PREC14A 1 PREC 14A SCHEDULE 14A INFORMATION PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE SECURITIES EXCHANGE ACT OF 1934 FILED BY THE REGISTRANT /X/ FILED BY A PARTY OTHER THAN THE REGISTRANT / / Check the appropriate box: /X/ Preliminary Proxy Statement / / Definitive Proxy Statement / / Definitive Additional Materials /X/ Soliciting Material Pursuant to sec. 240.14a-11(c) or sec. 240.14a-12 HILLS STORES COMPANY -------------------------------------------------------------------------------- (NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) NOT APPLICABLE -------------------------------------------------------------------------------- (NAME OF PERSON(S) FILING PROXY STATEMENT) PAYMENT OF FILING FEE (CHECK THE APPROPRIATE BOX): / / $125 per Exchange Act Rules 0-11(c)(1)(ii), 14a-6(i)(1), or 14a-6(i)(2) or Item 22(a)(2) of Schedule 14A. /X/ $500 per each party to the controversy pursuant to Exchange Act Rule 14a-6(i)(3). / / Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11. 1) Title of each class of securities to which transaction applies: ------------------------------------------------------------------------ 2) Aggregate number of securities to which transaction applies: ------------------------------------------------------------------------ 3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11:(1) ------------------------------------------------------------------------ 4) Proposed maximum aggregate value of transaction: ------------------------------------------------------------------------ 5) Total fee paid: ------------------------------------------------------------------------ (1)Set forth the amount on which the filing fee is calculated and state how it was determined. / / Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing. 1) Amount Previously Paid: ------------------------------------------------------------------------ 2) Form, Schedule or Registration Statement No.: ------------------------------------------------------------------------ 3) Filing Party: ------------------------------------------------------------------------ 4) Date Filed: ------------------------------------------------------------------------ [HSC LOGO/LETTERHEAD] May 30, 1995 IMPORTANT ANNUAL MEETING JUNE 23, 1995 Dear Fellow Shareholder: You are cordially invited to attend the Annual Meeting of Shareholders of Hills Stores Company (the "Company" or "Hills") to be held on Friday, June 23, 1995 at 10:00 AM at the Sheraton Tara Hotel, 37 Forbes Road, Braintree, Massachusetts 02184. Your Board of Directors and management look forward to greeting personally those shareholders able to attend. At this year's Annual Meeting, Hills' shareholders will elect seven directors. In selecting these directors, all shareholders will be making a critical choice in establishing a course for the future of the Company and their investment. As demonstrated by our financial results, Hills' operating plan is working and producing value for all our shareholders. We strongly believe we can deliver greater value to our shareholders by continuing to follow our plan, rather than selling your Company in an auction. On May 3, 1995, Dickstein Partners Inc. and certain of its affiliates (collectively, "Dickstein") made an unsolicited, conditional, and non-binding proposal to acquire, pursuant to a merger, all of Hills' outstanding shares of capital stock for $25.00 per share in cash, subject to Dickstein being able to obtain debt and equity financing (the "Dickstein Proposal"). On May 22, 1995, in a filing with the Securities and Exchange Commission, Dickstein no longer characterized the form of payment as "in cash" but stated that it could include "securities or other consideration." To further its own objectives, Dickstein has commenced a proxy contest and is now seeking your support to elect its own hand-picked nominees, including Mark Dickstein, in place of the experienced, qualified directors nominated by your Board. Dickstein has indicated that, if elected, its nominees would attempt to auction Hills. However, there is no guarantee that any such auction would take place or that it would be conducted in a disinterested manner. AFTER CAREFUL CONSIDERATION, HILLS' BOARD OF DIRECTORS UNANIMOUSLY REJECTED THE DICKSTEIN PROPOSAL. THE BOARD BELIEVES THAT THE COMPANY'S STRATEGIC GROWTH PLAN IS IN THE BEST INTERESTS OF HILLS' SHAREHOLDERS AND IS THE BEST OPPORTUNITY TO MAXIMIZE SHAREHOLDER VALUE. In arriving at this decision, the Board of Directors relied upon its own knowledge and understanding of Hills and the Company's prospects and considered the advice of Hills' financial advisor, Smith Barney Inc., that the Dickstein Proposal is inadequate, from a financial point of view, to the holders of Hills Common Stock (other than Dickstein). YOUR BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE "FOR" THE BOARD'S NOMINEES AS DIRECTORS OF YOUR COMPANY. DO NOT RETURN ANY PROXY CARDS SENT TO YOU BY DICKSTEIN. Enclosed with this letter is the Company's Notice of Annual Meeting and Proxy Statement and a WHITE proxy. You should read these materials for a more complete description of the matters to be considered at the Annual Meeting. Then, take a moment to sign, date and mail your WHITE proxy in the postage-paid envelope provided. HILLS' CURRENT GROWTH STRATEGY IS THE BEST WAY TO MAXIMIZE SHAREHOLDER VALUE Your Board of Directors is convinced that Hills' current growth strategy offers shareholders the best opportunity to maximize value. Over the past few years, Hills has undergone a remarkable rebirth as a well-managed and extremely competitive regional discount retailer. Your Company has in place a respected and exceptionally strong management team that has worked closely with the current directors to develop an operating strategy that is producing positive results. Our focus on growth and operating efficiency has increased sales and expanded operating profit margins in each of the last four years. Today, Hills ranks as one of the most profitable of the discount retailers. Your Board and management recently remodeled the entire chain of stores with an updated merchandise presentation. Our automated distribution center continues to shorten the distribution cycle, eliminate tasks, and produce savings in inventory and operating costs. We have developed an exciting new prototype store which will serve as the Company's new look for store openings in 1995 and beyond. The Company's new store program is a thoughtful and measured growth plan. We have set a goal that a new store will be opened only when management believes that during its first full year of operations the store can achieve a level of profitability equal to the entire chain's average profitability. For example, this past year a typical new store would involve capital expenditures of approximately $1.8 million and would be opened only if its ratio of earnings before interest, taxes, depreciation and amortization (EBITDA) to sales could be expected to equal or exceed 7% in its first full year of operations. In 1995, we have opened two new stores that we expect will meet this standard and anticipate opening an additional eight later this year, which will increase the chain to 164 stores. The Company's strategic plan is working. In 1994, Hills' first full year since emerging from bankruptcy, your Board and management team increased sales by 6%, increased operating earnings by more than 14%, and increased net income by 34.6%. We also successfully reduced our selling, general and administrative (SG&A) expenses as a percentage of sales in each of the last three years -- from 22.4% in 1991 to 20.9% in 1994. Our goal is to reduce SG&A to less than 20% of sales by fiscal 1996. EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
SALES 91 92 93 94 1.680 1.750 1.766 1.872
SALES Fiscal Year (in
OPERATING EARNINGS billions) EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC 91 $ 52.5 92 $ 77.9 93 $ 92.5 94 $ 105.8
OPERATING EARNINGS Fiscal Year (in millions) EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
SG&A REDUCTION 91 22.4% 92 21.9% 93 21.4% 94 20.9%
SG&A REDUCTION SG&A as a Percentage of Sales *Reflects the implementation of "fresh start" accounting and other transactions resulting from the reorganization as of January 1, 1993, on a pro forma basis. 2 As illustrated by the chart below, Hills' financial performance ranks at or near the top of the discount retail sector in all key financial performance ratios:
1994 MARGIN ANALYSIS (% OF SALES) --------------------------------------- 1994 GROSS NET COMP. PROFIT SG&A EBITDA EBIT INCOME SALES ------ ------ ------ ------- ------ ------ REGIONAL Hills Stores Company................... 28.4 % 20.9 % 7.6 % 5.6 % 2.2 % 5.1 % Bradlees, Inc.......................... 28.1 23.5 4.7 2.1 0.3 -2.7 Caldor Corp............................ 28.1 22.0 5.8 4.0 1.8 2.2 ShopKo Stores, Inc..................... 25.3 18.9 7.0 4.1 1.6 1.2 Venture Stores, Inc.................... 24.4 20.2 4.2 2.8 1.4 0.0 NATIONAL Kmart Corporation...................... 23.6 20.3 4.2 2.1 0.3 1.4 Wal-Mart Stores, Inc................... 20.5 14.1 7.3 6.0 3.2 7.0 Source: Based upon public filings and press releases.
The success of the Company's strategic plan and the strength of its management is highlighted by the fact that Hills has achieved superior financial results in an increasingly competitive environment. For example, in 1990, at least 20 Hills stores competed with Wal-Mart stores; today 106 Hills stores compete with Wal-Mart stores. In addition, almost every Hills store competes with a Kmart and at least 12 Hills stores compete with Target stores. The strength of Hills' management and balance sheet and the soundness of its competitive strategy position Hills to be an eventual consolidator in an industry in need of consolidation. NOW IS THE WRONG TIME TO SELL HILLS Your Board of Directors believes that now is NOT the time to sell Hills or change its management. Discount retail stocks are now trading at historically low values. Rather than maximizing value, we are convinced that an auction of the type Dickstein proposes would prevent shareholders from realizing the value inherent in Hills' business. While it does not make us feel any better, we are not alone in having our stock trading below our expectations. In fact, almost all stocks in the discount retail sector, such as Wal-Mart, Caldor, Bradlees, Kmart, Venture and Dayton Hudson, recently have traded at or near their 12-month lows. The chart set forth below illustrates the fluctuation of price/earnings multiples for an index of stocks in the discount retail sector over time. It shows that such multiples are now at or near 10-year lows. Despite the Company's strong operating results, Smith Barney, the Company's financial advisor, has advised us that the contraction of the price/earnings multiples in the discount retail sector has contributed to Hills' share price remaining flat. 3 INDEX OF GENERAL MERCHANDISE STORES 1 YEAR FORWARD PRICE/EARNINGS MULTIPLES EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
INDEX OF GENERAL MERCHANDISE STORES 1 Year Forward Price/Earnings Multiples 1983 1/83 13.84 2/83 14.64 3/83 18.02 4/83 13.89 5/83 14.38 6/83 15.48 7/83 16.14 8/83 15.47 9/83 15.81 10/83 14.56 11/83 15.30 12/83 14.09 1984 1/84 12.96 2/84 11.87 3/84 10.08 4/84 9.91 5/84 10.22 6/84 11.41 7/84 11.44 8/84 12.33 9/84 12.03 10/84 11.86 11/84 11.34 12/84 10.92 1985 1/85 12.95 2/85 12.97 3/85 11.23 4/85 10.84 5/85 12.35 6/85 12.55 7/85 11.79 8/85 12.31 9/85 11.61 10/85 12.70 11/85 14.25 12/85 15.20 1986 1/86 15.30 2/86 16.10 3/86 15.45 4/86 15.76 5/86 18.99 6/86 19.68 7/86 17.54 8/86 17.66 9/86 15.83 10/86 16.52 11/86 17.34 12/86 16.84 1987 1/87 17.56 2/87 19.72 3/87 16.12 4/87 16.12 5/87 16.56 6/87 18.59 7/87 20.40 8/87 21.58 9/87 20.45 10/87 14.74 11/87 12.95 12/87 14.02 1988 1/88 15.08 2/88 16.21 3/88 12.61 4/88 12.76 5/88 12.82 6/88 13.57 7/88 14.44 8/88 13.33 9/88 14.43 10/88 14.13 11/88 13.59 12/88 13.70 1989 1/89 14.75 2/89 14.03 3/89 11.71 4/89 12.65 5/89 13.37 6/89 13.28 7/89 15.17 8/89 15.05 9/89 14.74 10/89 14.78 11/89 15.45 12/89 15.89 1990 1/90 15.04 2/90 15.52 3/90 14.04 4/90 14.19 5/90 16.08 6/90 17.69 7/90 17.58 8/90 15.98 9/90 15.51 10/90 15.29 11/90 17.44 12/90 17.51 1991 1/91 19.20 2/91 20.85 3/91 18.84 4/91 19.61 5/91 20.74 6/91 20.68 7/91 23.07 8/91 24.58 9/91 23.24 10/91 22.52 11/91 24.01 12/91 28.95 1992 1/92 26.40 2/92 26.47 3/92 21.53 4/92 21.12 5/92 21.46 6/92 21.60 7/92 22.44 8/92 22.97 9/92 23.77 10/92 24.47 11/92 26.11 12/92 25.99 1993 1/93 26.29 2/93 26.49 3/93 21.51 4/93 18.19 5/93 18.94 6/93 18.05 7/93 17.57 8/93 18.04 9/93 17.38 10/93 18.48 11/93 20.06 12/93 17.70 1994 1/94 18.77 2/94 20.23 3/94 15.78 4/94 15.46 5/94 14.44 6/94 15.02 7/94 15.50 8/94 15.30 9/94 14.70 10/94 14.70 11/94 14.50 12/94 13.40 1995 1/95 14.60 2/95 15.10 3/95 14.30 4/95 13.50
This chart underscores why your Board believes that, at this time, an auction of the type that Dickstein claims its hand-picked nominees would pursue is not in the best interests of shareholders. The Dickstein nominees should not be allowed to auction the Company at a time when Hills may be substantially undervalued. ELECTION OF THE DICKSTEIN NOMINEES POSES SERIOUS RISKS TO HILLS' SHAREHOLDERS Election of Dickstein's nominees poses serious risks to your investment in Hills. It would disrupt the Company's management, employees, relationships with vendors and operations and do so solely to advance a speculative, contingent acquisition proposal. HILLS' SHAREHOLDERS SHOULD BE AWARE THAT ELECTION OF THE DICKSTEIN NOMINEES WOULD TRIGGER A "CHANGE IN CONTROL" UNDER THE INDENTURE COVERING HILLS' 10.25% SENIOR NOTES, THE CREDIT AGREEMENT GOVERNING THE COMPANY'S $225 MILLION WORKING CAPITAL FACILITY, AND THE EMPLOYMENT AGREEMENTS OF HILLS' KEY SENIOR EXECUTIVES. Hills could be required immediately to repay -- at a premium -- approximately $160 million in principal of existing senior debt as well as any accrued but unpaid interest. The loss of the credit facility could adversely affect the terms under which Hills purchases inventory from vendors. The Dickstein Proposal also calls for replacing Hills' unsecured working capital facility with a secured facility -- a change that could harm relationships with vendors and reduce the amount of trade credit available to the Company, adversely impacting the Company's cash flow. Perhaps most importantly, the key senior executives who have been responsible for Hills' success will be able to terminate their employment and obtain substantial severance benefits. There is no assurance that Hills' senior management would remain with the Company if the Dickstein nominees are elected. The 4 departure of those executives would be detrimental to the value of the Hills franchise. Remember, Dickstein has failed to disclose any business plan for Hills' day-to-day operations. ASK YOURSELF WHAT WILL HAPPEN TO YOUR INVESTMENT IF DICKSTEIN IS UNABLE TO SELL THE COMPANY AND YOUR PRESENT MANAGEMENT TEAM LEAVES HILLS. Your Board does not believe that shareholders should assume the risk of jeopardizing the Company's relationship with vendors and losing current management so that Dickstein can advance its own acquisition proposal. Do not forget that the Dickstein Proposal is contingent on financing, and Dickstein has neither the equity nor debt commitments in place to finance an acquisition of Hills. Even if Dickstein succeeds in obtaining financing, Dickstein has assumed that a portion of such financing will come from Hills' own available cash -- cash that will not be on hand until after the 1995 Christmas season. For these reasons, we believe that Dickstein's own financing plan -- if financing is available -- contemplates that its acquisition of Hills will not be completed until the end of 1995 or early 1996, if ever. In its May 3rd letter to the Company, Dickstein specified payment of $25.00 per share IN CASH. In an SEC filing that same day, Dickstein stated that it might offer securities or other consideration -- rather than cash -- to Hills' shareholders. In a May 22nd SEC filing, Dickstein deleted references to making payment "in cash." As a result, if Dickstein's nominees are elected, you cannot be certain of the type or value of the consideration you may receive and you may be issued illiquid debt or equity securities in a highly leveraged company. Finally, even if Dickstein's nominees are elected and proceed to conduct an auction, none of those nominees are independent from Dickstein. With the nominees having such a conflict of interest, how can the Dickstein nominees evaluate fairly the Dickstein Proposal against other proposals, if any, that may be made? An auction conducted by Dickstein's hand-picked nominees, in which Dickstein is a bidder, does not augur well for a fair and open auction process. NOW IS THE TIME TO ACT Now is the time to establish a course for the future success of your Company. We believe you should vote to continue Hills' current growth and operating strategy -- a strategy which your Board believes represents the best opportunity to maximize shareholder value. We believe that the course of action proposed by Dickstein is reckless. It is excessively short-term oriented, very costly and distracting to the Company, and would not deliver to shareholders the potential gain to be realized by continuing to pursue the Company's current strategy. We strongly urge you to vote in favor of the nominees proposed by your Board of Directors. Please sign, date and mail the enclosed WHITE proxy card in the enclosed envelope to support your Board's nominees. Please act today to ensure that your proxy is received in time to be counted. Remember, mailing in your proxy will not prevent you from voting at the Annual Meeting if you plan to attend. On behalf of your Board of Directors, thank you for your continued support. Sincerely, THOMAS H. LEE MICHAEL BOZIC CHAIRMAN OF THE BOARD PRESIDENT AND CHIEF EXECUTIVE OFFICER
5 IMPORTANT Your vote is important. Regardless of the number of shares of Hills common or preferred stock you own, please vote as recommended by your Board of Directors by taking these two simple steps: 1. PLEASE SIGN, DATE AND PROMPTLY MAIL THE ENCLOSED WHITE PROXY CARD IN THE POSTAGE-PAID ENVELOPE PROVIDED. 2. DO NOT RETURN ANY BLUE PROXY CARDS SENT TO YOU BY DICKSTEIN. IF YOU VOTED DICKSTEIN'S BLUE PROXY CARD BEFORE RECEIVING YOUR HILLS WHITE PROXY CARD, YOU HAVE EVERY RIGHT TO CHANGE YOUR VOTE SIMPLY BY SIGNING, DATING AND MAILING THE ENCLOSED WHITE PROXY CARD. THIS WILL CANCEL YOUR EARLIER VOTE SINCE ONLY YOUR LATEST DATED PROXY CARD WILL COUNT AT THE ANNUAL MEETING. If you own your shares in the name of a brokerage firm, only your broker can vote your shares on your behalf and only after receiving your specific instructions. Please call your broker and instruct him/her to execute a Hills WHITE card on your behalf. You should also promptly sign, date and mail your WHITE card when you receive it from your broker. Please do so for each separate account you maintain. You should return your WHITE proxy card at once to ensure that your vote is counted. This will not prevent you from voting in person at the meeting should you attend. IF YOU HAVE ANY QUESTIONS OR REQUIRE ASSISTANCE IN VOTING YOUR SHARES, PLEASE CALL: D. F. KING & CO., INC. 77 WATER STREET NEW YORK, NY 10005 (212) 269-5550 (COLLECT) CALL TOLL FREE (800) 290-6425 6 [LOGO] HILLS STORES COMPANY NOTICE OF ANNUAL MEETING OF SHAREHOLDERS TO BE HELD JUNE 23, 1995 Notice is hereby given that the Annual Meeting of Shareholders of Hills Stores Company (the "Company" or "Hills") will be held on Friday, June 23, 1995 in the ballroom of the Sheraton Tara Hotel, 37 Forbes Road, Braintree, MA 02184 at 10:00 AM local time to take action with respect to the following matters: 1. The election of seven directors to serve for the ensuing year and until their successors are elected and qualified; 2. The approval of the Company's 1995 Incentive and Nonqualified Stock Option Plan covering 500,000 shares of Common Stock; 3. The approval of the Hills Stores Company Associate Stock Purchase Plan covering 500,000 shares of Common Stock; and 4. Transaction of such other business as may properly be brought before the Annual Meeting or any adjournments thereof. Holders of record of Common Stock and Series A Preferred Stock at the close of business on April 24, 1995 are entitled to receive notice of and to vote at the meeting or any adjournments thereof. As noted in the enclosed proxy statement, Dickstein Partners Inc. and certain of its affiliates have initiated a proxy contest with the objective of electing their own representatives to Hills' Board of Directors instead of the candidates nominated by your Board. Your Board of Directors urges you NOT to return any blue proxies sent to you by Dickstein. To support your Board, please SIGN, DATE AND MAIL THE ENCLOSED WHITE PROXY. PLEASE ACT TODAY. By order of the Board of Directors William K. Friend VICE PRESIDENT-SECRETARY Canton, Massachusetts May 30, 1995 WE URGE YOU TO REJECT THE DICKSTEIN SOLICITATION -- DO NOT SIGN OR RETURN ANY BLUE PROXY CARD SENT YOU BY DICKSTEIN. TO SUPPORT YOUR BOARD OF DIRECTORS, PLEASE SIGN, DATE AND PROMPTLY MAIL YOUR WHITE PROXY CARD IN THE RETURN ENVELOPE. IF YOU HAVE ANY QUESTIONS OR NEED ASSISTANCE, PLEASE CALL D. F. KING & CO., INC., WHICH IS ASSISTING US, TOLL-FREE, AT 800-290-6425. PRELIMINARY PROXY STATEMENT - SUBJECT TO COMPLETION - HILLS STORES COMPANY 15 DAN ROAD, CANTON, MASSACHUSETTS 02021 (617) 821-1000 INTRODUCTION This Proxy Statement and the enclosed form of proxy have been mailed to shareholders on or about May 30, 1995 in connection with the solicitation by the Board of Directors of Hills Stores Company (the "Company" or "Hills") of proxies to be used at the June 23, 1995 Annual Meeting of Shareholders. At the meeting, shareholders will elect seven directors who will determine the future direction of the Company. In addition, shareholders will be asked to approve the Company's 1995 Incentive and Nonqualified Stock Option Plan (the "1995 Stock Option Plan") and the Hills Stores Company Associate Stock Purchase Plan (the "Stock Purchase Plan"). On May 3, 1995, Dickstein Partners Inc. and certain of its affiliates (collectively, "Dickstein") made an unsolicited non-binding proposal to acquire, pursuant to a merger, all of Hills' outstanding shares of capital stock for $25.00 per share in cash, subject to Dickstein being able to obtain debt and equity financing (the "Dickstein Proposal"). On May 22, 1995, in a filing with the Securities and Exchange Commission, Dickstein no longer characterized the form of payment as "in cash" but stated that it could include "securities or other consideration." To further its own objectives, Dickstein has indicated that it will solicit proxies (the "Dickstein Solicitation") to elect its own hand-picked nominees in place of the experienced, qualified directors nominated by your Board. Dickstein has indicated that, if elected, its nominees would attempt to auction Hills. However, there is no guarantee that any such auction would take place or that it would be conducted in a disinterested manner. Your Board strongly recommends a vote "FOR" the Board's nominees because the Board believes that Hills' current growth strategy represents the best opportunity to maximize shareholder value and that election of the Dickstein nominees poses serious risks to Hills' shareholders. IMPORTANT YOUR BOARD OF DIRECTORS BELIEVES THAT IT IS IN THE BEST INTERESTS OF HILLS SHAREHOLDERS TO ELECT THE BOARD'S NOMINEES AS DIRECTORS OF THE COMPANY. YOUR BOARD URGES YOU TO REJECT THE DICKSTEIN SOLICITATION AND NOT SIGN OR RETURN ANY BLUE PROXY CARD SENT TO YOU BY DICKSTEIN. Your vote is important, regardless of how many shares you own. Please sign and date the accompanying WHITE proxy card and mail it in the envelope provided as promptly as possible, whether or not you expect to attend the Annual Meeting. Whether or not you have previously signed a proxy card sent by Dickstein, the Board urges you to show your support for the Board by signing, dating and promptly mailing the enclosed WHITE proxy card. By signing and dating the WHITE proxy card, you will revoke any earlier dated proxy card solicited by Dickstein which you may have signed. Remember, it will not help your Board to return a Dickstein blue proxy card voting to "withhold authority". Do not return any BLUE card sent to you by Dickstein. The only way to support your Board's nominees is to vote "FOR" those nominees on the WHITE proxy card. IF YOUR SHARES ARE HELD IN THE NAME OF A BANK, BROKER, OR OTHER NOMINEE, WE URGE YOU TO CONTACT THE PARTY RESPONSIBLE FOR YOUR ACCOUNT AND DIRECT HIM OR HER TO VOTE "FOR" YOUR BOARD'S NOMINEES ON THE HILLS WHITE PROXY CARD. THEN, SIGN, DATE AND MAIL YOUR WHITE PROXY ONCE YOU RECEIVE IT FROM THE BANK, BROKER OR OTHER NOMINEE TO ENSURE THAT YOUR VOTE IS COUNTED. 