto as is satisfactory in all respects to Landlord and is sufficient to effect a complete discharge of such lien on the Premises. Landlord shall have the right, but not the obligation, without in any way limiting Landlord's other rights and remedies under this Lease, to enter upon the Premises, or to take such other actions as it deems necessary or advisable, to investigate, clean up, remove or remediate any Hazardous Materials or contamination by Hazardous Materials present on, in, at, under or emanating from the Premises or the Property in violation of Tenant's obligations under this Lease or under any laws regulating Hazardous Materials. Notwithstanding any other provision of this Lease, Landlord shall have the right, at its election, in its own name or as Tenant's agent, to negotiate, defend, approve and appeal, at Tenant's expense, any action taken or order issued by any governmental agency or authority with any governmental agency or authority against Tenant, Landlord or the Premises or Property relating to any Hazardous Materials or under any related law or the occurrence of any event or existence of any condition that would cause a breach of any of the covenants set forth in this Section 9.03. Prior to or promptly after the expiration or termination of this Lease, Landlord may require an environmental audit of the Premises by a qualified environmental consultant. If such audit finds that there has been an occurrence of any event or existence of any condition that would constitute a breach by Tenant of any of the covenants set forth in this Section 9.03, then Tenant shall pay the costs of such audit and shall, at its sole cost and expense, take all actions recommended in such audit to remediate any environmental conditions.. The provisions of this Section 9.03 shall survive the expiration or earlier termination of this Lease. 9.04 Signs and Auctions. Tenant shall not place any signs on the Property without Landlord's prior written consent, which shall not be unreasonably withheld or delayed. Except in the ordinary course of business, Tenant shall not conduct or permit any auctions or sheriff's sales at the Property. 9.05 Landlord's Access. Landlord or its agents may enter the Premises at all reasonable times to show the Premises to potential buyers, investors or tenants or other parties; to do any other act or to inspect and conduct tests in order to monitor Tenant's compliance with all applicable environmental laws and all laws governing the presence and use of Hazardous Material; or for any other purpose Landlord deems necessary. Landlord shall give Tenant prior notice (which may be oral) of such entry, except in the case of an emergency, in which event Landlord shall make reasonable efforts to notify Tenant. Landlord may place customary "For Sale" or "For Lease" signs on the Premises. 11 ARTICLE TEN - CONDITION AND MAINTENANCE OF PREMISES 10.01 Existing Conditions. Tenant shall accept the Property and the Premises in their As-Is condition as of the execution of the Lease, subject to all recorded matters, laws, ordinances, and governmental regulations and orders. Except as provided herein, Tenant acknowledges that neither Landlord nor any agent of Landlord has made any representation as to the condition of the Property or the suitability of the Property for Tenant's intended use. Tenant represents and warrants that Tenant has made its own inspection of and inquiry regarding the condition of the Property and is not relying on any representations of Landlord or any Broker with respect thereto. 10.02 Exemption of Landlord from Liability. Tenant shall insure its personal property under an all risk full replacement cost property insurance policy as provided in Section 7.04. Landlord shall not be liable for any damage or injury to the person, business (or any loss of income therefrom), goods, wares, merchandise or other property of Tenant, Tenant's employees, invitees, customers or any other person or about the Property, whether such damage or injury is caused by or results from: (a) fire, steam, electricity, water, gas or rain; (b) the breakage, leakage, obstruction or other defects of pipes, sprinklers, wires, appliances, plumbing, air conditioning or lighting fixtures or any other cause; (c) conditions arising in or about the Premises or from other sources or places; or (d) any act or omission of any other tenant of the Property. Tenant shall give Landlord prompt notice upon the occurrence of any accident or casualty at the Premises. Landlord shall not be liable for any such damage or injury even though the cause of or the means of repairing such damage or injury are not accessible to Tenant. The provisions of this Section 10.02 shall not, however, exempt Landlord from liability for Landlord's gross negligence or willful misconduct. 10.03 Landlord's Obligations. Subject to the provisions of Article Eleven (Damage or Destruction) and Article Twelve (Condemnation), and except for damage caused by any act or omission of Tenant, or Tenant's employees, agents, contractors or invitees, Landlord shall keep the foundation and structural supports of the improvements on the Property in good order, condition and repair. Landlord shall not be obligated to maintain or repair windows, doors, plate glass or the surfaces of walls. Tenant shall promptly report in writing to Landlord any defective condition known to it which Landlord is required to repair. Tenant hereby waives the benefit of any present or future law which provides Tenant the right to repair the Premises or Property at Landlord's expense or to terminate this Lease because of the condition of the Property or Premises. 10.04 Tenant's Obligations. -------------------- 10.04(a) Repair and Maintenance. Except as provided in Section 10.03, Article Eleven (Damage or Destruction) and Article Twelve (Condemnation), Tenant shall keep all portions of the Premises including the electrical, 12 plumbing, fire protection, heating, ventilating and air conditioning systems and equipment in good order, condition and repair (including repainting and refinishing, as needed). If any portion of the Premises or any system or equipment in the Premises which Tenant shall be obligated to repair can not be fully repaired or restored, Tenant shall promptly replace such portion of the Premises or system or equipment, regardless of whether the benefit of such replacement extends beyond the Lease Term; but if the benefit or useful life of such replacement extends beyond the Lease Term (as such term may be extended by exercise of any options), the useful life of such replacement shall be prorated over the remaining portion of the Lease Term (as extended). Tenant shall maintain a preventive maintenance contract providing for the regular inspection and maintenance of the heating and air conditioning system by a heating and air conditioning contractor, such contract and such contractor to be approved by Landlord. Landlord shall have the right, upon written notice to Tenant, to undertake the responsibility for maintenance of the heating and air conditioning system at Tenant's expense. Landlord shall, at Tenant's expense, repair any damage to the portions of the Property Landlord shall be required to maintain caused by Tenant's acts or omissions. 10.04(b) Tenant's Expense. Tenant shall fulfill all of Tenant's obligations under this Section 10.04 at Tenant's sole expense. If Tenant shall fail to maintain, repair or replace the Premises as required by this Section 10.04, Landlord may, upon ten (10) days' prior notice to Tenant (except that no notice shall be required in the case of an emergency), enter the Premises and perform such maintenance or repair (including replacement, as needed) on behalf of Tenant. In such case, Tenant shall reimburse Landlord for all costs reasonably incurred in performing such maintenance, repair or replacement immediately upon demand. 