<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission File Number
January 2, 1999 0-23669
SHOE PAVILION, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3289691
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
___________________________
3200-F Regatta Boulevard, Richmond, California 94804
(Address of principal executive offices) (Zip Code)
Telephone Number: (510) 970-9775
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Name of each exchange
Title of each class on which registered
------------------- ---------------------
None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock
------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
______ ______.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K ((S) 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [_]
At March 18, 1999, the aggregate market value of the registrant's Common Stock
held by non affiliates of the registrant was approximately $13,465,500.
At March 18, 1999, the number of shares outstanding of registrant's Common
Stock was 6,800,000.
DOCUMENTS INCORPORATED BY REFERENCE
Definitive Proxy Statement for the Company's 1999 Annual Meeting of
Stockholders - Part III of this Form 10-K.
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Shoe Pavilion, Inc.
Index to Annual Report on Form 10-K
For the year ended January 2, 1999
Page
----
PART I
Item 1 Business............................................. 3
Item 2 Properties........................................... 9
Item 3 Legal Proceedings.................................... 9
Item 4 Submission of Matters to a Vote of Security Holders.. 10
PART II
Item 5 Market for the Registrant's Common Equity and
Related Stockholder Matters........................ 10
Item 6 Selected Financial Data.............................. 11
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations................ 12
Item 7A Quantitative and Qualitative Disclosure About
Market Risk........................................ 21
Item 8 Financial Statements and Supplementary Data.......... 22
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................ 36
PART III
Item 10 Directors and Executive Officers of the Registrant... 36
Item 11 Executive Compensation............................... 36
Item 12 Security Ownership of Certain Beneficial Owners
and Management..................................... 36
Item 13 Certain Relationships and Related Transactions....... 36
PART IV
Item 14 Exhibits, Financial Statement Schedules and
Reports on Form 8-K................................ 36
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PART I
Item 1 -- Business
General
Shoe Pavilion, Inc., founded in 1979, is the largest independent off-price
footwear retailer on the West Coast that offers a broad selection of women's and
men's designer label and name brand merchandise. The Company was among the first
footwear retailers on the West Coast to expand the off-price concept into the
designer and name brand footwear market. As of January 2, 1999, the Company
operated 69 retail stores in California, Washington and Oregon under the trade
name Shoe Pavilion.
The Company offers quality designer and name brand footwear such as Amalfi,
Clarks, Dexter, Fila, Florsheim, Naturalizer and Rockport, typically at 30% to
70% below department store regular prices for the same shoes. Such price
discounts appeal to value-oriented consumers seeking quality brand name footwear
not typically found at other off-price retailers or mass merchandisers. The
Company is able to offer lower prices by (i) selectively purchasing large blocks
of production over-runs, over-orders, mid- and late-season deliveries and last
season's stock from manufacturers and other retailers at significant discounts,
(ii) sourcing in-season name brand and branded design merchandise directly from
factories in Italy, Brazil and China and (iii) negotiating favorable prices with
manufacturers by ordering merchandise during off-peak production periods and
taking delivery at one central warehouse.
During 1998, the Company purchased its merchandise from over 100 domestic and
international vendors, independent resellers, manufacturers and other retailers
that have frequent excess inventory for sale. Budgeted production over-runs due
to the long lead-times associated with the design and manufacturing of new
shoes, as well as retail overstock, provide the Company with a wide selection of
branded merchandise. The Company emphasizes brand name merchandise that it
believes has long-term consumer appeal.
The Company's stores utilize a self-service format that allows inventory to be
stored directly under a displayed shoe, thereby eliminating the need for a
stockroom and significantly increasing retail floor space. The functionality and
simplicity of this format enable flexible store layouts that can be easily
reconfigured to accommodate a new mix of merchandise. Moreover, this format
allows customers to locate all available sizes of a particular shoe and to try
them on for comfort and fit without a salesperson's assistance, thereby reducing
in-store staffing needs and allowing customers to make independent, rapid
purchasing decisions.
The Company's stores are strategically located in strip malls, outlet centers
and downtown locations, frequently in close proximity to other off-price apparel
retailers that attract similar customers. Stores generally range in size from
3,000 to 14,000 square feet and offer between 15,000 and 30,000 pairs of shoes.
In early 1997, the Company entered the Los Angeles market by assuming the
leasehold interests of Standard Shoes, a Los Angeles based footwear retailer.
The Company subsequently converted nine Standard Shoes locations to Shoe
Pavilion stores. The Company opened, net of closures, 14 stores in 1998, 14
stores in 1997 and three stores in 1996.
The Company's objective is to be the leading off-price retailer of designer
label and name brand footwear in each of the markets it serves. The Company
intends to create greater name recognition and presence by opening new stores in
existing markets, moving into new markets with multiple store openings and
pursuing opportunities to acquire local and regional footwear retailers. The
Company intends to open 15 to 20 new stores, primarily in its existing markets,
close four to five stores, and relocate two to three stores in 1999.
The Company was incorporated in Delaware in November 1997 and is the successor
to Shoe Pavilion Corporation (formerly Shoe Inn, Inc.), which was incorporated
in Washington in 1983. In connection with the Company's initial public offering,
the previous sole stockholder of Shoe Pavilion Corporation entered into an
agreement providing for a reorganization prior to the offering. Under the terms
of this agreement all of the common stock of Shoe Pavilion Corporation was
exchanged for common stock of the Company and Shoe Pavilion Corporation became a
wholly owned subsidiary. The Company's executive offices are located at 3200-F
Regatta Boulevard, Richmond, California 94804, and its telephone number is
(510) 970-9775.
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Recent Developments
In May 1998, the Company launched on-line shopping through its website,
shoepavilion.com, and in December 1998, the Company began offering its shoes on
Yahoo! Shopping. In addition, the Company announced in February 1999 that a
direct link had been established with America Online through it's website,
AOL.com and another direct link with imall.com.
Operating Strategy
The Company's objective is to be the leading off-price retailer of designer
label and name brand footwear in each of the markets it serves. The Company's
operating strategy is designed to allow the Company to offer its customers
quality footwear typically at 30% to 70% below department store prices for the
same shoes. The following summarizes key elements of the Company's operating
strategy:
* Off-Price Concept, Premium Name Brands. The Company differentiates itself
from other off-price retailers and deep discount chains by focusing on
higher price point merchandise, extending the off-price concept into the
designer and name brand footwear market. As such, the Company generally
does not compete with other discount stores in obtaining the majority of
its merchandise. Similarly, while some department store and brand name
retail chains operate discount outlets, such operations generally obtain
merchandise from existing inventory of their retail affiliates rather than
from external sources. The Company's focus on premium brand name footwear
also enables store openings in close proximity to other off-price footwear
retailers. Some of the Company's most successful stores have benefited from
the heightened consumer awareness and preference to shop at discount malls
or outlet centers, both of which typically include other off-price
retailers.
* Broad Selection of Designer Footwear. The Company offers a broad selection
of quality footwear from over 75 name brands such as Amalfi, Clarks,
Dexter, Fila, Florsheim, Naturalizer and Rockport. The availability and
wide variety of premium brand names distinguish Shoe Pavilion and serve to
attract first time buyers and consumers who otherwise might shop at more
expensive department stores. The wide variety of brand names also enables
the Company to tailor its merchandise from store to store to accommodate
consumer preferences that may vary by location.
* Selective Bulk Purchases; Diverse Vendor Network. The Company is able to
offer lower prices by selectively purchasing large blocks of over-runs,
over-orders, mid- and late-season deliveries and last season's stock from
over 100 domestic and international vendors, independent resellers,
manufacturers and other retailers at significant discounts. The diversity
and scope of its vendor network help to provide a constant source of
quality merchandise, and the purchase of name brand, traditional styles
mitigates the likelihood of inventory writedowns. To augment available
merchandise with the latest in-season styles, the Company purchases branded
design footwear directly from factories in Italy, Brazil and China.
* Self-Service Stores. Between late 1993 and 1995, the Company reconfigured
its stores from a traditional retail format to the current self-service
format. The Company believes that the self-service format reinforces its
off-price strategy and appeals to value-oriented consumers. The Company's
format allows inventory to be stored directly under a displayed shoe,
thereby eliminating the need for a stockroom and significantly increasing
retail floor space. The functionality and simplicity of this format enable
flexible store layouts that can be easily rearranged to complement the
current merchandise. Moreover, this format allows customers to locate all
available sizes of a particular shoe and to try them on for comfort and fit
without a salesperson's assistance, thereby reducing in-store staffing
needs and allowing customers to make independent, rapid purchasing
decisions.
* Internet Commerce. The Company sells its products online via its website,
shoepavilion.com. In addition, the Company has formed partnerships with
various internet service providers and multimedia companies to sell its
products on their website or have direct links back to the Company's
website.
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Growth Strategy
Since opening its first store in 1979, the Company has grown through internal
expansion and operated 69 stores as of January 2, 1999. The Company intends to
continue to expand by opening new stores, enhancing comparable store sales,
pursuing acquisition opportunities and promoting internet commerce.
* Continue New Store Openings. The Company intends to increase its presence
in its current markets and to enter new markets by selectively opening new
stores, which can be served by the Company's distribution infrastructure.
When entering a new market, the Company prefers to open multiple stores,
thereby creating an immediate market presence and enabling television
advertising costs to be spread economically across a number of stores. The
Company opened 16 stores in 1998, 16 stores in 1997 and nine stores in 1996
and closed two stores in 1998, two stores in 1997 and six stores in 1996.
The Company intends to open 15 to 20 stores, primarily in its existing
markets, in 1999. Management believes that new store openings in the
Company's current markets will further increase name recognition, which, in
turn, will facilitate expansion into new markets.
* Increase Comparable Store Sales. Management intends to continue to seek
additional comparable store growth through a continuing refinement of its
store locations and merchandise selection. However, there can be no
assurance that the Company will experience comparable store growth in the
future.
* Pursue Acquisition Opportunities. The retail footwear industry is highly
fragmented and includes family and specialty shoe stores, which represent
approximately 20% of total retail footwear sales. Accordingly, management
believes that a number of opportunities exist to acquire one or more
regional or local footwear retailers. The Company intends to evaluate
opportunities to acquire existing footwear retailers and convert the
acquired stores to the Company's off-price merchandising concept.
* Promote Internet Commerce. Management intends to continue to expand the
offerings on it's website, shoepavilion.com, and seek alliances with other
electronic retailers that present synergistic opportunities. The Company
believes that internet commerce will enhance revenues and further increase
name recognition.
The Company's ability to execute its operating and growth strategy is subject
to numerous risks and uncertainties. There can be no assurance that the Company
will be successful in implementing its strategy or that its strategy, even if
implemented, will lead to successful achievement of the Company's objectives. If
the Company were unable to implement its strategy effectively, the Company's
business, financial condition and results of operations would be materially
adversely affected.
Merchandising
Unlike deep-discount retailers, Shoe Pavilion offers high quality merchandise
and a consistent selection of name brand dress and casual shoes for men and
women. List prices generally range between $19.99 and $69.99 for women's shoes,
and between $39.99 and $99.99 for men's shoes.
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The principal categories of footwear offered by Shoe Pavilion stores, and
selected brands for each, are summarized in the following table:
Women's Men's Athletic
- -------------------- ------------------------ ------------------------
Amalfi Bally Adidas
DKNY Bass Asics
Esprit Bostonian Avia
Easy Spirit Clarks Brooks
Hush Puppies Dexter Fila
Life Stride Florsheim New Balance
Naturalizer Nunn Bush Nike
Nickles Rockport Puma
Rockport Skechers Reebok
Via Spiga Timberland Saucony
The Shoe Pavilion Concept And Store Design
Shoe Pavilion is a standardized concept that offers a bright, clean, low
maintenance and functional shopping environment to customers interested in
purchasing quality men's and women's value priced footwear. The Company's stores
carry between 15,000 and 30,000 pairs of shoes and generally range in size from
3,000 to 16,000 square feet.
Between late 1993 and 1995, the Company reconfigured its stores from a
traditional retail format to the current self-service format. The Company
believes that the self-service format reinforces its off-price strategy and
appeals to value-oriented consumers. The Company's format allows inventory to be
stored directly under a displayed shoe, thereby eliminating the need for a
stockroom and significantly increasing retail floor space. The functionality and
simplicity of this format enable flexible store layouts that can be easily
rearranged to complement the current merchandise. Moreover, this format allows
customers to locate all available sizes of a particular shoe and to try them on
for comfort and fit without the need of a salesperson's assistance, thereby
reducing in-store staffing needs and allowing customers to make independent,
rapid purchasing decisions. The Company believes that these efficiencies and
selling strategies have improved the Company's financial performance while
addressing a shift in consumer buying patterns towards independent, value-
priced shopping. See "Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations--Factors Affecting Financial
Performance--Inventory Shrinkage."
Site Selection, Opening Costs And Leases
The Company uses an exclusive broker on the West Coast to identify potential
retail sites as well as possible acquisition candidates. Before entering a new
market, management reviews detailed reports on demographics; spending, traffic,
and consumption patterns; and other site and market related data. As of January
2, 1999, 33 of the Company's stores were located in strip malls, 11 were located
in outlet centers, 12 were located in free standing stores and 13 were located
in other types of facilities.
Opening costs for stores are typically minimal, excluding the initial stocking
of inventory. The Company estimates that its total cash requirements to open a
typical new store average $250,000 to $400,000, consisting of approximately
$40,000 to $50,000 for fixtures, equipment and leasehold improvements; $200,000
to $325,000 for inventory; and the balance for working capital needs. Costs vary
from store to store depending on, among other things, the location, size,
property condition, and the tenant improvement package offered by the landlord.
The Company has been able to renegotiate some of its existing leases to be more
heavily revenue-based. The Company does not own any of its real estate.
The Company actively monitors individual store performance and has closed
underperforming stores, including two stores in 1998, two stores in 1997 and six
stores in 1996. The relatively small investment required to open new stores
affords the Company the flexibility to close stores more quickly than other
retailers. The Company intends to
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close four to five stores and relocate two to three stores in 1999. If the
Company were to close a number of stores, it could incur significant
termination costs and reductions in net sales. In addition, the Company may
not be able to close certain underperforming stores on a timely basis because
of lease terms. A significant increase in termination costs, or the inability
to close one or more underperforming stores on a timely basis, could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations--Factors Affecting Financial
Performance--Risks Associated with Expansion."
Sourcing And Purchasing
Vendors. During 1998, the Company purchased its inventory from over 100
domestic and international vendors, independent resellers and other retailers
who have over bought merchandise. Name brands sold include Amalfi, Clarks,
Dexter, Fila, Florsheim, Naturalizer and Rockport, among others. Since the
Company has locations in a number of markets along the West Coast, Shoe Pavilion
can accommodate and distribute a wide variety of merchandise that meets the
needs of customers in different geographic areas. In 1998, the Company's top
ten suppliers accounted for 46.9% of inventory purchases, of which purchases
from Intershoe, Inc. and Global Sports, Inc. accounted for 8.8% and 8.3% of
total inventory purchases, respectively. The Company purchases from its
suppliers on an order-by-order basis and has no long-term purchase contracts or
other contractual assurances of continued supply or pricing. Management believes
that the strength and variety of its supplier network mitigates much of the
Company's exposure to inventory supply risks, attracts first time buyers, and
encourages repeat shopping. See "Item 7 -- Management's Discussion and Analysis
of Financial Condition and Results of Operations--Factors Affecting Financial
Performance--Inventory and Sourcing Risk."
Direct Sourcing. The Company purchases in-season name brand and branded design
merchandise directly from factories in Italy, Brazil and China. These purchases
include both labeled and non-labeled goods and provide a consistent base of in-
season merchandise. Directly sourced goods accounted for approximately 12.9% and
15.7% of the Company's net sales in 1998 and 1997, respectively. The Company
purchases from its manufacturing sources on an order-by-order basis and has no
long-term purchase contracts or other contractual assurances of continued supply
or pricing. See "Item 7 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations--Factors Affecting Financial Performance--
International Purchasing."
Marketing
In 1998 and 1997, the Company spent approximately 5.4% of net sales, or $3.0
million, and 4.5% of net sales, or $2.0 million, respectively, on television
advertising. The Company believes that television advertising benefits all
stores in a common viewing market. The Company believes that advertising costs
for a particular market will be more effectively and economically leveraged as
the number of stores increases in that market. The Company occasionally uses
print advertising, usually upon a new store opening; however, it has found print
advertising to be less effective than television advertising. Shoe Pavilion's
signage is consistent among all of the locations, and highly visible at the
front and, when appropriate, rear of the store.
Merchandise Distribution
In March 1997, the Company relocated from a 20,000 square foot distribution
facility in Bellevue, Washington to a 58,000 square foot and more centrally
located facility in Richmond, California. In September 1998, the Company amended
its lease to add an additional 34,000 square feet effective January 1, 1999.
This expanded distribution facility also houses the Company's executive and
administrative headquarters. Vendors ship all products to this distribution
center where the merchandise is inspected, verified against the original
purchase order, ticketed and repackaged for shipment to stores. The Company
believes that this 92,000 square foot facility can accommodate the Company's
planned growth for the foreseeable future.
Information Systems
The Company's is currently engaged in an enterprise wide project to upgrade
its information systems, including all critical areas of corporate office,
network infrastructure and point of sale (POS) to a fully-integrated and cost
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effective means of conducting its business. This upgrade, which is expected to
be completed by the end of the second quarter of 1999, will provide the Company
with a stable platform utilizing an IBM AS 400 that is reliable and scalable
allowing simple upgrades of processing power as the business grows. In addition,
the corporate network infrastructure is being upgraded to a Windows NT
environment with standardized workstations and a common set of desktop
applications being implemented throughout the Company. This upgrade will provide
a more stable networking environment as well as provide a proper foundation for
future growth. The Company currently estimates that the total costs for
implementing the new systems will approximate $2 million of which $1.25 million
has been incurred through January 2, 1999. See "Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operation--Impact
of Year 2000."
Competition
The retail footwear market is highly competitive, and the Company expects the
level of competition to increase. The Company competes with off-price and
discount retailers (e.g., Nordstrom Rack, Payless ShoeSource, Ross Dress for
Less and Famous Footwear), branded retail outlets (e.g., Nine West), national
retail stores (e.g., Nordstrom, Marshalls, Macy's, Sears, J.C. Penney,
Loehmann's, Robinsons-May and Mervyn's), traditional shoe stores and mass
merchants. Many of these competitors have stores in the markets in which the
Company now operates and in which it plans to expand. Many of the Company's
competitors have significantly greater financial, marketing and other resources
than the Company. In addition, there can be no assurance that future
participants will not enter the off-price segment of the footwear market.
Competitive pressures resulting from competitors' pricing policies could
materially adversely affect the Company's gross margins. There can be no
assurance that the Company will not face greater competition from other
national, regional or local retailers or that the Company will be able to
compete successfully with existing and new competitors. The inability of the
Company to respond to such competition could have a material adverse effect on
the Company's business, financial condition and results of operations.
Employees
As of January 2, 1999, the Company had approximately 241 full-time employees
and 235 part-time employees. The number of part-time employees fluctuates
depending upon seasonal needs. The Company's 25 warehouse employees are
represented by Local 315, International Brotherhood of Teamsters. In December
1998, the Company signed a collective bargaining agreement with Local 315 that
terminates on January 31, 2002. The Company generally considers its relationship
with its employees to be good.
Executive Officers
Certain information regarding the executive officers of the Company is set
forth below:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Dmitry Beinus.......................... 46 Chairman of the Board, President and Chief Executive Officer
Robert R. Hall......................... 46 Vice President and Chief Operating Officer
Gary A. Schwartz....................... 47 Vice President of Finance, Chief Financial Officer, Secretary and Director
Keith C. Gossett, Jr................... 41 Vice President of Operations
Linda C. Hickey........................ 35 Vice President of Administration
</TABLE>
Dmitry Beinus has served as Chairman of the Board, President and Chief
Executive Officer of the Company since founding the Company in 1979. From 1976
to 1978, Mr. Beinus was employed in the shoe department of Nordstrom, Inc. Mr.
Beinus' current responsibilities include overseeing the growth of the Company's
operations, maintaining its competitive position within the marketplace, and
facilitating the acquisition of inventory.
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Robert R. Hall has served as Vice President and Chief Operating Officer of the
Company since January 1997. Mr. Hall joined the Company as a Regional Manager in
1990, and has held various positions within the Company including Operations
Manager and Vice President of Merchandising. Mr. Hall's current responsibilities
are to oversee the Regional Managers as well as the Company's centralized
warehouse operations. From 1976 to 1990, Mr. Hall held various positions with
Nordstrom, Inc., most recently as Merchandising Manager for the shoe departments
within the San Francisco Bay Area stores.
Gary A. Schwartz has served as Vice President of Finance and Chief Financial
Officer of the Company since September 1997 and as Secretary and a Director
since November 1997. From January 1997 until April 1997, Mr. Schwartz served as
Vice President, Retail and Licensing of Jessica McClintock, Inc., a women's
apparel and fragrance company. From 1979 to 1996, Mr. Schwartz served as Vice
President and Chief Financial Officer of Byer California, an apparel
manufacturer and commercial real estate company. Mr. Schwartz is a Certified
Public Accountant.
Keith C. Gossett, Jr., has served as Vice President of Operations since April
1997. From 1994 to April 1997, Mr. Gossett was President of Easy Street Shoe
Co., a division of Colby Footwear. From 1990 to 1994, Mr. Gossett served as Vice
President of Sales and Marketing for Mark Lemp Footwear, and from 1986 to 1990,
he was the National Sales Manager for the Women's Division of Florsheim.
Linda C. Hickey has served as Vice President of Administration since January
1997. Ms. Hickey joined the Company in 1984 as a Sales Associate. From 1985 to
1992, Ms. Hickey held various positions that included inventory control,
accounting, payroll, and personnel, and from 1992 to 1996, she served as
Director of Administration. Ms. Hickey's current responsibilities include
overseeing internal administrative functions as well as assisting Mr. Beinus
with lease and vendor negotiations.
The Company's executive offers serve at the discretion of the Board of
Directors. There is no family relationship between any of the Company's
executive officers or between any executive officer and any of the Company's
directors.
Item 2 -- Properties
The Company's corporate offices and distribution facility are located in a
92,000 square foot facility in Richmond, California, which the Company occupies
under a lease expiring in 2002. As of January 2, 1999, the Company's 69 stores
occupied an aggregate of approximately 493,000 square feet of space. The Company
leases all of its stores, with leases expiring between 1999 and 2007. The
Company has options to renew most of its leases.
Store Locations
As of January 2, 1999, the Company operated 69 retail stores in the states of
California, Washington and Oregon. The number of stores in each geographic area
is set forth below:
<TABLE>
<CAPTION>
Stores at Year End
--------------------------------------------------------
Location 1998 1997 1996 1995 1994
- --------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Northern California........................................ 27 24 22 22 22
Southern California........................................ 25 16 4 2 2
Nevada..................................................... 0 1 1 1 1
Oregon..................................................... 4 2 2 0 0
Washington................................................. 13 12 12 13 11
---- ---- ---- ---- ----
Total.................................................... 69 55 41 38 36
==== ==== ==== ==== ====
</TABLE>
Item 3 -- Legal Proceedings
The Company is not a party to any material pending legal proceedings.
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Item 4 -- Submission of Matters to a Vote of Security Holders
Inapplicable.
