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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
AMENDMENT NO. 1
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM
--------------- TO
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COMMISSION FILE NUMBER 0-27920
GARDEN BOTANIKA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C>
WASHINGTON 91-1464962
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
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8624 - 154TH AVENUE NE
REDMOND, WASHINGTON 98052
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(425) 881-9603
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE PER SHARE
(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 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. [ ]
The aggregate market value of the Common Stock of the Registrant held by
nonaffiliates of the Registrant on April 27, 1998, was $10,464,832. The
aggregate market value was computed by reference to the closing price of the
stock on the Nasdaq National Market on such date. For the purposes of this
response, executive officers and directors are deemed to be the affiliates of
the Registrant and the holding by nonaffiliates was computed as 6,439,897
shares. In making such calculation, the Registrant does not determine the
affiliate or nonaffiliate status of any shareholder for any other purpose.
The Registrant had 7,069,098 shares of Common Stock, $0.01 par value,
outstanding at April 27, 1998.
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FORWARD-LOOKING STATEMENTS
Certain statements within the following description of the business of
Garden Botanika, Inc. ("Garden Botanika" or the "Company") and elsewhere in this
Form 10-K constitute "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors that
may cause actual results, performance or achievements of the Company or its
industry to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements. Such
factors include, among other things, the Company's losses and lack of
profitability to date; fluctuations and/or declines in comparable store sales
results; competition; and the Company's ability to successfully implement
strategies in new channels of distribution.
PART I
ITEM 1. BUSINESS
GENERAL
Garden Botanika develops, manufactures, distributes and sells high-quality,
reasonably priced personal care products. The Company's proprietary products
encompass such categories as color cosmetics, skin care, fragrances, bath and
body care and related accessories and gifts. Garden Botanika develops its
branded products and distributes them for sale primarily through its 280
Company-owned and -operated specialty retail stores in 41 states nationwide and
through the Company's catalog. In addition, the Company has begun limited
commercial sales through third-party retailers and intends to explore new
channels of distribution in order to increase sales and brand awareness. The
Company believes that its brand identity is based upon (i) high-quality products
with botanically based formulations subject to strict ingredient guidelines;
(ii) its value-oriented pricing and promotional strategies; and (iii) a
high-quality shopping experience, which the Company provides through its upscale
store design, customer service and the visual presentation of its products and
signage. The Company believes that the strength of its brand in the markets in
which it competes most successfully will provide opportunities to develop new
products, sales in new channels of distribution and a broader customer base.
Garden Botanika's marketing and merchandising efforts have historically
targeted working women who may have purchased skin care and cosmetic products
from mall-based department stores and who ideally utilize quality personal care
products both on a daily basis and as an affordable luxury item. The Company
believes these women appreciate value pricing without having to sacrifice high
quality and service, and that working women increasingly will be looking to
personal care products to mitigate the impact of aging. Garden Botanika also
believes that its marketing strategy has attracted a broad cross-section of
other consumers beyond its primary target, including younger customers who are
attracted to the Company's hands-on merchandising approach. The Company is
seeking to extend its customer base by means of its promotional activities,
third-party commercial sales, television shopping channels, international
licensing opportunities and an expanded hotel amenities program.
After opening 66 and 101 stores in fiscal years 1995 and 1996,
respectively, the Company slowed its rate of growth significantly, opening only
27 stores in fiscal 1997 and planning to open only one store in fiscal 1998. The
average performance of the 167 stores opened in fiscal 1995 and 1996 has been
substantially below historical experience and the Company's expectations, which
the Company believes is the result of such stores being geographically dispersed
and not having sufficient market penetration to benefit effectively from the
Garden Botanika brand, as well as the result of facing intense competition from
Bath and Body Works, the Body Shop and other specialty retailers and mass
merchandisers. In fiscal 1998, the Company plans to review the productivity of
each store in its real estate portfolio with the view toward closing certain
stores that fail to meet performance standards. The Company currently
contemplates that approximately 12 stores will be closed in fiscal 1998,
although the exact number may differ depending upon the results of its review
and other factors, such as the possible emergence of a buyer for one or more of
the Company's stores. Garden Botanika achieved average annual sales per square
foot of $324 in fiscal 1997, at the end of which the average age of its stores
was
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32 months. The Company's comparable store sales increased 16%, 7% and 1% during
fiscal 1995, 1996 and 1997, respectively.