1 WHY IT IS IMPORTANT THAT YOU VOTE "FOR" YOUR BOARD'S NOMINEES After careful consideration, Hills' Board of Directors unanimously rejected the Dickstein Proposal. The Board believes that the Company's strategic growth plan is in the best interests of Hills' shareholders and represents the best opportunity to maximize shareholder value. In arriving at its decision, the Board of Directors relied upon its own knowledge and understanding of Hills and the Company's prospects and considered the advice of Hills' financial advisor, Smith Barney Inc. ("Smith Barney"), that the Dickstein Proposal is inadequate, from a financial point of view, to the holders of Hills Common Stock (other than Dickstein). A copy of Smith Barney's opinion is attached as Exhibit 1 to this Proxy Statement. The Board of Directors is convinced that Hills' current growth strategy offers shareholders the best opportunity to maximize value. Over the past few years, Hills has undergone a remarkable rebirth as a well-managed, highly respected and extremely competitive regional discount retailer. The Company has in place a respected and exceptionally strong management team that has worked closely with the current directors to develop an operating strategy that is producing positive results. The Board of Directors and management have focused on growth and operating efficiency, thereby expanding operating profit margins in each of the last four years. Today, Hills ranks as one of the most profitable of the discount retailers. The Board and management recently remodeled the entire chain of stores with an updated merchandise presentation. The Company's automated distribution center continues to shorten the distribution cycle, eliminate tasks, and produce savings in inventory and operating costs. The Board and management have developed an exciting new prototype store which will serve as the Company's new look for store openings in 1995 and beyond. The Company's new store program is a thoughtful and measured growth plan. The Board and management have set a goal that a new store will be opened only when management believes that during its first full year of operations the store can achieve a level of profitability equal to the entire chain's average profitability. For example, this past year a typical new store would involve capital expenditures of approximately $1.8 million and would be opened only if its ratio of earnings before interest, taxes, depreciation and amortization (EBITDA) to sales could be expected to equal or exceed 7% in its first full year of operations. In 1995, the Company has opened two new stores that we expect will meet this standard, and anticipate opening an additional eight later this year, which will increase the chain to 164 stores. The Company's strategic plan is working. In 1994, Hills' first full year since emerging from bankruptcy, the Board and Hills' management team increased sales by 6%, increased operating earnings by more than 14%, and increased net income by 34.6%. The Board and management also successfully reduced Hills selling, general and administrative (SG&A) expenses as a percentage of sales in each of the last three years -- from 22.4% in 1991 to 20.9% in 1994. Our goal is to reduce SG&A to less than 20% of sales by fiscal 1996. Hills' financial performance ranks at or near the top of the discount retail sector in all key financial performance ratios. The success of the Company's strategic plan and the strength of its management is highlighted by the fact that Hills has achieved superior financial results in an increasingly competitive environment. For example, in 1990, at least 20 Hills stores competed with Wal-Mart stores; today 106 Hills stores compete with Wal-Mart stores. In addition, almost every Hills store competes with a Kmart and at least 12 Hills stores compete with Target stores. The strength of Hills' management and balance sheet and the soundness of its competitive strategy position Hills to be an eventual consolidator in an industry in need of consolidation. The Board of Directors believes that now is NOT the time to sell Hills or change its management. Discount retail stocks are now trading at historically low values. The Board of Directors and management of Hills are convinced that an auction of the type Dickstein proposes, rather than maximizing value, would prevent shareholders from realizing the value inherent in Hills' business. The Board of Directors and management have noted that Hills is not alone in having its stock trade below expectations. In fact, almost all stocks in the discount retail sector, such as Wal-Mart, Caldor, Bradlees, Kmart, Venture and Dayton Hudson, have traded recently at or near their 12 month lows. Therefore, at this time, an auction of the type 2 that Dickstein claims its hand-picked nominees would pursue is not in the best interests of shareholders. The Dickstein nominees should not be allowed to auction the Company at a time when Hills may be substantially undervalued. Election of Dickstein's nominees poses serious risks to your investment in Hills. It would disrupt the Company's management, employees, relationships with vendors and operations and do so solely to advance a speculative, contingent acquisition proposal. ELECTION OF THE DICKSTEIN NOMINEES WOULD TRIGGER A "CHANGE IN CONTROL" UNDER THE INDENTURE COVERING HILLS' 10.25% SENIOR NOTES, THE CREDIT AGREEMENT GOVERNING THE COMPANY'S $225 MILLION WORKING CAPITAL FACILITY, AND THE EMPLOYMENT AGREEMENTS OF HILLS' KEY SENIOR EXECUTIVES. Hills could be required immediately to repay -- at a premium -- approximately $160 million in principal of existing senior debt as well as any accrued but unpaid interest. The loss of the credit facility could adversely affect the terms under which Hills purchases inventory from vendors. The Dickstein Proposal also calls for replacing Hills' unsecured working capital facility with a secured facility -- a change that could harm relationships with vendors and reduce the amount of trade credit available to the Company, adversely impacting the Company's cash flow. Perhaps most importantly, the key senior executives who have been responsible for Hills' recent successes will be able to terminate their employment and obtain substantial severance benefits. See "Employment Contracts" below. There is no assurance that Hills' senior management would remain with the Company if the Dickstein nominees are elected. The departure of those executives would be detrimental to the value of the Hills franchise. Moreover, Dickstein has failed to disclose a business plan for Hills' day-to-day operations if members of top management leave the Company. The Board of Directors does not believe that shareholders should assume the risk of jeopardizing the Company's relationship with vendors and losing current management so that Dickstein can advance its own acquisition proposal. The Dickstein Proposal is contingent on financing, and Dickstein has neither the equity nor debt commitments in place to finance an acquisition of Hills. Even if Dickstein succeeds in obtaining financing, Dickstein has assumed that a portion of such financing will come from Hills' own available cash -- cash that will not be on hand until after the 1995 Christmas season. For these reasons, the Board of Directors believes that Dickstein's own financing plan -- if financing is available -- contemplates that its acquisition of Hills will not be completed until the end of 1995 or early 1996, if ever. In its May 3rd letter to the Company, Dickstein specified payment of $25.00 per share IN CASH. In an SEC filing that same day, Dickstein stated that it might offer securities or other consideration -- rather than cash -- to Hills' shareholders. In a May 22nd SEC filing, Dickstein deleted references to making payment "in cash." As a result, if Dickstein's nominees are elected, Hills' shareholders cannot be certain of the type or value of the consideration they may receive and may be issued illiquid debt or equity securities in a highly leveraged company. Finally, even if Dickstein's nominees are elected and proceed to conduct an auction, none of those nominees are independent from Dickstein. With the nominees having such a conflict of interest, how can the Dickstein nominees evaluate fairly the Dickstein Proposal against other proposals, if any, that may be made? An auction conducted by Dickstein's hand-picked nominees, in which Dickstein is a bidder, does not augur well for a fair and open auction process. BACKGROUND OF RECENT EVENTS On August 16, 1994, Dickstein commenced a consent solicitation to remove without cause four members of the Board and replace them with four Dickstein nominees (the "Dickstein Consent Solicitation"). On September 21, 1994, the Company announced that the Board had approved a program to enhance stockholder value, including the implementation of the growth plan described above and the decision to pursue the repurchase of up to 3 million shares of the Common Stock for $25 in cash (the "Tender Offer"). The approval of this program resulted from an in-depth analysis of various ways for the Company to enhance shareholder value that was conducted by the Board, in consultation with the Company's senior management, during August and September 1994. Two days following the announcement of the Company's plan to 3 enhance shareholder value and implement the Company's growth plan, the Company and Dickstein entered into a Settlement Agreement (the "Dickstein Settlement Agreement") whereby Dickstein agreed, among other things, to cease the Dickstein Consent Solicitation. In the Dickstein Settlement Agreement, the Company agreed to pay Dickstein $600,000 as a reimbursement of Dickstein's expenses in connection with the Dickstein Consent Solicitation and to use the Company's best efforts to consummate the Tender Offer. On January 24, 1995, the Company commenced the Tender Offer. On February 21, 1995, the Tender Offer expired and the Company accepted approximately 3 million shares of the Common Stock for payment at $25 per share in cash. Among the shares accepted for payment and purchased pursuant to the Tender Offer were shares tendered by Dickstein. On May 3, 1995, approximately two months following Dickstein's sale of 313,728 shares in the Tender Offer, Dickstein proposed to acquire, pursuant to a merger, all of Hills' outstanding shares for $25 per share in cash, subject to arranging equity and debt financing. In addition, Dickstein announced the nomination of a slate for election as directors of Hills, each of whom is either affiliated with Dickstein or has been compensated by Dickstein in consideration for such nomination. In May 1995, the Board retained Smith Barney as its financial advisor to evaluate, from a financial point of view, the Dickstein Proposal and other alternatives available to the Company. On May 15, 1995, the Board rejected the Dickstein Proposal as not in the best interest of Hills' shareholders and reaffirmed its belief that Hills' current plan will result in shareholders achieving the greatest value. In arriving at its decision, the Board considered the opinion of Smith Barney that the Dickstein Proposal is inadequate from a financial point of view, as well as the Board's own knowledge and understanding of Hills and its prospects. See "Financial Advisor." The Board noted that neither the equity nor the debt financing for the Dickstein Proposal was in place. On May 16, 1995, Dickstein reiterated its intention to solicit proxies for the purpose of electing its slate of nominees to the Hills Board. VOTING On April 24, 1995, the record date for the Annual Meeting, there were 9,273,306 shares of Common Stock and 1,451,590 shares of Series A Preferred Stock outstanding, each entitled to one vote. It is important that your shares be represented and voted at the Annual Meeting regardless of the number of shares that you own. Accordingly, you are asked to sign, date and promptly mail the accompanying WHITE proxy card in order to ensure that your shares are voted. Shares cannot be voted at the Annual Meeting unless the owner is represented, by proxy or in person. A majority of the shares entitled to vote at the Annual Meeting must be present either in person or by proxy in order for there to be a quorum. Abstentions and broker non-votes do not affect the determination of a quorum. Elections for director will be decided by a plurality of the votes cast. Approval of the Hills Stores Company 1995 Incentive and Nonqualified Stock Option Plan (the "1995 Stock Option Plan") and approval of the Hills Stores Company Associate Stock Purchase Plan (the "Stock Purchase Plan") will be decided by majority vote of shares present or represented by proxy at the Annual Meeting and entitled to vote. With respect to the election of directors, abstentions and broker non-votes will not count as votes for or against any such election. With respect to approval of the 1995 Stock Option Plan and the Stock Purchase Plan, abstentions as to each proposal will have the same effect as votes against that proposal, but broker non-votes as to each such proposal will not be deemed to be part of the voting power present with respect to that proposal and therefore will not count as votes for or against that proposal and will not be included in calculating the number of votes necessary for approval of that proposal. Proxies received by the Company prior to the Annual Meeting will be voted in accordance with shareholders' specifications marked thereon. In the absence of specification, the WHITE proxies distributed by the Hills Board of Directors will be voted FOR the election of the Board's nominees herein listed, FOR approval of the 1995 Stock Option Plan and FOR approval of the Stock Purchase Plan. 4 Each shareholder appointing a proxy has the power to revoke such appointment by a later-dated proxy delivered to the Company, by giving notice of revocation to the Company in writing or by voting at the meeting. Any vote taken prior to a revocation is not affected. The presence at the Annual Meeting of the shareholder appointing a proxy does not in and of itself revoke the appointment. Prior to its October 4, 1993 emergence from Chapter 11 proceedings, Hills Stores Company was a wholly-owned subsidiary of Hills Department Stores, Inc. (the "Predecessor Company"). Pursuant to the Company's Plan of Reorganization, effective October 4, 1993, the Predecessor Company was dissolved. References herein to periods prior to October 4, 1993 may, as appropriate, refer either to the Company or the Predecessor Company. References to periods from and after October 4, 1993 refer to the Company. MATTERS TO BE VOTED ON ITEM 1 -- ELECTION OF DIRECTORS It is proposed that seven directors, constituting the current Board of Directors, be elected for the ensuing year and until their successors are elected and qualified. It is intended that the shares represented by the WHITE proxy, unless otherwise instructed, will be voted FOR the election of the Board of Director's seven nominees listed in the following section. Insofar as is known, all of the nominees will be able to serve. Should any nominee become unavailable, the persons named in the proxy may vote for a substitute for such nominee. IN CONNECTION WITH ITEM 1, ALL SHAREHOLDERS SHOULD READ THE SECTION "WHY IT IS IMPORTANT THAT YOU VOTE "FOR" YOUR BOARD'S NOMINEES", BEGINNING ON PAGE 2 OF THIS PROXY STATEMENT. THE BOARD OF DIRECTORS STRONGLY RECOMMENDS A VOTE "FOR" THE BOARD'S NOMINEES. WE URGE YOU TO SIGN THE ENCLOSED WHITE PROXY CARD AND NOT TO SIGN ANY PROXY CARDS SENT TO YOU BY DICKSTEIN. INFORMATION ABOUT NOMINEES All of the nominees are currently directors of the Company and of its subsidiary, Hills Department Store Company. The nominees are:
DIRECTOR NAME AGE POSITION SINCE --------------------------------- --- ---------------------------- ----------- Thomas H. Lee.................... 51 Chairman of the Board 1985 Michael Bozic.................... 54 Director, President and 1991 Chief Executive Officer Susan E. Engel................... 48 Director 1993 Richard B. Loynd................. 67 Director 1993 Norman S. Matthews............... 62 Director 1990 James L. Moody, Jr............... 63 Director 1987 John G. Reen..................... 45 Director, Executive Vice 1993 President -- Chief Financial Officer
THOMAS H. LEE was elected Chairman of the Board of the Predecessor Company in November 1990. He was also Chief Executive Officer of the Predecessor Company from November 1990 to April 1991. He has been President since 1974 of Thomas H. Lee Company, a firm engaged in investment activities. In addition, he has been Chairman since 1987 of Thomas H. Lee Advisors I and the individual general partner since 1989 of Thomas H. Lee Advisors II, L.P. and THL Equity Advisors Limited Partnership, all of which are investment advisors. He is a director of J. Baker, Inc., General Nutrition, Inc., Playtex Family Products Corporation, Health o meter, Inc., Autotote Corporation, Finlay Fine Jewelry Corporation, Live Entertainment of Canada, Inc. and Gillett Holdings, Inc. He also is an individual general partner of ML-Lee Acquisition Fund, L.P., ML-Lee Acquisition Fund II, L.P., and ML-Lee Acquisition Fund (Retirement Accounts) II, L.P. 5 MICHAEL BOZIC became the President and Chief Executive Officer of the Predecessor Company in May 1991. He was President and Chief Operating Officer from August 1990 to January 1991 and Chairman and Chief Executive Officer from 1987 to 1990 of the Sears Merchandise Group. He is a director of Domain, Inc., Eaglemark Financial Services, Inc., Weirton Steel Corporation and Dean Witter InterCapital, Inc. SUSAN E. ENGEL has been President and Chief Operating Officer of Department 56, Inc. since September 1994. She was a consultant from September 1993 to September 1994 and was President and Chief Executive Officer of Champion Products, a manufacturer of athletic apparel, from October 1991 to September 1993. She was Vice President of Booz, Allen and Hamilton prior to October 1991. She is a director of Penn Traffic and Ryka, Inc. RICHARD B. LOYND has been President and Chief Executive Officer of Interco Incorporated since 1989 and Chairman of Interco Incorporated since 1990. Interco Incorporated filed for Chapter 11 bankruptcy protection in January 1991 and emerged from bankruptcy protection in August 1992. He is a director of Interco Incorporated, Emerson Electric Co., The Florsheim Shoe Company and Converse, Inc. NORMAN S. MATTHEWS, former President of Federated Department Stores, Inc., has been a retail consultant since 1988. Mr. Matthews is a director of Lechter's, Inc., Loehman's Inc., Finlay Fine Jewelry Corporation, Progressive Corp. and Eye Care Centers of America. Mr. Matthews was Chairman of the Board and Chief Executive Officer of Home Ltd. from 1988 until October 1993. Home Ltd. filed for Chapter 11 bankruptcy protection in May 1993 and was liquidated in October 1993. JAMES L. MOODY, JR. has been Chairman of the Board of Hannaford Bros. Co., a chain of food stores, since 1984 and was its Chief Executive Officer from 1973 to May 1992. Mr. Moody was a director of the Predecessor Company until October 4, 1993. He became a director of the Company November 19, 1993. He is also a director of Penobscot Shoe Company, UNUM Corporation, IDEXX Laboratories, Inc. and a Trustee of a number of mutual funds managed by The Colonial Group, Inc. JOHN G. REEN has been Executive Vice President-Chief Financial Officer of the Company since March 1992. He had been Senior Vice President-Chief Financial Officer since February 1991 and Vice President-Controller from December 1985 to January 1991. Directors of the Company and Hills Department Store Company are elected for a term of one year or until their successors are elected and qualified. During the fiscal year ended January 28, 1995, the Board of Directors of the Company met eleven times. No incumbent director attended fewer than 75% of the total number of meetings of the Board and Committees of the Board on which he or she served. The Board of Directors has a standing Audit Committee and a standing HR/Compensation Committee. The Board of Directors does not have a Nominating Committee. During the fiscal year ended January 28, 1995, the Audit Committee met three times and the HR/Compensation Committee met four times. The Audit Committee, consisting entirely of non-employee directors, is composed of Mr. Loynd, as Chairman, Ms. Engel and Mr. Moody. The Audit Committee's functions include the following: Recommendation to the full Board concerning the engagement or discharge of independent auditors; direction and supervision of investigations into matters within the scope of the Committee's duties; review with auditors of plans and results of auditing procedures; review, for Board approval, of each significant professional service provided by auditors and review of the independence of the auditors; consideration of the range of audit and nonaudit fees and the adequacy of the Company's system of internal accounting controls. 