PART II
Item 5 -- Market for the Registrant's Common Equity and Related Stockholder
Matters
The Common Stock of the Company has been traded on the Nasdaq National Market
under the symbol SHOE since the Company's initial public offering on February
23, 1998. The following table sets forth, for the periods indicated, the
highest and lowest closing sale prices for the Common Stock, as reported by the
Nasdaq National Market.
<TABLE>
<CAPTION>
High Low
------------- ----------
<S> <C> <C>
1998
First Quarter (since February 23, 1998)....................... 11.250 6.625
Second Quarter................................................ 10.625 7.875
Third Quarter................................................. 9.000 5.500
Fourth Quarter................................................ 9.188 3.563
</TABLE>
As of January 2, 1999, there were approximately 14 holders of record of the
Company's Common Stock.
From August 1988 through February 1998, the Company made distributions to its
sole stockholder primarily to allow the stockholder to pay taxes on earnings of
the Company included or includable in the taxable income of the stockholder as a
result of the Company's S corporation status. Upon completion of its initial
public offering, the Company made an S corporation distribution in the amount of
$7.8 million to its previous sole stockholder, which approximately equaled the
estimated earned and previously undistributed taxable S corporation income of
the Company through the day preceding the termination date of its S corporation
status. Except as mentioned in the previous sentences, the Company has not paid
any cash dividends in the past. The Company currently intends to retain any
earnings for use in its business and does not anticipate paying any cash
dividends on its Common Stock in the foreseeable future. In addition, the
Company's line of credit restricts the Company's ability to pay dividends. See
Note 4 of Notes to Consolidated Financial Statements.
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Item 6 -- Selected Financial Data
The selected consolidated financial and operating data set forth below should
be read in conjunction with "Item 8 -- Financial Statements and Supplemental
Data--Consolidated Financial Statements of the Company and related Notes thereto
and Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations" included herein.
<TABLE>
<CAPTION>
Year Ended
-------------------------------------------------------
1998(1) 1997 1996 1995 1994
(in thousands, except per share and operating data) ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net sales.......................................... $55,907 $45,074 $30,315 $25,539 $21,515
Cost of sales and related occupancy expenses....... 35,777 28,922 20,318 17,723 15,007
------- ------- ------- ------- -------
Gross profit....................................... 20,130 16,152 9,997 7,816 6,508
------- ------- ------- ------- -------
Selling expenses................................... 11,472 8,800 5,592 4,835 4,976
General and administrative expenses................ 3,664 3,106 2,630 1,809 1,638
------- ------- ------- ------- -------
Income (loss) from operations...................... 4,993 4,246 1,775 1,172 (106)
Interest and other expense, net.................... (453) (520) (287) (524) (404)
------- ------- ------- ------- -------
Income (loss) before income taxes.................. 4,540 3,726 1,488 648 (510)
Provision for income taxes......................... (1,147) (261) (98) (35) -
------- ------- ------- ------- -------
Net income (loss).................................. $ 3,393 $ 3,465 $ 1,390 $ 613 $ (510)
======= ======= ======= ======= =======
Net income (loss) per share:
Basic............................................ $0.53 $0.77 $0.31 $.09 $(.07)
Diluted.......................................... $0.52 $0.77 $0.31 $.09 $(.07)
Weighted average shares outstanding:
Basic............................................ 6,462 4,500 4,500 4,500 4,500
Diluted.......................................... 6,474 4,500 4,500 4,500 4,500
Pro Forma:
Historical income (loss) before income taxes....... $ 4,540 $ 3,726 $ 1,488 $ 648 $ (510)
Pro forma (provision) benefit for income taxes(2).. (1,748) (1,435) (566) (246) 183
------- ------- ------- ------- -------
Pro forma net income (loss)(2)..................... $ 2,792 $ 2,291 $ 922 $ 402 $ (327)
======= ======= ======= ======= =======
Pro forma net income per share(2).................. $0.42 - - - -
Weighted average shares outstanding(2)............. 6,660 - - - -
Selected Operating Data:
Number of stores:
Opened during period............................. 16 16 9 6 9
Closed during period............................. 2 2 6 4 0
Open at end of period............................ 69 55 41 38 36
Comparable store sales increase (decrease)(1)(3)... 6.1% 4.6% 8.0% (1.0)% (12.4)%
<CAPTION>
Year Ended
-------------------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Working capital.................................... $13,739 $ 6,045 $ 3,783 $ 2,876 $ 1,964
Total assets....................................... 33,534 22,646 15,146 9,473 10,079
Total indebtedness (including current portion)..... 8,494 7,658 3,673 3,872 4,912
Shareholders' equity............................... 17,028 7,328 4,567 2,695 2,083
</TABLE>
_________________
(1) In 1998, the Company changed its year end to a 52-53 week year ending on the
Saturday nearest to December 31. Due to this change, sales for the fourth
quarter and year ended January 2, 1999 include two additional days; had
these days not been included comparable store sales would have increased
5.3% for the year ended January 2, 1999. All references herein to 1998 refer
to the year ended January 2, 1999.
(continued on following page)
11
<PAGE>
(continued from previous page)
(2) Prior to February 1998, the Company operated as an S corporation and was not
subject to federal and certain state income taxes. Upon the completion of
its initial public offering, the Company became subject to federal and state
income taxes. Pro forma net income (loss) reflects federal and state income
taxes as if the Company had not elected S corporation status for income tax
purposes. Pro forma net income per share is based on the weighted average
number of shares of common stock outstanding during the period plus the
estimated number of shares offered by the Company (1,271,722 shares) which
were necessary to fund the $7.8 million distribution paid to the Company's
stockholder upon termination of the Company's status as an S Corporation.
See Note 3 of Notes to Consolidated Financial Statements.
(3) The Company believes that the decreases in comparable store sales in 1994
and 1995 were due, in part, to temporary store closures and business
disruptions resulting from the reconfiguration of the Company's stores from
a traditional retail format to the current self-service format. The Company
believes that the increase in comparable store sales in 1996 was due, in
part, to the completion of the reconfiguration of the Company's comparable
stores.
Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations
The statements contained in this Form 10-K which are not historical facts are
forward-looking statements that are subject to risks and uncertainties that
could cause actual results to differ materially from those set forth in or
implied by forward-looking statements. Factors that could cause or contribute
to such differences include those discussed in the Company's filings with the
Securities and Exchange Commission, including, without limitation, the factors
discussed in this Form 10-K under the captions "--Factors Affecting Financial
Performance" and "--Liquidity and Capital Resources," as well as those discussed
elsewhere in this Form 10-K.
Overview
Shoe Pavilion, founded in 1979, is the largest independent off-price footwear
retailer on the West Coast that offers a broad selection of women's and men's
designer label and name brand merchandise. The Company was among the first
footwear retailers on the West Coast to expand the off-price concept into the
designer and name brand footwear market. As of January 2, 1999, the Company
operated 69 retail stores in California, Washington and Oregon under the trade
name Shoe Pavilion.
The Company opened, net of closures, 14 stores in 1998, 14 stores in 1997 and
three stores in 1996. In early 1997, the Company entered the Los Angeles market
by assuming the leasehold interests of Standard Shoes, a Los Angeles based
footwear retailer. In connection therewith, the Company purchased the inventory
of Standard Shoes at 60% of Standard Shoes' cost. The Company subsequently
converted nine Standard Shoes locations to Shoe Pavilion stores. The Company
intends to open approximately 15 to 20 new stores, primarily in its existing
markets, close four to five stores and relocate two to three stores in 1999.
The Company's growth in net sales historically has resulted primarily from
new store openings, and the Company expects that the primary source of future
sales growth, if any, will continue to be new store openings. The Company's
comparable store sales have fluctuated widely, and the Company does not expect
that comparable store sales will contribute significantly, if at all, to future
growth in net sales. The Company defines comparable stores as those stores that
have been open for at least 14 consecutive months. Stores open less than 14
consecutive months are treated as new stores, and stores closed during the
period are excluded from comparable store sales. The Company's comparable store
sales increased 6.1% in 1998, 4.6% in 1997 and 8.0% in 1996 and decreased 1.0%
in 1995 and 12.4% in 1994. In 1998, the Company changed its year end to a 52-53
week year ending on the Saturday nearest to December 31. Due to this change,
sales for the fourth quarter and year ended January 2, 1999 include two
additional days; had these days not been included comparable store sales would
have increased 5.3% for the year ended January 2, 1999. The Company believes
that the decreases in comparable store sales in 1994 and 1995 were due, in part,
to temporary store closures and business disruptions resulting from the
reconfiguration of the Company's stores from a traditional retail format to the
current self-service format. The Company believes that the increase in
comparable store sales in 1996 was due, in part, to the completion of the
reconfiguration of the Company's comparable stores. The Company does not
anticipate realizing similar increases in subsequent periods, and no assurance
can be given as to the Company's ability to maintain recent comparable store
sales growth. See "Item 7 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations--Factors Affecting Financial Performance--
Uncertainty of Future Operating Results; Fluctuations in Comparable Store
Sales."
12
<PAGE>
Between late 1993 and 1995, the Company reconfigured substantially all of its
stores from a traditional retail format to the current self-service format. This
reconfiguration resulted in increased expenses associated with the conversion
and decreased net sales due to the temporary closure of the stores. The majority
of the reconfigurations occurred during 1994 and contributed to a loss before
income taxes of $510,000 in 1994.
The Company acquires merchandise opportunistically to obtain favorable terms
and in quantities large enough to support future growth, which results in
increased inventory levels at various times throughout the year. As a result,
similar to other off-price retailers, the Company's inventory turnover rates are
typically less than full-price retailers. The Company's inventory levels have
increased from $19.8 million at December 31, 1997 to $26.9 million at January 2,
1999. This increase is due in part to the substantial increase in the number of
the Company's stores. To the extent that the Company's current or future
inventory is comprised of older or obsolescent shoes, the Company will be
required to mark-down the sale price of those shoes, which could have a material
adverse effect on operating margins in affected periods. See "--Factors
Affecting Financial Performance--Inventory and Sourcing Risk."
Prior to its initial public offering in February 1998, Shoe Pavilion was
treated as an S corporation for federal and certain state income tax purposes
since August 1988. As a result, the Company's earnings from August 1988 through
February 22, 1998 were taxed, with certain exceptions, directly to the Company's
stockholder rather than to the Company. The Company's S corporation status
terminated on February 22, 1998, and the Company is now subject to state and
federal income taxes as a C corporation. In connection with its conversion to C
corporation status, the Company recorded a nonrecurring tax benefit of $485,000.
The pro forma adjustments reflect federal and state income taxes as if the
Company had not elected S corporation status for income tax purposes. See Note 3
of Notes to Consolidated Financial Statements.
In 1998, the Company changed its year end to a 52-53 week year ending on the
Saturday nearest to December 31. The effect of this change was immaterial. All
references herein to 1998 refer to the year ended January 2, 1999.
Results of Operations
The following table sets forth, for the periods indicated, the relative
percentages that certain income and expense items bear to net sales:
<TABLE>
<CAPTION>
Year Ended
----------------------------------------------------
1998 1997 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Net sales............................................. 100.0% 100.0% 100.0%
Gross profit.......................................... 36.0 35.8 33.0
Selling expenses...................................... 20.5 19.5 18.4
General and administrative expenses................... 6.6 6.9 8.7
-------------- -------------- --------------
Income from operations................................ 8.9 9.4 5.9
Interest and other expense, net....................... (0.8) (1.1) (1.0)
-------------- -------------- --------------
Income before income taxes............................ 8.1 8.3 4.9
Pro forma provision for income taxes.................. (3.1) (3.2) (1.9)
-------------- -------------- --------------
Pro forma net income.................................. 5.0% 5.1% 3.0%
============== ============== ==============
</TABLE>
1998 Compared with 1997
Net Sales. Net sales increased 24.0% to $55.9 million for 1998 from $45.1
million for 1997. This increase in net sales was primarily attributable to new
store sales, including sales from 16 stores opened during 1998, which
contributed $15.3 million and a 6.1% increase in comparable store sales of $40.6
million.
Gross Profit. Cost of sales includes landed merchandise and occupancy costs.
Gross profit increased 24.6% to $20.1 million for 1998 from $16.2 million for
1997, and increased as a percentage of net sales to 36.0% from 35.8%.
13
<PAGE>
The increase in gross profit percentage was primarily attributable to the
Company's ability to purchase merchandise in larger quantities at a lower cost
per unit in 1998 as well as leverage in occupancy costs.
Selling Expenses. Selling expenses consist of payroll and related costs,
advertising and promotional expenses. Selling expenses increased 30.4% to $11.5
million for 1998 from $8.8 million for 1997, and increased as a percentage of
net sales to 20.5% from 19.5%. The increase in selling expenses was primarily
attributable to increases in payroll and related expenses as a result of new
stores and advertising expenses.
General and Administrative Expenses. General and administrative expenses
consist primarily of corporate and administrative expenses, including payroll,
employee benefits and warehousing costs. General and administrative expenses
increased 18.0% to $3.7 million for 1998 from $3.1 million for 1997, and
decreased slightly as a percentage of net sales to 6.6% from 6.9%, primarily as
a result of improved expense leverage, offset by costs related to being a public
company.
Interest and Other Expense, Net. Interest and other expense, net, decreased
12.8% to $453,000 for 1998 from $520,000 for 1997. The decrease was attributable
to lower average borrowings outstanding on the Company's revolving line of
credit. During the quarter ended March 31, 1998, $6.0 million of the Company's
line of credit was repaid with the proceeds from the Company's initial public
offering.
Pro Forma Taxes. The pro forma taxes on income for 1998 were $1.7 million
compared to $1.4 million for 1997. The pro forma effective tax rate for 1998 and
1997 was 38.5%.
1997 Compared with 1996
Net Sales. Net sales increased 48.7% to $45.1 million for 1997 from $30.3
million for 1996. This increase in net sales was primarily attributable to new
store sales, including sales from 16 stores opened during 1997, which
contributed $15.0 million and a 4.6% increase in comparable store sales of $1.2
million. Stores closed during 1996 and 1997 had contributed an additional $1.4
million to net sales during 1996.
Gross Profit. Gross profit increased 61.6% to $16.2 million for 1997 from
$10.0 million for 1996, and increased as a percentage of net sales to 35.8% from
33.0%. The increase in gross profit was primarily attributable to the Company's
ability to purchase merchandise in larger quantities at a lower cost per unit in
1997 as well as favorable gross profit margins on the inventory purchased from
Standard Shoes. Cost of sales includes landed merchandise costs and occupancy
costs.
Selling Expenses. Selling expenses increased 57.4% to $8.8 million for 1997
from $5.6 million for 1996, and increased as a percentage of net sales to 19.5%
from 18.4%. The increase in selling expenses was primarily attributable to
increases in payroll and related expenses as a result of new stores and, to a
lesser extent, advertising expenses.
General and Administrative Expenses. General and administrative expenses
increased 18.1% to $3.1 million for 1997 from $2.6 million for 1996, and
decreased as a percentage of net sales to 6.9% from 8.7%, primarily as a result
of improved expense leverage.
Interest and Other Expense, Net. Interest and other expense, net, increased
81.0% to $520,000 for 1997 from $287,000 for 1996. The increase was attributable
to higher borrowings outstanding on the Company's revolving line of credit to
support increased inventory levels, including inventory purchased from Standard
Shoes.
Pro Forma Taxes. The pro forma taxes on income for 1997 were $1.4 million
compared to $566,000 for 1996. The pro forma effective tax rate for 1997 was
38.5% compared to 38.0% for 1996.
Inflation
The Company does not believe that inflation has had a material impact on its
results of operations. However, there can be no assurance that inflation will
not have such an effect in future periods.
14
<PAGE>
Liquidity and Capital Resources
The Company had $13.7 million in working capital as of January 2, 1999,
compared to $6.0 million as of December 31, 1997. The Company's capital
requirements relate primarily to merchandise inventory and leasehold
improvements. The Company's working capital needs are typically higher in the
second and third quarters as a result of increased inventory purchases for
spring and fall selling seasons.
Historically, the Company has funded its cash requirements primarily through
cash flow from operations and borrowings under its credit facility, and
beginning in February 1998, proceeds from its initial public offering. Net cash
provided by (used in) operating activities was ($3.0) million, ($1.8) million
and $566,000 for 1998, 1997, and 1996, respectively. Net cash provided by (used
in) operating activities historically has been driven primarily by net income
and fluctuations in inventory and accounts payable. Inventory levels have
increased throughout these periods due to a net increase in the number of
stores. During 1998, the Company experienced delays in the timing of opening
certain new stores. While these delays were largely caused by factors outside
the Company's control, they shifted the timing of the revenue contribution of
certain new stores to a later quarter from the one that was planned. During
1999, the Company anticipates that cash will be used primarily for merchandise
inventory and capital expenditures.
Capital expenditures were $2.6 million, $1.2 million and $569,000 in 1998,
1997 and 1996, respectively. Expenditures for 1998 were primarily for the build-
out of 16 new stores, plus work-in-progress of the Company's new management
information systems. Expenditures for 1997 were primarily for the build-out of
16 new stores and the relocation of the Company's corporate office and
distribution center. The Company estimates that capital expenditures for 1999
will total approximately $2.0 million, primarily for the build-out of
approximately 15 to 20 new stores and costs associated with the Company's
management information systems.
Financing activities provided cash of $7.1 million, $3.2 million and $93,000
in 1998, 1997 and 1996, respectively. The increase in cash provided by financing
activities for 1998, primarily reflects $14.1 million raised in the Company's
initial public offering offset by $7.8 million payment for an S corporation
distribution and a $1.0 million increase on the Company's line of credit. During
1997 and 1996, the Company made distributions to its then sole stockholder of
$704,000 and $300,000, respectively. Upon completion of its initial public
offering, the Company made an S corporation distribution in the amount of $7.8
million to its previous sole stockholder, which approximately equaled the
estimated earned and previously undistributed taxable S corporation income of
the Company through the day preceding the termination date of its S corporation
status. See Note 3 of Notes to Consolidated Financial Statements.
During most of 1998, the Company had a credit facility agreement, which
included a revolving line of credit for $10.0 million along with a $500,000 term
line available for the purchase or lease of equipment. The Company paid interest
on outstanding amounts at a rate of 0.25% over the bank's prime rate or LIBOR
plus 300 basis points, at the Company's option. During the quarter ended March
31, 1998, $6.0 million of this line of credit was repaid with the proceeds from
the initial public offering. The balance of this credit facility was paid off
in December 1998 from borrowings under the Company's new credit facility
described below.
In December 1998, the Company entered into a new a credit facility agreement,
which includes a revolving line of credit for $15.0 million expiring on December
1, 2000. This line of credit is also available for the issuance of commercial
and standby letters of credit up to $4.0 million. The Company pays interest on
outstanding amounts at the bank's prime rate or LIBOR plus 130 basis points, at
the Company's option. Borrowings under the credit facility are secured by the
Company's accounts receivable, general intangibles, inventory and other rights
to payment. The agreement contains restrictive covenants that require, among
other things, that (a) total liabilities may not exceed 1.5 times tangible net
worth, (b) quarterly net income after taxes and pre-tax profit must each not be
less than one dollar, (c) EBITDA must not be less than $3.75 million on a
rolling four-quarter basis and (d) the outstanding balance on the line of credit
may not exceed 0.5 times inventory plus the amount available under outstanding
letters of credit, and prohibits the declaration and payment of cash or stock
dividends. As of January 2, 1999, the Company was in compliance with all
covenants and the unused and available portion of the credit facility was
approximately $6.6 million.
15
<PAGE>
As part of its growth strategy, the Company plans to pursue opportunities to
acquire complementary businesses, although no such transactions are being
considered as of the date of this Form 10-K. To the extent that cash resources
are insufficient to fund the purchase price of future acquisitions, if any, or
the operations of any acquired business, additional external capital may be
required. There can be no assurance that additional financing will be available
on reasonable terms or at all. The Company expects that anticipated cash flow
from operations and available borrowings under the Company's new credit facility
will satisfy its cash requirements for at least the next 12 months. The
Company's capital requirements program may vary significantly from those
anticipated depending upon such factors as operating results, the number and
timing of new store openings, and the number and size of any future
acquisitions.
Impact of Year 2000
The Company is currently in the process of addressing a problem that is facing
all users of automated information systems. The "Year 2000 Issue" is the result
of computer programs being written using two digits rather than four to define
the applicable year. Computer programs that have time-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
situation could result in a system failure or miscalculations causing
disruptions to operations, including, among other things, a temporary inability
to process transactions, send payments, or engage in similar normal business
activities.
State of Readiness. Beginning in early 1998, the Company began an overall
assessment of its computer systems, including Year 2000 readiness. The Company
determined that certain of its software was not Year 2000 compliant. In mid-
1998, the Company, with the guidance of outside consultants, implemented a plan
to replace its existing information systems primarily in response to business
demand and growth. The new systems are designed to replace the Company's
information systems for order processing, warehousing, finance and point-of-sale
on a fully integrated enterprise-wide basis. These systems will replace
existing software that is not Year 2000 compliant.
The Company will utilize both internal and external resources to replace and
test its information systems software for Year 2000 compliance. An Executive
Oversight Steering Committee, consisting of internal executive management, the
Company's information systems officer and various outside third parties, has
been formed to supervise the replacement, implementation and testing process.
Installation of the new systems began in June 1998, and Company personnel are
currently being trained on the new systems. The Company estimates that the
installation of the new systems will be completed by the end of the second
quarter of 1999, and testing will be completed thereafter. The Company expects
to fully convert to the new, Year 2000 compliant information systems no later
than September 30, 1999.
The Company has begun communicating with significant suppliers to determine
the extent to which the Company may be vulnerable to a failure by any of these
third parties to remediate their own Year 2000 issues. The Company's exposure to
supplier Year 2000 business disruptions is reduced because it does not currently
communicate electronically with its suppliers. In addition to suppliers, the
Company also relies upon governmental agencies, utility companies,
telecommunication service companies and other service providers outside of the
Company's control. There can be no assurance that the Company's suppliers,
governmental agencies or other third parties will not suffer a Year 2000
business disruption that could have a material adverse effect on the Company's
business, financial condition and operating results. The Company has not been
informed by any supplier of inability to comply with year 2000 issues.
Costs to Address the Year 2000 Issue. The Company has incurred, through
January 2, 1999, approximately $1.25 million relating to the implementation of
the new systems and addressing Year 2000 issues. The Company currently
estimates that the total costs for implementing the new systems will approximate
$2 million. Included in the costs of implementing the new systems is the cost of
equipment which the Company presently plans to lease over 36 to 60 months. The
Company will capitalize and depreciate the new systems technology over its
estimated useful life and to the extent that Year 2000 costs do not qualify as
capital investments, the Company will expense such costs as incurred.
The costs of Year 2000 compliance and the date on which the Company believes
it will complete the project are based on management's best estimates, which
were derived utilizing numerous assumptions of future events, including the
continued availability of certain third party resources and other factors.
However, there can be no
16
<PAGE>
guarantee that these estimates will be achieved and actual results could differ
materially from those anticipated. Specific factors that might cause such
material differences include, but are not limited to, the availability and cost
of personnel trained in this area, supplier compliance and contingency actions,
and similar uncertainties. The Company's total Year 2000 project costs do not
include the estimated costs and time associated with anticipated third party
Year 2000 issues based on presently available information.
Risks Presented by the Year 2000 Issue. The Company presently believes that
with the implementation of new systems and conversion to new software, the Year
2000 Issue will not pose significant operational problems for its computer
systems. However, if such conversions are not made, or are not completed in a
timely manner, the Year 2000 Issue could have a material impact on the
operations of the Company. In addition, if any third parties which provide
goods or services essential to the Company's business activities fail to address
appropriately their Year 2000 issues, such failure could have a material adverse
effect on the Company's business, financial condition and operating results.