10.05 Alterations, Additions, and Improvements. ---------------------------------------- 10.05(a) Tenant's Work. Tenant shall not make any installations, alterations, additions, or improvements in or to the Premises, including, without limitation, any apertures in the walls, partitions, ceilings or floors, without on each occasion obtaining the prior written consent of Landlord. Any such work so approved by Landlord shall be performed only in accordance with plans and specifications therefor approved by Landlord. Tenant shall procure at Tenant's sole expense all necessary permits and licenses before undertaking any work on the Premises and shall perform all such work in a good and workmanlike manner employing materials of good quality and so as to conform with all applicable zoning, building, fire, health and other codes, regulations, ordinances and laws and with all applicable insurance requirements. If requested by Landlord, Tenant shall furnish to Landlord prior to commencement of any such work a bond or other security acceptable to Landlord assuring that any work by Tenant will be completed in accordance with the approved plans and specifications and that all subcontractors will be paid. Tenant shall employ for such work only contractors approved by Landlord and shall require all contractors employed by Tenant to carry worker's compensation insurance in accordance with statutory requirements and commercial general liability insurance covering such contractors on or about the Premises with a combined single limit not less than $3,000,000 and shall submit certificates evidencing such coverage to Landlord prior to the commencement of such work. Tenant shall indemnify and hold harmless Landlord from all injury, loss, claims or damage to any person or property occasioned by or growing out of such work. Landlord may inspect the work of Tenant at reasonable times and given notice of observed defects. Upon completion of any such work, Tenant shall provide Landlord with "as built" plans, copies of all construction contracts and proof of payment for all labor and materials. 13 10.05(b) No Liens. Tenant shall pay when due all claims for labor and material furnished to the Premises and shall at all times keep the Property free from liens for labor and materials. Tenant shall give Landlord at least twenty (20) days' prior written notice of the commencement of any work on the Premises, regardless of whether Landlord's consent to such work is required. Landlord may record and post notices of non-responsibility on the Premises. 10.06 Condition upon Termination. Upon the expiration or termination of this Lease, Tenant shall surrender the Premises to Landlord broom clean and in the condition which Tenant shall have been required to maintain the Premises under this Lease, ordinary wear and tear excepted. Tenant shall not be obligated to repair any damage which Landlord is required to repair under Article Eleven (Damage or Destruction). Landlord may require Tenant to remove any alterations, additions or improvements (whether or not made with Landlord's consent) prior to the expiration of the Lease and to restore the Premises to their prior condition, all at Tenant's expense. With respect to any alterations, additions or improvements which require Landlord's approval, at the time of such approval Landlord shall specify if Tenant shall not be required to remove the same, and such items shall become Landlord's property and shall be surrendered to Landlord upon the expiration or earlier termination of the Lease, except that Tenant may remove any of Tenant's machinery or equipment which can be removed without damage to the Property. Tenant shall repair, at Tenant's expense, any damage to the Property caused by the removal of any such machinery or equipment. In no event, however, shall Tenant remove any of the following materials or equipment (which shall be deemed Landlord's property), without Landlord's prior written consent; unless the same shall have been installed by Tenant at its expense: any power wiring or wiring panels; lighting or lighting fixtures; wall coverings; drapes, blinds or other window coverings; carpets or other floor coverings; heaters, air conditioners or any other heating or air conditioning equipment; fencing or security gates; or other similar building operating equipment. ARTICLE ELEVEN - DAMAGE OR DESTRUCTION 11.01 Damage to Premises. ------------------ 11.01(a) Tenant shall notify Landlord in writing immediately upon the occurrence of any damage to the Premises. If the Premises shall be only partially damaged (i.e., the restoration shall be estimated by Landlord to require less than six (6) months from the date of such damage) and if the proceeds received by Landlord from the insurance policies described in Section 7.06 shall be sufficient to pay for the necessary repairs, this Lease shall remain in effect and Landlord shall repair the damage as soon as reasonably possible. Landlord may elect (but shall not be required) to repair any damage to Tenant's fixtures, equipment, or improvements at Tenant's expense. 14 11.01(b) If the insurance proceeds received by Landlord shall not be sufficient to pay the entire cost of repair, or if the damage shall not be covered by the insurance policies which Landlord shall maintain under Section 7.06, Landlord may elect either to (i) repair the damage as soon as reasonably possible, in which case this Lease shall remain in full force and effect, or (ii) terminate this Lease as of the date the damage occurred. Landlord shall notify Tenant within thirty (30) days after receipt of notice of the occurrence of the damage whether Landlord elects to repair the damage or terminate this Lease. If Landlord shall elect to repair the damage, Tenant shall pay Landlord the portion of the "deductible amount" under Landlord's insurance allocable to the damage to the Premises and, if the damage shall have been due to an act or omission of Tenant, or Tenant's employees, agents, contractors or invitees, the difference between the actual cost of repair and any insurance proceeds received by Landlord. 11.01(c) If the damage to the Premises shall occur during the last six (6) months of the Lease Term and such damage shall be estimated by Landlord to require more than thirty (30) days to repair, either Landlord or Tenant may elect to terminate this Lease as of the date the damage shall have occurred, regardless of the sufficiency of any insurance proceeds. The party electing to terminate this Lease shall give written notification to the other party of such election within ten (10) days after Tenant's notice to Landlord of the occurrence of the damage. 11.02 Temporary Reduction of Rent. If the Property shall be destroyed or damaged and Landlord shall repair or restore the Property pursuant to the provisions of this Article Eleven, any Rent payable during the period of such damage, repair and/or restoration shall be reduced according to the degree, if any, to which Tenant's use of the Premises shall be impaired. Except for such possible reduction in Base Rent, insurance premiums and real property taxes, Tenant shall not be entitled to any compensation, reduction or reimbursement from Landlord as a result of any damage, destruction, repair, or restoration of the Property. 