6 The HR/Compensation Committee, consisting entirely of non-employee directors, is composed of Mr. Moody, as Chairman, Ms. Engel and Mr. Loynd. The HR/Compensation Committee's functions include the following: Reviewing the corporate compensation programs and policies, including the compensation of the Chief Executive Officer, to assure that said programs and policies are competitive and provide for internal equity; reviewing and advising the Chief Executive Officer on specific compensation matters for officers and executives; oversight of the Company's performance bonus program; and performance of such other duties as the Chairman of the Board may require. ITEM 2 -- ADOPTION OF THE HILLS STORES COMPANY 1995 STOCK OPTION PLAN The Company is seeking shareholder approval of the adoption of the 1995 Stock Option Plan. The total number of shares of Common Stock which may be granted under the 1995 Stock Option Plan is 500,000 subject to adjustment for recapitalizations, stock splits, stock dividends and similar events. The 1995 Stock Option Plan was adopted by the Board of Directors on March 30, 1995, subject to shareholder approval. Shareholder approval is also being sought (a) so that Incentive Stock Options granted pursuant to the 1995 Stock Option Plan will comply with Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), (b) in order that the purchase of shares pursuant to the 1995 Stock Option Plan may be eligible for exemption from the short-swing profits requirements of Section 16(b) of the Securities and Exchange Act of 1934 (the "Exchange Act") and (c) in order to meet the requirements of Section 162(m) of the Code with respect to deductibility of executive compensation in excess of $1 million. A copy of the 1995 Stock Option Plan is attached hereto as Exhibit 2. The Board of Directors believes that approval of the 1995 Stock Option Plan will further align the interests of management and shareholders and is in the best interest of the Company. The Hills Stores Company 1993 Stock Option Plan (the "1993 Stock Option Plan") was adopted as part of the Company's Plan of Reorganization. As of May 5, 1995, 15,979 shares of Common Stock have been issued pursuant to options which have been exercised, 998,021 shares of Common Stock are reserved for issuance pursuant to outstanding stock options, and only 39,763 options remain available for grant under the 1993 Stock Option Plan. The Board of Directors believes that the 1995 Stock Option Plan will be an important retention mechanism for the Chief Executive Officer and other key executives. The Board of Directors also believes that the 1995 Stock Option Plan will permit the Company to provide additional incentives to the officers, associates, and certain other individuals providing services to the Company by enabling persons to whom options are granted to acquire or increase their proprietary interest in the Company through acquisition of shares of the Company's Common Stock. On the last business day of January of each year, each director who is not an employee of or a paid consultant to the Company, its parent or subsidiaries ("Outside Director") will, without any action of the Stock Option Committee, be granted a Nonqualified Option to purchase 2,000 shares of Common Stock. Each such non-discretionary option will expire on the fifth anniversary of the date of the grant and will vest at the rate of 500 option shares on each of the first four anniversary dates of the grant. The Board of Directors believes that these options, exercisable at not less than the fair market value of the Company's Common Stock on the date of the grant, will further align the interests of Board members with the Company's shareholders. Not more than 50,000 shares may be issued pursuant to such non-discretionary grants, subject to adjustment for recapitalizations, stock splits, stock dividends or similar events. The 1995 Stock Option Plan is administered by the Stock Option Committee of the Company's Board of Directors, consisting of Thomas H. Lee and James L. Moody, Jr., both of whom are non-employee directors and neither of whom has been granted any stock options under either the 1993 Stock Option Plan or the 1995 Stock Option Plan within the past year. The functions of the Stock Option Committee are: (a) to determine the persons to whom options are to be granted and to prescribe the terms, conditions, restrictions, if any, and provisions (which need not be identical) of each option granted; (b) to interpret the 1995 Stock Option Plan 7 and to establish, amend and revoke rules and regulations for the administration of the 1995 Stock Option Plan and (c) to make, in its sole discretion, changes to outstanding options, including (i) to reduce the exercise price, (ii) to accelerate the vesting schedule and (iii) to extend the expiration date. No individual may receive grants to purchase more than 150,000 shares of Common Stock under the 1995 Stock Option Plan during any three year period. Options are exercisable at a price and subject to vesting and other conditions as prescribed by the Stock Option Committee, provided that the exercise price shall not be less than the fair market value of the Common Stock on the date of the grant (110% of the fair market value in the case of an Incentive Stock Option granted to a greater than ten percent shareholder). Fair market value means the closing price on the New York Stock Exchange on the date of the grant. Except for non-discretionary grants to Outside Directors, which are for a term of five years, options are for a term of ten years from the date of the grant (five years in the case of a greater than ten percent shareholder). If a grantee ceases to be employed by the Company for any reason other than death, disability, retirement or termination without cause, all of such grantee's unvested options shall expire. If a grantee whose employment or services are terminated by the Company without cause has an employment, consulting or retention agreement in force immediately prior to such termination, then in such event such option shall remain in force to the stated expiration date of such employment, consulting or retention agreement with vesting accruing to such termination date. Payment for shares of Common Stock purchased pursuant to the exercise of an option may be made either by (i) cash, certified check, bank draft or money order, or (ii) with the consent of the Stock Option Committee, shares of the Company's Common Stock having a fair market value equal to the option price, or (iii) with the consent of the Stock Option Committee such other consideration as is acceptable to the Stock Option Committee and has a fair market value equal to the option price. Grants may consist of Incentive Stock Options, Nonqualified Stock Options or a combination thereof. Incentive Stock Options may be granted only to officers and other associates of the Company, its parent or its subsidiaries. In addition to non-discretionary grants to Outside Directors described above, nonqualified Stock Options may be granted to officers (including officers who are also directors) or other associates of the Company, its parent or subsidiaries and to consultants (including consultants who are also directors) and other persons who render services to the Company. The aggregate fair market value (determined at the time of the grant) of the Common Stock with respect to which Incentive Stock Options under all stock option plans of the Company are exercisable for the first time in any calendar year may not exceed $100,000. As of May 5, 1995, the Company had approximately 18,000 associates eligible to participate and five non-employee directors. The number of eligible consultants and other persons who provide services to the Company cannot be determined. The Board of Directors may modify, revise or terminate the 1995 Stock Option Plan at any time and from time to time, except that the class of persons eligible to receive options and the aggregate number of shares issuable may not be changed or increased without shareholder consent, except in the case of recapitalizations, stock splits, stock dividends and similar events. The provisions relating to non-discretionary grants to Outside Directors may not be amended more often than every six months, other than to comport with the Code, the Employee Retirement Income Security Act or the rules thereunder. In addition, the Board of Directors may amend the 1995 Stock Option Plan at any time or from time to time to conform to Rule 16b-3 under the Exchange Act, as that Rule may be amended from time to time. Generally, there is no taxable income realized by the recipient on the grant or exercise of an Incentive Stock Option, nor is the Company entitled to a deduction at such time. If the recipient of an Incentive Stock Option holds the shares acquired upon exercise for the required holding period (the later of two years from the date of the grant or one year from exercise), then upon disposition of the shares, the recipient will have a long term capital gain equal to the difference between the amount received from the disposition and the exercise price. If the recipient disposes of the shares prior to the end of the holding period, the recipient will have compensation income in the year of the disposition equal to the lesser of (i) the fair market value of the shares on the date of exercise or (ii) the fair market value on the date of disposition over the exercise price. Any excess gain will be treated as a capital gain. 8 Generally, there is no taxable income realized by the recipient on the grant of Nonqualified Stock Options, nor is the Company entitled to a deduction at such time. Upon exercise of a Nonqualified Stock Option, if the shares received are not subject to restrictions on transfer and substantial risk of forfeiture, the recipient will have compensation income equal to the difference between the fair market value at the date of exercise and the exercise price, and the Company may have withholding obligations. The amount taxed to the recipient will be added to the recipient's basis for determining future gain or loss. The following table sets forth grants made pursuant to the 1995 Stock Option Plan. NEW PLAN BENEFITS
NUMBER OF SHARES OF COMMON STOCK UNDERLYING NAME & POSITION DOLLAR VALUE(1) OPTIONS GRANTED (2)(3) ----------------------------------------------------------- --------------- ------------------------ Michael Bozic ............................................. $ 431,250 150,000 President & Chief Executive Officer John G. Reen .............................................. 143,750 50,000 Executive Vice President Chief Financial Officer Andrew J. Samuto .......................................... 71,875 25,000 Executive Vice President Real Estate & Support Services E. Jackson Smailes ........................................ 143,750 50,000 Executive Vice President General Merchandise Manager Robert J. Stevenish ....................................... 143,750 50,000 Executive Vice President Store & Distribution Operations Executive Officers, ....................................... 970,312 337,500 Including the Above Named Officers, as a Group Non-Executive Director .................................... -- 0 Group Non-Executive Officer ..................................... -- 0 Employee Group ------------------------ (1) Based upon the closing price of $23.00 per share of the Common Stock on the New York Stock Exchange on May 22, 1995, and the exercise price of $20.125 per share (the closing price of the Common Stock on the New York Stock Exchange on April 28, 1995, the date of the grant). (2) The grants were made April 28, 1995, and the exercise price is $20.125 per share (the closing price of the Common Stock on the New York Stock Exchange on the date of the grant). The options granted will expire April 28, 2005 and will vest over the first five years following the grant as follows: After 12 Months -- 20.0% Vested After 24 Months -- 45.0% Vested After 36 Months -- 75.0% Vested After 48 Months -- 87.5% Vested After 60 Months -- 100.0% Vested (3) If shareholder approval of the 1995 Stock Option Plan is not obtained, the foregoing grants will be rescinded.
Information as to grants made to the individuals named in the Summary Compensation Table pursuant to the 1993 Stock Option Plan may be obtained from the tables on page 17. THE BOARD OF DIRECTORS RECOMMENDS UNANIMOUSLY A VOTE "FOR" ITEM NUMBER 2. 9 ITEM 3 -- HILLS STORES COMPANY ASSOCIATE STOCK PURCHASE PLAN The Stock Purchase Plan was adopted by the Board of Directors on January 18, 1995. The Stock Purchase Plan is being submitted to the Company's shareholders as required by applicable provisions of Section 423 of the Code, relating to "employee stock purchase plans" as defined therein. If the Stock Purchase Plan is approved by shareholders, an associate participating in the Stock Purchase Plan will incur no federal income tax liability upon the purchase of shares under the Stock Purchase Plan. Approval by the Company's shareholders is also being sought in order that the purchase of shares under the Stock Purchase Plan may be eligible for exemption from the short-swing profits and reporting requirements of the Exchange Act. There shall be reserved for issuance and purchase by associates under the Stock Purchase Plan, an aggregate of 500,000 shares of the Company's Common Stock, subject to adjustment for stock splits or stock dividends. Shares subject to the Stock Purchase Plan may be shares of the Company's Common Stock now or hereafter authorized but unissued or shares that were once issued but subsequently reacquired by the Company. A copy of the Stock Purchase Plan is attached to this Proxy Statement as Exhibit 3. PURPOSE AND ELIGIBILITY The purpose of the Stock Purchase Plan is to secure for the Company and its shareholders the benefits of the incentives inherent in the ownership of the Company's capital stock by present and future associates of the Company and its subsidiaries. The Stock Purchase Plan is intended to strengthen the mutuality of interests between the Company's shareholders and associates, including non-management associates, by encouraging greater numbers of such associates to acquire and hold shares of the Company's Common Stock. Stock purchase plans similar to the Stock Purchase Plan are common in the retail industry and have proven to be an effective method of motivating and retaining associates at all levels. The Company anticipates that participation in the Stock Purchase Plan will benefit the Company and its shareholders through enhanced associate motivation and awareness of the Company's stock performance. Any of the approximately 18,000 associates (i.e. all persons employed by the Company and its subsidiaries) of the Company and its subsidiaries at May 5, 1995, and any future associates of the Company and its present and future subsidiaries, if they are eligible associates, may participate under the Stock Purchase Plan except as noted below. All regular associates who have attained the age of majority as determined by the laws of their state of residence and who have completed at least six months employment and have customary employment of a minimum of twenty hours per week are eligible to participate. Associates who own 5% or more of the Company's voting stock are not eligible to participate in the Stock Purchase Plan. Additionally, there is a dollar limit for certain highly compensated employees, and highly compensated employees who are also directors of the Company, including Messrs. Bozic and Reen, are ineligible. Associates on leave of absence or on temporary layoff as of either of the twice-yearly offering commencement dates who are otherwise eligible to participate in the Stock Purchase Plan are permitted to enroll in the offering beginning on that offering commencement date; payroll deductions with respect to any such associate will begin as of the first pay period after he or she resumes employment. COMMENCEMENT, TERMINATION AND MODIFICATION The Stock Purchase Plan will become effective as of August 1, 1995 and is subject to shareholder approval to obtain the benefits mentioned above for participating associates. The Stock Purchase Plan and all rights of associates under the Stock Purchase Plan will terminate (a) on the investment date that participating associates would, but for the limitation set forth below, become entitled to purchase a number of shares greater than the number of reserved shares remaining available for purchase or (b) at the discretion of the Board of Directors, at any time before that. If the Stock Purchase Plan terminates because participating associates have become entitled to purchase more shares than are 10 available for purchase, reserved shares remaining available for purchase as of the termination date will be issued to participating associates on a pro rata basis, and any excess funds thereafter remaining in associates' accounts will be refunded. The Board of Directors may amend the Stock Purchase Plan in any respect, except that the Stock Purchase Plan may not be amended in any way that will cause rights issued under it to fail to meet the requirements for an employee stock purchase plan as defined in Section 423 of the Internal Revenue Code which, among other things, requires shareholder approval for an increase in the number of shares issuable under the Stock Purchase Plan except pursuant to the anti-dilution provisions of the Stock Purchase Plan. If the shareholders do not approve the Stock Purchase Plan, it is possible that the Board of Directors may terminate the Stock Purchase Plan. Without shareholder approval, current federal tax law provides that the 15% discount from the fair market value of the stock will be treated as taxable compensation in the year of purchase by the participating associate, thus negating the advantageous federal tax treatment the Stock Purchase Plan is expected to provide to associates. ADMINISTRATION The Stock Purchase Plan is administered, at the Company's expense, by the HR/Compensation Committee of the Board of Directors. The Committee may request advice or assistance and employ or direct any other persons necessary for the proper administration of the Stock Purchase Plan. Subject to the express provisions of the Stock Purchase Plan, the Committee has the authority to interpret the Stock Purchase Plan, to prescribe, amend and rescind rules and regulations relating to the Stock Purchase Plan, and to make all other determinations necessary or advisable in administering the Stock Purchase Plan, all of which determinations will be final and binding upon all persons, unless otherwise determined by the Board of Directors. The Board of Directors has selected Smith Barney to maintain the investment accounts of participating associates, and will pay Smith Barney a fee based on the number of associate accounts enrolled at the time of each quarterly stock allocation. PURCHASE PRICE AND METHOD OF PURCHASE Participating associates will authorize the Company or subsidiary employer to make payroll deductions, not exceeding 10% of their salary or wages during the prior 12-month period, divided by the number of pay periods in the following twelve months. The minimum deductions shall be $5.00 per pay period. The payroll deductions will be used to purchase shares of stock at the end of each quarter at a price equal to 85% of the average of the high and low prices of the Company's Common Stock traded on the New York Stock Exchange on the last day in the calendar quarter on which the stock was traded. Smith Barney, which will maintain an investment account for each participating associate, intends to issue periodic reports to the associate of his or her shareholdings, although the Stock Purchase Plan does not expressly require such reports to be issued. Participating associates will not pay any brokerage or similar commission in connection with the purchase of stock under the Stock Purchase Plan. Because the Stock Purchase Plan limits each associate's participation to 10% of his or her compensation, with a calendar year purchase limit of $25,000 of the fair market value of the purchased stock, each associate with annual compensation exceeding $250,000, which includes each of the executive officers named in the Summary Compensation Table and some of the other eligible executive officers, could obtain a maximum annual benefit of $3,750.00 (I.E. 15% of $25,000) under the Stock Purchase Plan. Lesser-paid associates would have available a proportionately reduced maximum annual benefit. On May 22, 1995, the closing price of the Company's Common Stock on the New York Stock Exchange was $23.00. THE BOARD OF DIRECTORS RECOMMENDS UNANIMOUSLY A VOTE "FOR" ITEM NUMBER 3. 11 BENEFICIAL OWNERSHIP The following table sets forth as of May 5, 1995 information with respect to beneficial ownership of shares of the Company's Common Stock and Series A Preferred Stock. The information was obtained from Company records and information supplied by the shareholders, including information on Schedules 13D and 13G and Forms 4 prescribed by the Securities and Exchange Commission ("SEC"). Each share of Series A Preferred Stock is immediately convertible into one share of Common Stock, and the Series A Preferred Stock has coextensive voting rights with the Company's Common Stock.