For example, a Year 2000 related disruption on the part of the financial
institutions which process the Company's credit card sales would have a material
adverse effect on the Company's business, financial condition and operating
results.
Contingency Plans. The Company's Executive Oversight Steering Committee
intends to develop contingency plans in the event that the Company has not
completed all of its remediation plans in a timely manner or any third parties
who provide goods or services essential to the Company's business fail to
appropriately address their Year 2000 issues. The committee expects to conclude
the development of these contingency plans by the end of the second quarter of
1999.
Weather and Seasonality
The Company has experienced, and expects to continue to experience, seasonal
fluctuations in its net sales and net income. Historically, net sales and net
income have been weakest during the first quarter. Because the Company's
operations are geographically concentrated, it is vulnerable to adverse weather
conditions and natural disasters in the regions in which it operates stores,
including the San Francisco Bay Area, Seattle and Los Angeles. If one of these
regions were to experience prolonged adverse weather conditions or a natural
disaster, the Company's business, financial condition and results of operations
could be materially adversely affected. The Company's quarterly results of
operations may also fluctuate significantly as a result of a variety of factors,
including timing of new store openings, the level of net sales contributed by
new stores, merchandise mix, the timing and level of price markdowns,
availability of inventory, store closures, advertising costs, competitive
pressures and changes in the demand for off-price footwear. Any such
fluctuations could have a material adverse effect on the market price of the
Company's Common Stock.
Factors Affecting Financial Performance
In addition to the other information in this Form 10-K, the following factors
should be considered carefully in evaluating an investment in the shares of
Common Stock of the Company. The statements contained in this Form 10-K which
are not historical facts are forward-looking statements that are subject to
risks and uncertainties that could cause actual results to differ materially
from those set forth in or implied by forward-looking statements. Factors that
could cause or contribute to such differences include those discussed below, as
well as those discussed elsewhere in this Form 10-K.
Risks Associated With Expansion
The Company has experienced rapid and substantial growth in net sales as well
as in its employee base. The Company's continued growth will depend to a
significant degree on its ability to expand its operations through the opening
of new stores, to operate these stores on a profitable basis and to increase
comparable store sales. The success of the Company's planned expansion will be
significantly dependent upon the Company's ability to locate suitable store
sites and negotiate acceptable lease terms. In addition, several other factors
could affect the Company's ability to expand, including the adequacy of the
Company's capital resources, the ability to hire, train and integrate employees
and the ability to adapt the Company's distribution and other operational
systems. There can be no assurance that the Company will achieve its planned
expansion or that any such expansion will be profitable. In addition, there can
be no assurance that the Company's expansion within its existing markets will
not adversely
17
<PAGE>
affect the individual financial performance of the Company's existing stores or
its overall operating results, or that new stores will achieve net sales and
profitability levels consistent with existing stores, or at all. To manage its
planned expansion, the Company regularly evaluates the adequacy of its existing
systems and procedures, including product distribution facilities, store
management, financial controls and management information systems. However,
there can be no assurance that the Company will anticipate all of the changing
demands that expanded operations may impose on such systems. Failure to adapt
its distribution capabilities or other internal systems or procedures as
required could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company actively monitors individual store performance and has closed
underperforming stores in the past, including two each in 1998 and 1997, six in
1996 and four in 1995. The Company intends to continue to close underperforming
stores in the future, and if it were to close a number of stores, it could incur
significant closure costs and reductions in net sales. In addition, the Company
may be unable to close certain underperforming stores on a timely basis because
of lease terms. A significant increase in closure costs or the inability to
close one or more underperforming stores on a timely basis could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Inventory And Sourcing Risk
The Company's future success will be significantly dependent on its ability to
obtain merchandise that consumers want to buy, particularly name brand
merchandise with long-term retail appeal, and to acquire such merchandise under
favorable terms and conditions. In 1998, the Company's top ten suppliers
accounted for 46.9% of inventory purchases, of which purchases from Intershoe,
Inc. and Global Sports, Inc. accounted for 8.8% and 8.3% of total inventory
purchases, respectively. The deterioration of the Company's relationship with
any key vendor could result in delivery delays, merchandise shortages or less
favorable terms than the Company currently enjoys. The Company deals with its
suppliers on an order-by-order basis and has no long-term purchase contracts or
other contractual assurances of continued supply or pricing. As the Company's
operations expand, its demand for off-price inventory will continue to increase.
The Company's products typically are manufacturing over-runs, over-orders, mid-
or late-season deliveries or last season's stock. The inability of the Company
to obtain a sufficient supply of readily salable, high margin inventory, to
negotiate favorable discount and payment agreements with its suppliers or to
sell large inventory purchases without markdowns could have a material adverse
effect on the Company's business, financial condition and results of operations.
See " Item 1 -- Business--Sourcing and Purchasing."
Reliance On Key Personnel
The Company's future success will be dependent, to a significant extent, on
the efforts and abilities of its executive officers, particularly Dmitry Beinus,
the Company's Chairman of the Board, President and Chief Executive Officer. The
Company has obtained key man life insurance in the amount of $3.0 million on Mr.
Beinus. The loss of the services of any one of the Company's executive officers
could have a material adverse effect on the Company's operating results. In
addition, the Company's continued growth will depend, in part, on its ability to
attract, motivate and retain additional skilled managerial and merchandising
personnel. Competition for such personnel is intense, and there can be no
assurance that the Company will be able to retain its existing personnel or
attract additional qualified personnel in the future.
Uncertainty Of Future Operating Results; Fluctuations In Comparable Store
Sales
Although the Company recently has been profitable, there can be no assurance
that the Company will remain profitable in the future. Future operating results
will depend upon many factors, including general economic conditions, the level
of competition and the ability of the Company to acquire sufficient inventory,
achieve its expansion plans and effectively monitor and control costs. There can
be no assurance that the Company's recent gross margin levels will be
sustainable in the future. Historically, the Company's growth in net sales has
resulted primarily from new store openings, and the Company expects that the
primary source of future sales growth, if any, will continue to be new store
openings.
The Company's comparable store sales have fluctuated widely, and the Company
does not expect that comparable store sales will contribute significantly, if at
all, to future growth in net sales. The Company defines
18
<PAGE>
comparable stores as those stores that have been open for at least 14
consecutive months. Stores open less than 14 consecutive months are treated as
new stores, and stores closed during the period are excluded from comparable
store sales. The Company's comparable store sales increased 6.1% in 1998, 4.6%
in 1997 and 8.0% in 1996 and decreased 1.0% in 1995 and 12.4% in 1994. The
Company believes that the decreases in comparable store sales in 1995 and 1994
were due, in part, to temporary store closures and business disruptions
resulting from the reconfiguration of the Company's stores from a traditional
retail format to the current self-service format. The Company believes that the
increase in comparable store sales in 1996 was due, in part, to the completion
of the reconfiguration of the Company's comparable stores. The Company does not
anticipate realizing similar increases in subsequent periods, and no assurance
can be given as to the Company's ability to maintain recent comparable store
sales growth.
Risks Associated With Possible Acquisitions
The Company may pursue the acquisition of companies and assets that complement
its existing business. Acquisitions involve a number of special risks, including
the diversion of management's attention to the assimilation of the operations
and personnel of the acquired businesses, potential adverse short-term effects
on the Company's operating results and amortization of acquired intangible
assets. The Company has limited experience in identifying, completing and
integrating acquisitions. The Company does not have any current plans to acquire
any other companies, and there can be no assurance that the Company will
identify attractive acquisition candidates, that acquisitions will be
consummated on acceptable terms or that any acquired companies will be
integrated successfully into the Company's operations.
Seasonality And Quarterly Fluctuations
The Company has experienced, and expects to continue to experience, seasonal
fluctuations in its net sales and net income. Historically, net sales and net
income have been weakest during the first quarter. Because the Company's
operations are geographically concentrated, it is vulnerable to adverse weather
conditions and natural disasters in the regions in which it operates stores,
including the San Francisco Bay Area, Seattle and Los Angeles. If one of these
regions were to experience prolonged adverse weather conditions or a natural
disaster, the Company's business, financial condition and results of operations
could be materially adversely affected. The Company's quarterly results of
operations may also fluctuate significantly as a result of a variety of factors,
including timing of new store openings, the level of net sales contributed by
new stores, merchandise mix the timing and level of price markdowns,
availability of inventory, store closures, advertising costs, competitive
pressures and changes in the demand for off- price footwear. Any such
fluctuations could have a material adverse effect on the market price of the
Company's Common Stock.
Dependence On Consumer Spending And Preferences
The success of the Company's operations depends upon a number of factors
relating to consumer spending, including employment levels, business conditions,
interest rates, inflation and taxation. There can be no assurance that consumer
spending will not decline in response to economic conditions, thereby adversely
affecting the Company's operating results.
All of the Company's products are subject to changing consumer preferences.
Consumer preferences could shift to types of footwear other than those that the
Company currently offers. Any such shift could have a material adverse effect on
the Company's operating results. The Company's future success will depend, in
part, on its ability to anticipate and respond to changes in consumer
preferences, and there can be no assurance that the Company will be able to
anticipate effectively or respond to such changes on a timely basis or at all.
Failure to anticipate and respond to changing consumer preferences could lead
to, among other things, lower net sales, excess inventory and lower gross
margins, any of which could have a material adverse effect on the Company's
business, financial condition and results of operations.
19
<PAGE>
International Purchasing
The Company purchases in-season name brand and branded-design merchandise
directly from factories in Italy, Brazil and China. Directly-sourced goods
accounted for approximately 12.9% and 15.7% of net sales in 1998 and 1997,
respectively. The Company has no long-term contracts with direct manufacturing
sources and competes with other companies for production facilities. All of the
manufacturers with which the Company conducts business are located outside of
the United States, and the Company is subject to the risks generally associated
with an import business, including foreign currency fluctuations, unexpected
changes in foreign regulatory requirements, disruptions or delays in shipments
and the risks associated with United States import laws and regulations,
including quotas, duties, taxes, tariffs and other restrictions. There can be no
assurance that the foregoing factors will not disrupt the Company's supply of
directly-sourced goods or otherwise adversely impact the Company's business,
financial condition and results of operations in the future. See "Item 1 --
Business--Sourcing and Purchasing."
Inventory Shrinkage
The retail industry is subject to theft by customers and employees. By
converting to a self-service format, where shoppers have access to both shoes of
a pair, the Company substantially increased the need for store security.
Although the Company has implemented enhanced security procedures, there can be
no assurance that the Company will not suffer from significant inventory
shrinkage in the future, which could have a material adverse effect on the
Company's business, financial condition and results of operations.
Competition
The retail footwear market is highly competitive, and the Company expects the
level of competition to increase. The Company competes with off-price and
discount retailers (e.g., Nordstrom Rack, Payless ShoeSource, Ross Dress for
Less and Famous Footwear), branded retail outlets (e.g., Nine West), national
retail stores (e.g., Nordstrom, Marshalls, Macy's, Sears, J.C. Penney,
Loehmann's, Robinsons-May and Mervyn's), traditional shoe stores and mass
merchants. Many of these competitors have stores in the markets in which the
Company now operates and in which it plans to expand. Many of the Company's
competitors have significantly greater financial, marketing and other resources
than the Company. In addition, there can be no assurance that future
participants will not enter the off-price segment of the footwear market.
Competitive pressures resulting from competitors' pricing policies could
materially adversely affect the Company's gross margins. There can be no
assurance that the Company will not face greater competition from other
national, regional or local retailers or that the Company will be able to
compete successfully with existing and new competitors. The inability of the
Company to respond to such competition could have a material adverse effect on
the Company's business, financial condition and results of operations.
Future Capital Needs
The Company expects that anticipated cash flow from operations and available
borrowings under the Company's credit facility will satisfy its cash
requirements for at least the next 12 months. However, the Company may incur
significant working capital requirements and capital expenditures in connection
with its growth strategy and otherwise. To the extent that the foregoing cash
resources are insufficient to fund the Company's activities, including new store
openings planned for 1999, additional funds will be required. There can be no
assurance that additional financing will be available on reasonable terms or at
all. Failure to obtain such financing could delay or prevent the Company's
planned expansion, which could adversely affect the Company's business,
financial condition and results of operations. In addition, if additional
capital is raised through the sale of additional equity or convertible
securities, dilution to the Company's stockholders could occur.
Substantial Control By Single Stockholder
Dmitry Beinus, the Company's Chairman of the Board, President and Chief
Executive Officer owns approximately 66.2% of the Company's outstanding Common
Stock. As a result, Mr. Beinus is able to decide all matters requiring
stockholder approval, including the election of directors and approval of
significant corporate
20
<PAGE>
transactions. Concentration of stock ownership could also have the effect of
delaying or preventing a change in control of the Company.
Possible Volatility Of Stock Price
The Common Stock is quoted on the NASDAQ National Market, which has
experienced and is likely to experience in the future significant price and
volume fluctuations, either of which could adversely affect the market price of
the Common Stock without regard to the operating performance of the Company. In
addition, the trading price of the Company's Common Stock could be subject to
wide fluctuations in response to quarterly variations in operating results,
fluctuations in the Company's comparable store sales, announcements by other
footwear retailers, the failure of the Company's earnings to meet the
expectations of securities analysts and investors, as well as other events or
factors.
Anti-Takeover Effect Of Certain Charter Provisions
The Board of Directors has the authority to issue up to 1,000,000 shares of
Preferred Stock, and to determine the rights, preferences and restrictions of
such shares, without further stockholder approval. The rights of holders of
Common Stock will be subject to, and may be adversely affected by, the rights of
the holders of any Preferred Stock that may be issued in the future. The
issuance of Preferred Stock may have the effect of delaying or preventing a
change in control of the Company. In addition, certain provisions of the
Company's Certificate of Incorporation and Bylaws and of Delaware law could
discourage potential acquisition proposals and could delay or prevent a change
in control of the Company. Such provisions could diminish the opportunities for
a stockholder to participate in tender offers, including tender offers at a
price above the then-current market value of the Common Stock. Among other
things, these provisions (i) provide that only the Board of Directors or certain
members thereof or officers of the Company may call special meetings of the
stockholders; (ii) eliminate the ability of the stockholders to take action
without a meeting; and (iii) authorize the issuance of "blank check" preferred
stock having such designations, rights and preferences as may be determined from
time to time by the Board of Directors.
Item 7A -- Quantitative and Qualitative Disclosure About Market Risk
The Company is exposed to market risks, which include changes in U.S. interest
rates and foreign exchange rates. The Company does not engage in financial
transactions for trading or speculative purposes.
Interest Rate Risk. The interest payable on the Company's bank line of credit
is based on variable interest rates and therefore affected by changes in market
rates. The Company does not use derivative financial instruments in its
investment portfolio and believes that the market risk is immaterial.
Commodity Prices. The Company is not exposed to fluctuation in market prices
for any commodities.
Foreign Currency Risks. The Company has minimal purchases outside of the
United States that involve foreign currency contracts and, therefore, has only
minimal exposure to foreign currency exchange risks. The Company does not hedge
against foreign currency risks and believes that foreign currency exchange risk
is immaterial.
21
<PAGE>
Item 8 -- Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Shoe Pavilion, Inc.
<S> <C>
Independent Auditor's Report............................................................. 23
Consolidated Balance Sheets January 2, 1999 and December 31, 1997........................ 24
Consolidated Statements of Income for Years Ended January 2, 1999,
December 31, 1997 and December 31, 1996............................................... 25
Consolidated Statements of Shareholders' Equity for Years Ended
January 2, 1999, December 31, 1997 and December 31, 1996.............................. 26
Consolidated Statements of Cash Flows for Years Ended January 2, 1999,
December 31, 1997 and December 31, 1996............................................... 27
Notes to Consolidated to Financial Statements for Years Ended January 2, 1999,
December 31, 1997 and December 31, 1996............................................... 28
</TABLE>
22
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders of
Shoe Pavilion, Inc.
We have audited the accompanying consolidated balance sheets of Shoe Pavilion,
Inc. and subsidiary (the "Company") as of January 2, 1999 and December 31, 1997,
and the related consolidated statements of income, stockholders' equity, and
cash flows for each of the three years in the period ended January 2, 1999.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of January 2, 1999
and December 31, 1997, and the results of its operations and its cash flows for
each of the three years in the period ended January 2, 1999 in conformity with
generally accepted accounting principles.
DELOITTE & TOUCHE LLP
San Francisco, California
February 12, 1999
23
<PAGE>
<TABLE>
<CAPTION>
SHOE PAVILION, INC.
CONSOLIDATED BALANCE SHEETS
January 2, December 31,
1999 1997
------------ -------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash ............................................................ $ 1,921,870 $ 394,660
Inventories ..................................................... 26,892,101 19,795,599
Prepaid expenses and other ...................................... 257,378 72,955
------------ ------------
Total current assets ..................................... 29,071,349 20,263,214
FIXED ASSETS:
Store fixtures and equipment .................................... 2,800,448 2,158,704
Leasehold improvements .......................................... 2,144,028 1,499,813
Stores and systems projects in-progress ......................... 1,330,780 99,776
------------ ------------
Total .................................................... 6,275,256 3,758,293
Less accumulated depreciation ................................... 2,440,441 1,683,604
------------ ------------
Net fixed assets ................................................ 3,834,815 2,074,689
DEFERRED INCOME TAXES AND OTHER ...................................... 628,070 307,955
------------ ------------
TOTAL .................................................... $ 33,534,234 $ 22,645,858
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ................................................ $ 5,967,211 $ 5,920,980
Accrued expenses ................................................ 946,116 842,812
Short-term borrowings ........................................... 8,407,262 7,387,125
Current portion of capitalized lease obligations ................ 11,868 67,542
------------ ------------
Total current liabilities ................................ 15,332,457 14,218,459
DEFERRED RENT ........................................................ 1,098,662 909,226
CAPITALIZED LEASE OBLIGATIONS, less current portion .................. 74,745 190,117
COMMITMENTS AND CONTINGENCIES ........................................ - -
STOCKHOLDERS' EQUITY:
Preferred stock - $.001 par value; 1,000,000 shares authorized;
no shares issued or outstanding ................................ - -
Common stock - $.001 par value: 15,000,000 shares authorized;
issued and outstanding; 6,800,000 and 4,500,000 ................ 6,800 4,500
Additional paid-in capital ...................................... 13,967,258 812,033
Retained earnings ............................................... 3,054,312 6,511,523
------------ ------------
Total stockholders' equity ............................... 17,028,370 7,328,056
------------ ------------
TOTAL .................................................... $ 33,534,234 $ 22,645,858
============ ============
</TABLE>
See notes to consolidated financial statements
24
<PAGE>
<TABLE>
<CAPTION>
SHOE PAVILION, INC.
CONSOLIDATED STATEMENTS OF INCOME
December 31,
January 2, ---------------------------
1999 1997 1996
------------- ----------- ------------
<S> <C> <C> <C>
NET SALES ................................................ $ 55,907,211 $ 45,074,041 $ 30,315,326
COST OF SALES AND RELATED OCCUPANCY EXPENSES 35,777,493 28,922,392 20,317,844
------------- ----------- ------------
Gross profit .................................... 20,129,718 16,151,649 9,997,482
SELLING EXPENSES ......................................... 11,472,385 8,800,332 5,592,472
GENERAL AND ADMINISTRATIVE EXPENSES 3,663,852 3,105,717 2,630,044
------------- ----------- ------------
Income from operations .......................... 4,993,481 4,245,600 1,774,966
OTHER INCOME (EXPENSE):
Interest ............................................. (430,359) (575,471) (259,281)
Other - net ............................................ (22,716) 55,601 (27,934)
------------- ----------- ------------
Total other expense - net ......................... (453,075) (519,870) (287,215)
------------- ----------- ------------
Income before income taxes .............................. 4,540,406 3,725,730 1,487,751
PROVISION FOR INCOME TAXES ............................... (1,146,954) (260,800) (98,000)
------------- ----------- ------------
NET INCOME ............................................... $ 3,393,452 $ 3,464,930 $ 1,389,751
============= =========== ============
Net income per share:
Basic .................................................... $ 0.53 $ 0.77 $ 0.31
Diluted .................................................. $ 0.52 $ 0.77 $ 0.31
Weighted average shares outstanding:
Basic .................................................... 6,461,580 4,500,000 4,500,000
Diluted .................................................. 6,473,771 4,500,000 4,500,000
PRO FORMA
Historical income before taxes on income ............... $ 4,540,406 $ 3,725,730 $ 1,487,751
Pro forma provision for income taxes ................... (1,748,000) (1,434,406) (565,345)
------------- ----------- ------------
Pro forma net income ................................... $ 2,792,406 $ 2,291,324 $ 922,406
============= =========== ============
Pro forma net income per share:
Basic .................................................... $ 0.42 - -
Diluted .................................................. $ 0.42 - -
Pro forma weighted average shares outstanding:
Basic .................................................... 6,647,871 - -
Diluted .................................................. 6,660,062 - -
</TABLE>
See notes to consolidated financial statements
25
<PAGE>
<TABLE>
<CAPTION>
SHOE PAVILION, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock
------------------- Additional
Number Paid-in Retained
of Shares Amount Capital Earnings Total
---------- ------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1996.................... 4,500,000 $ 4,500 $ 30,500 $ 2,660,385 $ 2,695,385
Net income.................................. 1,389,751 1,389,751
Conversion of note payable to equity........ 781,533 781,533
Distribution to previous sole stockholder... (300,000) (300,000)
--------- ------- ------------ ----------- ------------
BALANCE AT DECEMBER 31, 1996.................. 4,500,000 4,500 812,033 3,750,136 4,566,669
Net income.................................. 3,464,930 3,464,930
Distribution to previous sole stockholder... (703,543) (703,543)
--------- ------- ------------ ----------- ------------
BALANCE AT DECEMBER 31, 1997.................. 4,500,000 4,500 812,033 6,511,523 7,328,056
Issuance of stock through initial
public offering.......................... 2,300,000 2,300 14,104,562 14,106,862
Net income.................................. 3,393,452 3,393,452
Distribution to previous sole stockholder... (949,337) (6,850,663) (7,800,000)
--------- ------- ------------ ----------- ------------
BALANCE AT JANUARY 2, 1999.................... 6,800,000 $ 6,800 $ 13,967,258 $ 3,054,312 $ 17,028,370
========= ======= ============ =========== ============
</TABLE>
See notes to consolidated financial statements.