11.03 Waiver. Tenant waives the protection of California Civil Code Sections 1932 and 1933(4) and any other statute, code or judicial decision which shall grant a tenant the right to terminate a lease in the event of the damage or destruction of the leased property and the provisions of this Article 11 shall govern the rights and obligations of Landlord and Tenant in the event of any damage or destruction of or to the Property. ARTICLE TWELVE - CONDEMNATION 12.01 Condemnation. If more than twenty percent (20%) of the floor area of the Premises or more than twenty-five percent (25%) of the parking on the Property shall be taken by eminent domain either Landlord or Tenant may terminate this Lease as of the date the condemning authority takes title or possession, by delivering notice to the other within ten (10) days after receipt of written notice of such taking (or in the absence of such notice, within ten (10) days after the condemning authority shall take title or possession). If neither Landlord nor Tenant shall terminate this Lease, this Lease shall remain in effect as to the portion of the Premises not taken, except that the Base Rent shall be reduced in proportion to the reduction in the floor area of the Premises. If this Lease shall be terminated, any condemnation award or payment shall be distributed to the Landlord. Tenant shall have no claim against Landlord for the value of the unexpired lease term or otherwise. 15 ARTICLE THIRTEEN - ASSIGNMENT AND SUBLETTING 13.01 Landlord's Consent Required. No sale, assignment, mortgage, sublease, or transfer of of Tenant's interest in this Lease shall be made to any other person or entity, without Landlord's prior written consent, which consent shall not be unreasonably withheld or delayed. Any attempted transfer without consent shall be void and shall constitute a non curable breach of this Lease. 13.02 No Release of Tenant. No assignment or transfer shall release Tenant or change Tenant's primary liability to pay the Rent and to perform all other obligations of Tenant under this Lease. Landlord's acceptance of Rent from any other person shall not be a waiver of any provision of this Article Thirteen. Consent to one transfer shall not be deemed a consent to any subsequent transfer or a waiver of the obligation to obtain consent on subsequent occasions. If Tenant's assignee or transferee shall default under this Lease, Landlord may proceed directly against Tenant without pursuing remedies against the assignee or transferee. 13.03 Landlord's Consent. If Tenant shall assign or sublease, the following shall apply: Tenant shall pay to Landlord as Additional Rent fifty percent (50%) of the Proceeds (defined below) on such transaction (such amount being Landlord's share) as and when received by Tenant, unless Landlord shall give notice to Tenant and the assignee or subtenant that Landlord's Share shall be paid by the assignee or subtenant to Landlord directly. Proceeds shall mean (a) all Rent and all fees and other consideration paid for or in respect of the assignment or sublease, including fees under any collateral agreements less (b) the Rent and other sums payable under this Lease (in the case of a sublease of less than all of the Premises, allocable to the subleased premises) and all reasonable costs and expenses directly incurred by Tenant in connection with the execution and performance of such assignment or sublease for reasonable real estate broker's commissions, costs associated with marketing the Premises for such assignment or sublease and reasonable costs of renovation or construction of tenant improvements required under such assignment or sublease. Tenant shall be entitled to recover such reasonable costs and expenses before Tenant shall be obligated to pay Landlord's Share to Landlord. Tenant shall provide Landlord a written statement certifying all amounts to be paid from any assignment or sublease of the Premises within thirty (30) days after the transaction shall be signed and from time to time thereafter on Landlord's request, and Landlord may inspect Tenant's books and records to verify the accuracy of such statement. On written request, Tenant shall promptly furnish to Landlord copies of all the transaction documentation, all of which shall be certified by Tenant to be complete, true and correct. Tenant shall promptly reimburse Landlord for all legal costs and expenses incurred by Landlord in connection with a request for a sublease or assignment of this Lease. 16 ARTICLE FOURTEEN - DEFAULTS; REMEDIES 14.01 Covenants and Conditions. Tenant's performance of each of Tenant's obligations under this Lease is a condition as well as a covenant. Tenant's right to continue in possession of the Premises is conditioned upon such performance. Time is of the essence in the performance by Tenant of all covenants and conditions. 14.02 Defaults. Each of the following shall be an event of default under -------- this Lease: 14.02(a) Tenant shall abandon or vacate the Premises; 14.02(b) Tenant shall fail to pay Rent or any other sum payable under this Lease within five (5) days after it is due; 14.02(c) Tenant shall fail to perform any of Tenant's other obligations under this Lease and such failure shall continue for a period of thirty (30) days after notice from Landlord; provided that if more than thirty (30) days shall be required to complete such performance, Tenant shall not be in default if Tenant shall commence such performance within the thirty (30) day period and shall thereafter diligently pursue its completion. 14.02(d) (i) Tenant shall make a general assignment or general arrangement for the benefit of creditors; (ii) a petition for adjudication of bankruptcy or for reorganization or rearrangement shall be filed by or against Tenant and shall not be dismissed within sixty (60) days; (iii) a trustee or receiver shall be appointed to take possession of substantially all of Tenant's assets located at the Premises or Tenant's interest in this Lease and possession shall be subjected to attachment, execution or other judicial seizure which shall not be discharged within sixty (60) days. If a court of competent jurisdiction shall determine that any of the acts described in this subsection (d) is not a default under this Lease, and a trustee shall be appointed to take possession (or if Tenant shall remain a debtor in possession) and such trustee or Tenant shall assign, sublease, or transfer Tenant's interest hereunder, then Landlord shall receive, as Additional Rent, the excess, if any, of the Rent (or any other consideration) paid in connection with such assignment, transfer or sublease over the Rent payable by Tenant under this Lease. 14.03 Remedies. On the occurrence of an event of default by Tenant, Landlord may, at any time thereafter, with or without notice or demand (except as provided in Section 14.02) and without limiting Landlord in the exercise of any right or remedy which Landlord may have: 14.03(a) Without further notice or demand of any kind to Tenant or any other person, terminate this Lease and re-enter the Premises and take possession thereof and remove all persons therefrom, and Tenant shall have no further claim thereon or hereunder. Any notice given by Landlord pursuant to Section 14.02 may be the notice required or permitted pursuant to Section 1161 et seq. of the California Code of Civil Procedure or successor statutes, and the provisions of this Lease shall not require the giving of a notice in addition to such statutory notice to terminate this Lease and Tenant's right to possession of the Premises. The periods specified in Section 14.02 within which Tenant is permitted to cure any default following notice from Landlord shall run 17 concurrently with any cure period provided by applicable laws. Should Landlord elect to terminate this Lease, Landlord may recover from Tenant, as damages, the following: (i) The Worth at the Time of Award of the unpaid Rent which had been earned at the time of termination; plus (ii) The Worth at the Time of Award of the amount by which the unpaid Rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; plus (iii) The Worth at the Time of Award of the amount by which the unpaid Rent for the balance of the Term after the time of award exceeds the amount of such rental loss that Tenant proves could be reasonably avoided; plus (iv) Any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, including, but not limited to, any cost or expenses incurred by Landlord in (A) retaking possession of the Premises, including reasonable attorneys' fees therefor, (B) maintaining or preserving the Premises after such default, (C) preparing the Premises for reletting to a new tenant, including repairs or alterations to the Premises for such reletting, (D) leasing commissions and attorneys' fees incurred in connection with any re-letting, or (E) any other costs necessary or appropriate to relet the Premises; plus (v) At Landlord's election, such other amounts in addition to or in lieu of the foregoing as may be permitted from time to time by the laws of the State in which the Premises is located. As used in subsections (a)(i) and (ii) above, the "Worth at the Time of Award" shall be computed by allowing interest at the interest rate specified in Section 4.04. As used in subsection (a)(iii) above, the "Worth at the Time of Award" shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). 