AMOUNT AND NATURE TITLE OF NAME AND ADDRESS OF BENEFICIAL PERCENT OF PERCENT OF VOTING CLASS OF BENEFICIAL OWNER OWNERSHIP CLASS STOCK (1) ------------ ----------------------------------------------- --------------------- ----------- ----------------- Common Dickstein Partners Inc. (2) 1,113,459(2) 11.73 10.38 Dickstein Partners, L.P. Dickstein & Co., L.P. Dickstein Focus Fund L.P. Mark Dickstein 9 West 57th Street Suite 4630 New York, NY 10019 Dickstein International Limited 129 Front Street Hamilton HM12 Bermuda Common Heine Securities Corporation (3) 952,885(3) 9.96 8.88 51 John F. Kennedy Parkway Short Hills, NJ 07078 Common FMR Corp. (4) 808,814(4) 8.52 7.54 Fidelity Management and Trust Company 82 Devonshire Street Boston, MA 02109-3614 Common ML-Lee Acquisition Fund II, L.P. (5), ML-Lee 786,683(5) 8.22 7.28 Acquisition Fund (Retirement Accounts) II, L.P., Thomas H. Lee Advisors II, L.P. Thomas H. Lee World Financial Center South Tower, 23rd Fl. New York, NY 10080-6123 Common Wellington Management Company 677,245 7.14 6.31 75 State Street Boston, MA 02109 Common Richard S. Karpin, Assistant Special Deputy 591,047(6) 6.08 5.51 Superintendent of Insurance of the State of New York, as Agent of the Rehabilitator of Executive Life Insurance Company of New York 123 William Street New York, NY 10038-3889 ------------------------ (1) Represents the percentage of shares of Common Stock and Series A Preferred Stock owned beneficially to the aggregate of 9,490,183 shares of Common Stock and 1,234,713 shares of Series A Preferred Stock. (2) Dickstein Partners Inc., Dickstein Partners, L.P., Dickstein & Co., L.P., Dickstein Focus Fund L.P., Dickstein International, Limited and Mark Dickstein have filed a Schedule 13D and amendments
12 thereto showing beneficial ownership of an aggregate of 1,113,459 shares. Of the 1,113,459 total shares owned beneficially, Dickstein & Co., L.P. owned beneficially 727,315 of such shares. Dickstein Focus Fund L.P. owned beneficially 90,995 of such shares and Dickstein International Limited owned beneficially 295,149 of such shares. Dickstein Partners, L.P. is the general partner of Dickstein & Co., L.P. and Dickstein Focus Fund L.P. Dickstein Partners Inc. is the general partner of Dickstein Partners, L.P. and is the advisor to Dickstein International Limited. Since Mark Dickstein is the President and sole director of Dickstein Partners Inc., he may be deemed to own beneficially all shares shown. (3) Michael F. Price is the President of Heine Securities Corporation and he may be deemed to own beneficially all the shares owned by Heine Securities Corporation. (4) FMR Corp. has filed a Schedule 13D and amendments thereto showing beneficial ownership of 808,814 shares. The Company believes that FMR Corp. and Fidelity Management and Trust Company may be deemed a "group" as that term is used in Rule 13d5(b) of the Exchange Act. The shares listed are owned beneficially by Fidelity Management and Trust Company, a trustee or managing agent for various private investment accounts, primarily employee benefit plans, and an investment advisor to certain other funds which are generally offered to limited groups of investors. (5) ML-Lee Acquisition Fund II, L.P. owns beneficially 458,432 shares of Common Stock, and ML-Lee Acquisition Fund (Retirement Accounts) II, L.P. owns beneficially 244,818 shares of Common Stock. Thomas H. Lee Advisors II, L.P., as the investment advisor to both Funds, shares the power to vote and to direct the disposition of securities held by the Funds and therefore may be deemed to own beneficially the 703,250 shares of Common Stock owned beneficially in the aggregate by the Funds. Thomas H. Lee, Chairman of the Board, is a General Partner of both Funds. The shares listed include 83,433 shares of Common Stock owned beneficially by Mr. Lee individually, including 441 shares of Common Stock issuable upon conversion of Series A Preferred Stock and 77,759 shares of Common Stock issuable upon exercise of Series 1993 Warrants. Mr. Lee disclaims beneficial ownership of 87 shares of Common Stock issuable upon exercise of Series 1993 Warrants he holds as custodian for his son. (6) The shares listed include 229,559 shares of Common Stock issuable upon conversion of 229,559 shares of Series A Preferred Stock (18.59% of the Series A Preferred) and 5,929 shares of Common Stock issuable upon exercise of Series 1993 Warrants.
13 BENEFICIAL OWNERSHIP OF DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth as of May 5, 1995 the beneficial ownership of the Company's Common Stock and Series A Preferred Stock held by each director, the nominees for director, the executive officers named in the Summary Compensation Table and directors and executive officers as a group. Each share of Series A Preferred Stock is immediately convertible into one share of Common Stock, and the Series A Preferred Stock has coextensive voting rights with the Common Stock.
AMOUNT AND NATURE TITLE OF NAME AND ADDRESS OF BENEFICIAL PERCENT OF PERCENT OF CLASS OF BENEFICIAL OWNER OWNERSHIP CLASS VOTING STOCK (1) ------------ ------------------------------------ --------------------- ------------- ----------------- Common Thomas H. Lee 786,683(2)(13) 8.22 7.28 Common Michael Bozic 41,000(3) * * Common Susan E. Engel 500(4) * * Common Richard B. Loynd 1,500(5) * * Common Norman S. Matthews 26,307(6)(13) * * Common James L. Moody, Jr. 1,763(7)(13) * * Common John G. Reen 15,799(8)(13) * * Common Andrew J. Samuto 11,968(9)(13) * * Common E. Jackson Smailes 14,600(10) * * Common Robert J. Stevenish 14,600(11) * * Common Directors and Executive Officers 925,064(12)(13) as a Group (13 Persons) 9.55 8.47 ------------------------ * Represents less than 1% of outstanding shares. (1) Represents the percentage of shares of Common Stock and Series A Preferred Stock owned beneficially to the aggregate of 9,490,183 shares of Common Stock and 1,234,713 shares of Series A Preferred Stock, which have coextensive voting rights. (2) Includes 703,250 shares of Common Stock owned beneficially by ML-Lee Acquisition Fund II, L.P. and ML-Lee Acquisition Fund (Retirement Accounts) II, L.P. of which Mr. Lee is a general partner, 5,674 shares of Common Stock, including 441 shares of Common Stock issuable upon conversion of Series A Preferred Stock, and 77,759 shares issuable upon exercise of Series 1993 Warrants held by the 1989 Thomas H. Lee Nominee Trust, of which Mr. Lee is the beneficiary and settlor. Mr. Lee disclaims beneficial ownership of 87 shares issuable upon exercise of Series 1993 Warrants he holds as custodian for his son. (3) Consists of 5,479 shares issued upon exercise of stock options exercised November 19, 1994, 5,000 shares issued upon exercise of stock options exercised January 10, 1995 and 30,521 exercisable stock options. (4) Consists of exercisable stock options. (5) Includes 1,000 shares of Common Stock and 500 exercisable stock options. (6) Includes 26,000 exercisable stock options and 307 shares issuable upon exercise of Series 1993 Warrants to purchase Common Stock. (7) Includes 1,000 shares of Common Stock, 500 exercisable stock options and 263 shares issuable upon exercise of Series 1993 Warrants to purchase Common Stock. (8) Includes 270 shares of Common Stock, 14,600 exercisable options and 929 shares issuable upon exercise of Series 1993 Warrants to purchase Common Stock. (9) Includes 858 shares of Common Stock, 11,000 exercisable options and 110 shares issuable upon exercise of Series 1993 Warrants to purchase Common Stock. (10) Consists of 1,000 shares issued upon exercise of stock options exercised January 27, 1995 and 13,600 exercisable stock options. (11) Consists of 1,000 shares issued upon exercise of stock options exercised April 17, 1995 and 13,600 exercisable stock options. (12) Consists of 724,089 shares of Common Stock including 441 shares of Common Stock issuable upon conversion of Series A Preferred Stock, 120,921 exercisable stock options and 80,054 shares issuable upon exercise of Series 1993 Warrants to purchase Common Stock. (13) Although each Series 1993 Warrant is immediately exercisable for one share of Common Stock, each such Series 1993 Warrant is, at present, significantly "out of the money" ($30 per share exercise price versus $23.00 per share closing price on the New York Stock Exchange on May 5, 1995.)
14 SECURITIES AND EXCHANGE COMMISSION FILINGS Section 16(a) of the Exchange Act requires the Company's officers and directors, and persons who own more than ten percent of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the SEC and the New York Stock Exchange. Officers, directors and greater than 10% shareholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no Forms 5 were required for those persons, the Company believes that for the fiscal year ended January 28, 1995, its officers, directors, and greater than 10% beneficial owners complied with all filing requirements applicable to them. EXECUTIVE COMPENSATION The following table sets forth the annual and long-term compensation for service in all capacities to the Company for the fiscal year ended January 28, 1995 and the two prior fiscal years of those persons who were at January 28, 1995, (i) the Chief Executive Officer and (ii) the other four most highly compensated executive officers of the Company whose salary and bonus exceed $100,000: SUMMARY COMPENSATION TABLE ANNUAL COMPENSATION
LONG TERM COMPENSATION AWARDS: NAME AND OTHER ANNUAL STOCK ALL OTHER PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS COMPENSATION (1) ------------------------------------------------- ---- ---------- ------------ ------------ ------------ ---------------- Michael Bozic ................................... 1994 $875,000 $ 537,500 -- 35,000 $3,000 President & Chief Executive Officer 1993 875,000 1,437,500(2) -- 170,000 -- 1992 834,289 437,500 -- -- -- John G. Reen .................................... 1994 284,583 215,000 -- 23,000 6,000 Executive Vice President 1993 256,250 447,947(2) -- 50,000 -- Chief Financial Officer 1992 250,000 362,339 -- -- -- Andrew J. Samuto ................................ 1994 288,333 175,000 -- 15,000 5,845 Executive Vice President 1993 280,000 326,656(2) -- 40,000 -- Real Estate and Support Services 1992 280,000 160,000 -- -- -- E. Jackson Smailes .............................. 1994 375,000 257,500 -- 18,000 3,000 Executive Vice President 1993 375,000 272,450(2) $210,988(4) 55,000 -- General Merchandise Manager 1992 217,361(3) 35,000(3) -- -- -- Robert J. Stevenish ............................. 1994 258,333 202,500 -- 18,000 3,000 Executive Vice President 1993 225,000 194,068(2) 41,934(5) 55,000 -- Store and Distribution Operations 1992 156,250(3) 30,000(3) -- -- -- ------------------------------ (1) Represents Company Contributions to the Company's 401(k) Plan. (2) Includes both annual and emergence bonuses. Emergence bonuses were paid upon confirmation of the Company's Plan of Reorganization by the United States Bankruptcy Court for the Southern District of New York, effective October 4, 1993, pursuant to an emergence bonus plan approved by the Bankruptcy Court. (3) Amounts shown represent a partial year. Messrs. Smailes and Stevenish commenced their employment with the Company during fiscal 1992. (4) Consists of relocation expenses, including a "gross up" of $91,134 for federal and state taxes. (5) Consists of relocation expenses, including a "gross up" of $10,143 for federal and state taxes.
15 EMPLOYMENT CONTRACTS On September 30, 1994, the Company entered into employment agreements with the executive officers listed in the Summary Compensation Table which replaced existing employment agreements with such persons. The new employment agreements provided for a term of employment of each employee to December 31, 1996. The new agreements contain a rolling one-year extension provision if no notice to terminate is given by either party at least 90 days prior to the end of the term of the agreements. There was no change in compensation amounts from that provided in the prior employment agreements. The new employment agreements establish minimum base salary (subject to annual increases approved by the Board) and bonus level (as a percentage of base salary if annual goals established by the Board are attained) for each employee as follows:
1995 BASE EMPLOYEE SALARY BONUS LEVEL ------------------------------------------------------------------- ----------- ---------------- Michael Bozic...................................................... $ 925,000 50% John G. Reen....................................................... 315,000 50% Andrew J. Samuto................................................... 290,000 50% E. Jackson Smailes................................................. 390,000 50% Robert J. Stevenish................................................ 290,000 50%
The employment agreements provide that if the Company fails to pay amounts due under or otherwise is in material breach of the employment agreements or in the event of a significant diminution of an executive's responsibility and authority, it will be considered a "Good Reason" for such executive to terminate his agreement. The agreements further provide that an executive may terminate his agreement following a "Change in Control." A Change in Control is considered to have occurred if any person or group (i) becomes the beneficial owner of more than 50% of the Company's voting stock or (ii) elects more than 30% of the members of the Board of Directors (40% if there are nine or more directors), rounded down to the nearest whole number, as the result of an election contest. In the event an executive terminates his employment agreement for Good Reason (other than following a Change in Control) or the Company terminates his agreement without cause (including the failure of the Company to extend), such executive will receive a lump sum payment equal to (i) all earned but unpaid salary and a pro rated bonus to the time of termination and (ii) two times such executive's annual base salary in effect at the time of such termination; and such executive will continue to be entitled to benefits and perquisites during the stated term of the agreement. In the event an executive terminates his employment with Good Reason within one year after a Change in Control approved by a majority of the Company's continuing directors (an "Approved Change in Control"), such executive will receive a lump sum payment equal to (i) all earned but unpaid salary and a pro rated bonus to the time of termination and (ii) three times the sum of (a) such executive's annual base salary at the time of termination and (b) any bonus compensation to which such executive would have been entitled if such executive had remained as an employee to the end of the fiscal year in which such executive's employment terminated; and such executive will continue to be entitled to benefits and perquisites during the stated term of the agreement. In the event an executive terminates his employment agreement within one year after a Change in Control (other than an Approved Change in Control) such executive will receive a lump sum payment equal to (i) all earned but unpaid salary and a pro rated bonus to the time of termination and (ii) three times such executive's 1994 base salary and bonus, subject to adjustment under certain circumstances; and such executive will continue to be entitled to benefits and perquisites during the stated term of the agreement. The employment agreements provide that all options granted to an executive will immediately vest in the event of such executive's (i) death or disability, (ii) termination of his employment agreement for Good Reason or (iii) termination of his employment agreement following a Change in Control, other than an Approved Change in Control. The employment agreements also provide that an executive will be fully 16 indemnified by the Company for any and all expenses, fees (including legal fees), liabilities and obligations resulting from the executive's employment with the Company or enforcement of the terms of his employment agreement. COMPENSATION OF DIRECTORS The Company pays to independent, non-employee directors a fee of $2,000 per month plus $1,000 for each meeting of the Board and $500 for each committee meeting attended, plus expenses. Committee Chairmen receive $750 for each committee meeting attended. Pursuant to a consulting agreement entered into on September 30, 1994 with Norman S. Matthews, which replaced his previous consulting agreement, Mr. Matthews agreed to devote two-thirds of his professional time (determined on an annual basis) to the Company's business until December 31, 1996. Under the agreement, Mr. Matthews receives an annual fee of $500,000 (subject to annual increases approved by the Board), annual bonuses at the 50% level, based upon the attainment of annual goals established by the Board, and reimbursement of expenses. In addition, for the fiscal year ended January 28, 1995, Mr. Matthews received a special discretionary bonus of $70,000. Mr. Matthews' consulting agreement contains substantially similar provisions with respect to termination for Good Reason or following a Change in Control as the employment agreements described above under "Executive Compensation -- Employment Agreements". Mr. Lee, who is Chairman of the Board, is a financial consultant to the Company with a fee of $250,000 per year. Outside Directors will each receive a non-discretionary grant of a stock option to purchase 2,000 shares of Common Stock pursuant to the 1995 Stock Option Plan on the last day of January of each year if the 1995 Stock Option Plan is approved by shareholders. RELATED TRANSACTIONS Mr. Lee, who is Chairman of the Board, is a director of J. Baker, Inc. and owns less than 1% of the outstanding capital stock of J. Baker, Inc. The Company and J. Baker, Inc. are parties to a license agreement pursuant to which J. Baker, Inc. operates footwear departments in Hills Department Stores and pays the Company a license fee. STOCK OPTION TABLE The following table sets forth grants of options to purchase shares of the Company's Common Stock under the Company's 1993 Stock Option Plan to the individuals named in the Summary Compensation Table during the fiscal year ended January 28, 1995:
POTENTIAL REALIZABLE VALUE OF ASSUMED ANNUAL NUMBER OF RATES OF STOCK PRICE SECURITIES % OF TOTAL APPRECIATION FOR OPTION UNDERLYING OPTIONS GRANTED EXERCISE OR TERM (2) OPTIONS TO EMPLOYEES IN BASE EXPIRATION ------------------------ NAME GRANTED (1) FISCAL YEAR PRICE (2) DATE 5% 10% ---------------------------------- ----------- --------------- ----------- ------------ ---------- ------------ Michael Bozic..................... 35,000 18.3% $ 19.50 04/21/2004 $ 429,221 $ 1,087,729 John G. Reen...................... 23,000 12.0% 19.50 04/21/2004 282,059 714,793 Andrew J. Samuto.................. 15,000 7.9% 19.50 04/21/2004 183,952 466,170 E. Jackson Smailes................ 18,000 9.4% 19.50 04/21/2004 220,742 559,404 Robert J. Stevenish............... 18,000 9.4% 19.50 04/21/2004 220,742 559,404 ------------------------ (1) The options vest over the first five years following the grant as follows: After 12 Months -- 20.0% Vested After 24 Months -- 45.0% Vested After 36 Months -- 75.0% Vested After 48 Months -- 87.5% Vested After 60 Months -- 100.0% Vested
17 (2) The exercise price is equal to the market value on the date of the grant. The amounts shown as potential realizable value illustrate what might be realized upon exercise immediately prior to expiration using the 5% and 10% appreciation rates established in regulations of the SEC, compounded annually. The potential realizable value is not intended to predict future appreciation of the price of the Company's Common Stock. The values shown do not consider nontransferability, vesting over five years or termination of the options upon termination of employment.