26
<PAGE>
<TABLE>
<CAPTION>
SHOE PAVILION, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
December 31,
January 2, -----------------------------------
1999 1997 1996
------------ ------------ -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income ............................................. $ 3,393,452 $ 3,464,930 $ 1,389,751
Adjustments to reconcile net income to net cash
provided (used) by operating activities
Depreciation ......................................... 798,566 617,878 449,864
Other ................................................ 34,965 701 32,134
Deferred income taxes ................................ (485,447) - -
Effect of changes in:
Inventories ....................................... (7,096,502) (6,309,873) (5,303,009)
Prepaid expenses and other ........................ (19,092) (298,844) (2,597)
Accounts payable .................................. 46,231 226,411 3,780,250
Accrued expenses and deferred rent ................ 305,689 527,842 219,501
------------ ------------ ------------
Net cash provided (used) by operating activities (3,022,138) (1,770,955) 565,894
------------ ------------ ------------
INVESTING ACTIVITIES:
Purchase of fixed assets ............................ (2,593,656) (1,210,911) (569,228)
------------ ------------ ------------
FINANCING ACTIVITIES:
Net proceeds from initial public offering ........... 14,106,862 - -
Proceeds from long-term debt ........................ - - 23,129
Short-term borrowings ............................... 1,020,137 3,987,125 459,577
Principal payments on capital leases ................ (183,995) (38,220) (21,067)
Principal payments on long-term debt ................ - (70,633) (68,511)
Distributions paid to previous sole stockholder ..... (7,800,000) (703,543) (300,000)
------------ ------------ ------------
Net cash provided by financing activities ...... 7,143,004 3,174,729 93,128
------------ ------------ ------------
NET INCREASE IN CASH ................................... 1,527,210 192,863 89,794
CASH, BEGINNING OF PERIOD .............................. 394,660 201,797 112,003
------------ ------------ ------------
CASH, END OF PERIOD .................................... $ 1,921,870 $ 394,660 $ 201,797
============ ============ ============
CASH PAID FOR:
INTEREST ............................................... $ 416,072 $ 571,764 $ 259,281
INCOME TAXES ........................................... 1,826,000 332,262 28,031
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING
AND FINANCING ACTIVITIES:
Note payable to stockholder converted to equity ...... - - $ 781,533
Capital lease obligations for store equipment ........ - $ 105,993 189,918
</TABLE>
See notes to consolidated financial statements.
27
<PAGE>
SHOE PAVILION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND OPERATIONS
General--Shoe Pavilion, Inc. (the "Company"), a Delaware corporation, is the
successor to Shoe Pavilion Corporation (formerly Shoe Inn, Inc.), which was
incorporated in the State of Washington in 1983. In connection with the initial
public offering, the previous sole stockholder of Shoe Pavilion Corporation
entered into an agreement providing for a reorganization prior to the offering.
Under the terms of this agreement all of the common stock of Shoe Pavilion
Corporation was exchanged for common stock of the Company and Shoe Pavilion
Corporation became a wholly owned subsidiary. The Company was incorporated in
November 1997 for this purpose. The terms of the reorganization provided for the
issuance of 9,000 shares of the Company's common stock for every one share of
Shoe Pavilion Corporation common stock. The accompanying financial statements
reflect the reorganization as if Shoe Pavilion Corporation had always been a
wholly owned subsidiary of the Company. However, the accompanying financial
statements do not reflect the termination of Shoe Pavilion Corporation's S
corporation status until February 23, 1998. All share and per share information
has been retroactively restated to reflect the reorganization.
Public Offering--On February 27, 1998, the Company sold 2,300,000 shares of
its common stock for net proceeds of $14,107,000. In connection with the
offering, the Company terminated its status as an S corporation and recorded a
deferred income tax benefit of $485,000.
Operations--The Company operates as a single business segment of off-price
shoe stores located in California, Washington and Oregon, under the name Shoe
Pavilion. The Company had 69, 55 and 41 stores open as of January 2, 1999,
December 31, 1997 and 1996, respectively. The Company purchases inventory from
international and domestic vendors. For 1998, the Company's top ten suppliers
accounted for 46.9% of inventory purchases.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Consolidation Policy--The consolidated financial statements include the
Company and its wholly owned subsidiary, Shoe Pavilion Corporation. All
significant intercompany balances and transactions have been eliminated.
Change of Year--In December 1998, the Company changed its year end to a 52-53
week year ending on the Saturday nearest to December 31. All references
herein to 1998 refer to the year ending January 2, 1999.
Cash represents cash on hand and cash held in banks.
Inventories are stated at the lower of average cost (determined on a first-
in, first-out basis) or market.
Fixed assets are stated at cost and depreciation and amortization are provided
on the straight-line method over the estimated useful lives of the assets
ranging from three to five years. Leasehold improvements are amortized on the
straight-line method over the shorter of the useful lives of the assets or lease
term, generally five years. At January 2, 1999, the fixed assets include
approximately $1,247,000 in costs related to the implementation of the Company's
new management information systems, which will be completed in 1999.
Other assets at January 2, 1999 primarily represent deferred income taxes and
deposits.
28
<PAGE>
SHOE PAVILION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Income Taxes--Effective February 23, 1998, the Company is taxed as a C
corporation for federal and state income tax purposes. The income tax provision
as of January 2, 1999 reflects this status. Prior to February 23, 1998, the
Company was taxed as an S corporation for federal income tax reporting
purposes, which provides that taxable income or loss of the Company is generally
passed through to the individual stockholders. Accordingly, no provision for
federal income taxes has been recorded in the accompanying financial statements
prior to February 23, 1998. Upon conversion from an S corporation to a C
corporation, the Company recorded a deferred tax asset of $485,477, which
reduced tax expense. The Company elected to be a C corporation in the state of
California. Accordingly, taxes are provided for income attributable to the
Company's operations in this state.
Deferred Rent--Certain of the Company's store leases provide for free or
reduced rent during an initial portion of the lease term. Deferred rent consists
of the aggregate obligation for lease payments under these leases amortized on a
straight-line basis over the lease term, in excess of amounts paid. In addition,
deferred rent includes construction allowances received from landlords, which
are amortized on a straight-line basis over the initial lease term.
Preopening Costs--Store preopening costs are charged to expense as incurred.
Long-lived Assets--The Company periodically reviews long-lived assets for
impairment to determine whether any events or circumstances indicate that the
carrying amount of the assets may not be recoverable. Such review includes
estimating expected future cash flows. No impairment loss provisions have been
required to date.
Net Income Per Share--Basic income per share is computed as net income divided
by the weighted average number of common shares outstanding during the period.
Diluted income per share reflects the potential dilution that could occur from
the exercise of outstanding stock options and is computed by dividing net income
by the weighted average number of common shares outstanding for the period plus
the dilutive effect of outstanding stock options.
Comprehensive Income equals net income.
New Accounting Pronouncements--In April 1998, the Accounting Standards
Executive Committee issued Statement of Position ("SOP") 98-5, Reporting on the
Costs of Start-Up Activities, which requires costs of start-up activities and
organization costs to be expensed as incurred. The SOP requires entities to
expense as incurred all start-up and preopening costs that are not otherwise
capitalizable as long-lived assets. The SOP will be effective for years
beginning after December 15, 1998. As the Company charges store preopening
costs to expense as incurred, adoption of this statement will not impact the
Company's financial position.
Reclassifications--Certain 1997 amounts have been reclassified to conform with
the 1998 presentation.
3. PRO FORMA INFORMATION
The objective of the pro forma information is to show what the significant
effects on the historical information might have been had the Company not been
treated as an S corporation for tax purposes prior to February 23, 1998, the
effective date of the Company's initial public offering.
Income Taxes--The pro forma information presented in the consolidated
statements of income reflects a provision for income taxes at an effective rate
of 38.5% for the years ended January 2, 1999 and December 31, 1997.
29
<PAGE>
SHOE PAVILION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. PRO FORMA INFORMATION (CONTINUED)
Pro Forma Net Income Per Share--Pro forma basic net income per share is based
on the weighted average number of shares of common stock outstanding during the
period plus the estimated number of shares offered by the Company (1,271,722)
which were necessary to fund the $7,800,000 distribution paid to the Company's
stockholder upon termination of the Company's status as an S corporation. Pro
forma diluted net income per share is calculated using the number of shares used
in the basic calculation plus the dilutive effect of stock options outstanding
during the period.
4. FINANCING AGREEMENTS
In December 1998, the Company entered into a new a credit facility agreement
with a financial institution, which includes a revolving line of credit for
$15.0 million expiring on December 1, 2000. This line of credit is also
available for the issuance of commercial and standby letters of credit up to
$4.0 million. The Company pays interest on outstanding amounts at the bank's
prime rate or LIBOR plus 130 basis points, at the Company's option. The weighted
average interest rate was 6.7% at January 2, 1999. Borrowings under the credit
facility are secured by the Company's accounts receivable, general intangibles,
inventory and other rights to payment. The agreement contains restrictive
covenants that require, among other things, that (a) total liabilities may not
exceed 1.5 times tangible net worth, (b) quarterly net income after taxes and
pre-tax profit must each not be less than one dollar, (c) EBITDA must not be
less than $3.75 million on a rolling four-quarter basis and (d) outstanding
balance on the line of credit may not exceed 0.5 times inventory plus the amount
available under outstanding letters of credit, and prohibits the declaration and
payment of cash or stock dividends . The Company was in compliance with all
covenants for the period ended January 2, 1999. As of January 2, 1999, the
unused and available portion of the credit facility was approximately $6.6
million.
5. COMMITMENTS AND CONTINGENCIES
Leases--The Company is obligated under operating leases for store and
warehouse locations and equipment. While most of the agreements provide for
minimum lease payments and include rent escalation clauses, certain of the store
leases provide for additional rentals contingent upon prescribed sales volumes.
Additionally, the Company is required to pay common area maintenance and other
costs associated with the centers in which the stores operate. Most of the
leases provide for renewal at the option of the Company.
The Company's assets under capital leases as of January 2, 1999 and December
31, 1997 are as follows:
<TABLE>
<CAPTION>
January 2, December 31,
1999 1997
--------- ---------
<S> <C> <C>
Total assets under capital leases..................... $ 295,911 $ 295,911
Less accumulated amortization......................... 127,731 74,160
--------- ---------
Total................................................. $ 168,180 $ 221,751
========= =========
</TABLE>
30
<PAGE>
SHOE PAVILION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Future minimum lease payments required are:
<TABLE>
<CAPTION>
Capital Operating
Leases Leases
--------- ------------
<S> <C> <C>
Year ending:
2000............................................... $ 20,832 $ 6,627,506
2001............................................... 20,832 5,666,794
2002............................................... 20,832 5,104,137
2003............................................... 47,614 3,609,458
2004............................................... - 2,374,239
Thereafter...................................... - 4,070,130
-------- ------------
Total minimum lease payments....................... 110,110 $ 27,452,264
============
Less amounts representing interest................. 23,497
--------
Present value of capital lease obligations......... 86,613
Less current portion............................... 11,868
--------
Total long-term portion............................ $ 74,745
========
</TABLE>
Rental expense for the years ended January 2, 1999, December 31, 1997 and 1996
was, $5,934,733, $5,438,395 and $3,768,318, respectively, including contingent
rentals of $307,355, $278,740 and $204,587, respectively.
Letters of Credit--The Company has obtained letters of credit in connection
with overseas purchase arrangements. The total amount outstanding was $1,118,114
as of January 2, 1999. The Company also has standby letters of credit relating
to rental agreements of $53,236 as of January 2, 1999.
Contingencies--The Company is party to various legal proceedings arising from
normal business activities. Management believes that the resolution of these
matters will not have an adverse material effect on the Company's financial
position or results of operations.
31
<PAGE>
SHOE PAVILION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. INCOME TAXES
The following table reflects the components of deferred tax assets at January
2, 1999:
<TABLE>
<CAPTION>
Net Deferred
Income Tax
Asset (Liability)
----------------------
<S> <C>
Uniform capitalization of inventory costs............................. $182,218
Inventory reserve..................................................... 7,703
Prepaid expenses...................................................... (7,986)
Difference in basis of fixed assets................................... (44,575)
Other................................................................. 2,889
Deferred rent and tenant improvements................................. 345,198
--------
Net Deferred Tax Asset................................................ $485,447
========
</TABLE>
The 1998 provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
Current:
<S> <C>
Federal............................................................ $1,419,981
State.............................................................. 212,450
----------
Total current...................................................... 1,632,431
Deferred.............................................................. 485,477
----------
Total provision....................................................... $1,146,954
==========
</TABLE>
A reconciliation of the statutory federal income tax rate with the Company's
effective income tax rate as of January 2, 1999 is as follows:
<TABLE>
<CAPTION>
Rate Amount
------- -----------
<S> <C> <C>
Income before income taxes..................................... $4,540,406
Statutory federal rate......................................... 34.00% 1,543,738
State income taxes, net of federal income tax benefit.......... 3.09 140,217
Other.......................................................... (1.14) (51,554)
Change in tax status........................................... (10.69) (485,447)
------- ----------
Effective tax rate............................................. 25.26% $1,146,954
======= ==========
</TABLE>
32
<PAGE>
7. STOCKHOLDERS' EQUITY
Stock Options--In January 1998, the Company adopted the 1998 Equity Incentive
Plan (the "1998 Plan") authorizing the issuance of 1,000,000 shares of Common
Stock to key employees and consultants of the Company. The 1998 Plan provides
for awards of nonqualified stock option grants to purchase Common Stock at
prices equal to fair market value at the date of grant. During 1998, the Company
granted options under this plan for the purchase of 319,000 shares of Common
Stock at exercise prices ranging from $4.75 to $10.25 per share, the fair market
value of the shares at the date of grant. Such options vest at 20% each year,
beginning at the date of grant and expire ten years from that date. At January
2, 1999, 707,000 options were available for grants and no options were
exercisable.
Directors' Stock Options--In January 1998, the Company adopted the Directors'
Stock Option Plan (the "Directors' Plan") authorizing the issuance of 100,000
shares of Common Stock to non-employee directors of the Company. The Directors'
Plan provides for awards of nonqualified stock options to purchase Common Stock
at prices equal to fair market value at the date of grant. During 1998, the
Company granted options under this plan for the purchase of 15,000 shares of
Common Stock at an exercise price of $7.00 per share, the fair market value of
the shares at the date of grant. Such options vest 100% at the expiration of one
year from grant date and expire six years from that date. At January 2, 1999,
85,000 options were available for grant and no options were exercisable.
The following tables summarize information about the stock options under both
plans outstanding at January 2,1999:
<TABLE>
<CAPTION>
Weighted
Number Average
of Shares Exercise Price
--------- --------------
<S> <C> <C>
Balance at December 31, 1997 - -
Option granted 334,000 $ 6.96
Options canceled..... (26,000) (7.52)
------- ------
Balance at January 2, 1999. 308,000 $ 6.91
======= ======
Weighted average fair value of
options granted during 1998..... $ 5.06
</TABLE>
<TABLE>
<CAPTION>
Weighted Average
Number of Remaining Number
Range of Outstanding at Contractual Life Weighted Average Exercisable at Weighted Average
Exercise Prices January 2, 1999 (in years) Exercise Price January 2, 1999 Exercise Price
- ---------------- --------------- ---------------- ---------------- ------------------- ----------------
<S> <C> <C> <C> <C> <C>
$4.75 30,000 9.82 $4.75 0 $0.00
$7.00 264,000 9.15 $7.00 0 $0.00
$9.69-$10.25 14,000 9.39 $9.85 0 $0.00
- ----------------- ------- ------ ----- - -----
$4.75-$10.25 308,000 9.22 $6.91 0 $0.00
================= ======= ====== ===== = =====
</TABLE>
The Company accounts for its stock option plans in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and
its related interpretations. Accordingly, no compensation expense has been
recognized in the financial statements for stock option arrangements.
33
<PAGE>
SHOE PAVILION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. STOCKHOLDERS' EQUITY (CONTINUED)
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the
disclosure of pro forma net income and net income per share had the Company
adopted the fair value method as of the beginning of 1995. Under SFAS No. 123,
the fair value of stock-based awards to employees is calculated through the use
of option pricing models, even though such models were developed to estimate the
fair value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option awards.
These models also require subjective assumptions, including future stock price
volatility and expected time to exercise, which greatly affect the calculated
values. The Company's calculations were made using the Black-Scholes option
pricing model with the following weighted average assumptions: expected life of
5.7 years following vesting; stock price volatility of 85.17%; risk free
interest rate of 6.0%; and no dividends during the expected term. Forfeitures
are recognized as they occur. If the computed fair values of the 1998 awards had
been amortized to expense over the vesting period of the awards, pro form net
income would have been reduced to the pro form amounts indicated below.
<TABLE>
<CAPTION>
Year Ended
January 2, 1999
-----------------
<S> <C>
Net income:
As reported........................................................... $3,393,452
Pro forma for the effect of stock options............................. $2,994,316
Net income per share:
As reported:
Basic................................................................. $ 0.53
Diluted............................................................... $ 0.52
Pro forma for the effect of stock options:
Basic and diluted..................................................... $ 0.46
</TABLE>
8. EMPLOYEE BENEFIT PLAN
The Company established a 401(k) Savings Plan (the "Plan") effective January
1, 1998. An employee becomes eligible to participate in the Plan after
completing one year of service and attainment of age 21; however, all employees
hired prior to January 1, 1998, regardless of length of service, were permitted
to enroll in the Plan. Generally, employees may contribute up to 15% of their
compensation or a maximum of $10,000 in accordance with IRC Sections 402(g),
401(k) and 415. For every dollar contributed to the Plan, the Company will match
50 cents, up to a maximum of 3% of the employee's compensation. There were no
Company contributions for the year ending January 2, 1999. The Company's
contributions vest over a five year period.
During 1998, the Plan was not implemented and was subsequently amended to
permit enrollment in the Plan by employees, over the age of 21, hired prior to
January 1, 1999, regardless of length of service. This amendment was a one time
event as the service requirement was later reinstated by an additional
amendment. The Plan was fully implemented and will begin in the year ending
January 1, 2000.
34
<PAGE>
SHOE PAVILION, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
(In thousands, Historical Pro Forma (see Note 3)
except per share data) ----------------------------------------- ----------------------------------
Net Income Net Income
Per Share Per Share
Gross Net --------------- Net ---------------
Sales Profit Income Basic Diluted Income Basic Diluted
------- ------ ------ ----- ------- ------ ----- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1998 Quarters
4th Quarter ........................ $16,432 $6,145 $ 885 $0.13 $ 0.13 - - -
3rd Quarter ........................ 14,638 5,380 800 0.12 0.12 - - -
2nd Quarter ........................ 13,386 4,795 686 0.10 0.10 - - -
1st Quarter (1) .................... 11,451 3,810 1,022 0.19 0.19 $ 427 $0.07 $ 0.07
1997 Quarters
4th Quarter ........................ $12,889 $4,646 $1,234 $0.27 $ 0.27 $ 797 - -
3rd Quarter ........................ 11,856 4,049 558 0.12 0.12 374 - -
2nd Quarter ........................ 12,174 4,674 1,177 0.26 0.26 788 - -
1st Quarter ........................ 8,155 2,785 496 0.11 0.11 332 - -
</TABLE>
(1) In connection with its public offering in February 1998, the Company
terminated its status as an S corporation and recorded a deferred income tax
benefit of $485,000.
35
<PAGE>
Item 9 -- Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10 -- Directors and Executive Officers of the Registrant
The information required by this item is incorporated by reference from the
Company's Definitive Proxy Statement for the Company's 1999 Annual Meeting of
Stockholders under the captions "Election of Directors" and "Section 16(a)
Beneficial Ownership Reporting Compliance." See also Item 1 above.
Item 11 -- Executive Compensation
The information required by this item is incorporated by reference from the
Company's Definitive Proxy Statement for the Company's 1999 Annual Meeting of
Stockholders under the caption "Executive Compensation."
Item 12 -- Security Ownership of Certain Beneficial Owners and Management
The information required by this item is incorporated by reference from the
Company's Definitive Proxy Statement for the Company's 1999 Annual Meeting of
Stockholders under the caption "Ownership of Management and Principal
Stockholders."
Item 13 -- Certain Relationships and Related Transactions
The information required by this item is incorporated by reference from the
Company's Definitive Proxy Statement for the Company's 1999 Annual Meeting of
Stockholders under the captions "Compensation Committee Interlocks and Insider
Participation" and "Transactions with the Company."
PART IV
Item 14 -- Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as part of this report:
(1) Consolidated Financial Statements of the Company are included in Part
II, Item 8:
Independent Auditors' Report
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Cash Flows
Consolidated Statements of Shareholders' Equity
Notes to Consolidated Financial Statements
(2) Consolidated Supplementary Financial Statement Schedule for the years
ended January 2, 1999 and December 31, 1997:
None.
36
<PAGE>
All other schedules are omitted because of the absence of conditions under
which they are required or because the required information is included in the
consolidated financial statements or notes thereto.
(3) Exhibits:
See attached Exhibit Index.
(b) The Company filed the following reports on Form 8-K during the fourth
quarter of 1998:
(1) A report dated December 29, 1998 disclosing a fiscal year end change.
37
<PAGE>
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Date: March 19, 1999
SHOE PAVILION, INC.
By /s/ Dmitry Beinus
-------------------------------------------
Dmitry Beinus
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated.
<TABLE>
<CAPTION>
Signature Capacity Date
--------- -------- ----
<S> <C> <C>
/s/ Dmitry Beinus Chairman, President and Chief March 19, 1999
- ------------------------------------ Executive Officer (Principal
Dmitry Beinus Executive Officer)
/s/ Gary A. Schwartz Vice President, Chief Financial March 19, 1999
- ------------------------------------ Officer (Principal Financial Officer
Gary A. Schwartz and Principal Accounting Officer)
/s/ David H. Folkman Director March 19, 1999
- ------------------------------------
David H. Folkman
/s/ Peter G. Hanelt Director March 19, 1999
- ------------------------------------
Peter G. Hanelt
</TABLE>
38
<PAGE>
EXHIBIT INDEX
Set forth below is a list of exhibits that are being filed or incorporated by
reference into this Form 10-K:
<TABLE>
<CAPTION>
Exhibit
Number Exhibit
- -------- -------
<C> <S>
2.1 Exchange Agreement dated February 23, 1998 by and among Shoe
Pavilion, Inc., Shoe Inn, Inc. and Dmitry Beinus (Incorporated by
reference from Exhibit 2.1 to Registration Statement No. 333-41877).
3.1 Certificate of Incorporation of the Registrant (Incorporated by
reference from Exhibit 3.1 to Registration Statement No. 333-41877).
3.2 Bylaws of the Registrant (Incorporated by reference from Exhibit 3.2
to Registration Statement No. 333-41877).
4.1 Specimen Common Stock Certificate (Incorporated by reference from
Exhibit 4.1 to Registration Statement No. 33-41877).
10.1 Lease Agreement between Lincoln-Whitehall Pacific, LLC and Shoe Inn,
Inc. dated October 28, 1996 (Incorporated by reference from Exhibit
10.1 to Registration Statement No. 333-41877).
10.2 First Amendment to Lease Agreement between Lincoln-Whitehall
Pacific, LLC and Shoe Pavilion Corporation dated September 17, 1998.
10.3 Second Amendment to Lease Agreement between Lincoln-Whitehall
Pacific, LLC and Shoe Pavilion Corporation dated January 11, 1999.
10.4 1998 Equity Incentive Plan with forms of non-qualified and incentive
stock option agreements (Incorporated by reference from Exhibit 10.2
to Registration Statement No. 333-41877).
10.5 Directors' Stock Option Plan with form of stock option agreement
(Incorporated by reference from Exhibit 10.3 to Registration
Statement No. 333-41877).
10.6 Credit Agreement dated December 1, 1998 between Shoe Pavilion
Corporation and Wells Fargo Bank, National Association.
10.7 Revolving Line of Credit Note dated December 1, 1998 between Shoe
Pavilion Corporation and Wells Fargo Bank, National Association.
10.8 Continuing Guaranty dated December 1, 1998 between Shoe Pavilion,
Inc. and Wells Fargo Bank, National Association.
10.9 Tax Allocation Agreement dated February 18, 1998 between Shoe Inn,
Inc. and Dmitry Beinus (Incorporated by reference from Exhibit 10.5
to Registration Statement No. 333-41877).
10.10 Agreement of Purchase and Sale dated as of April 14, 1997 among
Standard Shoe Company and Shoe Inn, Inc. (Incorporated by reference
from Exhibit 10.6 to Registration Statement No. 333-41877).