14.03(b) Maintain Tenant's right to possession, in which case this Lease shall continue in effect whether or not Tenant has abandoned the Premises. Landlord has the remedy described in California Civil Code Section 1951.4. In such event, Landlord shall be entitled to enforce all of Landlord's rights and remedies under this Lease, including the right to recover the Rent as it becomes due. 14.03(c) Pursue any other remedy now or hereafter available to Landlord under the laws or judicial decisions of the state in which the Property is located. 18 14.04 Repayment of "Free" Rent. If this Lease provides for a postponement of any Base Rent or Additional Rent, a period of "free" Rent, reduced Rent, early occupancy, or other Rent concession, such postponed Rent, "free" Rent, reduced Rent or other Rent concession shall be referred to herein as the "Abated Rent". Tenant shall be credited with having paid all of the Abated Rent on the expiration of the Lease Term only if Tenant has fully, faithfully, and punctually performed all of Tenant's obligations hereunder, including the payment of all Rent (other than the Abated Rent) and all other monetary obligations and the surrender of the Premises in the physical condition required by this Lease. Tenant acknowledges that its right to receive credit for the Abated Rent is absolutely conditioned upon Tenant's full, faithful and punctual performance of its obligations under this Lease. If an event of default shall occur, the Abated Rent shall immediately become due and payable in full and this Lease shall be enforced as if there were no such Rent abatement or other Rent concession. In such case Abated Rent shall be calculated based on the full initial Rent payable under this Lease. 14.05 Automatic Termination; Damages. Notwithstanding any other term or provision hereof to the contrary, this Lease shall terminate on the occurrence of any act which affirms the Landlord's intention to terminate the Lease as provided in Section 14.03 hereof, including the filing of an unlawful detainer action against Tenant. On any termination, Landlord's damages for default shall include all costs and fees, including reasonable attorneys' fees that Landlord shall incur in connection with the filing, commencement, pursuing and/or defending of any action in any bankruptcy court or other court with respect to the Lease, the obtaining of relief from any stay in bankruptcy restraining any action to evict Tenant, or the pursuing of any action with respect to Landlord's right to possession of the Premises. All such damages suffered (apart from Base Rent and other Rent payable hereunder) shall constitute pecuniary damages which shall be reimbursed to Landlord prior to assumption of the Lease by Tenant or any successor to Tenant in any bankruptcy or other proceedings. 14.06 Cumulative Remedies. Except as otherwise expressly provided herein, any and all rights and remedies which Landlord may have under this Lease and at law and equity shall be cumulative and shall not be deemed inconsistent with each other, and any two or more of all such rights and remedies may be exercised at the same time to the greatest extent permitted by law. ARTICLE FIFTEEN - PROTECTION OF LENDERS 15.01 Subordination. At Landlord's election this Lease shall be automatically subordinated to any ground lease, deed of trust or mortgage encumbering the Property, any advances made on the security thereof and any renewals, modifications, consolidations, replacements or extensions thereof, whenever made or recorded, provided that Tenant obtain a non-disturbance and attornment agreement on reasonable market terms and provisions reasonably acceptable to the lender. Tenant shall cooperate with Landlord and any lender which shall acquire a security interest in the Property or the Lease. Tenant shall execute such further documents and assurances as such lender may require, provided that Tenant's obligations under this Lease shall not be increased in any material way (the performance of ministerial acts shall not be deemed material), and Tenant shall not be deprived of its rights under this Lease. If any ground lessor, beneficiary or mortgagee elects to have this Lease prior to the lien of its ground lease, deed of trust or mortgage and gives written notice thereof to Tenant, this Lease shall be deemed prior to such ground lease, deed of trust or mortgage whether this Lease is dated prior or subsequent to the date of said ground lease, deed of trust or mortgage or the date of recording thereof. 19 15.02 Attornment. If Landlord's interest in the Property is acquired by any ground lessor, beneficiary under a deed of trust, mortgagee, or purchaser at a foreclosure sale, Tenant shall attorn to the transferee of or successor to Landlord's interest in the Property and recognize such transferee or successor as Landlord under this Lease. Tenant waives the protection of any statute or rule of law which shall give Tenant any right to terminate this Lease or surrender possession of the Premises upon the transfer of Landlord's interest. 15.03 Signing of Documents. Tenant shall sign and deliver any instrument or documents necessary or appropriate to evidence any such attornment or subordination or agreement to do so. 15.04 Estoppel Certificates. Within ten (10) days after Landlord's request, Tenant shall execute, acknowledge and deliver to Landlord a written statement certifying: (i) that none of the terms or provisions of this Lease have been changed (or if they have been changed, stating how they have been changed); (ii) that this Lease has not been canceled or terminated; (iii) the last date of payment of the Base Rent and other charges and the time period covered by such payment; (iv) that Landlord is not in default under this Lease (or if Landlord is claimed to be in default, setting forth such default in reasonable detail); and (v) such other information with respect to Tenant or this Lease as Landlord may reasonably request or which any prospective purchaser or encumbrancer of the Property may require. Landlord may deliver any such statement by Tenant to any prospective purchaser or encumbrancer of the Property, and such purchaser or encumbrancer may rely conclusively upon such statement as true and correct. If Tenant shall not deliver such statement to Landlord within such ten (10) day period, Landlord, and any prospective purchaser or encumbrancer, may conclusively presume and rely upon the following facts: (i) that the terms and provisions of this Lease have not been changed except as otherwise represented by Landlord; (ii) that this Lease has not been canceled or terminated except as otherwise represented by Landlord; (iii) that not more than one month's Base Rent or other charges have been paid in advance; and (iv) that Landlord is not in default under this Lease. In such event, Tenant shall be estopped from denying the truth of such facts. 