INDUSTRY OVERVIEW
The highly fragmented personal care products industry, which includes color
cosmetics, skin care, fine fragrances and bath and body care, has annual sales
nationwide in excess of $20 billion. Historically, a leading distribution
channel for such products has been mall-based department stores. The Company
believes that consumer preferences have shifted in recent years to favor
distribution channels offering generally lower prices and a less intimidating
sales environment, such as drugstores, mass merchandisers, television
"infomercials" and shopping channels and specialty retailers.
The Company believes that, in targeting their respective market segments,
department stores on the one hand and the lower-priced mass distribution
channels on the other did not address or serve adequately a significant market
consisting of customers seeking a combination of quality products and reasonable
pricing. A number of specialty retailers, including Garden Botanika, have
addressed this market need by positioning themselves as alternatives to the
high-priced, high-quality designer brands offered by department stores and the
low-priced products sold by drugstores, mass merchandisers and supermarkets.
Within the personal care segment of specialty retailers, Garden Botanika has
sought to distinguish itself by its high-value, quality branded product
assortment, emphasizing color cosmetics, skin care and fine fragrance and by its
customer service.
MERCHANDISING
Product Quality. Garden Botanika's strict ingredient policy, using
botanical extracts and natural plant oils, is a major factor underlying the
quality of the Company's products. Garden Botanika believes that botanical
ingredients are more appealing to its customers because they are perceived to be
safer and more effective than many synthetic substances. Garden Botanika also
believes that its customers value the Company's use of ingredients that have
been tested through centuries of historical use. The Company avoids the use of
petrochemical oils and comedogenic materials that can block pores and cause
blemishes, as well as many common allergens. Many of the ingredients that the
Company avoids, such as mineral oil and petrolatum, are used regularly by some
of its competitors.
Product Assortment. While all Garden Botanika products feature a high level
of functional quality, care has also been taken to maintain a sense of variety
and fun in the Company's product assortment. Complementary accessory items,
ranging from overnight moisture gloves to scented candles and potpourri, are
color-coordinated with related products in order to add to the appeal of the
Company's merchandise assortment. The combination of sight, smell and touch is
meant to inspire add-on sales and heighten the customer's experience of Garden
Botanika's products and the ambiance of its stores.
In addition to offering conventional personal care lines such as cosmetics
and skin care, Garden Botanika has developed specialty branded product lines to
reinforce the uniqueness and expand the base of the Company's proprietary
products. For example, the Spa Botanika line is intended to offer affordable
luxury items such as body polishers, muds, soaks, tonics and special shampoos,
and the Prefix line is designed to correct a woman's skin and facial
imperfections before she applies her basic makeup. The Company also develops new
lines to capitalize on market or seasonal trends, such as its Transparencies
line of bright and fresh fragrances and its Gardener Botanika seasonal line of
intensive skin care for those with active, outdoor lifestyles. The Company
intends to introduce new specialty branded product lines in the future on a
regular basis and will replace older product lines with new ones in accordance
with customer demand. In addition, in the second and third quarters of fiscal
1997, the Company discontinued approximately 30% of its basic assortment,
primarily in less popular sizes, with the long-term goal of improving inventory
turnover.