10.11 Form of Indemnification Agreement between the Registrant and certain
of its officers and directors (Incorporated by reference from
Exhibit 10.7 to Registration Statement No. 333-41877).
21 List of Subsidiaries
23 Independent Auditors' Consent
27 Financial Data Schedule
</TABLE>
39
<PAGE>
Exhibit 10.2
FIRST AMENDMENT TO LEASE AGREEMENT
This First Amendment to Lease Agreement (the "Amendment") is made and entered
into as of September 17, 1998, by and between LINCOLN-WHITEHALL PACIFIC, LLC, A
DELAWARE LIMITED LIABILITY COMPANY ("LANDLORD"), and SHOE INN, INC., DBA SHOE
PAVILION, A WASHINGTON CORPORATION ("TENANT"), with reference to the following
facts.
RECITALS
A. Landlord and Tenant have entered into that certain Lease Agreement dated as
of October 28, 1996 (the "Lease"), for the leasing of certain premises
consisting of approximately 58,028 rentable square feet located at 3200 Regatta
Blvd., Unit F, Richmond, California (the "Original Premises") as such Original
Premises are more fully described in the Lease.
B. Landlord and Tenant now wish to amend the Lease to provide for, among other
things, the addition of certain contiguous space to the Original Premises, all
upon and subject to each of the terms, conditions, and provisions set forth
herein.
NOW, THEREFORE, in consideration of the foregoing and for other good and
valuable consideration, the receipt and adequacy of which are hereby
acknowledged, Landlord and Tenant agree as follows:
1. Recitals: Landlord and Tenant agree that the above recitals are true
--------
and correct and are hereby incorporated herein as though set forth in
full.
2. Premises:
--------
2.1 Commencing on January 1, 1999 (the "AP Commencement Date")
there shall be added to the Original Premises those certain premises
consisting of approximately 34,000 rentable square feet located at
3200 Regatta Blvd., Unit A, Richmond, California (the "Additional
Premises"), which Additional Premises are depicted on the site plan
attached hereto and made a part hereof as Exhibit A. Tenant hereby
acknowledges that the Additional Premises are presently being occupied
by IMSI (the "Existing Tenant"). Landlord's delivery to Tenant of
possession of the Additional Premises by January 1, 1999 is contingent
upon the Existing Tenant vacating the Additional Premises and
surrendering possession thereof to Landlord by December 31, 1998. If
Landlord cannot deliver to Tenant possession of the Additional
Premises broom clean but without the tenant improvements set forth
below, on January l, 1999, Landlord shall neither be subject to any
liability nor shall the validity of the Lease be affected, provided,
the Lease Term applicable to the Additional Premises shall be commence
on the date possession is tendered and in no event shall the
Expiration Date be extended.
2.2 For purposes of the Lease, from and after the AP
Commencement Date, the "Premises" as defined in Section 1 of the Lease
shall mean and refer to the aggregate of the Original premises and the
Additional Premises consisting of a combined total of approximately
92,028 rentable square feet located at 3200 Regatta Blvd., Units A and
F, Richmond, California. Accordingly, from and after the AP
Commencement Date, all references in this Amendment and in the Lease
to the term "Premises" shall mean and refer to the Original Premises
and the Additional Premises. Landlord and Tenant hereby agree that for
purposes of the Lease, from and after the AP Commencement Date, the
rentable square footage area of the Premises shall be conclusively
deemed to be 92,028 rentable square feet. In addition to the
foregoing, it is the parties express intention that the balance of the
Term of the Lease for the Original Premises and the Additional
Premises be coterminous with the Expiration Date of the initial Term
as specified in the Lease and that any option or renewal term
described in the Lease shall be applicable to both the Premises and
the Additional Premises.
2.3 Notwithstanding anything to the contrary contained herein or
in the Lease, Landlord shall neither be subject to any liability, nor
shall the validity of the Lease be affected if Landlord is notable to
deliver to Tenant possession of the Additional Premises by the AP
Commencement Date. Provided, however, Tenant's obligation to pay Rent
on
<PAGE>
* However, if Landlord does not deliver possession of Additional
Premises to Tenant by 3/1/99, Tenant shall have the right to terminate
its obligation regarding the Additional Premises as set forth in this
Amendment.
the Additional Premises shall commence on the date possession is
tendered.
3. Base Rent: The Basic Lease Information and Section 3 of the Lease are
---------
hereby modified to provide that during the Term of the Lease the
monthly Base Rent payable by Tenant to Landlord, in accordance with
the provisions of Section 3 of the Lease shall be as follows:
<TABLE>
<CAPTION>
Original Premises Additional Premises Aggregate Amount of
Period monthly Base Rent monthly Base Rent monthly Base Rent
------ ----------------- ----------------- -----------------
<S> <C> <C> <C>
1/1/99-2/28/99 $19,149.24 $11,560.00 $30,709.24
3/1/99-12/31/99 $19,729.52 $11,560.00 $31,289.52
1/1/00-2/28/00 $19,729.52 $11,900.00 $31,629.52
3/1/00-12/31/00 $20,309.80 $11,900.00 $32,209.80
1/1/01-2/28/01 $20,309.80 $12,240.00 $32,549.80
3/1/01-2/28/02 $20,890.08 $12,240.00 $33,130.08
</TABLE>
The initial monthly Base Rent for any extended or option term shall be
determined in accordance with Addendum 2 to the Lease for both the
Original Premises and Additional Premises.
4. Condition of the Additional Premises: Subject to the provisions of
------------------------------------
Section 2 above, on the AP Commencement Date Landlord shall deliver to
Tenant possession of the Additional Premises in its then existing
condition and state of repair, "AS IS", without any obligation of
landlord to remodel, improve or alter the Additional Premises, to
perform any other construction or work of improvement upon the
Additional Premises, or to provide Tenant with any construction or
refurbishing allowance. Notwithstanding the foregoing, Landlord at
Landlord's sole cost and expense shall: (I) install two 12' x 12'
openings in the demising wall between Units F and A; and (ii) deliver
the Premises with the existing HVAC in good working condition.
5. Tenant's Share of Operating Expenses: As of the AP Commencement Date,
------------------------------------
the Lease shall be modified to provide that Tenant's Share of
Operating Expenses (as defined in the Basic Lease Information and
Section 6 of the Lease) shall be increased to 22.35%.
6. Tenant's Share of Tax Expenses: As of the AP Commencement Date, the
------------------------------
Lease shall be modified to provide that Tenant's Share of Tax Expenses
(as defined in the Basic Lease Information and Section 6 of the Lease)
shall be increased to 22.35%.
7. Tenants' Share of Utility Expenses: As of the AP Commencement Date,
----------------------------------
the Lease shall be modified to provide that Tenant's Share of Utility
Expenses (as defined in the Basic Lease Information and Section 7 of
the Lease) shall be increased to 22.35%.
8. Tenant's Share of Common Area Utility Costs: As of the AP
-------------------------------------------
Commencement Date, the Lease shall be modified to provide that
Tenant's Share of Common Area Utility Costs (as defined in the Basic
Lease Information and Section 7 of the Lease) shall be increased to
22.35%.
9. Unreserved Parking Spaces: As of the AP Commencement Date, the Lease
-------------------------
shall be modified to provide that Tenant's Unreserved Parking Spaces
(as defined in the Basic Lease Information) shall be increased to 92.
10. Insurance: Tenant shall deliver to Landlord, upon execution of this
---------
Amendment, a certificate of insurance evidencing that the Additional
Premises are included within and covered by Tenant's insurance
policies required to be carried by Tenant pursuant to the Lease.
11. Brokers: Tenant warrants that it has had no dealings with any real
-------
estate broker or agent in connection with the negotiation of this
Amendment. If Tenant has dealt with any person, real estate broker or
agent with respect to this Amendment, Tenant shall be solely
responsible for the payment of any fee due to said person or firm, and
Tenant shall indemnify, defend and hold Landlord free and harmless
against any claims, judgments, damages, costs, expenses, and
liabilities with respect thereto, including attorneys' fees and costs.
2
<PAGE>
12. Effect of Amendment: Except as modified herein, the terms and
-------------------
conditions of the Lease shall remain unmodified and continue in full
force and effect. In the event of any conflict between the terms and
conditions of the Lease and this Amendment, the terms and conditions
of this Amendment shall prevail.
13. Definitions: Unless otherwise defined in this Amendment, all terms
-----------
not defined in this Amendment shall have the meanings assigned to such
terms in the Lease.
14. Authority: Subject to the assignment and subletting provisions of the
---------
Lease, this Amendment shall be binding upon and inure to the benefit
of the parties hereto, their respective heirs, legal representatives,
successors and assigns. Each party hereto and the persons signing
below warrant that the person signing below on such party's behalf is
authorized to do so and to bind such party to the terms of this
Amendment.
15. Incorporation: The terms and provisions of the Lease are hereby
-------------
incorporated in this Amendment.
IN WITNESS WHEREOF, the parties have executed this Amendment as of the date and
year first above written.
TENANT:
Shoe-Inn, Inc., dba Shoe Pavilion,
a Washington corporation
By: /s/ Dmitry Beinus
-----------------------------------
Its: President, CEO
-----------------------------------
Date: 9/21/98
-----------------------------------
By: /s/ Linda Hickey
-----------------------------------
Its: Vice President
-----------------------------------
Date: 9/21/98
-----------------------------------
LANDLORD:
Lincoln-Whitehall Pacific, LLC,
a Delaware limited liability company,
By: LPC MS, Inc.,
As manager and agent for Lincoln-Whitehall Pacific, LLC
By: /s/ illegible
---------------------------------
Senior Vice President
Date: _________________________________
If Tenant is a CORPORATION, the authorized officers must sign on behalf of the
-----------
corporation and indicate the capacity in which they are signing. The Lease must
be executed by the president or vice-president and the secretary or assistant
---
secretary, unless the bylaws or a resolution of the board of directors shall
------
otherwise provide, in which event, the bylaws or a certified copy of the
resolution, as the case may be, must be attached to this Lease.
3
<PAGE>
EXHIBIT A
ADDITIONAL PREMISES
[Map of lease premises.]
<PAGE>
Exhibit 10.3
SECOND AMENDMENT TO LEASE AGREEMENT
This Second Amendment to Lease Agreement (the "Amendment") is made and entered
into as of January 11, 1999, by and between LINCOLN-WHITEHALL PACIFIC, LLC, A
DELAWARE LIMITED LIABILITY COMPANY ("LANDLORD"), AND SHOE INN, INC., DBA SHOE
PAVILION, A WASHINGTON CORPORATION ("TENANT"), with reference to the following
facts.
RECITALS
A. Landlord and Tenant have entered into that certain Lease Agreement dated as
of October 28, 1996 as subsequently amended on September 17, 1998, pursuant
to that First Amendment (the "First Amendment") (collectively the "Lease"),
for the leasing of certain premises consisting of approximately 58,028
rentable square feet located at 3200 Regatta Blvd., Unit F, Richmond,
California (the "Original Premises") and for the leasing of certain
premises consisting of approximately 34,000 rentable square feet located at
3200 Regatta Blvd., Unit A, Richmond, California (the "Additional
Premises"), as such Original Premises and Additional Premises are more
fully described in the Lease.
B. Landlord and Tenant wish to amend the AP Commencement Date for the
Additional Premises, as set forth in the First Amendment.
NOW, THEREFORE, in consideration of the foregoing and for other good and
valuable consideration, the receipt and adequacy of which are hereby
acknowledged, Landlord and Tenant agree as follows:
1. Recitals: Landlord and Tenant agree that the above recitals are true
--------
and correct.
2. The AP Commencement Date of the Lease for the Additional Premises, as
set forth in the First Amendment shall be January 7, 1999.
3. The last day of the Term of the Lease for the Additional Premises and
the Original Premises (the "Expiration Date") shall be February 28,
2002.
4. The dates on which the Base Rent for the Additional Premises and the
Original Premises as set forth in the First Amendment will be adjusted
are :
for the period 1/7/99 to 2/28/99 the monthly Base Rent shall be
$30,709.24;
for the period 3/1/99 to 12/31/99 the monthly Base Rent shall be
$31,289.52;
for the period 1/1/00 to 2/28/00 the monthly Base Rent shall be
$31,629.52;
for the period 3/1/00 to 12/31/00 the monthly Base Rent shall be
$32,209.80;
for the period 1/1/01 to 2/28/01 the monthly Base Rent shall be
$32,549.80; and
for the period 3/1/01 to 2/28/02 the monthly Base Rent shall be
$33,130.08.
5. Effect of Amendment: Except as modified herein, the terms and
-------------------
conditions of the Lease shall remain unmodified and continue in full
force and effect. In the event of any conflict between the terms and
conditions of the Lease and this Amendment, the terms and conditions
of this Amendment shall prevail.
6. Definitions. Unless otherwise defined in this Amendment, all terms not
-----------
defined in this Amendment shall have the meaning set forth in the
Lease.
7. Authority: Subject to the provisions of the Lease, this Amendment
---------
shall be binding upon and inure to the benefit of the parties hereto,
their respective heirs, legal representatives, successors and assigns.
Each party hereto and the persons signing below warrant that the
person signing below on such party's behalf is authorized to do so and
to bind such party to the terms of this Amendment.
1
<PAGE>
8. The terms and provisions of the Lease are hereby incorporated in this
Amendment.
IN WITNESS WHEREOF, the parties have executed this Amendment as of the date and
year first above written.
TENANT:
Shoe-Inn, Inc., dba Shoe Pavilion;
a Washington corporation
By: __________________________________
Its: President, CEO
----------------------------------
Date: 1/13/99
----------------------------------
By: /s/ Linda Hickey
----------------------------------
Its: VP Administration
----------------------------------
Date: 1/13/99
----------------------------------
LANDLORD:
Lincoln-Whitehall Pacific, LLC,
a Delaware limited liability company,
By: Legacy Partners Commercial, Inc.,
as manager and agent for Lincoln-Whitehall Pacific, LLC
By: /s/ illegible
--------------------------------------
Senior Vice President
Date: _____________________________________
If Tenant is a CORPORATION, the authorized officers must sign on behalf of the
-----------
corporation and indicate the capacity in which they are signing. The Lease must
be executed by the president or vice-president and the secretary or assistant
---
secretary, unless the bylaws or a resolution of the board of directors shall
------
otherwise provide, in which event, the bylaws or a certified copy of the
resolution, as the case may be, must be attached to this Lease.
2
<PAGE>
Exhibit 10.6
CREDIT AGREEMENT
THIS AGREEMENT is entered into as of December 1, 1998, by and between SHOE
PAVILION CORPORATION, a Washington corporation ("Borrower"), and WELLS FARGO
BANK, NATIONAL ASSOCIATION ("Bank").
RECITAL
-------
Borrower has requested from Bank the credit accommodation described below,
and Bank has agreed to provide said credit accommodation to Borrower on the
terms and conditions contained herein.
NOW, THEREFORE, for valuable consideration, the receipt and sufficiency of
which are hereby acknowledged, Bank and Borrower hereby agree as follows:
ARTICLE I
---------
THE CREDIT
----------
SECTION 1.1. LINE OF CREDIT.
(a) Line of Credit. Subject to the terms and conditions of this Agreement,
--------------
Bank hereby agrees to make advances to Borrower from time to time up to and
including December 1, 2000, not to exceed at any time the aggregate principal
amount of Fifteen Million Dollars ($15,000,000.00) ("Line of Credit"), the
proceeds of which shall be used for working capital requirements, including,
without limitation, inventory purchases. Borrower's obligation to repay
advances under the Line of Credit shall be evidenced by a promissory note
substantially in the form of Exhibit A attached hereto ("Line of Credit Note"),
all terms of which are incorporated herein by this reference.
(b) Letter of Credit Subfeature. As a subfeature under the Line of Credit,
---------------------------
Bank agrees from time to time during the term thereof to issue commercial and
standby letters of credit for the account of Borrower to finance inventory
purchases (each, a "Letter of Credit" and collectively, "Letters of Credit");
provided however, that the form and substance of each Letter of Credit shall be
subject to approval by Bank, in its sole discretion, which forms shall be
substantially as set forth in Exhibits B and C; and provided further, that the
aggregate undrawn amount of all outstanding Letters of Credit shall not at any
time exceed Four Million Dollars ($4,000,000.00). Each Letter of Credit shall be
issued for a term not to exceed three hundred sixty-five (365) days, as
designated by Borrower; provided however, that no Letter of Credit shall have an
expiration date subsequent to the maturity date of the Line of Credit. The
undrawn amount of all Letters of Credit shall be
<PAGE>
reserved under the Line of Credit and shall not be available for borrowings
thereunder. Each Letter of Credit shall be subject to the additional terms and
conditions of the Letter of Credit Agreement and related documents, if any,
required by Bank in connection with the issuance thereof (each, a "Letter of
Credit Agreement" and collectively, "Letter of Credit Agreements"). Each draft
paid by Bank under a Letter of Credit shall be deemed an advance under the Line
of Credit and shall be repaid by Borrower in accordance with the terms and
conditions of this Agreement applicable to such advances; provided however, that
if advances under the Line of Credit are not available, for any reason, at the
time any draft is paid by Bank, then Borrower shall immediately pay to Bank the
full amount of such draft, together with interest thereon from the date such
amount is paid by Bank to the date such amount is fully repaid by Borrower, at
the rate of interest applicable to advances under the Line of Credit. In such
event Borrower agrees that Bank, in its sole discretion, may debit the following
demand deposit accounts maintained by Borrower with Bank for the amount of any
such draft: 4038-148870, 4038-148953, 4038-148912, and 4038-148995, or if there
are insufficient funds for such purpose in said accounts, any other demand
deposit account maintained by Borrower with Bank.
(c) Borrowing and Repayment. Borrower may from time to time during the
-----------------------
term of the Line of Credit borrow, partially or wholly repay its outstanding
borrowings, and reborrow, subject to all of the limitations, terms and
conditions contained herein or in the Line of Credit Note; provided however,
that the total outstanding borrowings under the Line of Credit shall not at any
time exceed the maximum principal amount available thereunder, as set forth
above.
SECTION 1.2. INTEREST/FEES.
(a) Interest. The outstanding principal balance of the Line of Credit
--------
shall bear interest at the rate of interest set forth in the Line of Credit
Note.
(b) Letter of Credit Fees. Borrower shall pay to Bank (i) a fee upon the
---------------------
issuance of each Letter of Credit equal to the greater of $125.00 or one-eighth
of one percent (0.125%) per annum of the face amount thereof, and (ii) a fee
upon each payment or negotiation by Bank of each draft under any Letter of
Credit equal to the greater of $110.00 or one-eighth percent of one percent
(0.125%) of the amount paid or negotiated, and (iii) a fee upon the occurrence
of any other activity with respect to any Letter of Credit (including without
limitation, the transfer, amendment or cancellation of any Letter of Credit)
determined in accordance with Bank's standard fees and charges then in effect
for such activity.
-2-
<PAGE>
(c) Computation and Payment. Interest (and fees computed on a "per annum"
-----------------------
basis) shall be computed on the basis of a 360-day year, actual days elapsed.
Interest shall be payable at the times and place set forth in the Line of Credit
Note.
SECTION 1.3. COLLECTION OF PAYMENTS. Borrower authorizes Bank to collect
all interest and fees due under the Line of Credit by charging Borrower's demand
deposit account number 4038-148870, 4038-148953, 4038-148912, and 4038-148995,
or if there are insufficient funds for such purpose in said accounts, any other
demand deposit account maintained by Borrower with Bank, for the full amount
thereof. Should there be insufficient funds in any such demand deposit account
to pay all such sums when due, the full amount of such deficiency shall be
immediately due and payable by Borrower.
SECTION 1.4. COLLATERAL.
As security for all indebtedness of Borrower to Bank subject hereto,
Borrower hereby grants to Bank security interests of first priority in all
Borrower's accounts, general intangibles, other rights to payment, and
inventory (with accounts, general intangibles and inventory as defined in the
California Uniform Commercial Code). All of the foregoing shall be evidenced by
and subject to the terms of a Continuing Security Agreement (Rights to Payment
and Inventory) and a UCC-1 Financing Statement, all in form and substance
satisfactory to Bank. Borrower shall reimburse Bank immediately upon demand for
all filing fees incurred in perfecting such security interests.
SECTION 1.5. GUARANTIES. All indebtedness of Borrower to Bank shall be
guaranteed by Shoe Pavilion, Inc. in the principal amount of Fifteen Million
Dollars ($15,000,000.00) each, as evidenced by and subject to the terms of a
Continuing Guaranty in form and substance satisfactory to Bank.
ARTICLE II
----------
REPRESENTATIONS AND WARRANTIES
------------------------------
Borrower makes the following representations and warranties to Bank, which
representations and warranties shall survive the execution of this Agreement and
shall continue in full force and effect until the full and final payment, and
satisfaction and discharge, of all obligations of Borrower to Bank subject to
this Agreement.
SECTION 2.1. LEGAL STATUS. Borrower is a corporation, duly organized and
existing and in good standing under the laws of the state of Washington, and is
qualified or licensed to do business (and is in good standing as a foreign
corporation, if applicable) in all jurisdictions in which such qualification or
-3-
<PAGE>
licensing is required or in which the failure to so qualify or to be so licensed
could have a material adverse effect on Borrower.
SECTION 2.2. AUTHORIZATION AND VALIDITY. This Agreement, the Line of
Credit Note, and each other document, contract and instrument required hereby or
at any time hereafter delivered to Bank in connection herewith (collectively,
the "Loan Documents") have been duly authorized, and upon their execution and
delivery in accordance with the provisions hereof will constitute legal, valid
and binding agreements and obligations of Borrower or the party which executes
the same, enforceable in accordance with their respective terms.
SECTION 2.3. NO VIOLATION. The execution, delivery and performance by
Borrower of each of the Loan Documents do not violate any provision of any law
or regulation, or contravene any provision of the Articles of Incorporation or
by-laws of Borrower, or result in any breach of or default under any contract,
obligation, indenture or other instrument to which Borrower is a party or by
which Borrower may be bound.
SECTION 2.4. LITIGATION. There are no pending, or to Borrower's actual
knowledge threatened, actions, claims, investigations, suits or proceedings by
or before any governmental authority, arbitrator, court or administrative agency
which could have a material adverse effect on the financial condition or
operation of Borrower other than those disclosed by Borrower to Bank in writing
prior to the date hereof.
SECTION 2.5. CORRECTNESS OF FINANCIAL STATEMENT. The financial statement
of Borrower dated September 30, 1998, a true copy of which has been delivered by
Borrower to Bank prior to the date hereof, (a) is complete and correct and
presents fairly the financial condition of Borrower, (b) discloses all
liabilities of Borrower that are required to be reflected or reserved against
under generally accepted accounting principles, whether liquidated or
unliquidated, fixed or contingent, and (c) has been prepared in accordance with
generally accepted accounting principles consistently applied. Since the date
of such financial statement there has been no material adverse change in the
financial condition of Borrower, nor has Borrower mortgaged, pledged, granted a
security interest in or otherwise encumbered any of its assets or properties
except in favor of Bank or as disclosed in Schedule 2.5 hereto.
SECTION 2.6. INCOME TAX RETURNS. Borrower has no knowledge of any pending
assessments or adjustments of its income tax payable with respect to any year.
SECTION 2.7. NO SUBORDINATION. There is no agreement, indenture, contract
or instrument to which Borrower is a party or
-4-
<PAGE>
by which Borrower may be bound that requires the subordination in right of
payment of any of Borrower's obligations subject to this Agreement to any other
obligation of Borrower.