15.05 Tenant's Financial Condition. Within ten (10) days after request from Landlord from time to time, Tenant shall deliver to Landlord Tenant's audited financial statements (which shall be for the latest available year and in any event for a year ended not more than fifteen (15) months prior to Landlord's request). Such financial statements shall be delivered to Landlord's mortgagees and lenders and prospective mortgagees, lenders and purchasers. Tenant represents and warrants to Landlord that each such financial statement shall be true and accurate as of the date of such statement. All financial statements shall be confidential and shall be used only for the purposes set forth in this Lease. 20 ARTICLE SIXTEEN - LEGAL COSTS 16.01 Legal Proceedings. If Tenant be in breach or default under this Lease, Tenant shall reimburse Landlord upon demand for any reasonable costs or expenses that Landlord shall incur in connection with any breach or default of Tenant, as provided in this Section. Such costs shall include reasonable legal fees and costs incurred for the negotiation of a settlement, enforcement of rights or otherwise. Tenant shall also indemnify Landlord against and hold Landlord harmless from all costs, expenses, demands and liability, including without limitation, legal fees and costs, Landlord shall incur if Landlord shall become or be made a party to any claim or action (a) instituted by Tenant against any third party, or by any third party against Tenant, or by or against any person holding any interest under or using the Premises by license of or agreement with Tenant; (b) for foreclosure of any lien for labor or material furnished to or for Tenant or such other person; (c) otherwise arising out of or resulting from any act or transaction of Tenant or such other person; or (d) necessary to protect Landlord's interest under this Lease in a bankruptcy of Tenant or similar proceeding. Tenant shall defend Landlord against any such claim or action at Tenant's expense with counsel reasonably acceptable to Landlord or, at Landlord's election, Tenant shall reimburse Landlord for any legal fees or costs Landlord shall incur in any such claim or action. ARTICLE SEVENTEEN - MISCELLANEOUS PROVISIONS 17.01 Non-Discrimination. Tenant agrees that it will not permit any discrimination against, or segregation of, any person or group of persons on the basis of race, color, sex, creed, disability, sexual preference, national origin or ancestry in the leasing, subleasing, transferring, occupancy, tenure or use of the Premises or any portion thereof. 17.02 Landlord's Liability; Certain Duties. ------------------------------------ 17.02(a) Bind and Inure; Limitation of Landlord's Liability. The obligations of this Lease shall run with the land, and this Lease shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. No owner of the Property shall be liable under this Lease except for breaches of Landlord's obligations occurring while owner of the Property. The obligations of Landlord shall be binding upon the assets of Landlord which comprise the Property but not upon other assets of Landlord. No individual partner, trustee, stockholder, officer, member, director, employee, or beneficiary of Landlord, or any partner, trustee, stockholder, officer, member, director, employee, advisor or beneficiary of any of the foregoing, shall be personally liable under this Lease and Tenant shall look solely to Landlord's interest in the Property in pursuit of its remedies upon an event of default hereunder, and the general assets of Landlord, its partners, trustees, stockholders, members, officers, employees, advisors or beneficiaries of any of the foregoing shall not be subject to levy, execution or other enforcement procedure for the satisfaction of the remedies of Tenant. 21 17.02(b) Notice. Tenant shall give written notice of any failure by Landlord to perform any of its obligations under this Lease to Landlord and to any ground lessor, mortgagee or beneficiary under any deed of trust encumbering the Property whose name and address shall have been furnished to Tenant. Landlord shall not be in default under this Lease unless Landlord (or such ground lessor, mortgagee or beneficiary) shall fail to cure such non- performance within thirty (30) days after receipt of Tenant's notice. However, if such non-performance shall reasonably require more than thirty (30) days to cure, Landlord shall not be in default if such cure shall be commenced within such thirty (30) day period and thereafter diligently pursued to completion. 17.03 Severability. A determination by a court of competent jurisdiction that any provision of this Lease or any part thereof is illegal or unenforceable shall not cancel or invalidate the remainder of such provision of this Lease, which shall remain in full force and effect. 17.04 Interpretation. The captions of the Articles or Sections of this Lease are not a part of the terms or provisions of this Lease. Whenever required by the context of this Lease, the singular shall include the plural and the plural shall include the singular. The masculine, feminine and neuter genders shall each include the other, in any provision relating to the conduct, acts or omissions of Tenant, the term "Tenant" shall include Tenant's agents, employees, contractors, invitees, successors or others using the Premises with Tenant's expressed or implied permission. This Lease shall not, and nothing contained herein, shall create a partnership or other joint venture between Landlord and Tenant. 17.05 Incorporation of Prior Agreements; Modifications. This Lease is the only agreement between the parties pertaining to the lease of the Premises and no other agreements shall be effective. All amendments to this Lease shall be in writing and signed by all parties. Any other attempted amendment shall be void. 17.06 Notices. All notices, requests and other communications required or permitted under this Lease shall be in writing and shall be personally delivered or sent by certified mail, return receipt requested, postage prepaid or by a national overnight delivery service which maintains delivery records. Notices to Tenant shall be delivered to Tenant's Address for Notices. Notices to Landlord shall be delivered to Landlord's Address for Notices. All notices shall be effective upon delivery (or refusal to accept delivery). Either party may change its notice address upon notice to the other party. 17.07 Waivers. All waivers shall be in writing and signed by the waiving party. Landlord's failure to enforce any provision of this Lease or its acceptance of Rent shall not be a waiver and shall not prevent Landlord from enforcing that provision or any other provision of this Lease in the future. No statement on a payment check from Tenant or in a letter accompanying a payment check shall be binding on Landlord. Landlord may, with or without notice to Tenant, negotiate such check without being bound by to the conditions of such statement. 22 17.08 No Recordation. Tenant shall not record this Lease. Either Landlord or Tenant may require that a notice, short form or memorandum of this Lease executed by both parties be recorded. The party requiring such recording shall pay all transfer taxes and recording fees. 17.09 Binding Effect; Choice of Law. This Lease shall bind any party who shall legally acquire any rights or interest in this Lease from Landlord or Tenant, provided that Landlord shall have no obligation to Tenant's successor unless the rights or interests of Tenant's successor are acquired in accordance with the terms of this Lease. The laws of the state in which the Property is located shall govern this Lease. 