OPTION EXERCISES IN FISCAL 1994 Mr. Bozic exercised 5,479 stock options on November 29, 1994 and 5,000 stock options on January 10, 1995. Mr. Smailes exercised 1,000 stock options on January 27, 1995. No other directors or executive officers exercised stock options during the fiscal year ended January 28, 1995. In addition, Mr. Stevenish exercised 1,000 stock options on April 17, 1995. As of January 28, 1995, the following table sets forth information regarding the number and value of unexercised stock options.
VALUE OF UNEXERCISED IN NUMBER OF UNEXERCISED THE MONEY OPTIONS AT YEAR SHARES OPTIONS AT FISCAL YEAR END END (2) ACQUIRED ON VALUE ---------------------------- -------------------------- NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE --------------------------------- ------------- ----------- ------------- ------------- ----------- ------------- Michael Bozic.................... 10,479 $ 22,653(1) 23,521 171,000 $ 70,563 $ 469,250 John G. Reen..................... 0 0 10,000 63,000 30,000 160,250 Andrew J. Samuto................. 0 0 8,000 47,000 24,000 122,250 E. Jackson Smailes............... 1,000 3,000(2) 10,000 62,000 30,000 163,500 Robert J. Stevenish.............. 0 0 11,000 62,000 33,000 163,500 ------------------------------ (1) Based on the difference between the exercise price of $18.25 and (a) the closing price of the Company's Common Stock on November 29, 1994 of $19.875 as to 5,479 shares and (b) the closing price of the Company's Common Stock on January 10, 1995 of $21.00 as to 5,000 shares. (2) Based on the difference between the closing price of the Company's Common Stock on January 27, 1995 of $21.25 per share and the exercise price of $18.25 per share, as to options granted November 4, 1993 and $19.50 per share as to options granted April 21, 1994.
LONG TERM INCENTIVE PLAN AWARDS Except for the Company's Stock Option Plans described above, the Company does not have a long term incentive plan, and the Company made no long term incentive plan awards in fiscal 1994. PENSION PLAN The following table shows the estimated annual retirement benefit payable on a straight life annuity basis to participating associates, including officers, in the earnings and years of service classifications indicated, under the Company's retirement plan which covered most officers and other salaried associates on a contributory basis. Such benefits reflect an integration of Social Security benefits. The Company's plan also provides for the payment of benefits to an associate's surviving spouse or other beneficiary, under alternative options.
HIGHEST AVERAGE ANNUAL COMPENSATION DURING ANY FIVE CONSECUTIVE YEARS YEARS OF CREDITED SERVICE BETWEEN 1965 AND NORMAL --------------------------------------------------------------- RETIREMENT AGE OF 65 15 20 25 30 35 ------------------------ ----------- ----------- ----------- ----------- ----------- $ 250,000 $ 58,331 $ 77,775 $ 97,219 $ 116,663 $ 136,107* 300,000 71,456 95,275 119,094* 142,913* 166,732* 400,000 97,706 130,280* 162,850* 195,420* 227,990* 500,000 123,956* 165,275* 206,594* 247,913* 289,232* 1,000,000 255,210* 340,280* 425,350* 510,420* 595,490* 1,500,000 386,460* 515,280* 644,100* 772,920* 901,740* ------------------------ *Subject to limitations imposed by the Employees Retirement Income Security Act of 1974 ("ERISA"), as amended. The current maximum annual benefit allowed by ERISA is $118,800.
18 Benefits under the plan are calculated based upon 100% of cash compensation (salary and bonus) actually received during any calendar year, subject to any limitations imposed by law. The compensation upon which benefit calculations are based differs from compensation reported in the Cash Compensation Table set forth above because the Internal Revenue Service limits to $150,000 the amount of 1994 compensation to be used in calculating benefits under the pension plan. At April 30, 1994, the plan termination date, Messrs. Bozic, Reen, Samuto, Smailes and Stevenish had 3.0, 17.7, 29.2, 2.7 and 2.4 years of credited service, respectively, and the individual compensation for calendar year 1993 for purposes of the plan was $150,000 for each of Messrs. Bozic, Samuto and Reen. Messrs. Smailes and Stevenish do not participate in the pension plan. Subject to receiving necessary approvals from the Internal Revenue Service, the pension plan was terminated effective April 30, 1994. On May 12, 1995, the Company received a favorable determination from the Internal Revenue Service. The Company expects that during the current fiscal year accrued benefits will be transferred to associates participating in the pension plan in the form of either an annuity or a rollover into the associate's 401(k) savings account at the option of the associate. COMPENSATION COMMITTEE REPORT In accordance with the rules and regulations of the SEC, the following report of the Compensation Committee and the performance graph thereafter shall not be deemed to be "soliciting material" or to be "filed" with the SEC or subject to Regulations 14A or 14C of the Exchange Act or to the liabilities of Section 18 of the Exchange Act and shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, notwithstanding any general incorporation by reference of this Proxy Statement into any other filed document. The Company's Board of Directors has established the HR/Compensation Committee (the "Committee"), consisting entirely of non-employee directors. The Committee's functions include: (i) Reviewing the corporate compensation programs, including the compensation of the Chief Executive Officer, and policies to insure that the programs and policies are competitive and provide for internal fairness; (ii) Reviewing and advising the Chief Executive Officer about specific compensation matters for officers and executives; (iii) Overseeing the Company's performance bonus program; (iv) Administering the Hills Stores Company Associate Stock Purchase Plan; and (v) Such other duties as the Chairman of the Board may assign. OBJECTIVES The objective of the Company's executive compensation program is to attract and retain executives with high levels of talent and expertise in areas related to retailing and to encourage these executives to achieve superior performance on behalf of the Company and its shareholders. The Company has developed a compensation strategy that ties a substantial portion of executive compensation to the Company's success in meeting specified performance goals. The Company believes that its executive compensation program allows it to compete with other high volume discount retailers and to remain competitive in a demanding retail market. Executive compensation generally consists of three basic components: salary, performance bonus, and stock option grants. BASE SALARY Base salaries for executive officers are determined by the Company by evaluating the duties and responsibilities of each position and the experience of the executive and by conducting executive salary surveys and comparing salaries for similar positions with other companies. Annual salary increases and adjustments are determined by the Company and based on individual performance, changes in responsibilities, and market-based salary comparisons with other retail companies. Salaries of all executives are reviewed annually. 19 PERFORMANCE BONUS A significant portion of executive compensation is directly related to Company performance by means of the Company's performance bonus program. Depending on position, maximum bonus eligibility ranges from a low of 6% of an executive's base salary to a high of 50% of an executive's base salary. Actual pay-out is determined by Company performance, the achievement of financial and profit goals and individual performance. Early in each year, the Board of Directors approves performance goals for the Company and for individual executives. If the Company meets its performance goals, a maximum bonus pool is established. The bonus pool is reduced or eliminated depending on the level of performance achieved. In the fiscal year ended January 28, 1995, the Company goal was a target of earnings before interest, taxes, depreciation and amortization (EBITDA). EBITDA thresholds in descending amounts were established for a maximum bonus pool, a 67% bonus pool and a 33% bonus pool. If the lowest threshold is not met, there is no bonus pool. In the fiscal year ended January 28, 1995, the Company met the EBITDA threshold for a maximum bonus pool. In addition to the Company goal, each executive has individual performance goals. These individual goals vary by position. Even if the Company meets its maximum bonus goal, an executive may not receive a maximum bonus if individual performance goals are not met. Furthermore, executives who exceed their individual performance goals may be awarded special discretionary bonuses. For the fiscal year ended January 28, 1995, each executive officer named in the Summary Compensation Table, including the Chief Executive Officer, received special discretionary bonuses. STOCK OPTION PLAN The Company's 1993 Stock Option Plan is intended to provide a long-term incentive and to motivate executives to increase the long-term market value of the Company's common stock. During the fiscal year ended January 28, 1995, options to purchase a total of 191,000 shares of the Common Stock of the Company were granted to 24 individuals, including the Chief Executive Officer, all other executives named in the Summary Compensation Table and one non-employee director. The exercise price is equal to the market value on the date of the grant. Options may be exercised (subject to vesting) for ten years following the grant, with vesting occurring in annual increments during the first five years following the grant. Option grants are fully vested after five years from the date of the grant. The Stock Option Committee of the Board of Directors of the Company determines the amount and timing of grants under the Company's Stock Option Plan. The Stock Option Committee is comprised of Thomas H. Lee and James L. Moody, Jr., both of whom are non-employee directors and neither of whom has received grants under the 1993 Stock Option Plan within the last year. The Committee believes that the adoption of the 1995 Stock Option Plan described on pages 7 through 9 above, will further align the interests of management and the shareholders and is in the best interest of the Company. The 1993 Stock Option Plan was instituted in connection with the Company's emergence from Chapter 11 proceedings, and the number of shares available for grants thereunder was the product of the negotiation of the Company's Reorganization Plan. Only 39,763 shares remain available for grant under the 1993 Stock Option Plan. The Committee believes the number of shares available for grant should be increased by means of adoption of the 1995 Stock Option Plan in order to be available to further align the interests of management and shareholders and to provide additional incentives for management to continue to produce excellent operating results. COMPENSATION OF THE CHIEF EXECUTIVE OFFICER A substantial portion of Mr. Bozic's compensation was directly related to the Company's performance during the fiscal year ended January 28, 1995. Because the Company met its specified EBITDA goal, in addition to his base salary paid pursuant to his employment contract, Mr. Bozic received a maximum performance bonus of 50% of his base salary. Mr. Bozic also received a special discretionary bonus of $100,000 as a reward for the Company's outstanding operating results. In setting Mr. Bozic's bonus amounts, the Committee was mindful of federal tax limits on the deductibility of compensation amounts in excess of one million dollars. 20 COMPENSATION OF NAMED EXECUTIVE OFFICERS The other executives named in the Summary Compensation Table received a salary for the fiscal year ended January 28, 1995 pursuant to their respective employment contracts and received stock options pursuant to the Company's 1993 Stock Option Plan. Since the company met its EBITDA goal, each of the executives named in the Summary Compensation Table received maximum bonuses of 50% of their respective base salaries, and special discretionary bonuses in the following amounts: Mr. Reen, $70,000; Mr. Samuto, $30,000; Mr. Smailes, $70,000; Mr. Stevenish, $70,000. AMENDMENTS TO EMPLOYMENT AGREEMENTS The Committee decided that it was important and in the best interest of the Company and the shareholders to amend the employment agreements of key executives, including the Chief Executive Officer and the other executive officers named in the Summary Compensation Table, in order that key executives not be unnecessarily distracted by concerns about job security in the event of a change in control. In determining what constitutes appropriate protection, the Committee attempted to strike a balance between the need of the key executives for security and the need of the Company for the flexibility to make necessary management changes. The Committee considered primarily (i) the value of the executive to the Company (ii) the length of the term of the employment agreements (iii) the payment or other remedy to which an executive would be entitled in the event of a change in control and (iv) what events would constitute a change in control for the purpose of the employment agreements. During the fiscal year ended January 28, 1995, the Company entered into revised employment agreements with key executives, including the Chief Executive Officer and the executive officers named in the Summary Compensation Table. The revised employment agreements contain change in control provisions and are more particularly described on pages 16 and 17. The revised employment agreements do not change annual compensation or bonus levels for any executives. No member of the Committee is a current or former officer or employee of the Company or any of its subsidiaries. HR/COMPENSATION COMMITTEE James L. Moody, Jr. Susan E. Engel Richard B. Loynd 21 COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION During the fiscal year ended January 28, 1995, no executive officer of the Company (i) served on the board of directors of any company of which Mr. Moody, Ms. Engel or Mr. Loynd (the members of the Company's HR/Compensation Committee) was an executive officer or (ii) served as a member of the compensation committee (or other board committee performing equivalent functions or, in the absence of such a committee, on the board) of another entity, one of whose executive officers is a member of the Board of Directors of the Company. PERFORMANCE GRAPHS The following graphs compare the percentage change in cumulative total shareholders return on the Common Stock of the Company and the Predecessor Company to the cumulative total shareholders return of the S&P 500 and to the cumulative total shareholders return of the S&P Retail Composite. The Predecessor Company Graph covers the period February 3, 1990 to October 4, 1993 and assumes an investment of $100 in the Common Stock of the Predecessor Company and each index on February 3, 1990. The Company Graph covers the period from October 5, 1993 to January 28, 1995 and assumes an investment of $100 in the Company's Common Stock and in each index on October 5, 1993. TOTAL RETURN TO SHAREHOLDERS PREDECESSOR COMPANY COMPANY
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
10/5/93 JAN 94 JAN 95 HILLS STORES CO. 100 100.58 99.42 S&P 500 INDEX 100 105.12 105.67 RETAIL STORES - COMPOSITE 100 102.36 94.78
22 FINANCIAL ADVISOR On May 3, 1995, the Company retained Smith Barney as its financial advisor with respect to the Dickstein Proposal, any other unsolicited offer to acquire the Company or any possible transaction relating thereto. On May 15, 1995, Smith Barney advised the Board of Directors of the Company that the Dickstein Proposal is inadequate, from a financial point of view, to the holders of Hills Common Stock (other than Dickstein). A copy of the Smith Barney opinion is attached to this Proxy Statement as Exhibit 1. Pursuant to a letter agreement dated May 3, 1995, the Company agreed to pay Smith Barney: (a) an advisory fee of $1,750,000 payable in cash, $750,000 of which has been paid to Smith Barney, $250,000 of which will be due and payable on August 3, 1995 and the balance of which will be due and payable at the earlier of November 3, 1995 or the termination of the Dickstein Proposal and all other unsolicited offers to acquire the Company, if any, first publicly announced prior to the conclusion of the Annual Meeting; (b) in the event that the Company undertakes a recapitalization, a recapitalization fee of up to $1,000,000, based upon the size and complexity of the recapitalization and Smith Barney's contribution thereto, payable at the sole discretion of the Company's Board of Directors; and (c) a transaction fee payable in cash promptly upon the consummation during the term of the letter agreement or within 12 months thereafter of (i) any transaction or series of or combination of transactions, whether solicited or unsolicited, whereby, directly or indirectly, Control (as defined below) of the Company or any of its properties or assets are transferred for consideration, including, without limitation, a sale, merger or consolidation, tender or exchange offer, negotiated purchase, leverage buyout or partnership, collaborative venture or any similar extraordinary transaction involving corporate control of or major divestiture by the Company or (ii) any acquisition by the Company, other than in the ordinary course of business, which has not been publicly announced prior to the date of the letter agreement (collectively, a "Transaction"). The term "Control" as used in the letter agreement is defined as any event or transaction or series or combination of transactions whereby more than 50% of the outstanding capital stock of the Company on a fully diluted basis, or more than 50% of the assets or financial rights and obligations under any formal contract of the Company, is transferred for consideration. The amount of the transaction fee payable pursuant to the letter agreement is determined by applying a fee percentage, ranging from 0.40% to 2.00% depending on the size of the Transaction, to the value of the total proceeds and other consideration paid or received or to be paid or received in connection with the Transaction. In the event that nominees or representatives of Dickstein or any other person (or "group" of persons as defined in Rule 13d-5 under the Securities Exchange Act of 1934) (other than directors of the Company in office as of May 3, 1995) are elected to the Company's Board of Directors and such nominees or representatives constitute a majority of the Company's Board of Directors, Smith Barney will be entitled to receive immediately the advisory fee otherwise due under the letter agreement but not any recapitalization fee or transaction fee due thereunder. The advisory fee, whether or not previously paid, will be credited against any transaction fee that may become payable under the letter agreement. The Company has also agreed to indemnify Smith Barney against certain liabilities and expenses in connection with its engagement, including certain liabilities under the federal securities laws. SOLICITATION OF PROXIES The cost of the solicitation of proxies on behalf of the Board of Directors of the Company will be borne by the Company. The Company estimates that the total expenditures relating to such solicitation (other than salaries and wages of officers and employees) will be approximately $ , of which approximately $ has been spent to date. In addition to solicitation by mail, directors, officers and other employees of the Company may, without additional compensation, solicit proxies by mail, in person, by telecommunication or by other electronic means. The Company has retained D. F. King & Co., Inc. ("D. F. King"), at an estimated fee of $ , to assist in the solicitation of proxies. In addition, the Company will reimburse D. F. King for reasonable out-of-pocket expenses and will indemnify D. F. King against certain liabilities and expenses. Approximately persons will be utilized by such firm in its efforts. The Company will reimburse brokerage houses, banks, 23 custodians and other nominees and fiduciaries for out-of-pocket expenses incurred in forwarding the Company's proxy solicitation materials to, and obtaining instructions relating to such materials from, beneficial owners of capital stock. The Company anticipates that employees of Smith Barney may communicate in person, by telephone or otherwise with the Company's shareholders for the purpose of assisting in the solicitation of proxies in connection with the Dickstein Solicitation. Smith Barney will not receive separate compensation for such services. For additional expenses of the Company's solicitation, including a description of the fees and expenses of Smith Barney, see "Financial Advisor." Schedule A hereto contains certain information concerning persons who may be deemed to be "participants" in the Company's solicitation of proxies. Schedule B hereto sets forth transactions in the Company's securities by the "participants" during the last two years. Information about the present capital stock ownership of these participants is provided in "Beneficial Ownership of Directors and Executive Officers". OTHER MATTERS At the time this Proxy Statement was published, the Board of Directors knew of no other matters constituting a proper subject of action by the shareholders which would be presented at the meeting. Should any other matters be properly brought before the Annual Meeting, the persons appointed in the proxy or their substitutes will vote in accordance with their best judgment on such issues. NOTE: UPON WRITTEN REQUEST OF ANY SHAREHOLDER ENTITLED TO RECEIVE THIS PROXY STATEMENT, THE COMPANY WILL PROVIDE, WITHOUT CHARGE, A COPY OF ITS ANNUAL REPORT ON FORM 10-K AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. ANY SUCH REQUEST SHOULD BE ADDRESSED TO THE COMPANY AT 15 DAN ROAD, CANTON, MA 02021, ATTENTION: WILLIAM K. FRIEND, VICE PRESIDENT-SECRETARY. RELATIONSHIP OF INDEPENDENT ACCOUNTANTS The Board of Directors selects the independent accountants for the Company each year. Coopers & Lybrand, or its predecessor companies, has acted in this capacity since 1936 for the Company, the Predecessor Company and their respective affiliates and predecessors, and is expected to continue to do so. In connection with its audit functions, Coopers & Lybrand examined the Company's financial statements for the fiscal year ended January 28, 1995 and reviewed the Company's Annual Report and its filings with the SEC. Additionally, Coopers & Lybrand conducted reviews of the Company's interim financial statements during the fiscal year. Representatives of Coopers & Lybrand are expected to attend the Annual Meeting of Shareholders, may make a statement if they so desire and will be available to respond to questions submitted to the Company at 15 Dan Road, Canton, MA 02021, Attention: William K. Friend, Vice President-Secretary, in writing at least ten days prior to the meeting. LITIGATION On May 4, 1995 attorneys for Gayle L. Dolowich and Ivan S. Dolowich filed a lawsuit in the Court of Chancery of the State of Delaware against the seven directors of the Company, a former director of the Company and the Company on behalf of the named plaintiffs and purportedly on behalf of all other public shareholders of the Company. The complaint alleges, that the "Defendants have among other things, not properly responded to an offer by Dickstein to acquire the outstanding shares of Hills." In addition, the Company has received information, although it has not yet been served with court papers, that the same law firm representing the Dolowich couple also filed another lawsuit on May 4, 1995 in the same Delaware court on behalf of Joseph K. Weiss, who alleges he is a shareholder of the Company. The seven directors of the Company and the Company are the named defendants. The complaint seeks an injunction ordering the directors to abide by their fiduciary duties in respect of any proposal, including acquisition offers, to maximize shareholder value. The Company believes that both lawsuits are without merit. 24 SHAREHOLDER PROPOSALS In order to be considered for inclusion in the proxy materials related to the 1996 Annual Meeting of Shareholders, shareholder proposals must be received by the Company (addressed to the attention of the Secretary) not later than January 31, 1996. IMPORTANT It is important that your Shares are voted at the Annual Meeting. Shareholders are urged to promptly sign, date and mail the WHITE proxy in the enclosed postage-paid envelope. Please act today! If you have any questions, or need assistance, please call D. F. King & Co., Inc., which is assisting us, at the numbers listed below: D. F. KING CO., INC. 77 Water Street New York, New York 10005 (212) 269-5550 (Collect) or CALL TOLL-FREE -- 1-800-290-6425 25 SCHEDULE A INFORMATION CONCERNING THE DIRECTORS AND EXECUTIVE OFFICERS, AND CERTAIN EMPLOYEES AND OTHER REPRESENTATIVES OF HILLS The following table sets forth the name and the present principal occupation or employment (except with respect to the directors, whose principal occupation is set forth in the Proxy Statement), and the name, principal business and address of any corporation or other organization in which such employment is carried on, of the directors and certain executive officers of the Company who may assist in soliciting proxies from the Company's shareholders. Unless otherwise indicated below, the principal business address of each such person is 15 Dan Road, Canton, Massachusetts 02021 and such person is an employee of or consultant to the Company. Directors are indicated with an asterisk.