SECTION 2.8. PERMITS, FRANCHISES. Borrower possesses, and will hereafter
possess, all permits, consents, approvals, franchises and licenses required and
rights to all trademarks, trade names, patents, and fictitious names, if any,
necessary to enable it to conduct the business in which it is now engaged in
compliance with applicable law.
SECTION 2.9. ERISA. Borrower is in compliance in all material respects
with all applicable provisions of the Employee Retirement Income Security Act of
1974, as amended or recodified from time to time ("ERISA"); Borrower has not
violated any provision of any defined employee pension benefit plan (as defined
in ERISA) maintained or contributed to by Borrower (each, a "Plan"); no
Reportable Event as defined in ERISA has occurred and is continuing with respect
to any Plan initiated by Borrower; Borrower has met its minimum funding
requirements under ERISA with respect to each Plan; and each Plan will be able
to fulfill its benefit obligations as they come due in accordance with the Plan
documents and under generally accepted accounting principles.
SECTION 2.10. OTHER OBLIGATIONS. Borrower is not in default on any
obligation for borrowed money, any purchase money obligation or any other
material lease, commitment, contract, instrument or obligation.
SECTION 2.11. ENVIRONMENTAL MATTERS. Except as disclosed by Borrower to
Bank in writing prior to the date hereof, Borrower is, to Borrower's knowledge
(based on Borrower's reasonable due diligence), in compliance in all material
respects with all applicable federal or state environmental, hazardous waste,
health and safety statutes, and any rules or regulations adopted pursuant
thereto, which govern or affect any of Borrower's operations and/or properties,
including without limitation, the Comprehensive Environmental Response,
Compensation and Liability Act of 1980, the Superfund Amendments and
Reauthorization Act of 1986, the Federal Resource Conservation and Recovery Act
of 1976, and the Federal Toxic Substances Control Act, as any of the same may be
amended, modified or supplemented from time to time. To Borrower's knowledge
(based on Borrower's reasonable due diligence), none of the operations of
Borrower is the subject of any federal or state investigation evaluating whether
any remedial action involving a material expenditure is needed to respond to a
release of any toxic or hazardous waste or substance into the environment. To
Borrower's knowledge (based on Borrower's reasonable due diligence), Borrower
has no material contingent liability in connection with any release of any toxic
or hazardous waste or substance into the environment.
-5-
<PAGE>
SECTION 2.12 RETAIL SALES. To the best of Borrower's knowledge, 75% or
more in dollar volume of Borrower's total sales of all goods in the 12 month
period preceding the date of this Agreement were for personal, family or
household purposes.
ARTICLE III
-----------
CONDITIONS
----------
SECTION 3.1. CONDITIONS OF INITIAL EXTENSION OF CREDIT. The obligation of
Bank to extend any credit contemplated by this Agreement is subject to the
fulfillment to Bank's satisfaction of all of the following conditions:
(a) Approval of Bank Counsel. All legal matters incidental to the
------------------------
extension of credit by Bank shall be satisfactory to Bank's counsel.
(b) Documentation. Bank shall have received, in form and substance
-------------
satisfactory to Bank, each of the following, duly executed:
(i) This Agreement and the Note.
(ii) Continuing Security Agreement: Rights to Payment and Inventory.
(iii) Corporate Resolution: Borrowing.
(iv) Certificate of Incumbency.
(v) Continuing Guaranty.
(vi) Corporate Resolution: Continuing Guaranty.
(vii) UCC Financing Statements.
(viii) Such other documents as Bank may require under any other Section of
this Agreement.
(c) Financial Condition. There shall have been no material adverse change,
-------------------
as reasonably determined by Bank, in the financial condition or business of
Borrower or any guarantor hereunder, nor any material decline, as reasonably
determined by Bank, in the market value of any collateral required hereunder or
a substantial or material portion of the assets of Borrower or any such
guarantor.
(d) Insurance. Borrower shall have delivered to Bank evidence of insurance
---------
coverage on all Borrower's property, in form, substance, amounts, covering risks
and issued by companies satisfactory to Bank, and with respect to inventory
only, with loss payable endorsements in favor of Bank for claims in excess of
$500,000.00 individually or in the aggregate, provided that Bank shall have the
right to receive payments of all claims with respect to inventory following
written notice from Bank to the insurance company(ies) and Borrower that an
Event of Default exists.
-6-
<PAGE>
SECTION 3.2. CONDITIONS OF EACH EXTENSION OF CREDIT. The obligation of
Bank to make each extension of credit requested by Borrower hereunder shall be
subject to the fulfillment to Bank's satisfaction of each of the following
conditions:
(a) Compliance. The representations and warranties contained herein and in
----------
each of the other Loan Documents shall be true on and as of the date of the
signing of this Agreement and on the date of each extension of credit by Bank
pursuant hereto, with the same effect as though such representations and
warranties had been made on and as of each such date, and on each such date, no
Event of Default as defined herein, and no condition, event or act which with
the giving of notice or the passage of time or both would constitute such an
Event of Default, shall have occurred and be continuing or shall exist.
ARTICLE IV
----------
AFFIRMATIVE COVENANTS
---------------------
Borrower covenants that so long as Bank remains committed to extend credit
to Borrower pursuant hereto, or any liabilities (whether direct or contingent,
liquidated or unliquidated) of Borrower to Bank under any of the Loan Documents
remain outstanding, and until payment in full of all obligations of Borrower
subject hereto, Borrower shall, unless Bank otherwise consents in writing:
SECTION 4.1. PUNCTUAL PAYMENTS. Punctually pay all principal, interest,
fees or other liabilities due under any of the Loan Documents at the times and
place and in the manner specified therein, and immediately upon demand by Bank,
the amount by which the outstanding principal balance of the Line of Credit at
any time exceeds any limitation on borrowings applicable thereto.
SECTION 4.2. ACCOUNTING RECORDS. Maintain adequate books and records in
accordance with generally accepted accounting principles consistently applied,
and permit any representative of Bank, at any reasonable time (subject, if no
Event of Default exists, to reasonable notice), to inspect, audit and examine
such books and records, to make copies of the same, and to inspect the
properties of Borrower.
SECTION 4.3. FINANCIAL STATEMENTS. Provide to Bank all of the following,
in form and detail satisfactory to Bank:
(a) not later than 120 days after and as of the end of each fiscal year, an
audited financial statement of Borrower, prepared by an independent certified
public accountant acceptable to Bank, to include balance sheet, income
statement, statement of cash flow and all footnotes;
-7-
<PAGE>
(b) not later than 45 days after and as of the end of each fiscal quarter,
a financial statement of Borrower, prepared by Borrower, to include balance
sheet, income statement and the total of outstanding Letters of Credit;
(c) not later than ten (10) days after the filing thereof, copies of all
proxy statements, financial statements, reports, and notices sent or made
available generally by Borrower to its security holders or to any holders of its
debt and all regular, periodic and special reports, and all registration
statements filed with the Securities and Exchange Commission or any governmental
authority that may be substituted therefor, or with any national securities
exchange; and
(d) from time to time such other information as Bank may reasonably
request.
SECTION 4.4. COMPLIANCE. Preserve and maintain all licenses, permits,
governmental approvals, rights, privileges and franchises necessary for the
conduct of its business; and comply with the provisions of all documents
pursuant to which Borrower is organized and/or which govern Borrower's continued
existence and with the requirements of all laws, rules, regulations and orders
of any governmental authority applicable to Borrower and/or its business.
SECTION 4.5. INSURANCE. Maintain and keep in force insurance as required
under Section 3.1(d), with all such insurance carried with companies rated not
less than A-/VII and in amounts currently carried by Borrower (except that
Borrower may reduce coverage on property to an amount not less than 85% of the
replacement cost thereof), and deliver to Bank from time to time at Bank's
request schedules setting forth all insurance then in effect.
SECTION 4.6. FACILITIES. Subject to the terms of Borrower's leases of
real property, keep all properties useful or necessary to Borrower's business in
good repair and condition, and from time to time make necessary repairs,
renewals and replacements thereto so that such properties shall be fully and
efficiently preserved and maintained.
SECTION 4.7. TAXES AND OTHER LIABILITIES. Pay and discharge when due any
and all indebtedness, obligations, assessments and taxes, both real or personal,
including without limitation federal and state income taxes and state and local
property taxes and assessments, except such (a) as Borrower may in good faith
contest or as to which a bona fide dispute may arise, and (b) for which Borrower
has made provision, to Bank's satisfaction, for eventual payment thereof in the
event Borrower is obligated to make such payment.
-8-
<PAGE>
SECTION 4.8. FINANCIAL CONDITION. Maintain Borrower's financial condition
as follows using generally accepted accounting principles consistently applied
and used consistently with prior practices (except to the extent modified by the
definitions herein):
(a) Total Liabilities divided by Tangible Net Worth not at any time greater
than 1.5 to 1.0, with "Total Liabilities" defined as the aggregate of current
liabilities and non-current liabilities plus (inclusive of the amount available
to be drawn under outstanding Letters of Credit) less subordinated debt, and
with "Tangible Net Worth" defined as the aggregate of total stockholders' equity
plus subordinated debt less any intangible assets.
(b) Net income after taxes not less than $1.00 on a quarterly basis,
determined as of each fiscal quarter end, and pre-tax profit not less than $1.00
on a quarterly basis, determined as of each fiscal quarter end.
(c) EBITDA not less than $3,750,000.00 on a rolling four- quarter basis,
determined as of each fiscal quarter end, with "EBITDA" defined as net profit
before tax plus interest expense (net of capitalized interest expense),
depreciation expense and amortization expense.
(d) Ratio of (i) the outstanding principal balance of the Line of Credit
(inclusive of the aggregate amount available to be drawn under outstanding
Letters of Credit) to (ii) the book value of Borrower's inventory plus the
aggregate amount available to be drawn under outstanding Letters of Credit
issued to back inventory purchases by Borrower, not at any time greater than
0.50 to 1.00.
SECTION 4.9. NOTICE TO BANK. Promptly (but in no event more than five (5)
days after the occurrence of each such event or matter) give written notice to
Bank in reasonable detail of: (a) the occurrence of any Event of Default; (b)
any change in the name or the organizational structure of Borrower; (c) the
occurrence and nature of any Reportable Event or Prohibited Transaction, each as
defined in ERISA, or any funding deficiency with respect to any Plan; or (d) any
termination or cancellation of any insurance policy which Borrower is required
to maintain, or any uninsured or partially uninsured loss through liability or
property damage, or through fire, theft or any other cause affecting Borrower's
property.
SECTION 4.10. YEAR 2000 COMPLIANCE. Perform all acts reasonably necessary
to ensure that Borrower and any business in which Borrower holds a substantial
interest become, and use commercially reasonable efforts to attempt to cause all
suppliers and vendors that are material to Borrower's business to become
-9-
<PAGE>
Year 2000 Compliant in a timely manner so as not to materially disrupt
Borrower's operations. Such acts shall include, without limitation, performing a
comprehensive review and assessment of all of Borrower's systems and adopting a
detailed plan, with itemized budget, for the remediation, monitoring and testing
of such systems. As used herein, "Year 2000 Compliant" shall mean, in regard to
any entity, that all software, hardware, firmware, equipment, goods or systems
utilized by or material to the business operations or financial condition of
such entity, will properly perform date sensitive functions before, during and
after the year 2000. Borrower shall, immediately upon request, provide to Bank
such certifications or other evidence of Borrower's compliance with the terms
hereof as Bank may from time to time require.
ARTICLE V
---------
NEGATIVE COVENANTS
------------------
Borrower further covenants that so long as Bank remains committed to extend
credit to Borrower pursuant hereto, or any liabilities (whether direct or
contingent, liquidated or unliquidated) of Borrower to Bank under any of the
Loan Documents remain outstanding, and until payment in full of all obligations
of Borrower subject hereto, Borrower will not without Bank's prior written
consent:
SECTION 5.1. USE OF FUNDS. Use any of the proceeds of any credit extended
hereunder except for the purposes stated in Article I hereof.
SECTION 5.2. OTHER INDEBTEDNESS. Create, incur, assume or permit to exist
any indebtedness or liabilities resulting from borrowings, loans or advances,
whether secured or unsecured, matured or unmatured, liquidated or unliquidated,
joint or several, except (a) the liabilities of Borrower to Bank, (b) any other
liabilities of Borrower existing as of, and disclosed to Bank prior to, the date
hereof, and (c) additional purchase money indebtedness incurred to purchase
equipment or real estate not to exceed $1,000,000.00.
SECTION 5.3. MERGER, CONSOLIDATION, TRANSFER OF ASSETS. Merge into or
consolidate with any other entity (other than with entities acquired pursuant to
Section 5.5, so long as Borrower is the surviving entity); make any substantial
change in the nature of Borrower's business as conducted as of the date hereof;
acquire all or substantially all of the assets of any other entity in excess of
$3,000,000.00 per fiscal year, subject to the terms of Section 5.5; nor sell,
lease, transfer or otherwise dispose of all or a substantial or material portion
of Borrower's assets except in the ordinary course of its business.
-10-
<PAGE>
SECTION 5.4. GUARANTIES. Guarantee or become liable in any way as surety,
endorser (other than as endorser of negotiable instruments for deposit or
collection in the ordinary course of business), accommodation endorser or
otherwise for, nor pledge or hypothecate any assets of Borrower as security for,
any liabilities or obligations of any other person or entity, except any of the
foregoing in favor of Bank.
SECTION 5.5. LOANS, ADVANCES, INVESTMENTS. Make any loans or advances to
or investments in any person or entity, except any of the foregoing existing as
of, and disclosed to Bank prior to, the date hereof, except for acquisitions of
entities in the retail shoe business for an aggregate amount not to exceed
$3,000,000.00 per fiscal year, when added to the consideration for assets
acquired in such fiscal year under Section 5.3 above, provided however, that if
such entities are not, contemporaneously with their acquisition, merged into
Borrower, Bank shall be granted a first priority security interest in the
accounts, general intangibles, other rights to payment and inventory thereof.
SECTION 5.6. DIVIDENDS, DISTRIBUTIONS. Declare or pay any dividend or
distribution either in cash, stock or any other property on Borrower's stock now
or hereafter outstanding, nor redeem, retire, repurchase or otherwise acquire
any shares of any class of Borrower's stock now or hereafter outstanding.
SECTION 5.7. PLEDGE OF ASSETS. Mortgage, pledge, grant or permit to exist
a security interest in, or lien upon, all or any portion of Borrower's assets
now owned or hereafter acquired, except any of the foregoing (a) in favor of
Bank, (b) which is existing as of, and disclosed to Bank in writing prior to,
the date hereof, and (c) subject to the terms of Section 5.2(c), purchase money
security interests.
ARTICLE VI
----------
EVENTS OF DEFAULT
-----------------
SECTION 6.1. The occurrence of any of the following shall constitute an
"Event of Default" under this Agreement:
(a) Borrower shall fail to pay when due any principal, interest, fees or
other amounts payable under any of the Loan Documents.
(b) Any financial statement or certificate furnished to Bank in connection
with, or any representation or warranty made by Borrower or any other party
under this Agreement or any other Loan Document shall prove to be incorrect,
false or misleading in any material respect when furnished or made.
-11-
<PAGE>
(c) Any default in the performance of or compliance with any obligation,
agreement or other provision contained herein or in any other Loan Document
(other than those referred to in subsections (a) and (b) above), and with
respect to any such default which by its nature can be cured (other than a
breach of Section 4.9(d)), such default shall continue for a period of twenty
(20) days from its occurrence, or, with respect to a breach of Section 4.9(d),
such default shall continue for a period of 15 days from the date Borrower first
knew (or, using reasonable due diligence, should first have known) thereof.
(d) Any default in the payment or performance of any obligation, or any
defined event of default, under the terms of any contract or instrument (other
than any of the Loan Documents) pursuant to which Borrower or any guarantor
hereunder has incurred any debt or other liability to any person or entity,
including Bank, provided, however, that if the defaulted obligation(s) arises
under operating or real estate leases, the amount of thereof exceeds an
aggregate of $500,000.00.
(e) The filing of a notice of judgment lien against Borrower or any
guarantor hereunder; or the recording of any abstract of judgment against
Borrower or any guarantor hereunder in any county in which Borrower or such
guarantor has an interest in real property; or the service of a notice of levy
and/or of a writ of attachment or execution, or other like process, against the
assets of Borrower or any guarantor hereunder; or the entry of a judgment
against Borrower or any guarantor hereunder; and, with respect to any of the
foregoing, the amount in dispute exceeds an aggregate of $500,000.00.
(f) Borrower or any guarantor hereunder shall become insolvent, or shall
suffer or consent to or apply for the appointment of a receiver, trustee,
custodian or liquidator of itself or any of its property, or shall generally
fail to pay its debts as they become due, or shall make a general assignment for
the benefit of creditors; Borrower or any guarantor shall file a voluntary
petition in bankruptcy, or seeking reorganization, in order to effect a plan or
other arrangement with creditors or any other relief under the Bankruptcy Reform
Act, Title 11 of the United States Code, as amended or recodified from time to
time ("Bankruptcy Code"), or under any state or federal law granting relief to
debtors, whether now or hereafter in effect; or any involuntary petition or
proceeding pursuant to the Bankruptcy Code or any other applicable state or
federal law relating to bankruptcy, reorganization or other relief for debtors
is filed or commenced against Borrower or any guarantor hereunder, or Borrower
or any such guarantor shall file an answer admitting the jurisdiction of the
court and the material allegations of any involuntary petition; or Borrower or
any such guarantor shall be adjudicated a bankrupt, or an order for relief shall
be entered against Borrower or any such guarantor by any court of competent
-12-
<PAGE>
jurisdiction under the Bankruptcy Code or any other applicable state or federal
law relating to bankruptcy, reorganization or other relief for debtors.
(g) There shall exist or occur any event or condition which Bank
reasonably and in good faith believes impairs, or is substantially likely to
impair, the prospect of payment by Borrower of its obligations under any of the
Loan Documents.
(h) The dissolution or liquidation of Borrower or any guarantor hereunder;
or any of its directors, stockholders or members, shall take action seeking to
effect the dissolution or liquidation of Borrower or such guarantor.
(i) Any change in ownership during the term of this Agreement of an
aggregate of twenty-five percent (25%) or more of the common stock of Borrower
in a single or in affiliated transactions.
SECTION 6.2. REMEDIES. Upon the occurrence of any Event of Default: (a)
all indebtedness of Borrower under each of the Loan Documents, any term thereof
to the contrary notwithstanding, shall at Bank's option (and, without notice if
the Event of Default arises under Section 6.1(f), or, upon 5 days written notice
for all other Events of Default) become immediately due and payable without
presentment, demand, protest or notice of dishonor, all of which are hereby
expressly waived by each Borrower; (b) the obligation, if any, of Bank to extend
any further credit under any of the Loan Documents shall immediately cease and
terminate; and (c) Bank shall have all rights, powers and remedies available
under each of the Loan Documents, or accorded by law, including without
limitation the right to resort to any or all collateral for any credit
accommodation from Bank subject hereto and to exercise any or all of the rights
of a beneficiary or secured party pursuant to applicable law. All rights, powers
and remedies of Bank may be exercised at any time by Bank and from time to time
after the occurrence of an Event of Default, are cumulative and not exclusive,
and shall be in addition to any other rights, powers or remedies provided by law
or equity.
ARTICLE VII
-----------
MISCELLANEOUS
-------------
SECTION 7.1. NO WAIVER. No delay, failure or discontinuance of Bank in
exercising any right, power or remedy under any of the Loan Documents shall
affect or operate as a waiver of such right, power or remedy; nor shall any
single or partial exercise of any such right, power or remedy preclude, waive or
otherwise affect any other or further exercise thereof or the exercise of any
other right, power or remedy. Any waiver,
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<PAGE>
permit, consent or approval of any kind by Bank of any breach of or default
under any of the Loan Documents must be in writing and shall be effective only
to the extent set forth in such writing.
SECTION 7.2. NOTICES. All notices, requests and demands which any party is
required or may desire to give to any other party under any provision of this
Agreement must be in writing delivered to each party at the following address:
BORROWER: SHOE PAVILION CORPORATION
3200-F Regatta Boulevard
Richmond, CA 94804
BANK: WELLS FARGO BANK, NATIONAL ASSOCIATION
East Bay Regional Commercial Banking Office
One Kaiser Plaza, Suite 850
Oakland, CA 94612
or to such other address as any party may designate by written notice to all
other parties. Each such notice, request and demand shall be deemed given or
made as follows: (a) if sent by hand delivery by courier providing proof of
delivery, upon delivery; and (b) if sent by registered or certified mail, upon
the earlier of the date of receipt or three (3) days after deposit in the U.S.
mail, first class and postage prepaid.
SECTION 7.3. COSTS, EXPENSES AND ATTORNEYS' FEES. Borrower shall pay to
Bank immediately upon demand the full amount of all payments, advances, charges,
costs and expenses, including reasonable attorneys' fees (to include outside
counsel fees and all allocated costs of Bank's in-house counsel), expended or
incurred by Bank in connection with the negotiation and preparation of this
Agreement and the other Loan Documents (not to exceed $2,500.00), and the
preparation of any amendments and waivers hereto and thereto. The non-prevailing
party shall pay to the prevailing party immediately upon demand the full amount
of all payments, advances, charges, costs and expenses, including reasonable
attorneys' fees (to include outside counsel fees and all allocated costs of in-
house counsel), expended or incurred by the prevailing party in connection with
(a) the enforcement of the Bank's rights and/or the collection of any amounts
which become due to Bank under any of the Loan Documents, and (b) the
prosecution or defense of any action in any way related to any of the Loan
Documents, including without limitation, any action for declaratory relief,
whether incurred at the trial or appellate level, in an arbitration proceeding
or otherwise, and including any of the foregoing incurred in connection with any
bankruptcy proceeding (including without limitation, any adversary proceeding,
contested matter or motion brought by Bank, Borrower or any other person)
relating to any Borrower or any other person or entity.
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<PAGE>
SECTION 7.4. SUCCESSORS, ASSIGNMENT. This Agreement shall be binding upon
and inure to the benefit of the heirs, executors, administrators, legal
representatives, successors and assigns of the parties; provided however, that
Borrower may not assign or transfer its interest hereunder without Bank's prior
written consent. Bank reserves the right to sell, assign, transfer, negotiate or
grant participations in all or any part of, or any interest in, Bank's rights
and benefits under each of the Loan Documents to any bank or other financial
institution. In connection therewith, Bank may disclose all documents and
information which Bank now has or may hereafter acquire relating to any credit
extended by Bank to Borrower, Borrower or its business, any guarantor hereunder
or the business of such guarantor, or any collateral required hereunder, subject
to the terms of a confidentiality agreement reasonably acceptable to Borrower
and the proposed transferee.
SECTION 7.5. ENTIRE AGREEMENT; AMENDMENT. This Agreement and the other
Loan Documents constitute the entire agreement between Borrower and Bank with
respect to any extension of credit by Bank subject hereto and supersede all
prior negotiations, communications, discussions and correspondence concerning
the subject matter hereof. This Agreement may be amended or modified only in
writing signed by each party hereto.
SECTION 7.6. NO THIRD PARTY BENEFICIARIES. This Agreement is made and
entered into for the sole protection and benefit of the parties hereto and their
respective permitted successors and assigns, and no other person or entity shall
be a third party beneficiary of, or have any direct or indirect cause of action
or claim in connection with, this Agreement or any other of the Loan Documents
to which it is not a party.