17.10 Corporate Authority; Partnership Authority. If Tenant is a corporation, each person signing this Lease on behalf of Tenant represents and warrants that (s)he has full authority to do so and that this Lease binds the corporation. If Tenant is a partnership or limited liability company, each person or entity signing this Lease for Tenant represents and warrants that he or it is a general partner of the partnership or a manager or managing member of the company, that he or it has full authority to sign for the partnership or company and that this Lease binds the partnership and all general partners of the partnership or the company and its members. Within thirty (30) days after this Lease is signed, Tenant shall deliver to Landlord a copy of Tenant's recorded statement of partnership or certificate of limited partnership or certificate of formation or organization. 17.11 Joint and Several Liability. All parties signing this Lease as Tenant shall be jointly and severally liable for all obligations of Tenant. 17.12 Force Majeure. If Landlord can not perform any of its obligations due to events beyond Landlord's reasonable control, the time provided for performing such obligations shall be extended by a period of time equal to the duration of such events. Events beyond Landlord's reasonable control include, but are not limited to, acts of God, war, civil commotion, labor disputes, strikes, fire, flood or other casualty, shortages of labor or material, government regulation or restriction and weather conditions. 17.13 Execution of Lease. This Lease may be executed in counterparts and, when all counterpart documents are executed, the counterparts shall constitute a single binding instrument. Landlord's delivery of this Lease to Tenant shall not be deemed to be an offer to lease and shall not be binding upon either party until executed and delivered by both parties. 17.14 Survival. All representations and warranties of Landlord and Tenant, and all obligation of Tenant to pay Additional Rent hereunder, shall survive the termination of this Lease. 17.15 Examination of Lease. Submission of this Lease to Tenant shall not constitute an option to lease, and this Lease shall not be effective until execution and delivery by both Landlord and Tenant. 23 17.16 Security Deposit. Upon the execution of this Lease, Tenant shall deposit with Landlord the Security Deposit. Landlord may, at its option, apply all or part of the Security Deposit to any unpaid Rent or other charges due from Tenant, cure any other defaults of Tenant, or compensate Landlord for any loss or damage which Landlord may suffer due to Tenant's default. If Landlord shall so use any part of the Security Deposit, Tenant shall restore the Security Deposit to its full amount within ten (10) days after Landlord's request. No interest shall be paid on the Security Deposit, no trust relationship is created herein between Landlord and Tenant with respect to the Security Deposit, and the Security Deposit may be commingled with other funds of Landlord. Upon expiration or termination of this Lease not resulting from Tenant's default and after Tenant shall have vacated the Premises in the manner required by this Lease, Landlord shall pay to Tenant any balance of the Security Deposit not applied pursuant to this Section 17.16. 17.17 Limitation of Warranties. Landlord and Tenant expressly agree that there are and shall be no implied warranties of merchantability, habitability, suitability, fitness for a particular purpose or of any other kind arising out of this Lease, and there are no warranties which extend beyond those expressly set forth in this Lease. Without limiting the generality of the foregoing, Tenant expressly acknowledges that Landlord has made no warranties or representations concerning any hazardous materials or other environmental matters affecting any part of the Property and Landlord hereby expressly disclaims and Tenant waives any express or implied warranties with respect to any such matters. 17.18 Termination of Existing Lease. The existing lease agreement dated July 10, 1995 by and between Elliott-Mair, LLC as landlord and QTL Corporation as tenant is hereby terminated as of 11:59 p.m. on the day immediately preceding the Lease Commencement Date. 24 17.19 No Other Brokers. Tenant represents and warrants to Landlord that the Brokers are the only agents, brokers, finders or other parties with whom Tenant has dealt who may be entitled to any commission or fee with respect to this Lease or the Premises or the Property. Tenant agrees to indemnify and hold Landlord harmless from any claim, demand, cost or liability, including, without limitation, attorneys' fees and expenses, asserted by any party other than the Brokers based upon dealings of that party with Tenant. LANDLORD: ELLIOTT-MAIR SALINAS LLC, a California limited liability company By: _________________________________ Ronald Elliott Its: Manager Dated: August 9, 2000 TENANT: EARLYCHILDHOOD.COM LLC, a California limited liability company __________________________________ By: Scott Graves Its: Management Committee member Dated: August 9, 2000 25 EXHIBIT A - THE PREMISES 26 EXHIBIT B - RULES AND REGULATIONS 1. No advertisements, pictures or signs of any sort shall be displayed on or outside the Premises without the prior written consent of Landlord. This prohibition shall include any portable signs or vehicles placed within the parking lot, common areas or on streets adjacent thereto for the purpose of advertising or display. Landlord shall have the right to remove any such unapproved item without notice and at Tenant's expense. 2. Tenant shall not park or store motor vehicles, trailers or containers outside the Premises after the conclusion of normal daily business activity except in approved areas specifically designated by Landlord, acting reasonably. 3. Tenant shall not use any method of heating or air-conditioning other than that supplied by Landlord without the prior written consent of Landlord. 4. All window coverings and window films or coatings installed by Tenant and visible from outside of the building require the prior written approval of Landlord. Except for dock shelters and seals as may be expressly permitted by Landlord, no awnings or other projections shall be attached to the outside walls of the building. 5. Tenant shall not use, keep or permit to be used or kept any foul or noxious gas or substance on, in or around the Premises unless approved by Landlord. Tenant shall not use, keep or permit to be used or kept any flammable or combustible materials without proper governmental permits and approvals. 6. Tenant shall not use, keep or permit to be used or kept food or other edible materials in or around the Premises in such a manner as to attract rodents, vermin or other pests. Tenant shall not permit cooking in or about the Premises other than in microwave ovens. 7. Tenant shall not use or permit the use of the Premises for lodging or sleeping, for public assembly, or for any illegal or immoral purpose. 8. Tenant shall not alter any lock or install any new locks or bolts on any door at the Premises without the prior written consent of Landlord. Tenant agrees not to make any duplicate keys without the prior consent of Landlord. 9. Tenant shall park motor vehicles only in those general parking areas as designated by Landlord except for active loading and unloading. During loading and unloading of vehicles or containers, Tenant shall not unreasonably interfere with traffic flow within the parking lot or the loading and unloading areas of other tenants, if any. 27 10. Storage of propane tanks, whether interior or exterior, shall be in secure and protected storage enclosures approved by the local fire department and, if exterior, shall be located in areas specifically designated by Landlord. Safety equipment, including eye wash stations and approved neutralizing agents, shall be provided in areas used for the maintenance and charging of lead-acid batteries. Tenant shall protect electrical panels and building mechanical equipment from damage from forklift trucks. 11. Tenant shall not disturb, solicit or canvas any occupant of the Building and shall cooperate to prevent same. 12. No person shall go on the roof without Landlord's permission except to perform obligations under its lease. 