NAME AND PRINCIPAL PRESENT OFFICE OR OTHER PRINCIPAL BUSINESS ADDRESS OCCUPATION OR EMPLOYMENT ------------------------------------ ---------------------------------------------------------------------------- Thomas H. Lee* 75 State Street Boston, Massachusetts 02109 Michael Bozic* Susan E. Engel* One Village Place 6436 City West Parkway Eden Prairie, Minnesota 55344 Richard B. Loynd* 101 S. Hanley Road St. Louis, Missouri 63105 Norman S. Matthews* James L. Moody, Jr.* 145 Pleasant Hill Road Scarborough, Maine 04074 John G. Reen* William K. Friend Vice President-Secretary and Corporate Counsel, Hills Stores Company
26 SCHEDULE B SHARES HELD BY HILLS DIRECTORS AND CERTAIN EXECUTIVE OFFICERS AND OTHER REPRESENTATIVES OF HILLS AND CERTAIN TRANSACTIONS BETWEEN ANY OF THEM AND HILLS The following directors and executive officers of Hills have had the following transactions in the Company's securities within the past two years:
NUMBER OF SHARES OF CAPITAL STOCK PURCHASED (OR NAME SOLD) DATE ---------------------------------------------------------------------- ------------------ --------- Thomas H. Lee......................................................... 785,733(1)(2) 10/04/93 950(1) 03/20/95 Michael Bozic......................................................... 23,521(3) 11/04/94 5,479(4) 11/19/94 5,000(4) 01/10/95 7,000(3) 04/21/95 Susan E. Engel........................................................ 500(3) 11/19/94 Richard B. Loynd...................................................... 1,000(5) 11/30/93 500(3) 11/19/94 Norman S. Matthews.................................................... 307(1)(6) 10/04/93 22,000(3) 11/04/94 4,000(3) 04/21/95 James L. Moody, Jr.................................................... 263(1)(7) 10/04/93 1,000(7) 12/08/93 500(3) 11/19/94 John G. Reen.......................................................... 1,199(1)(8) 10/04/93 10,000(3) 11/04/94 4,600(3) 04/21/95 William K. Friend..................................................... 1,244(1)(9) 10/04/93 4,300(3) 11/04/94 1,000(3) 04/21/95 ------------------------ (1) Issued in connection with the confirmation of the Company's Plan of Reorganization by the United States Bankruptcy Court for the Southern District of New York effective October 4, 1993. (2) See note 2 to "Beneficial Ownership of Directors and Executive Officers". (3) Represents stock options that became exercisable on the date shown, but which have not yet been exercised. (4) Shares acquired upon exercise of stock options. (5) See note 5 to "Beneficial Ownership of Directors and Executive Officers". (6) See note 6 to "Beneficial Ownership of Directors and Executive Officers". (7) See note 7 to "Beneficial Ownership of Directors and Executive Officers". (8) See note 8 to "Beneficial Ownership of Directors and Executive Officers". (9) Includes 558 shares of Common Stock and 686 shares issuable upon exercise of Series 1993 Warrants to purchase Common Stock.
On September 30, 1994, the Company entered into an employment agreement with Mr. Friend which replaced the existing employment agreement with Mr. Friend. The new employment agreement is identical to the employment agreements described in the Proxy Statement under "Employment Agreements". Mr. Friend's 1995 base salary was $169,000 and his bonus level was 40%. 27 Except as disclosed in this Schedule or in the Proxy Statement, none of Hills, any of its directors or executive officers, or the employees or other representatives of Hills named in Schedule A owns any securities of Hills or any subsidiary of Hills, beneficially or of record, has purchased or sold any of such securities within the past two years or is or was within the past year a party to any contract, arrangement or understanding with any person with respect to any such securities. Except as disclosed in this Schedule or in the Proxy Statement, to the best knowledge of Hills, its directors and executive officers or the employees and other representatives of Hills named in Schedule A, none of their associates beneficially owns, directly or indirectly, any securities of Hills. Other than as disclosed in this Schedule and in the Proxy Statement, to the knowledge of Hills, none of Hills, any of its directors or executive officers, or the employees or other representatives of Hills named in Schedule A has any substantial interest, direct or indirect, by security holdings or otherwise, in any matter to be acted upon at the Annual Meeting. Other than as disclosed in this Schedule and in the Proxy Statement, to the knowledge of Hills, none of Hills, any of its directors or executive officers, or the employees or other representatives of Hills named in Schedule A is, or has been within the past year, a party to any contract, arrangement or understanding with any person with respect to any class of securities of Hills, including, but not limited to, joint ventures, loan or option arrangements, puts or calls, guarantees against loss or guarantees of profit, division of losses or profits, or the giving or withholding of proxies. Other than as set forth in this Schedule or in the Proxy Statement, to the knowledge of Hills, none of Hills, any of its directors or executive officers, or the employees or other representatives of Hills named in Schedule A, or any of their associates, has had or will have a direct or indirect material interest in any transaction or series of similar transactions since the beginning of Hills' last fiscal year or any currently proposed transactions, or series of similar transactions, to which Hills or any of its subsidiaries was or is to be a party in which the amount involved exceeds $60,000. Other than as set forth in this Schedule and the Proxy Statement, to the knowledge of Hills, none of Hills, any of its directors or executive officers, or the employees or other representatives of Hills named in Schedule A, or any of their associates (as defined in Rule 14a-1 promulgated under the Exchange Act), has any arrangements or understandings with any person or persons with respect to any future employment by Hills or its affiliates or with respect to any future transactions to which Hills or any of its affiliates will or may be a party. 28 IMPORTANT Your vote is important. Regardless of the number of shares of Hills common or preferred stock you own, please vote as recommended by your Board of Directors by taking these two simple steps: 1. PLEASE SIGN, DATE AND PROMPTLY MAIL THE ENCLOSED WHITE PROXY CARD IN THE POSTAGE-PAID ENVELOPE PROVIDED. 2. DO NOT RETURN ANY BLUE PROXY CARDS SENT TO YOU BY DICKSTEIN. IF YOU VOTED DICKSTEIN'S BLUE PROXY CARD BEFORE RECEIVING YOUR HILLS WHITE PROXY CARD, YOU HAVE EVERY RIGHT TO CHANGE YOUR VOTE SIMPLY BY SIGNING, DATING AND MAILING THE ENCLOSED WHITE PROXY CARD. THIS WILL CANCEL YOUR EARLIER VOTE SINCE ONLY YOUR LATEST DATED PROXY CARD WILL COUNT AT THE ANNUAL MEETING. If you own your shares in the name of a brokerage firm, only your broker can vote your shares on your behalf and only after receiving your specific instructions. Please call your broker and instruct him/her to execute a Hills WHITE card on your behalf. You should also promptly sign, date and mail your WHITE card when you receive it from your broker. Please do so for each separate account you maintain. You should return your WHITE proxy card at once to ensure that your vote is counted. This will not prevent you from voting in person at the meeting should you attend. IF YOU HAVE ANY QUESTIONS OR REQUIRE ASSISTANCE IN VOTING YOUR SHARES, PLEASE CALL: D. F. KING & CO., INC. 77 WATER STREET NEW YORK, NY 10005 (212) 269-5550 (COLLECT) CALL TOLL FREE (800) 290-6425 EXHIBIT 1 [SMITH BARNEY LETTERHEAD] CONFIDENTIAL May 15, 1995 The Board of Directors Hills Stores Company 15 Dan Road Canton, Massachusetts 02021 Members of the Board: You have requested our opinion regarding the financial terms of the written proposal dated May 3, 1995 of Dickstein Partners Inc. ("Dickstein") pursuant to which Dickstein has proposed to acquire all of the outstanding shares of the common stock, par value $0.01 per share, of Hills Stores Company ("Hills" and, such common stock, the "Hills Common Stock") for a total consideration of $25.00 per share in cash (the "Dickstein Proposal"). In arriving at our opinion, we reviewed the Dickstein Proposal and held discussions with certain senior officers, directors and other representatives and advisors of Hills concerning the business, operations and prospects of Hills. We examined certain publicly available business and financial information relating to Hills as well as certain financial forecasts and other data for Hills which were provided to us by the management of Hills. We reviewed the financial terms of the Dickstein Proposal in relation to, among other things: current and historical market prices and trading volumes of the Hills Common Stock; the historical and projected earnings of Hills; and the capitalization and financial condition of Hills. We also considered, to the extent publicly available, the financial terms of certain other similar transactions recently effected which we considered comparable to the transactions contemplated by the Dickstein Proposal and analyzed certain financial, stock market and other publicly available information relating to the businesses of other companies whose operations we considered comparable to those of Hills. In addition to the foregoing, we conducted such other analyses and examinations and considered such other financial, economic and market criteria as we deemed appropriate to arrive at our opinion. In rendering our opinion, we have assumed and relied, without independent verification, upon the accuracy and completeness of all financial and other information publicly available or furnished to or otherwise reviewed by or discussed with us. With respect to financial forecasts and other information provided to or otherwise reviewed by or discussed with us, we have been advised by the management of Hills that such forecasts and other information were reasonably prepared on bases reflecting the best currently available estimates and judgments of the management of Hills as to the future financial performance of Hills. We have not made or been provided with an independent evaluation or appraisal of the assets or liabilities (contingent or otherwise) of Hills nor have we made any physical inspection of the properties or assets of Hills. In connection with our engagement, we have not been requested to approach, and have not approached, third parties to solicit indications of interest in the acquisition of all or a part of Hills. Our opinion is necessarily based upon information available to us, and financial, stock market and other conditions and circumstances existing and disclosed to us, as of the date hereof. Smith Barney has been engaged to render financial advisory services to Hills in connection with the Dickstein Proposal and certain related matters and will receive a fee for our services. We also will receive a fee upon the delivery of this opinion. In the ordinary course of our business, we may actively trade the securities of Hills for our own account or for the account of our customers and, accordingly, may at any time hold a long or short position in such securities. We have in the past provided certain financial advisory services to Hills, including acting as financial advisor to Hills in connection with a consent solicitation by E-1 Dickstein commenced in August 1994 and the repurchase by Hills of shares of Hills Common Stock and related consent solicitation of Hills' bondholders in February 1995, for which services we have received compensation. Our advisory services and the opinion expressed herein are provided solely for the use of the Board of Directors of Hills in its evaluation of the Dickstein Proposal and may not be relied upon by any other person. Our opinion may not be published or otherwise used or referred to, nor shall any public reference to Smith Barney be made, without our prior written consent. Based upon and subject to the foregoing, our experience as investment bankers, our work as described above and other factors we deemed relevant, we are of the opinion that, as of the date hereof, the Dickstein Proposal is inadequate, from financial point of view, to the holders of Hills Common Stock (other than Dickstein and its affiliates). Very truly yours, SMITH BARNEY INC. E-2 EXHIBIT 2 HILLS STORES COMPANY 1995 INCENTIVE AND NONQUALIFIED STOCK OPTION PLAN SECTION 1. PURPOSE This 1995 Incentive and Nonqualified Stock Option Plan (the "Plan") of Hills Stores Company, a Delaware corporation (the "Company"), is designed to provide additional incentive to executives and other key employees of the Company, its parent and subsidiaries and for certain other individuals providing services to or acting as directors of the Company, its parent and subsidiaries. The Company intends that this purpose will be effected by the granting of incentive stock options ("Incentive Stock Options") as defined in Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), and nonqualified stock options ("Nonqualified Options") under the Plan which afford such executives and key employees an opportunity to acquire or increase their proprietary interest in the Company through the acquisition of shares of its Common Stock. The Company intends that Incentive Stock Options issued under the Plan will qualify as "incentive stock options" as defined in Section 422 of the Code and the terms of the Plan shall be interpreted in accordance with this intention. The terms "parent" and "subsidiary" shall have the respective meanings set forth in Section 424 of the Code. SECTION 2. ADMINISTRATION 2.1 THE COMMITTEE. The Plan shall be administered by a Committee (the "Committee") consisting of at least two members of the Company's Board of Directors (the "Board"). None of the members of the Committee shall be an officer or other employee of the Company, and none shall have been granted any incentive stock option or nonqualified option under this Plan or any other stock option plan of the Company within one year prior to service on the Committee. It is the intention of the Company that the Plan shall be administered by "disinterested persons" within the meaning of Rule 16b-3 under the Securities Exchange Act of 1934, but the authority and validity of any act taken or not taken by the Committee shall not be affected if any person administering the Plan is not a disinterested person. Except as specifically reserved to the Board under the terms of the Plan, the Committee shall have full and final authority to operate, manage and administer the Plan on behalf of the Company. Action by the Committee shall require the affirmative vote of a majority of all members thereof. 2.2 POWERS OF THE COMMITTEE. Subject to the terms and conditions of the Plan, the Committee shall have the power: (a) To determine from time to time the persons eligible to receive options and the options to be granted to such persons under the Plan and to prescribe the terms, conditions, restrictions, if any, and provisions (which need not be identical) of each option granted under the Plan to such persons; (b) To construe and interpret the Plan and options granted thereunder and to establish, amend, and revoke rules and regulations for administration of the Plan. In this connection, the Committee may correct any defect or supply any omission, or reconcile any inconsistency in the Plan, or in any option agreement, in the manner and to the extent it shall deem necessary or expedient to make the Plan fully effective. All decisions and determinations by the Committee in the exercise of this power shall be final and binding upon the Company and optionees; (c) To make, in its sole discretion, changes to any outstanding option granted under the Plan, including; (i) to reduce the exercise price, (ii) to accelerate the vesting schedule or (iii) to extend the expiration date; and (d) Generally, to exercise such powers and to perform such acts as are deemed necessary or expedient to promote the best interests of the Company with respect to the Plan. E-3 SECTION 3. STOCK 3.1 STOCK TO BE ISSUED. The stock subject to the options granted under the Plan shall be shares of the Company's authorized but unissued common stock, $.01 par value (the "Common Stock"), or shares of the Company's Common Stock held in treasury. The total number of shares that may be issued pursuant to options granted under the Plan shall not exceed an aggregate of 500,000 shares of Common Stock, of which not more than 50,000 shares may be issued pursuant to Section 4.4; provided, however, that the class and aggregate number of shares which may be subject to options granted under the plan shall be subject to adjustment as provided in Section 8 hereof. 3.2 EXPIRATION, CANCELLATION OR TERMINATION OF OPTION. Whenever any outstanding option under the Plan expires, is cancelled or is otherwise terminated (other than by exercise), the shares of Common Stock allocable to the unexercised portion of such option may again be the subject of options under the plan. SECTION 4. ELIGIBILITY 4.1 PERSONS ELIGIBLE. Incentive Stock Options under the Plan may be granted only to officers and other employees of the Company or its parent or subsidiaries. Nonqualified Options may be granted to officers or other employees of the Company or its parent or subsidiaries, and to members of the Board and consultants or other persons who render services to the Company (regardless of whether they are also employees). Nonqualified Options may be granted to members of the Board who are not employees of or paid consultants to the Company or its parent or subsidiaries ("Outside Directors") only as provided in Section 4.4 hereof. 4.2 GREATER-THAN-TEN-PERCENT STOCKHOLDERS. Except as may otherwise be permitted by the Code or other applicable law or regulation, no Incentive Stock Option shall be granted to an individual who, at the time the option is granted, owns (including ownership attributed pursuant to Section 424 of the Code) more than ten percent of the total combined voting power of all classes of stock of the Company or any parent or subsidiary (a "greater-than-ten-percent stockholder"), unless such Incentive Stock Option provides that (i) the purchase price per share shall not be less than one hundred ten percent of the fair market value of the Common Stock at the time such option is granted, and (ii) that such option shall be not exercisable to any extent after the expiration of five years from the date it is granted. 4.3 MAXIMUM AGGREGATE FAIR MARKET VALUE. The aggregate fair market value (determined at the time the option is granted) of the Common Stock with respect to which Incentive Stock Options are exercisable for the first time by any optionee during any calendar year (under the Plan and any other plans of the Company or any parent or subsidiary for the issuance of incentive stock options) shall not exceed $100,000 (or such greater amount as may from time to time be permitted with respect to incentive stock options by the Code or any other applicable law or regulation). 4.4 NON-DISCRETIONARY OPTION GRANTS TO OUTSIDE DIRECTORS. Any other provision of this plan to the contrary notwithstanding, Outside Directors shall not be eligible to receive options under the Plan except pursuant to this Section 4.4. On the last business day of January in each year (the "Grant Date"), each Outside Director shall without any action of the Committee be granted a Nonqualified Option to purchase 2,000 shares of the Common Stock of the Company. Options shall be granted pursuant to this Section 4.4 only to persons who are serving as Outside Directors on the Grant Date. The 2,000 share grant referred to in this Section shall be subject to adjustment in accordance with Section 8 hereof. The purchase price per share of the Common Stock under each option granted pursuant to this Section shall be equal to the fair market value of the Common Stock on the date the option is granted. Each such option shall expire on the fifth anniversary of the date of the grant and shall vest at the rate of 500 option shares on each of the first four anniversary dates of the of grant. 