SECTION 7.7. TIME. Time is of the essence of each and every provision of
this Agreement and each other of the Loan Documents.
SECTION 7.8. SEVERABILITY OF PROVISIONS. If any provision of this
Agreement shall be prohibited by or invalid under applicable law, such provision
shall be ineffective only to the extent of such prohibition or invalidity
without invalidating the remainder of such provision or any remaining provisions
of this Agreement.
SECTION 7.9. COUNTERPARTS. This Agreement may be executed in any number of
counterparts, each of which when executed and delivered shall be deemed to be an
original, and all of which when taken together shall constitute one and the same
Agreement.
SECTION 7.10. GOVERNING LAW. This Agreement shall be governed by and
construed in accordance with the laws of the State of California.
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<PAGE>
SECTION 7.11. ARBITRATION.
(a) Arbitration. Upon the demand of any party, any Dispute shall be
-----------
resolved by binding arbitration (except as set forth in (e) below) in accordance
with the terms of this Agreement. A "Dispute" shall mean any action, dispute,
claim or controversy of any kind, whether in contract or tort, statutory or
common law, legal or equitable, now existing or hereafter arising under or in
connection with, or in any way pertaining to, any of the Loan Documents, or any
past, present or future extensions of credit and other activities, transactions
or obligations of any kind related directly or indirectly to any of the Loan
Documents, including without limitation, any of the foregoing arising in
connection with the exercise of any self-help, ancillary or other remedies
pursuant to any of the Loan Documents. Any party may by summary proceedings
bring an action in court to compel arbitration of a Dispute. Any party who fails
or refuses to submit to arbitration following a lawful demand by any other party
shall bear all costs and expenses incurred by such other party in compelling
arbitration of any Dispute.
(b) Governing Rules. Arbitration proceedings shall be administered by the
---------------
American Arbitration Association ("AAA") or such other administrator as the
parties shall mutually agree upon in accordance with the AAA Commercial
Arbitration Rules. All Disputes submitted to arbitration shall be resolved in
accordance with the Federal Arbitration Act (Title 9 of the United States Code),
notwithstanding any conflicting choice of law provision in any of the Loan
Documents. The arbitration shall be conducted at a location in San Francisco or
Oakland, California selected by the AAA or other administrator. If there is any
inconsistency between the terms hereof and any such rules, the terms and
procedures set forth herein shall control. All statutes of limitation applicable
to any Dispute shall apply to any arbitration proceeding. All discovery
activities shall be expressly limited to matters directly relevant to the
Dispute being arbitrated. Judgment upon any award rendered in an arbitration may
be entered in any court having jurisdiction; provided however, that nothing
contained herein shall be deemed to be a waiver by any party that is a bank of
the protections afforded to it under 12 U.S.C. (S)91 or any similar applicable
state law.
(c) No Waiver; Provisional Remedies, Self-Help and Foreclosure. No
----------------------------------------------------------
provision hereof shall limit the right of any party to exercise self-help
remedies such as setoff, foreclosure against or sale of any real or personal
property collateral or security, or to obtain provisional or ancillary remedies,
including without limitation injunctive relief, sequestration, attachment,
garnishment or the appointment of a receiver, from a court of competent
jurisdiction before, after or during the pendency of any arbitration or other
proceeding. The exercise of
-16-
<PAGE>
any such remedy shall not waive the right of any party to compel arbitration or
reference hereunder.
(d) Arbitrator Qualifications and Powers; Awards. Arbitrators must be
--------------------------------------------
active members of the California State Bar or retired judges of the state or
federal judiciary of California, with expertise in the substantive laws
applicable to the subject matter of the Dispute. Arbitrators are empowered to
resolve Disputes by summary rulings in response to motions filed prior to the
final arbitration hearing. Arbitrators (i) shall resolve all Disputes in
accordance with the substantive law of the state of California, (ii) may grant
any remedy or relief that a court of the state of California could order or
grant within the scope hereof and such ancillary relief as is necessary to make
effective any award, and (iii) shall have the power to award recovery of all
costs and fees, to impose sanctions and to take such other actions as they deem
necessary to the same extent a judge could pursuant to the Federal Rules of
Civil Procedure, the California Rules of Civil Procedure or other applicable
law. Any Dispute in which the amount in controversy is $5,000,000 or less shall
be decided by a single arbitrator who shall not render an award of greater than
$5,000,000 (including damages, costs, fees and expenses). By submission to a
single arbitrator, each party expressly waives any right or claim to recover
more than $5,000,000. Any Dispute in which the amount in controversy exceeds
$5,000,000 shall be decided by majority vote of a panel of three arbitrators;
provided however, that all three arbitrators must actively participate in all
hearings and deliberations.
(e) Judicial Review. Notwithstanding anything herein to the contrary, in
---------------
any arbitration in which the amount in controversy exceeds $25,000,000, the
arbitrators shall be required to make specific, written findings of fact and
conclusions of law. In such arbitrations (i) the arbitrators shall not have the
power to make any award which is not supported by substantial evidence or which
is based on legal error, (ii) an award shall not be binding upon the parties
unless the findings of fact are supported by substantial evidence and the
conclusions of law are not erroneous under the substantive law of the state of
California, and (iii) the parties shall have in addition to the grounds referred
to in the Federal Arbitration Act for vacating, modifying or correcting an award
the right to judicial review of (A) whether the findings of fact rendered by the
arbitrators are supported by substantial evidence, and (B) whether the
conclusions of law are erroneous under the substantive law of the state of
California. Judgment confirming an award in such a proceeding may be entered
only if a court determines the award is supported by substantial evidence and
not based on legal error under the substantive law of the state of California.
-17-
<PAGE>
(f) Real Property Collateral; Judicial Reference. Notwithstanding anything
--------------------------------------------
herein to the contrary, no Dispute shall be submitted to arbitration if the
Dispute concerns indebtedness secured directly or indirectly, in whole or in
part, by any real property unless (i) the holder of the mortgage, lien or
security interest specifically elects in writing to proceed with the
arbitration, or (ii) all parties to the arbitration waive any rights or benefits
that might accrue to them by virtue of the single action rule statute of
California, thereby agreeing that all indebtedness and obligations of the
parties, and all mortgages, liens and security interests securing such
indebtedness and obligations, shall remain fully valid and enforceable. If any
such Dispute is not submitted to arbitration, the Dispute shall be referred to a
referee in accordance with California Code of Civil Procedure Section 638 et
seq., and this general reference agreement is intended to be specifically
enforceable in accordance with said Section 638. A referee with the
qualifications required herein for arbitrators shall be selected pursuant to the
AAA's selection procedures. Judgment upon the decision rendered by a referee
shall be entered in the court in which such proceeding was commenced in
accordance with California Code of Civil Procedure Sections 644 and 645.
(g) Miscellaneous. To the maximum extent practicable, the AAA, the
-------------
arbitrators and the parties shall take all action required to conclude any
arbitration proceeding within 180 days of the filing of the Dispute with the
AAA. No arbitrator or other party to an arbitration proceeding may disclose the
existence, content or results thereof, except for disclosures of information by
a party required in the ordinary course of its business, by applicable law or
regulation, or to the extent necessary to exercise any judicial review rights
set forth herein. If more than one agreement for arbitration by or between the
parties potentially applies to a Dispute, the arbitration provision most
directly related to the Loan Documents or the subject matter of the Dispute
shall control. This arbitration provision shall survive termination, amendment
or expiration of any of the Loan Documents or any relationship between the
parties.
-18-
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed as of the day and year first written above.
WELLS FARGO BANK,
SHOE PAVILION CORPORATION NATIONAL ASSOCIATION
By: /s/ Gary Schwartz By: /s/ Brian O'Melveny
------------------------- ---------------------
Brian O'Melveny
Vice President
Title: VP & CFO
----------------------
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<PAGE>
SCHEDULE 2.5
Since September 30, 1998, there has been no material adverse change in the
financial condition of Borrower, nor has Borrower mortgaged, pledged, granted a
security interest in or otherwise encumbered any of its assets or properties
except in favor of Bank or as disclosed below:
If none, so state.
<PAGE>
Exhibit 10.7
WELLS FARGO BANK REVOLVING LINE OF CREDIT NOTE
- -------------------------------------------------------------------------------
$15,000,000.00 OAKLAND, CALIFORNIA
DECEMBER 1, 1998
FOR VALUE RECEIVED, the undersigned SHOE PAVILION CORPORATION ("Borrower")
promises to pay to the order of WELLS FARGO BANK, NATIONAL ASSOCIATION ("Bank")
at its office at EAST BAY RCBO, ONE KAISER PLAZA, SUITE 850, OAKLAND, CA 94612,
or at such other place as the holder hereof may designate, in lawful money of
the United States of America and in immediately available funds, the principal
sum of $15,000,000.00, or so much thereof as may be advanced and be outstanding,
with interest thereon, to be computed on each advance from the date of its
disbursement as set forth herein.
DEFINITIONS:
As used herein, the following terms shall have the meanings set forth after
each, and any other term defined in this Note shall have the meaning set forth
at the place defined:
(a) "Business Day" means any day except a Saturday, Sunday or any other
day on which commercial banks in California are authorized or required by law to
close.
(b) "Fixed Rate Term" means a period commencing on a Business Day and
continuing for 1, 3, 6, 9 AND 12 MONTHS, as designated by Borrower, during which
all or a portion of the outstanding principal balance of this Note bears
interest determined in relation to LIBOR; provided however, that no Fixed Rate
Term may be selected for a principal amount less than $500,000.00; and provided
further, that no Fixed Rate Term shall extend beyond the scheduled maturity date
hereof. If any Fixed Rate Term would end on a day which is not a Business Day,
then such Fixed Rate Term shall be extended to the next succeeding Business Day.
(c) "LIBOR" means the rate per annum (rounded upward, if necessary, to the
nearest whole 1/8 of 1%) determined by dividing Base LIBOR by a percentage equal
to 100% less any LIBOR Reserve Percentage.
(i) "Base LIBOR" means the rate per annum for United States dollar
deposits quoted by Bank as the Inter-Bank Market Offered Rate, with the
understanding that such rate is quoted by Bank for the purpose of calculating
effective rates of interest for loans making reference thereto, on the first day
of a Fixed Rate Term for delivery of funds on said date for a period of time
approximately equal to the number of days in such Fixed Rate Term and in an
amount approximately equal to the principal amount to which such Fixed Rate Term
applies. Borrower understands and agrees that Bank may base its quotation of the
Inter-Bank Market Offered Rate upon such offers or other market indicators of
the Inter-Bank Market as Bank in its discretion deems appropriate including, but
not limited to, the rate offered for U.S. dollar deposits on the London Inter-
Bank Market.
(ii) "LIBOR Reserve Percentage" means the reserve percentage
prescribed by the Board of Governors of the Federal Reserve System for any
successor) for "Eurocurrency Liabilities" (as defined in Regulation D of the
Federal Reserve Board, as amended), adjusted by Bank for expected changes in
such reserve percentage during the applicable Fixed Rate Term.
(d) "Prime Rate" means at any time the rate of interest most recently
announced within Bank at its principal office as its Prime Rate, with the
understanding that the Prime Rate is one of Bank's base rates and serves as the
basis upon which effective rates of interest are calculated for those loans
making reference thereto, and is evidenced by the recording thereof after its
announcement in such internal publication or publications as Bank may designate.
INTEREST:
(a) Interest. The outstanding principal balance of this Note shall bear
--------
interest (computed on the basis of a 360-day year, actual days elapsed) either
(i) at a fluctuating rate per annum EQUAL TO the Prime Rate in effect from time
to time, or (ii) at a fixed rate per annum determined by Bank to be 1.30000%
above LIBOR in effect on the first day of the applicable Fixed Rate Term. When
interest is determined in relation to the Prime Rate, each change in the rate of
interest hereunder shall become effective on the date each Prime Rate change is
announced within Bank. With respect to each LIBOR selection option selected
hereunder, Bank is hereby authorized to note the date, principal amount,
interest rate and Fixed Rate Term applicable thereto and any payments made
thereon on Bank's books and records (either manually or by electronic entry)
and/or on any schedule attached to this Note, which notations shall be prima
facie evidence of the accuracy of the information noted.
(b) Selection of Interest Rate Options. At any time any portion of this
----------------------------------
Note bears interest determined in relation to LIBOR, it may be continued by
Borrower at the end of the Fixed Rate Term applicable thereto so that all or a
portion thereof bears interest determined in relation to the Prime Rate or to
LIBOR for a new Fixed Rate Term designated by Borrower. At any time any portion
of this Note bears interest determined in relation to the Prime Rate, Borrower
may convert all or a portion thereof so that it bears interest determined in
relation to LIBOR for a Fixed Rate Term designated by Borrower. At such time as
Borrower requests an advance hereunder or wishes to select a LIBOR option for
all or a portion of the outstanding principal balance hereof,
<PAGE>
and at the and of each Fixed Rate Term, Borrower shall give Bank notice
specifying: (i) the interest rate option selected by Borrower; (ii) the
principal amount subject thereto; and (iii) for each LIBOR selection, the length
of the applicable Fixed Rate Term. Any such notice may be given by telephone so
long as, with respect to each LIBOR selection, (A) Bank receives written
confirmation from Borrower not later than 3 Business Days after such telephone
notice is given, and (B) such notice is given to Bank prior to 10:00 a.m.,
California time, on the first day of the Fixed Rate Term. For each LIBOR option
requested hereunder, Bank will quote the applicable fixed rate to Borrower at
approximately 10:00 a.m., California time, on the first day of the Fixed Rate
Term. If Borrower does not immediately accept the rate quoted by Bank, any
subsequent acceptance by Borrower shall be subject to a redetermination by Bank
of the applicable fixed rate; provided however, that if Borrower fails to accept
any such rate by 11:00 a.m., California time, an the Business Day such quotation
is given, then the quoted rate shall expire and Bank shall have no obligation to
permit a LIBOR option to be selected on such day. If no specific designation of
interest is made at the time any advance is requested hereunder or at the end of
any Fixed Rate Term, Borrower shall be deemed to have made a Prime Rate interest
selection for such advance or the principal amount to which such Fixed Rate Term
applied.
(c) Additional LIBOR Provisions.
---------------------------
(i) If Bank at any time shall determine that for any reason adequate
and reasonable means do not exist for ascertaining LIBOR, then Bank shall
promptly give notice thereof to Borrower. If such notice is given and until such
notice has been withdrawn by Bank, then (A) no new LIBOR option may be selected
by Borrower, and (B) any portion of the outstanding principal balance hereof
which bears interest determined in relation to LIBOR, subsequent to the end of
the Fixed Rate Term applicable thereto, shall bear interest determined in
relation to the Prime Rate.
(ii) If any law, treaty, rule, regulation or determination of a court
or governmental authority or any change therein or in the interpretation or
application thereof (each, a "Change in Law") shall make it unlawful for Bank
(A) to make LIBOR options available hereunder, or (B) to maintain interest rates
based on LIBOR, then in the former event, any obligation of Bank to make
available such unlawful LIBOR options shall immediately be cancelled, and in the
latter event, any such unlawful LIBOR-based interest rates then outstanding
shall be converted, at Bank's option, so that interest on the portion of the
outstanding principal balance subject thereto is determined in relation to the
Prime Rate; provided however, that if any such Change in Law shall permit any
LIBOR-based interest rates to remain in effect until the expiration of the Fixed
Rate Term applicable thereto, then such permitted LIBOR-based interest rates
shall continue in effect until the expiration of such Fixed Rate Term. Upon the
occurrence of any of the foregoing events, Borrower shall pay to Bank
immediately upon demand such amounts as may be necessary to compensate Bank for
any fines, fees, charges, penalties or other costs incurred or payable by Bank
as a result thereof and which are attributable to any LIBOR options made
available to Borrower hereunder, and any reasonable allocation made by Bank
among its operations shall be conclusive and binding upon Borrower.
(iii) If any Change in Law or compliance by Bank with any request or
directive (whether or not having the force of law) from any central bank or
other governmental authority shall:
(A) subject Bank to any tax, duty or other charge with respect to
any LIBOR options, or change the basis of taxation of payments
to Bank of principal, interest, fees or any other amount payable
hereunder (except for changes in the rate of tax on the overall
net income of Bank); or
(B) impose, modify or hold applicable any reserve, special deposit,
compulsory loan or similar requirement against assets held by,
deposits or other liabilities in or for the account of, advances
or loans by, or any other acquisition of funds by any office of
Bank; or
(C) impose on Bank any other condition;
and the result of any of the foregoing is to increase the cost to Bank of
making, renewing or maintaining any LIBOR options hereunder and/or to reduce any
amount receivable by Bank in connection therewith, then in any such case,
Borrower shall pay to Bank immediately upon demand such amounts as may be
necessary to compensate Bank for any additional costs incurred by Bank and/or
reductions in amounts received by Bank which are attributable to such LIBOR
options. In determining which costs incurred by Bank and/or reductions in
amounts received by Bank are attributable to any LIBOR options made available to
Borrower hereunder, any reasonable allocation made by Bank among its operations
shall be conclusive and binding upon Borrower.
(d) Payment of Interest. Interest accrued on this Note shall be payable
-------------------
on the 1ST day of each MONTH, commencing JANUARY 1,1999.
(e) Default Interest. From and after the maturity date of this Note, or
----------------
earlier date as all principal owing hereunder becomes due and payable by
acceleration or otherwise, the outstanding principal balance of this Note shall
bear interest until paid in full at an increased rate per annum (computed on the
basis of 360-day year, actual days elapsed) equal to 4% above the rate of
interest from time to time applicable to this Note.
BORROWING AND REPAYMENT:
(a) Borrowing and Repayment. Borrower may from time to time during the
-----------------------
term of this Note borrow, partially or wholly repay its outstanding borrowings,
and reborrow, subject to all of the limitations, terms and
<PAGE>
conditions of this Note and of the Credit Agreement between Borrower and Bank
defined below; provided however, that the total outstanding borrowings under
this Note shall not at any time exceed the principal amount stated above. The
unpaid principal balance of this obligation at any time shall be the total
amounts advanced hereunder by the holder hereof less the amount of principal
payments made hereon by or for any Borrower, which balance may be endorsed
hereon from time to time by the holder. The outstanding principal balance of
this Note shall be due and payable in full on DECEMBER 1, 2000.
(b) Advances. Advances hereunder, to the total amount of the principal
--------
sum available hereunder, may be made by the holder at the oral or written
request of (i) GARY SCHWARTZ, any one acting alone, who are authorized to
request advances and direct the disposition of any advances until written notice
of the revocation of such authority is received by the holder at the office
designated above, or (ii) any person, with respect to advances deposited to the
credit of any account of any Borrower with the holder, which advances, when so
deposited, shall be conclusively presumed to have been made to or for the
benefit of each Borrower regardless of the fact that persons other than those
authorized to request advances may have authority to draw against such account.
The holder shall have no obligation to determine whether any person requesting
an advance is or has been authorized by any Borrower.
(c) Application of Payments. Each payment made on this Note shall be
-----------------------
credited first, to any interest then due and second, to the outstanding
principal balance hereof. All payments credited to principal shall be applied
first, to the outstanding principal balance of this Note which bears interest
determined in relation to the Prime Rate, if any, and second, to the outstanding
principal balance of this Note which bears interest determined in relation to
LIBOR, with such payments applied to the oldest Fixed Rate Term first.
PREPAYMENT:
(a) Prime Rate. Borrower may prepay principal on any portion of this Note
----------
which bears interest determined in relation to the Prime Rate at any time, in
any amount and without penalty.
(b) LIBOR. Borrower may prepay principal on any portion of this Note
-----
which bears interest determined in relation to LIBOR at any time and in the
minimum amount of $500,000.00; provided however, that if the outstanding
principal balance of such portion of this Note is less than said amount, the
minimum prepayment amount shall be the entire outstanding principal balance
thereof. In consideration of Bank providing this prepayment option to Borrower,
or if any such portion of this Note shall become due and payable at any time
prior to the last day of the Fixed Rate Term applicable thereto by acceleration
or otherwise, Borrower shall pay to Bank immediately upon demand a fee which is
the sum of the discounted monthly differences for each month from the month of
prepayment through the month in which such Fixed Rate Term matures, calculated
as follows for each such month:
(i) Determine the amount of interest which would have accrued each
---------
month on the amount prepaid at the interest rate applicable to such amount had
it remained outstanding until the last day of the Fixed Rate Term applicable
thereto.
(ii) Subtract from the amount determined in (i) above the amount of
--------
interest which would have accrued for the same month on the amount prepaid for
the remaining term of such Fixed Rate Term at LIBOR in effect on the date of
prepayment for new loans made for such term and in a principal amount equal to
the amount prepaid.
(iii) If the result obtained in (ii) for any month is greater than
zero, discount that difference by LIBOR used in (ii) above.
Each Borrower acknowledges that prepayment of such amount may result in Bank
incurring additional costs, expenses and/or liabilities, and that it is
difficult to ascertain the full extent of such costs, expenses and/or
liabilities. Each Borrower, therefore, agrees to pay the above-described
prepayment fee and agrees that said amount represents a reasonable estimate of
the prepayment costs, expenses and/or liabilities of Bank. If Borrower fails to
pay any prepayment fee when due, the amount of such prepayment fee shall
thereafter bear interest until paid at a rate per annum 2.000% above the Prime
Rate in effect from time to time (computed on the basis of a 360-day year,
actual days elapsed). Each change in the rate of interest on any such past due
prepayment fee shall become effective on the date each Prime Rate change is
announced within Bank.
EVENTS OF DEFAULT:
This Note is made pursuant to and is subject to the terms and conditions of
that certain Credit Agreement between Borrower and Bank dated as of DECEMBER 1,
1998, as amended from time to time (the "Credit Agreement"). Any default in the
payment or performance of any obligation under this Note, or any defined event
of default under the Credit Agreement, shall constitute an "Event of Default"
under this Note.
MISCELLANEOUS:
(a) Remedies. Upon the occurrence of any Event of Default as defined in
--------
the Credit Agreement, the holder of this Note, at the holder's option, may
declare* all sums of principal and interest outstanding hereunder to be
immediately due and payable without presentment, demand, notice of
nonperformance, notice of protest, protest or notice of dishonor, all of which
are expressly waived by each Borrower,* and the obligation, if any, of the
holder to extend any further credit hereunder shall immediately cease and
terminate. Each Borrower shall pay to the holder immediately upon demand the
full amount of all payments, advances,
*SUBJECT TO TERMS OF THE CREDIT AGREEMENT
<PAGE>
charges, costs and expenses, including reasonable attorneys' fees (to include
outside counsel fees and all allocated costs of the holder's in-house counsel),
expended or incurred by the holder in connection with the enforcement of the
holder's rights and/or the collection of any amounts which become due to the
holder under this Note, and the prosecution or defense of any action in any way
related to this Note, including without limitation, any action for declaratory
relief, whether incurred at the trial or appellate level, in an arbitration
proceeding or otherwise, and including any of the foregoing incurred in
connection with any bankruptcy proceeding (including without limitation, any
adversary proceeding, contested matter or motion brought by Bank or any other
person) relating to any Borrower or any other person or entity.
(b) Obligations Joint and Several. Should more than one person or entity
-----------------------------
sign this Note as a Borrower, the obligations of each such Borrower shall be
joint and several.
(c) Governing Law. This Note shall be governed by and construed in
-------------
accordance with the laws of the State of California.
IN WITNESS WHEREOF, the undersigned has executed this Note as of the date
first written above.