13. No animals (other than seeing eye dogs) or birds of any kind may be brought into or kept in or about the Premises. 14. Machinery, equipment and apparatus belonging to Tenant which cause noise or vibration that may be transmitted to the structure of the Building to such a degree as to be objectionable to Landlord or other tenants or to cause harm to the Building shall be placed and maintained by Tenant, at Tenant's expense, on vibration eliminators or other devices sufficient to eliminate the transmission of such noise and vibration. Tenant shall cease using any such machinery which causes objectionable noise and vibration which can not be sufficiently mitigated. 15. All goods, including material used to store goods, delivered to the Premises of Tenant shall be immediately moved into the Premises and shall not be left in parking or exterior loading areas overnight. 16. Tractor trailers which must be unhooked or parked with dolly wheels beyond the concrete loading areas must use steel plates or wood blocks of sufficient size to prevent damage to the asphalt paving surfaces. No parking or storing of such trailers will be permitted in the auto parking areas of the Property or on streets adjacent thereto. 17. Forklifts which operate on asphalt paving areas shall not have solid rubber tires and shall use only tires that do not damage the asphalt. 18. Tenant shall be responsible for the safe storage and removal of all pallets. Pallets shall be stored behind screened enclosures at locations approved by the Landlord. 19. Tenant shall be responsible for the safe storage and removal of all trash and refuse. All such trash and refuse shall be contained in suitable receptacles stored behind screened enclosures at locations approved by Landlord. Landlord reserves the right to remove, at Tenant's expense and without further notice, any trash or refuse left elsewhere outside of the Premises or on the Property. 28 20. Tenant shall not store or permit the storage or placement of goods or merchandise in or around the common areas surrounding the Premises. No displays or sales of merchandise shall be allowed in the parking lots or other common areas. 21. Tenant shall appoint an Emergency Coordinator who shall be responsible for assuring notification of the local fire department in the event of an emergency, assuring that sprinkler valves are kept open and implementing the Factory Mutual "Red Tag Alert" system including weekly visual inspection of all sprinkler system valves on or within the Premises. _________ Landlord _________ Tenant 29 EX-21.1 21 0021.txt SUBSIDIARIES OF THE REGISTRANT Exhibit 21.1 Subsidiaries of the Registrant 1. S-E Educational Merger Corp., Delaware, USA EX-23.2 22 0022.txt CONSENT OF PRICEWATERHOUSECOOPERS Exhibit 23.2 Consent of Independent Accountants We hereby consent to the use in this Registration Statement on Form S-4 of LearningStar Corp. of our report dated February 15, 2000, relating to the financial statements of SmarterKids.com, Inc., which appears in such Registration Statement. We also consent to the reference to us under the heading "Experts" in such Registration Statement. /s/ PricewaterhouseCoopers LLP Boston, Massachusetts January 9, 2001 EX-23.3 23 0023.txt CONSENT OF KPMG Exhibit 23.3 Report on Schedule and Consent of Independent Auditors Management Committee Earlychildhood LLC: The audits referred to in our report dated December 22, 2000 except for note 1 which is as of January 8, 2001, included the related Schedule of Valuation and Qualifying Accounts as of December 31, 1998 and 1999, and for the nine months ended December 31, 1998, and the year ended December 31, 1999, included in the Registration Statement on Form S-4. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We consent to the use of our reports included herein and to the reference to our firm under the headings "Accountants" and "Experts" in the Registration Statement. KPMG LLP San Francisco, California January 9, 2001 EX-23.4 24 0024.txt CONSENT OF INDEPENDENT ACCOUNTANTS Exhibit 23.4 Consent of Independent Auditors The Board of Directors Educational Products, Inc.: We consent to the use of our report included herein and to the reference to our firm under the heading "Experts" in the Registration Statement. KPMG LLP San Francisco, California January 9, 2001 EX-99.3 25 0025.txt FORM OF PROXY EXHIBIT 99.3 SMARTERKIDS.COM, INC. SPECIAL MEETING OF STOCKHOLDERS TO BE HELD ON ____________ ___, 2001 THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS The undersigned, revoking all prior proxies, hereby appoints David Blohm and Robert Cahill and each of them, with full power of substitution, as proxies to represent and vote all shares of common stock, par value $.01 per share ("Common Stock") of SmarterKids.com, Inc., a Delaware corporation (the "Company"), which the undersigned would be entitled to vote if personally present at the special seeting of stockholders of the Company to be held on ______ ___, 2001, at 10:00 a.m. local time, at the offices of Testa, Hurwitz & Thibeault, LLP, 125 High Street, High Street Tower 22nd Floor, Boston, Massachusetts 02110, and at all postponements and adjournments thereof, upon matters set forth in the Notice of Special Meeting of Stockholders and the Proxy Statement-Prospectus dated ______ ___, 2001, a copy of which has been received by the undersigned. The proxies are further authorized to vote, in their discretion, upon such other business as may properly come before the special meeting or any postponements and adjournments thereof. The Board of Directors recommends a vote FOR the approval and adoption of the combination agreement by and among SmarterKids.com, Inc., Earlychildhood LLC, LearningStar Corp. and S-E Educational Merger Corp. and the transactions contemplated thereby. SEE REVERSE SIDE THIS PROXY, WHEN PROPERLY EXECUTED WILL BE VOTED IN THE MANNER DIRECTED BY THE UNDERSIGNED STOCKHOLDER(S). IF NO DIRECTION IS GIVEN, THIS PROXY WILL BE VOTED FOR THE ELECTION OF DIRECTORS AND FOR THE PROPOSALS IN ITEMS 2 AND 3. [X] Please mark votes as in this example. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" ITEM 1 To consider and vote upon a proposal to approve and adopt the Contribution Agreement and Plan of Reorganization and Merger by and among Earlychildhood, SmarterKids.com,inc., LearningStar Corp., and S-E Educational Merger Corp. pursuant to which, among other things, the combination of SmarterKids.com and Earlychildhood.com will be effected by: . the contribution to LearningStar by the holders of all of Earlychildhood's outstanding membership interests of their entire ownership interest in Earlychildhood.com such that Earlychildhood will become a wholly-owned subsidiary of LearningStar, and the holders of Earlychildhood.com membership interests will be entitled to receive an aggregate of ___________ shares of LearningStar common stock; and . the merger of S-E Educational Merger Corp. with and into SmarterKids.com such that SmarterKids.com will become a wholly-owned subsidiary of LearningStar and each issued and outstanding share of SmarterKids.com common stock will be converted into the right to receive one share of LearningStar common stock. [_] FOR [_] AGAINST [_] ABSTAIN [_] MARK HERE FOR ADDRESS CHANGE AND NOTE BELOW _______________________________________ _______________________________________ Please sign exactly as name appears below. Joint owners must both sign. Attorney, executor, administrator, trustee or guardian must give full title as such. A company or partnership must sign its full name by authorized person. __________________________________________ Signature of Stockholder Date:_________________________________, 2001 __________________________________________ Signature if held jointly PLEASE COMPLETE, SIGN DATE AND RETURN THIS PROXY CARD PROMPTLY USING THE ENCLOSED ENVELOPE. I/We will attend the meeting. [_] YES [_] NO EX-99.4 26 0026.txt SMARTERKIDS.COM STOCKHOLDER LETTER EXHIBIT 