4.5 MAXIMUM NUMBER OF OPTIONS THAT MAY BE GRANTED IN ANY THREE YEAR PERIOD. Notwithstanding any other provision of the Plan or any option agreement, no individual may be granted options to purchase more than 150,000 shares of Common Stock in any three (3) year period pursuant to the Plan. This maximum number of shares which may be purchased pursuant to options granted under the Plan is subject to adjustment in accordance with Section 8 hereof. E-4 SECTION 5. TERMINATION OF EMPLOYMENT OR DEATH OF OPTIONEE 5.1 TERMINATION OF EMPLOYMENT. Except as may be otherwise expressly provided herein, options shall terminate on the earlier of: (a) the date of the expiration thereof, (b) the date of termination of the optionee's employment with or services to the Company by it for cause (as determined by the Company), or voluntarily (other than early or normal retirement in accordance with the Company's retirement policies) by the optionee; or (c) ninety days after the date of termination of the optionee's employment with or services to the Company by it without cause; PROVIDED, that Options need not, unless the Committee determines otherwise, be subject to the provisions set forth in clauses (b) and (c) above, and PROVIDED FURTHER, that if the optionee, whose employment or services are terminated by the Company without cause, has an employment, consulting or retention contract with the Company in force immediately prior to such termination, then in such event such option shall remain in force to the stated expiration date of such employment, consulting or retention contract with vesting accruing to such expiration date. An employment relationship between the Company and the optionee shall be deemed to exist during any period in which the optionee is employed by the Company or its parent or any subsidiary. Whether authorized leave of absence, or absence on military or government service, shall constitute termination of the employment relationship between the Company and the optionee shall be determined by the Committee at the time thereof. As used herein, "cause" shall mean (i) any material breach by the optionee of any agreement to which the optionee and the Company are both parties, (ii) the willful engagement by the optionee in conduct which is materially injurious to the Company or any of its subsidiaries or affiliates, monetarily or otherwise, (iii) the misappropriation (including the unauthorized use or disclosure of confidential or proprietary information of the Company or any of its subsidiaries or affiliates) or embezzlement with respect to the Company or any of its subsidiaries or affiliates, (iv) a conviction of or guilty plea or confession by the optionee to any fraud, conversion, misappropriation, embezzlement or felony, or (v) any material misconduct or material neglect of duties by the Holder in connection with the business or affairs of the Company or any affiliate of the Company. 5.2 DEATH OR PERMANENT DISABILITY OF OPTIONEE. In the event of the death or permanent and total disability of the holder of an option that is subject to clause (b) or (c) of Section 5.1 above prior to termination of the optionee's employment with or services to the Company and before the date of expiration of such option, such option shall terminate on the earlier of such date of expiration or one year following the date of such death or disability. After the death of the optionee, his/her executors, administrators or any person or persons to whom his/her option may be transferred by will or by the laws of descent and distribution, shall have the right, at any time prior to such termination, to exercise the option to the extent the optionee was entitled to exercise such option immediately prior to his/her death. An optionee is permanently and totally disabled if he/she is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to last for a continuous period of not less than 12 months; permanent and total disability shall be determined in accordance with Section 22(e)(3) of the Code and the regulations issued thereunder. SECTION 6. TERMS OF THE OPTION AGREEMENTS Each option agreement shall be in writing and shall contain such terms, conditions, restrictions, if any, and provisions as the Committee shall from time to time deem appropriate. Such provisions or conditions may include without limitation restrictions on transfer, repurchase rights, or such other provisions as shall be determined by the Committee; PROVIDED THAT such additional provisions shall not be inconsistent with any other term or condition of the Plan and such additional provisions shall not cause any Incentive Stock Option granted under the Plan to fail to qualify as an incentive option within the meaning of Section 422 of E-5 the Code. The shares of stock issuable upon exercise of an option by an executive officer, director or beneficial owner of more than ten percent of the Common Stock of the Company may not be sold or transferred (except that such shares may be issued upon exercise of such option) by such officer, director or beneficial owner for a period of six months following the grant of such option. Option agreements need not be identical, but each option agreement by appropriate language shall include the substance of all of the following provisions: 6.1 EXPIRATION OF OPTION. Notwithstanding any other provision of the Plan or of any option agreement, each option shall expire on the date specified in the option agreement, which date shall not, in the case of an Incentive Stock Option, be later than the tenth anniversary (fifth anniversary in the case of a greater-than-ten-percent stockholder) of the date on which the option was granted, or as specified in Section 5 of this Plan. 6.2 EXERCISE. Each option may be exercised, so long as it is valid and outstanding, from time to time in part or as a whole, subject to any limitations with respect to the number of shares for which the option may be exercised at a particular time and to such other conditions as the Committee in its discretion may specify upon granting the option. 6.3 PURCHASE PRICE. The purchase price per share under each option shall be determined by the Committee at the time the option is granted; provided, however, that the price of any option shall not, be less than the fair market value of the Common Stock on the date the option is granted (110% of the fair market value in the case of an Incentive Stock Option grant to a greater-than-ten-percent stockholder). For the purpose of the Plan, the fair market value of the Common Stock shall be the closing price per share on the date of grant of the option as reported by a nationally recognized stock exchange, or, if the Common Stock is not listed on such an exchange, as reported by the National Association of Securities Dealers Automated Quotation System, Inc. ("NASDAQ"), or, if the Common Stock is not quoted on NASDAQ, the fair market value as determined by the Committee. 6.4 TRANSFERABILITY OF OPTIONS. Options shall not be transferrable by the optionee otherwise than by will or under the laws of descent and distribution, and shall be exercisable, during his or her lifetime, only by him or her. 6.5 RIGHTS OF OPTIONEES. No optionee shall be deemed for any purpose to be the owner of any shares of Common Stock subject to any option unless and until the option shall have been exercised pursuant to the terms thereof, and the Company shall have issued and delivered the shares to the optionee. 6.6 REPURCHASE RIGHT. The Committee may in its discretion provide upon the grant of any option hereunder that the Company shall have an option to repurchase upon such terms and conditions as determined by the Committee all or any number of shares purchased upon exercise of such option. The repurchase price per share payable by the Company shall be such amount or be determined by such formula as is fixed by the Committee at the time the option for the shares subject to repurchase is granted. In the event the Committee shall grant options subject to the Company's repurchase option, the certificates representing the shares purchased pursuant to such option shall carry a legend satisfactory to counsel for the Company referring to the Company's repurchase option. SECTION 7. METHOD OF EXERCISE, PAYMENT OF PURCHASE PRICE 7.1 METHOD OF EXERCISE. Any option granted under the Plan may be exercised by the optionee by delivering to the Company on any business day a written notice specifying the number of shares of Common Stock the optionee then desires to purchase and specifying the address to which the certificates for such shares are to be mailed (the "Notice"), accompanied by payment for such shares. 7.2 PAYMENT OF PURCHASE PRICE. Payment for the shares of Common Stock purchased pursuant to the exercise of an option shall be made either by (i) cash, certified check, bank draft or postal or express money order equal to the option price for the number of shares specified in the Notice, or (ii) with the consent of the Committee, shares of Common Stock of the Company having a fair market value equal to the option price of such shares, or (iii) with the consent of the Committee, such other consideration which is acceptable to the E-6 Committee and which has a fair market value equal to the option price of such shares, or (iv) with the consent of the Committee, a combination of (i), (ii) and/or (iii). For the purpose of the preceding sentence, the fair market value per share of Common Stock so delivered to the Company shall be determined in the manner specified in Section 6.3. As promptly as practicable after receipt of the Notice and accompanying payment, the Company shall deliver to the optionee certificates for the number of shares with respect to which such option has been so exercised, issued in the optionee's name; provided, however, that such delivery shall be deemed effected for all purposes when the Company or a stock transfer agent of the Company shall have deposited such certificates in the United States mail, addressed to the optionee, at the address specified in the Notice. SECTION 8. CHANGES IN THE COMPANY'S CAPITAL STRUCTURE 8.1 RIGHTS OF COMPANY. The existence of outstanding options shall not affect in any way the right or power of the Company or its stockholders to make or authorize, without limitation, any or all adjustments, recapitalizations, reorganizations or other changes in the Company's capital structure or its business, or any merger or consolidation of the Company, or any issue of Common Stock, or any issue of bonds, debentures, preferred or prior preference stock or other capital stock ahead of or affecting the Common Stock or the rights thereof, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding, whether of a similar character or otherwise. 8.2 RECAPITALIZATION, STOCK SPLITS AND DIVIDENDS. If the Company shall effect a subdivision or consolidation of shares or other capital readjustment, the payment of a stock dividend, or other increase or reduction of the number of shares of the Common Stock outstanding, in any such case without receiving compensation therefor in money, services or property, then (i) the number, class, and price per share of shares of stock subject to outstanding options hereunder shall be appropriately adjusted in such a manner as to entitle an optionee to receive upon exercise of an option, for the same aggregate cash consideration, the same total number and class of shares as he or she would have received as a result of the event requiring the adjustment had he or she exercised his or her option in full immediately prior to such event; and (ii) the number and class of shares with respect to which options may be granted under the Plan shall be adjusted by substituting for the total number of shares of Common Stock then reserved for issuance under the Plan that number and class of shares of stock that the owner of an equal number of outstanding shares of Common Stock would own as the result of the event requiring the adjustment. 8.3 MERGER WITHOUT CHANGE OF CONTROL. After a merger of one or more corporations into the Company, or after a consolidation of the Company and one or more corporations in which (i) the Company shall be the surviving corporation, and (ii) the stockholders of the Company immediately prior to such merger or consolidation own after such merger or consolidation shares representing at least fifty percent of the voting power of the Company, each holder of an outstanding option shall, at no additional cost, be entitled upon exercise of such option to receive in lieu of the number of shares as to which such option shall then be so exercisable, the number and class of shares of stock or other securities to which such holder would have been entitled pursuant to the terms of the agreement of merger or consolidation, if, immediately prior to such merger or consolidation, such holder had been the holder of record of a number of shares of Common Stock equal to the number of shares for which such option was exercisable. 8.4 SALE OR MERGER WITH CHANGE OF CONTROL. If the Company is merged into or consolidated with another corporation under circumstances where the Company is not the surviving corporation, or if there is a merger or consolidation where the Company is the surviving corporation but the stockholders of the Company immediately prior to such merger or consolidation do not own after such merger or consolidation shares representing at least fifty percent of the voting power of the Company, or if the Company is liquidated, or sells or otherwise disposes of substantially all of its assets to another corporation while unexercised options remain outstanding under the Plan, (i) subject to the provisions of clause (iii) below, after the effective date of such merger, consolidation, liquidation, sale or disposition, as the case may be, each holder of an outstanding option shall be entitled, upon exercise of such option, to receive, in lieu of shares of Common Stock, shares of such stock or other securities, cash or properties as the holders of shares E-7 of Common Stock received pursuant to the terms of the merger, consolidation, liquidation, sale or disposition; (ii), the Committee may accelerate the time for exercise of all unexercised and unexpired options to and after a date prior to the effective date of such merger, consolidation, liquidation, sale or disposition, as the case may be, specified by the Committee; or (iii) all outstanding options may be cancelled by the Committee as of the effective date of any such merger, consolidation, liquidation, sale or disposition provided that (x) notice of such cancellation shall be given to each holder of an option and (y) each holder of an option shall have the right to exercise such option to the extent that the same is then exercisable or, if the Committee shall have accelerated the time for exercise of all unexercised or unexpired options, in full during the 30-day period preceding the effective date of such merger, consolidation, liquidation, sale or disposition. 8.5 ADJUSTMENTS TO COMMON STOCK SUBJECT TO OPTIONS. Except as hereinbefore expressly provided, the issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, for cash or property, or for labor or services, either upon direct sale or upon the exercise of rights or warrants to subscribe therefor, or upon conversion of shares or obligations of the Company convertible into such shares or other securities, shall not affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock then subject to outstanding options. 8.6 MISCELLANEOUS. Adjustments under this Section 8 shall be determined by the Committee, and such determinations shall be conclusive. No fractional shares of Common Stock shall be issued under the Plan on account of any adjustment specified above. SECTION 9. GENERAL RESTRICTIONS 9.1 INVESTMENT REPRESENTATIONS. The Company may require any person to whom an option is granted, as a condition of exercising such option, to give written assurances in substance and form satisfactory to the Company to the effect that such person is acquiring the Common Stock subject to the option for his or her own account for investment and not with any present intention of selling or otherwise distributing the same, and to such other effects as the Company deems necessary or appropriate in order to comply with federal and applicable state securities laws. 9.2 COMPLIANCE WITH SECURITIES LAWS. The Company shall not be required to sell or issue any shares under any option if the issuance of such shares shall constitute a violation by the optionee or by the Company of any provisions of any law or regulation of any governmental authority. In addition, in connection with the Securities Act of 1933, as now in effect or hereafter amended (the "Act"), upon exercise of any option, the Company shall not be required to issue such shares unless the Committee has received evidence satisfactory to it to the effect that the holder of such option will not transfer such shares except pursuant to a registration statement in effect under such Act or unless an opinion of counsel satisfactory to the Company has been received by the Company to the effect that such registration is not required. Any determination in this connection by the Committee shall be final, binding and conclusive. In the event the shares issuable on exercise of an option are not registered under the Act, the Company may imprint upon any certificate representing shares so issued the following legend or any other legend which counsel for the Company considers necessary or advisable to comply with the Act and with applicable state securities laws: The shares of stock represented by this certificate have not been registered under the Securities Act of 1933 or under the securities laws of any State and may not be sold or transferred except upon such registration or upon receipt by the Corporation of an opinion of counsel satisfactory to the Corporation, in form and substance satisfactory to the corporation, that registration is not required for such sale or transfer. The Company may, but shall in no event be obligated to, register any securities covered hereby pursuant to the Act; and in the event any shares are so registered the Company may remove any legend on certificates representing such shares. The Company shall not be obligated to take any other affirmative action in order to cause the exercise of an option or the issuance of shares pursuant thereto to comply with any law or regulation of any governmental authority. E-8 9.3 EMPLOYMENT OBLIGATION. The granting of any option shall not impose upon the Company any obligation to employ or continue to employ any optionee; and the right of the Company to terminate the employment of any officer or other employee shall not be diminished or affected by reason of the fact that an option has been granted to him or her. SECTION 10. AMENDMENT OR TERMINATION OF THE PLAN The Board of Directors may modify, revise or terminate this Plan at any time and from time to time, except that the class of persons eligible to receive options and the aggregate number of shares issuable pursuant to this Plan shall not be changed or increased, other than by operation of Section 8 hereof, without the consent of the stockholders of the Company. In addition, the provisions of Section 4.4 shall not be amended more than once every six months, other than to comport with changes in the Code, the Employee Retirement Income Security Act, or the rules thereunder. Without limiting the generality of the foregoing, the Board is expressly authorized to amend the Plan, at any time and from time to time, to conform it to the provisions of Rule 16b-3 under the Exchange Act, as that Rule may be amended from time to time. SECTION 11. NONEXCLUSIVITY OF THE PLAN Neither the adoption of the Plan by the Board of Directors nor the submission of the Plan to the stockholders of the Company for approval shall be construed as creating any limitations on the power of the Board of Directors to adopt such other incentive arrangements as it may deem desirable, including, without limitation, the granting of stock options otherwise than under the Plan, and such arrangements may be either applicable generally or only in specific cases. SECTION 12. EFFECTIVE DATE AND DURATION OF PLAN The Plan shall become effective upon its adoption by the Board of Directors provided that the stockholders of the Company shall have approved the Plan within twelve months prior to or following the adoption of the Plan by the Board. No option may be granted under the Plan after the tenth anniversary of the effective date. The Plan shall terminate (i) when the total amount of the Stock with respect to which options may be granted shall have been issued upon the exercise of options or (ii) by action of the Board of Directors pursuant to Section 10 hereof, whichever shall first occur. * * * * * * * * * * * * E-9 EXHIBIT 3 HILLS STORES COMPANY ASSOCIATE STOCK PURCHASE PLAN 1. PURPOSE OF THE PLAN: The purpose of the Hills Stores Company Associate Stock Purchase Plan (the "Plan") is to secure for Hills Stores Company, a Delaware corporation ("Hills"), and its stockholders, the benefits of the incentives inherent in the ownership of Hills capital stock by present and future associates of Hills and its subsidiaries. The Plan is intended to comply with the provisions of Sections 421, 423, and 424 of the Internal Revenue Code of 1986, as amended (the "Code"), and the Plan shall be administered, interpreted and construed in accordance with such provisions. 