SHOE PAVILION CORPORATION
By: /s/ Gary Schwartz
-------------------
GARY SCHWARTZ
VICE PRESIDENT & CHIEF FINANCIAL OFFICER
<PAGE>
Exhibit 10.8
CONTINUING GUARANTY
TO: WELLS FARGO BANK, NATIONAL ASSOCIATION
1. GUARANTY; DEFINITIONS. In consideration of any credit or other
financial accommodation heretofore, now or hereafter extended or made to SHOE
PAVILION CORPORATION ("Borrower") by WELLS FARGO BANK, NATIONAL ASSOCIATION
("Bank"), and for other valuable consideration, the undersigned SHOE PAVILION,
INC. ("Guarantor") unconditionally guarantees and promises to pay to Bank, or
order, on demand in lawful money of the United States of America and in
immediately available funds, any and all Indebtedness of Borrower to Bank. The
word "Indebtedness" is used herein in its most comprehensive sense and means any
and all advances, debts, obligations and liabilities of Borrower heretofore, now
or hereafter made, incurred or created under or in connection with a Credit
Agreement between Borrower and Bank dated as of December 1, 1998, together with
all promissory notes issued thereunder, as hereafter amended, renewed, replaced
or restated (collectively, the "Credit Agreement"), whether voluntary or
involuntary and however arising, whether due or not due, absolute or contingent,
liquidated or unliquidated, determined or undetermined, and whether Borrower may
be liable individually or jointly with others, or whether recovery upon such
Indebtedness may be or hereafter becomes unenforceable.
2. MAXIMUM LIABILITY; SUCCESSIVE TRANSACTIONS; REVOCATION; OBLIGATION
UNDER OTHER GUARANTIES. The liability of Guarantor shall not exceed at any one
time the sum of FIFTEEN MILLION Dollars ($15,000,000.00) for principal, plus
all interest thereon and costs and expenses pertaining to the enforcement of
this Guaranty and/or the collection of the Indebtedness of Borrower to Bank.
Notwithstanding the foregoing, Bank may permit the Indebtedness of Borrower to
exceed Guarantor's liability. This is a continuing guaranty and all rights,
powers and remedies hereunder shall apply to all past, present and future
Indebtedness of Borrower to Bank, including that arising under successive
transactions which shall either continue the Indebtedness, increase or decrease
it, or from time to time create new Indebtedness after all or any prior
Indebtedness has been satisfied, and notwithstanding the death, incapacity,
dissolution, liquidation or bankruptcy of Borrower or Guarantor or any other
event or proceeding affecting Borrower or Guarantor. This Guaranty shall not
apply to any new Indebtedness created after actual receipt by Bank of written
notice of the revocation of this Guaranty by Guarantor as to such new
Indebtedness; provided however, that loans or advances made by Bank to Borrower
after revocation under commitments existing prior to receipt by Bank of such
revocation, and extensions, renewals or modifications, of any kind, of
Indebtedness incurred by Borrower or committed by Bank prior to receipt by Bank
of such revocation, shall not be considered new Indebtedness. Any such notice
must
<PAGE>
be sent to Bank by registered U.S. mail, postage prepaid, addressed to its
office at One Kaiser Plaza, Suite 850, Oakland, California 94612, or at such
other address as Bank shall from time to time designate. Any payment by
Guarantor shall not reduce Guarantor's maximum obligation hereunder unless
written notice to that effect is actually received by Bank at or prior to the
time of such payment. The obligations of Guarantor hereunder shall be in
addition to any obligations of Guarantor under any other guaranties of any
liabilities or obligations of Borrower or any other person heretofore or
hereafter given to Bank unless said other guaranties are expressly modified or
revoked in writing; and this Guaranty shall not, unless expressly herein
provided, affect or invalidate any such other guaranties.
3. OBLIGATIONS JOINT AND SEVERAL; SEPARATE ACTIONS; REINSTATEMENT OF
LIABILITY. The obligations hereunder are joint and several and independent of
the obligations of Borrower, and a separate action or actions may be brought and
prosecuted against Guarantor whether action is brought against Borrower or any
other person, or whether Borrower or any other person is joined in any such
action or actions. Guarantor acknowledges that this Guaranty is absolute and
unconditional, there are no conditions precedent to the effectiveness of this
Guaranty, and this Guaranty is in full force and effect and is binding on
Guarantor as of the date written below, regardless of whether Bank obtains
collateral or any guaranties from others or takes any other action contemplated
by Guarantor. The liability of Guarantor hereunder shall be reinstated and
revived and the rights of Bank shall continue if and to the extent for any
reason any amount at any time paid on account of any Indebtedness guaranteed
hereby is rescinded or must otherwise be restored by Bank, whether as a result
of any proceedings in bankruptcy or reorganization or otherwise, all as though
such amount had not been paid. The determination as to whether any amount so
paid must be rescinded or restored shall be made by Bank in its reasonable
discretion; provided however, that if Bank chooses to contest any such matter at
the request of Guarantor, Guarantor agrees to indemnify and hold Bank harmless
from and against all costs and expenses, including reasonable attorneys' fees,
expended or incurred by Bank in connection therewith, including without
limitation, in any litigation with respect thereto.
4. AUTHORIZATIONS TO BANK. Guarantor authorizes Bank either before or
after revocation hereof, without notice to or demand on Guarantor, and without
affecting Guarantor's liability hereunder, from time to time to: (a) alter,
compromise, renew, extend, accelerate or otherwise change the time for payment
of, or otherwise change the terms of the Indebtedness or any portion thereof,
including increase or decrease of the rate of interest thereon; (b) take and
hold security for the payment of this Guaranty or the Indebtedness or any
portion thereof, and exchange, enforce, waive, subordinate or release any such
-2-
<PAGE>
security; (c) apply such security and direct the order or manner of sale
thereof, including without limitation, a non-judicial sale permitted by the
terms of the controlling security agreement or deed of trust, as Bank in its
discretion may determine; (d) release or substitute any one or more of the
endorsers or any other guarantors of the Indebtedness, or any portion thereof,
or any other party thereto; and (e) apply payments received by Bank from
Borrower to any Indebtedness of Borrower to Bank, in such order as (i) Borrower
shall direct (so long as such direction is consistent with the terms of the
Credit Agreement) or (ii) if an Event of Default has occurred or Borrower has
not provided direction, Bank shall determine in its reasonable discretion,
whether or not such Indebtedness is covered by this Guaranty, and Guarantor
hereby waives any provision of law regarding application of payments which
specifies otherwise. Bank may without notice assign this Guaranty in whole or in
part. Upon Bank's request, Guarantor agrees to provide to Bank copies of
Guarantor's financial statements.
5. REPRESENTATIONS AND WARRANTIES. Guarantor represents and warrants to
Bank that: (a) this Guaranty is executed at Borrower's request; (b) Guarantor
shall not, without Bank's prior written consent, sell, lease, assign, encumber,
hypothecate, transfer or otherwise dispose of all or a substantial or material
part of Guarantor's assets other than in the ordinary course of Guarantor's
business; (c) Bank has made no representation to Guarantor as to the
creditworthiness of Borrower; and (d) Guarantor has established adequate means
of obtaining from Borrower on a continuing basis financial and other information
pertaining to Borrower's financial condition. Guarantor agrees to keep
adequately informed from such means of any facts, events or circumstances which
might in any way affect Guarantor's risks hereunder, and Guarantor further
agrees that Bank shall have no obligation to disclose to Guarantor any
information or material about Borrower which is acquired by Bank in any manner.
6. GUARANTOR'S WAIVERS.
(a) Guarantor waives any right to require Bank to: (i) proceed against
Borrower or any other person; (ii) marshal assets or proceed against or exhaust
any security held from Borrower or any other person; (iii) give notice of the
terms, time and place of any public or private sale of personal property
security held from Borrower or any other person, or otherwise comply with the
provisions of Section 9504 of the California Uniform Commercial Code; (iv) take
any action or pursue any other remedy in Bank's power; or (v) make any
presentment or demand for performance, or give any notice of nonperformance,
protest, notice of protest or notice of dishonor hereunder or in connection with
any obligations or evidences of indebtedness held by Bank as security for or
which constitute in whole or in part
-3-
<PAGE>
the Indebtedness guaranteed hereunder, or in connection with the creation of new
or additional Indebtedness.
(b) Guarantor waives any defense to its obligations hereunder based upon
or arising by reason of: (i) any disability or other defense of Borrower or any
other person; (ii) the cessation or limitation from any cause whatsoever, other
than payment in full, of the Indebtedness of Borrower or any other person; (iii)
any lack of authority of any officer, director, partner, agent or any other
person acting or purporting to act on behalf of Borrower, if a corporation,
partnership or other type of entity, or any defect in the formation of such
Borrower; (iv) the application by Borrower of the proceeds of any Indebtedness
for purposes other than the purposes represented by Borrower to, or intended or
understood by, Bank or Guarantor; (v) any act or omission by Bank which directly
or indirectly results in or aids the discharge of Borrower or any portion of the
Indebtedness by operation of law or otherwise, or which in any way impairs or
suspends any rights or remedies of Bank against Borrower; (vi) any impairment of
the value of any interest in any security for the Indebtedness or any portion
thereof, including without limitation, the failure to obtain or maintain
perfection or recordation of any interest in any such security, the release of
any such security without substitution, and/or the failure to preserve the value
of, or to comply with applicable law in disposing of, any such security; or
(vii) any modification of the Indebtedness, in any form whatsoever, including
any modification made after revocation hereof to any Indebtedness incurred prior
to such revocation, and including without limitation the renewal, extension,
acceleration or other change in time for payment of, or other change in the
terms of, the Indebtedness or any portion thereof, including increase or
decrease of the rate of interest thereon. Until all Indebtedness shall have been
paid in full, Guarantor shall have no right of subrogation, and Guarantor waives
any right to enforce any remedy which Bank now has or may hereafter have against
Borrower or any other person, and waives any benefit of, or any right to
participate in, any security now or hereafter held by Bank. Guarantor further
waives all rights and defenses Guarantor may have arising out of (A) any
election of remedies by Bank, even though that election of remedies, such as a
non-judicial foreclosure with respect to any security for any portion of the
Indebtedness, destroys Guarantor's rights of subrogation or Guarantor's rights
to proceed against Borrower for reimbursement, or (B) any loss of rights
Guarantor may suffer by reason of any rights, powers or remedies of Borrower in
connection with any anti-deficiency laws or any other laws limiting, qualifying
or discharging Borrower's Indebtedness, whether by operation of Sections 726,
580a or 580d of the Code of Civil Procedure as from time to time amended, or
otherwise, including any rights Guarantor may have to a Section 580a fair market
value hearing to determine the size of a deficiency following any trustee's
-4-
<PAGE>
foreclosure sale or other disposition of any real property security for any
portion of the Indebtedness.
7. BANK'S RIGHTS WITH RESPECT TO GUARANTOR'S PROPERTY IN BANK'S
POSSESSION. In addition to all liens upon and rights of setoff against the
monies, securities or other property of Guarantor given to Bank by law, Bank
shall have a lien upon and a right of setoff, exercisable after an Event of
Default under the Credit Agreement, against all monies, securities and other
property of Guarantor now or hereafter in the possession of or on deposit with
Bank, whether held in a general or special account or deposit or for safekeeping
or otherwise, and every such lien and right of setoff may be exercised without
demand upon or notice to Guarantor. No lien or right of setoff shall be deemed
to have been waived by any act or conduct on the part of Bank, or by any neglect
to exercise such right of setoff or to enforce such lien, or by any delay in so
doing, and every right of setoff and lien shall continue in full force and
effect until such right of setoff or lien is specifically waived or released by
Bank in writing.
8. SUBORDINATION. INTENTIONALLY DELETED.
9. REMEDIES; NO WAIVER. All rights, powers and remedies of Bank
hereunder are cumulative. No delay, failure or discontinuance of Bank in
exercising any right, power or remedy hereunder shall affect or operate as a
waiver of such right, power or remedy; nor shall any single or partial exercise
of any such right, power or remedy preclude, waive or otherwise affect any other
or further exercise thereof or the exercise of any other right, power or remedy.
Any waiver, permit, consent or approval of any kind by Bank of any breach of
this Guaranty, or any such waiver of any provisions or conditions hereof, must
be in writing and shall be effective only to the extent set forth in writing.
10. COSTS, EXPENSES AND ATTORNEYS' FEES. The non-prevailing party shall
pay to the prevailing party immediately upon demand the full amount of all
payments, advances, charges, costs and expenses, including reasonable attorneys'
fees (to include outside counsel fees and all allocated costs of in-house
counsel), expended or incurred by the prevailing party in connection with the
enforcement of any of the prevailing party's rights, powers or remedies and/or
the collection of any amounts which become due to the prevailing under this
Guaranty, and the prosecution or defense of any action in any way related to
this Guaranty, whether incurred at the trial or appellate level, in an
arbitration proceeding or otherwise, and including any of the foregoing incurred
in connection with any bankruptcy proceeding (including without limitation, any
adversary proceeding, contested matter or motion brought by Bank, Borrower,
Guarantor or any other person) relating to Guarantor or any other person or
-5-
<PAGE>
entity. All of the foregoing shall be paid by the non-prevailing party with
interest from the date of demand until paid in full at a rate per annum equal to
ten percent (10%).
11. SUCCESSORS; ASSIGNMENT. This Guaranty shall be binding upon and inure
to the benefit of the heirs, executors, administrators, legal representatives,
successors and assigns of the parties; provided however, that Guarantor may not
assign or transfer any of its interests or rights hereunder without Bank's prior
written consent. Guarantor acknowledges that Bank has the right to sell,
assign, transfer, negotiate or grant participations in all or any part of, or
any interest in, any Indebtedness of Borrower to Bank and any obligations with
respect thereto, including this Guaranty. In connection therewith, Bank may
disclose all documents and information which Bank now has or hereafter acquires
relating to Guarantor and/or this Guaranty, whether furnished by Borrower,
Guarantor or otherwise. Guarantor further agrees that Bank may disclose such
documents and information to Borrower.
12. AMENDMENT. This Guaranty may be amended or modified only in writing
signed by Bank and Guarantor.
13. INTENTIONALLY DELETED.
14. UNDERSTANDING WITH RESPECT TO WAIVERS; SEVERABILITY OF PROVISIONS.
Guarantor warrants and agrees that each of the waivers set forth herein is made
with Guarantor's full knowledge of its significance and consequences, and that
under the circumstances, the waivers are reasonable and not contrary to public
policy or law. If any waiver or other provision of this Guaranty shall be held
to be prohibited by or invalid under applicable public policy or law, such
waiver or other provision shall be ineffective only to the extent of such
prohibition or invalidity, without invalidating the remainder of such waiver or
other provision or any remaining provisions of this Guaranty.
15. GOVERNING LAW. This Guaranty shall be governed by and construed in
accordance with the laws of the State of California.
16. ARBITRATION.
(a) Arbitration. Upon the demand of any party, any Dispute shall be
-----------
resolved by binding arbitration (except as set forth in (e) below) in accordance
with the terms of this Guaranty. A "Dispute" shall mean any action, dispute,
claim or controversy of any kind, whether in contract or tort, statutory or
common law, legal or equitable, now existing or hereafter arising under or in
connection with, or in any way pertaining to, this Guaranty and each other
document, contract and instrument required hereby or now or hereafter delivered
to Bank in connection herewith (collectively, the "Documents"), or any past,
present or future
-6-
<PAGE>
extensions of credit and other activities, transactions or obligations of any
kind related directly or indirectly to any of the Documents, including without
limitation, any of the foregoing arising in connection with the exercise of any
self-help, ancillary or other remedies pursuant to any of the Documents. Any
party may by summary proceedings bring an action in court to compel arbitration
of a Dispute. Any party who fails or refuses to submit to arbitration following
a lawful demand by any other party shall bear all costs and expenses incurred by
such other party in compelling arbitration of any Dispute.
(b) Governing Rules. Arbitration proceedings shall be administered by the
---------------
American Arbitration Association ("AAA") or such other administrator as the
parties shall mutually agree upon in accordance with the AAA Commercial
Arbitration Rules. All Disputes submitted to arbitration shall be resolved in
accordance with the Federal Arbitration Act (Title 9 of the United States Code),
notwithstanding any conflicting choice of law provision in any of the Documents.
The arbitration shall be conducted at a location in San Francisco or Oakland,
California selected by the AAA or other administrator. If there is any
inconsistency between the terms hereof and any such rules, the terms and
procedures set forth herein shall control. All statutes of limitation
applicable to any Dispute shall apply to any arbitration proceeding. All
discovery activities shall be expressly limited to matters directly relevant to
the Dispute being arbitrated. Judgment upon any award rendered in an
arbitration may be entered in any court having jurisdiction; provided however,
that nothing contained herein shall be deemed to be a waiver by any party that
is a bank of the protections afforded to it under 12 U.S.C. (S)91 or any similar
applicable state law.
(c) No Waiver; Provisional Remedies, Self-Help and Foreclosure. No
----------------------------------------------------------
provision hereof shall limit the right of any party to exercise self-help
remedies such as setoff, foreclosure against or sale of any real or personal
property collateral or security, or to obtain provisional or ancillary remedies,
including without limitation injunctive relief, sequestration, attachment,
garnishment or the appointment of a receiver, from a court of competent
jurisdiction before, after or during the pendency of any arbitration or other
proceeding. The exercise of any such remedy shall not waive the right of any
party to compel arbitration or reference hereunder.
(d) Arbitrator Qualifications and Powers; Awards. Arbitrators must be
--------------------------------------------
active members of the California State Bar or retired judges of the state or
federal judiciary of California, with expertise in the substantive law
applicable to the subject matter of the Dispute. Arbitrators are empowered to
resolve Disputes by summary rulings in response to motions filed prior to the
final arbitration hearing. Arbitrators (i) shall resolve all
-7-
<PAGE>
Disputes in accordance with the substantive law of the state of California, (ii)
may grant any remedy or relief that a court of the state of California could
order or grant within the scope hereof and such ancillary relief as is necessary
to make effective any award, and (iii) shall have the power to award recovery of
all costs and fees, to impose sanctions and to take such other actions as they
deem necessary to the same extent a judge could pursuant to the Federal Rules of
Civil Procedure, the California Rules of Civil Procedure or other applicable
law. Any Dispute in which the amount in controversy is $5,000,000 or less shall
be decided by a single arbitrator who shall not render an award of greater than
$5,000,000 (including damages, costs, fees and expenses). By submission to a
single arbitrator, each party expressly waives any right or claim to recover
more than $5,000,000. Any Dispute in which the amount in controversy exceeds
$5,000,000 shall be decided by majority vote of a panel of three arbitrators;
provided however, that all three arbitrators must actively participate in all
hearings and deliberations.
(e) Judicial Review. Notwithstanding anything herein to the contrary, in
---------------
any arbitration in which the amount in controversy exceeds $25,000,000, the
arbitrators shall be required to make specific, written findings of fact and
conclusions of law. In such arbitrations (i) the arbitrators shall not have the
power to make any award which is not supported by substantial evidence or which
is based on legal error, (ii) an award shall not be binding upon the parties
unless the findings of fact are supported by substantial evidence and the
conclusions of law are not erroneous under the substantive law of the state of
California, and (iii) the parties shall have in addition to the grounds referred
to in the Federal Arbitration Act for vacating, modifying or correcting an award
the right to judicial review of (A) whether the findings of fact rendered by the
arbitrators are supported by substantial evidence, and (B) whether the
conclusions of law are erroneous under the substantive law of the state of
California. Judgment confirming an award in such a proceeding may be entered
only if a court determines the award is supported by substantial evidence and
not based on legal error under the substantive law of the state of California.
(f) Real Property Collateral; Judicial Reference. Notwithstanding anything
--------------------------------------------
herein to the contrary, no Dispute shall be submitted to arbitration if the
Dispute concerns indebtedness secured directly or indirectly, in whole or in
part, by any real property unless (i) the holder of the mortgage, lien or
security interest specifically elects in writing to proceed with the
arbitration, or (ii) all parties to the arbitration waive any rights or benefits
that might accrue to them by virtue of the single action rule statute of
California, thereby agreeing that all indebtedness and obligations of the
parties, and all
-8-
<PAGE>
mortgages, liens and security interests securing such indebtedness and
obligations, shall remain fully valid and enforceable. If any such Dispute is
not submitted to arbitration, the Dispute shall be referred to a referee in
accordance with California Code of Civil Procedure Section 638 et seq., and this
general reference agreement is intended to be specifically enforceable in
accordance with said Section 638. A referee with the qualifications required
herein for arbitrators shall be selected pursuant to the AAA's selection
procedures. Judgment upon the decision rendered by a referee shall be entered in
the court in which such proceeding was commenced in accordance with California
Code of Civil Procedure Sections 644 and 645.
(g) Miscellaneous. To the maximum extent practicable, the AAA, the
-------------
arbitrators and the parties shall take all action required to conclude any
arbitration proceeding within 180 days of the filing of the Dispute with the
AAA. No arbitrator or other party to an arbitration proceeding may disclose the
existence, content or results thereof, except for disclosures of information by
a party required in the ordinary course of its business, by applicable law or
regulation, or to the extent necessary to exercise any judicial review rights
set forth herein. If more than one agreement for arbitration by or between the
parties potentially applies to a Dispute, the arbitration provision most
directly related to the Documents or the subject matter of the Dispute shall
control. This arbitration provision shall survive termination, amendment or
expiration of any of the Documents or any relationship between the parties.
IN WITNESS WHEREOF, the undersigned Guarantor has executed this Guaranty as
of December 16, 1998.
SHOE PAVILION, INC.
By: /s/ Gary Schwartz
-----------------
Title: CFO & VP
--------------
-9-
<PAGE>
EXHIBIT 21
LIST OF SUBSIDIARIES
The following table sets forth certain information concerning the sole
subsidiary of the Company.
State or Other
Name Jurisdiction of Incorporation
---- -----------------------------
Shoe Pavilion Corporation Washington
<PAGE>
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
333-49007 and 333-49009 of Shoe Pavilion, Inc. each on Form S-8 regarding the
Directors' Stock Option Plan and the 1998 Equity Incentive Plan, respectively,
of our report dated February 12, 1999, appearing in this Annual Report on Form
10-K of Shoe Pavilion, Inc. for the year ended January 2, 1999.
DELOITTE & TOUCHE LLP
San Francisco, California
March 19, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> JAN-02-1999 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> JAN-02-1999 DEC-31-1997
<CASH> 1,922 395
<SECURITIES> 0 0
<RECEIVABLES> 0 0
<ALLOWANCES> 0 0
<INVENTORY> 26,892 19,796
<CURRENT-ASSETS> 29,071 20,263
<PP&E> 6,275 3,758
<DEPRECIATION> 2,440 1,684
<TOTAL-ASSETS> 33,534 22,646
<CURRENT-LIABILITIES> 15,332 14,218
<BONDS> 0 0
0 0
0 0
<COMMON> 7 4
<OTHER-SE> 17,021 7,324
<TOTAL-LIABILITY-AND-EQUITY> 33,534 22,646
<SALES> 55,907 45,074
<TOTAL-REVENUES> 55,907 45,074
<CGS> 35,777 28,922
<TOTAL-COSTS> 35,777 28,922
<OTHER-EXPENSES> 15,136 11,906
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 430 575
<INCOME-PRETAX> 4,540 3,726
<INCOME-TAX> 1,147 261
<INCOME-CONTINUING> 3,393 3,465
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 3,393 3,465
<EPS-PRIMARY> .53 .77
<EPS-DILUTED> .52 .77
</TABLE>