99.4 [LOGO OF SMARTERKIDS.COM] [LOGO OF EARLYCHILDHOOD] To the stockholders of SmarterKids.com, Inc. A COMBINATION PROPOSAL--YOUR VOTE IS VERY IMPORTANT SmarterKids.com and Earlychildhood have agreed to combine. We are proposing the combination and soliciting your proxy to approve it because we believe the combined strengths of SmarterKids.com and Earlychildhood will enable us to build a stronger provider of children's educational products, information and services to both the school and consumer markets and through a variety of distribution channels. The new combined company will be named LearningStar Corp. and will be managed by executive officers from both SmarterKids.com and Earlychildhood. If the combination is completed, stockholders of SmarterKids.com and members of Earlychildhood will each receive shares of LearningStar common stock in exchange for their existing common stock or membership interests, as the case may be. Each issued and outstanding share of SmarterKids.com common stock will be converted into the right to receive one newly-issued share of LearningStar common stock. All of the issued and outstanding membership interests in Earlychildhood and options therefor will be exchanged for the right to receive an aggregate of 46,388,575 newly-issued shares of LearningStar common stock. Following the combination, SmarterKids.com stockholders will own approximately one-third of the LearningStar capital stock and Earlychildhood members will own approximately two-thirds of the LearningStar capital stock. It is anticipated that LearningStar will apply for approval for quotation of its common stock on the Nasdaq National Market. A new market for trading in the LearningStar common stock will commence immediately following the effectiveness of the combination, which we expect to occur in the spring of 2001. No cash is included as consideration in the combination, except for cash received in lieu of fractional shares of LearningStar common stock. The SmarterKids.com board of directors has unanimously determined that the combination of SmarterKids.com and Earlychildhood is advisable and in the best interests of its stockholders. The SmarterKids.com board of directors has unanimously approved the combination agreement and the combination and unanimously recommends that you vote FOR approval and adoption of the combination agreement and the transactions contemplated thereby. The management committee of Earlychildhood and the holders of all outstanding membership interests in Earlychildhood approved the combination immediately prior to the signing of the combination agreement. No further action is required by Earlychildhood's management committee or members to effect the combination. Information about the combination is contained in this proxy statement- prospectus. We urge you to read this document carefully, including the section describing risk factors that begins on page 18. The special meeting of SmarterKids.com stockholders will be held at the offices of Testa, Hurwitz & Thibeault, LLP, 125 High Street, High Street Tower, 22nd Floor, Boston, Massachusetts on , 2001 at 10:00 a.m. Your vote is very important, regardless of the number of shares you own. Whether or not you plan to attend the special meeting, please vote as soon as possible to make sure that your shares are represented at the special meeting. David Blohm President and Chief Executive Officer SmarterKids.com, Inc. This proxy statement-prospectus is dated , 2001, and is first being mailed to SmarterKids.com stockholders on or about , 2001. As of , 2001, there were approximately holders of SmarterKids.com common stock. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of the securities to be issued in connection with the combination or determined if this proxy statement- prospectus is accurate or complete. Any representation to the contrary is a criminal offense. EX-99.5 27 0027.txt SMARTERKIDS.COM NOTICE OF SPECIAL MEETING EXHIBIT 99.5 [LOGO OF SMARTERKIDS.COM, INC.] SMARTERKIDS.COM, INC. 15 Crawford Street Needham, Massachusetts 02494 Notice of Special Meeting of SmarterKids.com Stockholders , 2001 at 10:00 a.m. To the stockholders of SmarterKids.com, Inc.: Notice is hereby given that a special meeting of stockholders of SmarterKids.com, Inc. will be held on , 2001 at 10:00 a.m., local time, at the offices of Testa, Hurwitz & Thibeault, LLP, 125 High Street, High Street Tower, 22nd Floor, Boston, Massachusetts for the following purposes: 1. To consider and vote upon a proposal to approve and adopt the Contribution Agreement and Plan of Reorganization and Merger by and among Earlychildhood, SmarterKids.com, LearningStar and S-E Educational Merger Corp. pursuant to which, among other things, the combination of SmarterKids.com and Earlychildhood will be effected by: . the contribution to LearningStar by the holders of all of Earlychildhood's outstanding membership interests of their entire ownership interest in Earlychildhood such that Earlychildhood will become a wholly-owned subsidiary of LearningStar, and the holders of Earlychildhood membership interests and options therefor will be entitled to receive an aggregate of 46,388,575 shares of LearningStar common stock; and . the merger of S-E Educational Merger Corp. with and into SmarterKids.com such that SmarterKids.com will become a wholly-owned subsidiary of LearningStar and each issued and outstanding share of SmarterKids.com common stock will be converted into the right to receive one share of LearningStar common stock. 2. To transact any other business as may properly come before the special meeting or any adjournment or postponement of the special meeting. The SmarterKids.com board of directors has unanimously determined that the combination of SmarterKids.com and Earlychildhood is advisable and in the best interests of its stockholders. The SmarterKids.com board of directors has unanimously approved the combination agreement and the combination and unanimously recommends that you vote FOR approval and adoption of the combination agreement and the transactions contemplated thereby. We have described the proposed combination in more detail in the attached proxy statement-prospectus, which you should read in its entirety before voting. A copy of the combination agreement is attached as Annex A to the proxy statement-prospectus. Only holders of record of SmarterKids.com common stock at the close of business on , 2001, the record date for the special meeting, are entitled to notice of, and to vote at, the special meeting and any adjournments or postponements of the special meeting. On the record date there were outstanding shares of SmarterKids.com common stock. SmarterKids.com is a Delaware corporation. Under Delaware law, the affirmative vote of a majority of the shares of SmarterKids.com common stock outstanding on the record date is required to approve and adopt the combination agreement and the transactions contemplated thereby. Your vote is very important, regardless of the number of shares you own. Please vote as soon as possible to make sure that your shares are represented at the special meeting. To vote your shares, you may complete and return the enclosed proxy card. If you are a holder of record, you may also cast your vote in person at the special meeting. If you do not vote, it will have the effect of a vote against approval and adoption of the combination agreement and the transactions contemplated thereby. If your shares are held in an account at a brokerage firm or bank, you must instruct it how to vote your shares. If you do not instruct your broker or bank on how to vote, it will have the same effect as voting against approval and adoption of the combination agreement and the transactions contemplated thereby. By order of the Board of Directors of SmarterKids.com, Inc. David Blohm Corporate Secretary Needham, Massachusetts , 2001 -----END PRIVACY-ENHANCED MESSAGE-----