2. SHARES RESERVED FOR THE PLAN: There shall be reserved for issuance and purchase by associates under the Plan, an aggregate of 500,000 shares of common stock, par value $.01 per share, of Hills ("Common Stock"), subject to adjustment as provided in Section 12. Shares subject to the Plan may be shares now or hereafter authorized but unissued, or shares that were once issued and subsequently reacquired by Hills. The right to purchase shares hereunder shall be made available in a series of semi-annual offerings (the "Offering" or "Offerings") to eligible associates by means of payroll deductions beginning on the pay date first occurring after the Offering Commencement Date and ending on the Offering Termination Date (each as hereinafter defined). If and to the extent that any right to purchase reserved shares shall not be exercised by any associate for any reason or if such right to purchase shall terminate as provided herein, shares that have not been so purchased hereunder shall again become available for the purposes of the Plan unless the Plan shall have terminated, but such unpurchased shares shall not be deemed to increase the aggregate number of shares specified above to be reserved for purposes of the Plan (subject to adjustment as provided in Section 12). 3. ADMINISTRATION OF THE PLAN: The Plan shall be administered, at the expense of Hills, by the Compensation Committee of the Board of Directors of Hills (the "Committee"). The Committee consists of not less than three (3) members of the Board of Directors who shall serve at the pleasure of the Board of Directors. The Committee may request advice or assistance and employ or direct such other persons as are necessary for the proper administration of the Plan. Subject to the express provisions of the Plan, the Committee shall have the authority to interpret the Plan, to prescribe, amend and rescind rules and regulations relating to it, and to make all other determinations necessary or advisable in administering the Plan, all of which determinations shall be final and binding upon all persons unless otherwise determined by the Board of Directors. 4. ELIGIBLE ASSOCIATES: Each associate of Hills and its subsidiaries (which means any present or future corporation which is or would constitute a "subsidiary corporation" as that term is defined in Section 424 of the Code) who has attained the age of majority as determined by the laws of such associate's state of residence, shall be eligible to participate in the Plan on an Enrollment Date, as hereinafter defined, provided that each such employee, (a) has been employed by Hills and/or any of its subsidiaries for at least six months prior to August 1, 1995, with respect to the initial offering hereunder, and thereafter prior to the first day of the month preceding the Offering Commencement Date; (b) has customary employment of a minimum of 20 hours per week; (c) does not own, immediately after the right is granted, stock possessing five (5%) percent or more of the total combined voting power or value of all classes of capital stock of Hills or of a subsidiary thereof; and E-10 (d) is not a highly compensated employee within the meaning of Section 414(q) of the Code who is also a member of the Board of Directors of Hills. In determining stock ownership under this paragraph, the rules of Section 424(d) of the Code shall apply and stock that the associate may purchase under outstanding options shall be treated as stock owned by the associate. "Enrollment Date" shall mean August 1, 1995, and thereafter the first day of the week preceding the week in which June 1 or December 1 occurs. Associates eligible to participate in the Plan pursuant to the provisions of this Section 4 are hereinafter referred to as "Eligible Associates". 5. ELECTION TO PARTICIPATE AND PAYROLL DEDUCTIONS: Each Eligible Associate, during the enrollment period just prior to each Enrollment Date, may, except as provided below, elect to participate in the Plan by completing, and returning to Hills, an enrollment form authorizing specified regular payroll deductions with respect to said Offering. The maximum payroll deduction per pay period is ten (10%) percent of the Eligible Associate's Eligible Compensation (as hereinafter defined) in effect on the applicable Enrollment Date divided by the number of pay periods during the next twelve-month period, subject to the limits set forth in Section 6. For the purpose of this Plan, "Eligible Compensation" for any Offering shall mean: (a) with respect to individuals who are full-time associates, their base salary in effect as of the Enrollment Date; and (b) with respect to individuals who are part-time associates, the product of their week day hourly rate and the number of their annualized hours, in effect as of the Enrollment Date. Eligible Compensation shall not include any deferred compensation other than contributions by an individual through a salary reduction agreement to a cash or deferred plan pursuant to Section 401(k) of the Code or to a cafeteria plan pursuant to Section 125 of the Code. The maximum number of shares of Common Stock which an Eligible Associate may purchase during each Offering shall be equal to the quotient obtained by dividing (a) the product of the amount of such associate's payroll deduction per pay period in effect as of the applicable Enrollment Date multiplied by the number of pay periods during the Offering by (b) $1.00. The minimum payroll deduction per pay period is $5.00 (the "Minimum Deduction"). Such payroll deductions (the "Payroll Deductions") shall be made regularly and in equal amounts with respect to the applicable Offering and shall be credited, as promptly as practicable, to an account in the name of the Eligible Associate (the "Payroll Deductions Account"). Each Payroll Deductions Account constitutes only a convenient bookkeeping entry by Hills, and no interest will be paid or due on any money paid into the Plan or credited to the account of an Eligible Associate. Associates who elect to participate in the Plan are referred to herein as "Participating Associates". Payroll Deductions with respect to Participating Associates participating in a given Offering, will commence on the first pay date on or after September 1 initially and July 1 or January 1, as the case may be, thereafter with respect to each Offering (the "Offering Commencement Date"). Payroll Deductions shall continue with respect to an Offering, unless earlier terminated pursuant to the terms of the Plan, until the first subsequent December 31st or June 30th, as the case may be, or the last New York Stock Exchange trading day prior thereto if December 31st or June 30th is not a New York Stock Exchange trading day (the "Offering Termination Date"). A Participating Associate in the Plan during one Offering will be deemed to have elected to participate in each subsequent Offering, provided he or she is eligible to participate during each such subsequent Offering. Such Participating Associate will also be deemed to have authorized the same Payroll Deductions for each subsequent Offering; provided, however, that, during the enrollment period prior to each new Offering, the Participating Associate may elect to change his or her Payroll Deductions by submitting a new enrollment form. A Participating Associate may at any time notify Hills in writing to terminate his or her Payroll Deductions and thereby cease to be a Participating Associate in the Plan; provided, however, if the E-11 written notice is not received by Hills three (3) business days before the Investment Date, then the amount of his or her Payroll Deductions not theretofore invested shall be used to purchase whole shares and/or fractional interest in shares of Common Stock at the next Investment Date. "Investment Date" shall mean the last day of each calendar quarter during each Offering, which is a trading day on the New York Stock Exchange. Any associate who has so terminated his or her Payroll Deductions may, if then eligible, elect to participate in a subsequent Offering. A Participating Associate who is an officer or director of Hills within the meaning of Section 16 of the Securities Act of 1934, as amended (the "1934 Act") and who withdraws from the Plan during any Offering will not be eligible to participate in the Plan again for a period of six (6) months. A Participating Associate may at any time during an Offering (but not more than two times) decrease their Payroll Deductions (but not to an amount below the Minimum Deduction) by filing the required form with Hills, which decrease shall become effective as soon as practicable. Associates on approved leave of absence or on temporary layoff as of an Enrollment Date who are eligible to participate in the Plan pursuant to the provisions of Section 4 shall be permitted to enroll in said Offering in accordance with Section 5; payroll deductions with respect to said associates shall commence as of the first pay period after the recommencement of employment. Before Payroll Deductions commence and during such leave of absence or layoff, associates may participate in the Plan by making cash payments to the Company equal to their normal payroll deduction on the normal pay date. 6. LIMITATION OF NUMBER OF SHARES THAT AN ASSOCIATE MAY PURCHASE: No right to purchase shares under this Plan shall permit an employee to purchase stock under all employee stock purchase plans (as defined in Section 423 of the Code) of Hills and its subsidiaries at a rate which in aggregate exceeds $25,000 of fair market value of such stock (determined at the time the right is granted) for the calendar year in which the right is outstanding at any time. 7. PURCHASE PRICE: The purchase price for each share of Common Stock shall be eighty-five (85%) percent of the fair market value of such share on the Investment Date. "Fair market value" shall mean the average of the high and low sales prices of a share of Common Stock as published by the New York Stock Exchange in its official trading report for the close of business on the Investment Date, or if the Common Stock shall not have been traded on such exchange on such date, the average of the high and low sales prices on such exchange on the first day prior thereto on which the Common Stock was so traded or such other amount as may be determined by the Committee by any fair and reasonable means. 8. METHOD OF PURCHASE AND PARTICIPATING ASSOCIATE'S INVESTMENT ACCOUNTS: As of the Investment Date, each Participating Associate shall have the right to purchase the number of whole shares and fractional interest in shares of Common Stock determined by dividing the amount of his or her Payroll Deductions not theretofore invested or withdrawn by the purchase price as determined by Section 7. Each Participating Associate having Payroll Deductions not theretofore invested or withdrawn on an Investment Date shall be deemed, without any further action, to have purchased with such Payroll Deductions the number of whole shares and/or fractional interest in shares that he or she has the right to purchase at the purchase price on that Investment Date. The shares of stock purchased by a Participating Associate who is an officer or director subject to Section 16 of the 1934 Act, at each Investment Date may not be sold or transferred by such Participating Associate for a period of six (6) months following such Investment Date. Certificates representing said shares of stock issued pursuant to this Plan may bear legends to that effect. Excess amounts remaining in the Payroll Deductions Account of a Participating Associate who has purchased the maximum number of shares to which said associate is entitled under Section 5 or 6 shall be refunded to said associate. All whole shares and/or fractional interest in shares purchased shall be held in separate Participating Associate's Investment Accounts ("Participating Associate's Investment Accounts") maintained by such brokerage house, investment banking firm, commercial bank or other such similar institution as may be selected by the Board of Directors for the Participating Associate. All dividends paid with respect to the whole shares and/or fractional interest in shares in a Participating Associate's Investment Account shall be credited to his or her Participating Associate's Investment Account to be disposed of at such associate's discretion. E-12 9. TITLE OF ACCOUNTS: Each Participating Associate's Investment Account shall be in the name of the Participating Associate. 10. RIGHTS AS A SHAREHOLDER: At the time a Participating Associate's Payroll Deductions Account shall be charged with the amount of the purchase price of the Common Stock, he or she shall have all of the rights and privileges of a shareholder of Hills with respect to shares purchased under the Plan whether or not certificates representing full shares have been issued. 11. RIGHTS NOT TRANSFERABLE: Rights granted under the Plan are not transferable by a Participating Associate other than by will or the laws of descent and distribution and are exercisable during his or her lifetime only by him or her. 12. ADJUSTMENT IN CASE OF CHANGES AFFECTING HILLS COMMON STOCK: In the event of a subdivision of outstanding shares of Common Stock, or the payment of a stock dividend thereon, the number of shares reserved or authorized to be reserved under this Plan shall be increased proportionately, and such other adjustment shall be made as may be deemed necessary or equitable by the Board of Directors. In the event of any other change affecting the Common Stock, such adjustment shall be made as may be deemed equitable by the Board of Directors to give proper effect to such event subject to the limitation of Section 424 of the Code. 13. RETIREMENT, TERMINATION AND DEATH: In the event of a Participating Associate's retirement, death or termination of employment during an Offering, the amount of his or her Payroll Deductions not theretofore invested shall be used to purchase whole shares and/or fractional interest in shares of Common Stock at the next Investment Date in the absence of a notice of termination from the Participating Associate or his or her legal representative in accordance with Section 5. 14. DESIGNATION OF BENEFICIARY: A Participating Associate is not entitled to designate a beneficiary under this Plan. In the event of death, the Participating Associate's Investment Account, opened in a Participating Associate's name, becomes the property of the estate of the Participating Associate unless such account is a joint tenancy with rights of survivorship. 15. AMENDMENT OF THE PLAN: The Board of Directors may at any time, or from time to time, amend the Plan in any respect; provided, however, that the Plan may not be amended in any way that will cause rights issued under it to fail to meet the requirements for employee stock purchase plans set forth in Section 423 of the Code, nor may an amendment be made without prior approval of the shareholders of Hills if such shareholder approval is required under Section 423 of the Code. 16. TERMINATION OF THE PLAN: The Plan and all rights of associates hereunder shall terminate: (a) on the Investment Date that Participating Associates become entitled to purchase a number of shares greater than the number of reserved shares remaining available for purchase; or (b) at any time, at the discretion of the Board of Directors. In the event that the Plan terminates under circumstances described in (a) above, reserved shares remaining as of the termination date shall be issued to Participating Associates in the proportion that the amount in each Participating Associate's Payroll Deductions Account bears to the total amount in all Payroll Deductions Accounts; excess amounts thereafter remaining in a Participating Associate's Payroll Deductions Account shall be refunded to said associate. E-13 17. EFFECTIVE DATE OF PLAN AND APPROVAL OF SHAREHOLDERS: The Plan shall be effective as of August 1, 1995. The Plan is subject to the approval of the shareholders of Hills at their next annual meeting or at any special meeting of the shareholders for which one of the purposes of such a special meeting shall be to act upon the Plan. 18. GOVERNMENTAL AND OTHER REGULATIONS: The Plan, and the grant and exercise of the rights to purchase shares hereunder, and Hills' obligation to sell and deliver shares upon the exercise of rights to purchase shares, shall be subject to all applicable Federal, State and foreign laws, rules and regulations, and to such approvals by any regulatory or governmental agency as may, in the opinion of counsel for Hills, be required. The Plan shall be governed by, and construed and enforced in accordance with, the provisions of Sections 421, 423 and 424 of the Code and the substantive laws of the Commonwealth of Massachusetts. In the event of any inconsistency between such provisions of the Code and any such laws, said provisions of the Code shall govern to the extent necessary to preserve favorable federal income tax treatment afforded associate stock purchase plans under Section 423 of the Code. 19. INDEMNIFICATION OF COMMITTEE: Service on the Committee shall constitute service as a Director of Hills so that members of the Committee shall be entitled to indemnification and reimbursement as Directors of Hills pursuant to its Certificate of Incorporation, By-Laws, or resolutions of its Board of Directors or shareholders. ********** E-14 PROXY HILLS STORES COMPANY THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS OF HILLS STORES COMPANY FOR THE JUNE 23, 1995 ANNUAL MEETING OF SHAREHOLDERS The undersigned hereby appoints John R. Caban, Richard C. Doran, and Kelly D. McCarthy, or any of them, with power of substitution in each, proxies for the undersigned, to represent the undersigned, and to vote all Common Stock and Series A Preferred Stock of the Company which the undersigned would be entitled to vote, as fully as the undersigned could vote and act if personally present, at the Annual Meeting of Shareholders to be held on June 23, 1995 at 10:00 a.m. at the Sheraton Tara Hotel, 37 Forbes Road, Braintree, Massachusetts 02184, or at any adjournment thereof. The Proxies are authorized to vote in their discretion for approval of the minutes of the preceding meeting and matters incident to the conduct of the meeting and in their discretion upon all other matters which may properly come before the meeting. The undersigned hereby acknowledges receipt of the Notice of Annual Meeting and Proxy Statement, each dated May __, 1995 and the 1994 Annual Report of the Company. Any proxy heretofore given to vote said stock is hereby revoked. THIS PROXY WHEN PROPERLY EXECUTED WILL BE VOTED IN THE MANNER DIRECTED HEREIN BY THE UNDERSIGNED STOCKHOLDER. IF NO DIRECTION IS MADE, THIS PROXY WILL BE VOTED FOR THE COMPANY'S NOMINEES FOR ELECTION AS DIRECTORS, FOR ADOPTION OF THE HILLS STORES COMPANY 1995 INCENTIVE AND NONQUALIFIED STOCK OPTION PLAN AND FOR ADOPTION OF THE HILLS STORES COMPANY ASSOCIATE STOCK PURCHASE PLAN. This proxy is continued on the reverse side. Please complete and sign the reverse side and mail promptly. -------------------------------------------------------------------------------- /X/ PLEASE MARK YOUR CHOICE LIKE THIS ________________ ____________________________ COMMON STOCK SERIES A PREFERRED STOCK The Board of Directors unanimously recommends a vote "FOR" all nominees listed below, "FOR" Adoption of the Hills Stores Company 1995 Incentive and Nonqualified Stock Option Plan and "FOR" Adoption of the Hills Stores Company Associate Stock Purchase Plan. For all Nominees Withheld all Nominees / / / / Item 1--ELECTION OF DIRECTORS Election of the following nominees as Directors: Thomas H. Lee, Michael Bozic, Susan E. Engel, Richard B. Loynd, Norman S. Matthews, James L. Moody, Jr. and John G. Reen. Withheld for the following only: (Write the name of the nominee(s) in the space below) ------------------------------------------------------- Item 2--Adoption of the Hills Stores Company 1995 Incentive and Nonqualified Stock Option Plan / / / / / / Item 3--Adoption of the Hills Stores Company Associate Stock Purchase Plan For Against Abstain / / / / / / I plan to attend the meeting / / Please mark, date and sign as your name(s) appear(s) to the left and return in the enclosed envelope. If acting as an executor, administrator, trustee, guardian, etc., you should so indicate when signing. In the case of corporation, please sign the full corporate name, by duly authorized officer. Date , 199 ---------------------------------------------- -- Signature ------------------------------------------------ Signature ------------------------------------------------ No postage is required if this Proxy is returned in the enclosed envelope and mailed in the United States.