Product Pricing. Garden Botanika is committed to providing high value to
its customers. The Company seeks to price its products at a substantial discount
to those offered at department stores for comparable products. In addition, the
Company regularly monitors the price levels of comparable products offered by
its competitors, including specialty retailers, and Garden Botanika is committed
to making pricing adjustments to
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ensure that its products remain competitive. For instance, in fiscal 1997, the
Company significantly lowered the pricing of its basic toiletries (bath, body
and hair care) in an effort to attract customers from its direct mall-based
competitors. Short-term promotional offerings of particular products are
intended to provide greater savings and generate additional sales.
With commercial sales, such as sales of specially bundled products to
Costco Wholesale or television shopping channels, the pricing of the Company's
products for purchase by the ultimate consumer may be subject to the policies of
others. Generally, the Company expects that sales of its products to the general
public by third parties would be at a discount over the Company's prices at its
retail locations, and, as a result, sales by the Company to third party
wholesalers may have a substantially different margin structure than retail
sales in Company-owned stores. To date, the Company believes that the reduced
margins required for commercial sales are justified by their potential volume,
the lack of associated expense in operational costs at the retail store level
and the opportunity to enhance brand awareness.
Packaging. The Company believes that attractive merchandise displays and
well-designed, aesthetically pleasing product packaging play an important role
in enhancing the image of its products and the Garden Botanika brand name. The
Company regularly bundles several related products together, which are then
offered at a discount from the purchase price of each item alone. Such bundled
discounts are characteristic of both the Company's promotions and its gift
lines. Bundled discounts have also characterized the Company's offerings to
Costco Wholesale and Home Shopping Network.
NEW PRODUCT DEVELOPMENT
Garden Botanika is committed to the introduction of new products and
formulations on a regular basis. The Company also devotes substantial resources
to monitoring, market by market, which products are becoming more or less
important to its customers and uses this information in its new product
development efforts. For example, soon after consumers showed interest in
products containing alpha hydroxy acids, the Company introduced its Skin
Renewing treatment and lotion with a fruit-based acid complex. Similarly, the
Company's Transparencies line was introduced to capitalize on a market trend for
bright and fresh fragrances (in contrast, for instance, to more heavy
traditional floral scents). The Company believes that its ability to develop,
test and market new products helps reinforce the appealing, fresh nature of the
Garden Botanika brand.
In October 1995, Garden Botanika acquired a manufacturing facility that,
depending on seasonal needs, employs 20 to 30 persons in Oceanside, California.
The Company's control of its product development and manufacturing capabilities
allows for in-house research and development and the introduction of new
products more quickly and at a lower cost. In addition, the laboratory
capabilities acquired allow the Company to conduct quality testing of the
products it manufactures as well as those products produced for Garden Botanika
by outside suppliers.
STORE ENVIRONMENT
The Company seeks to offer an attractive store environment that showcases
its product offerings and promotes product testing and trial by its customers.
Garden Botanika's brightly lit stores were designed to project an upscale
atmosphere and to reinforce the Company's distinctive brand image. Since opening
its first store in August 1990, Garden Botanika has refined and improved its
store design to position itself and establish a distinctive image in the
marketplace. The current design of the Company's stores incorporates neutral
white fixtures with merchandise displays and product arrangements that allow for
self-selection. In August 1996, Garden Botanika opened its first store
incorporating a Color Studio into its prototype design, with makeover stations
and a significantly expanded assortment of color cosmetics displayed to allow
for in-store experimentation and trial. The Company's staff for its Color Studio
stores includes sales associates with special training and expertise who can
demonstrate the latest make-up techniques and suggest colors and products to
suit each particular customer. Twelve of the 101 new stores opened in fiscal
1996, and 23 of the 27 new stores opened in fiscal 1997, contained Color
Studios, and five stores were remodeled in the last two fiscal years to become
Color Studio stores.
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In the second quarter of fiscal 1997, to encourage hands-on interaction
with the merchandise and strengthen the visual appeal of its stores, the Company
undertook a major remerchandising effort. As part of that effort, Garden
Botanika doubled the color range of the cosmetics assortment in its traditional
stores, introduced new floor cosmetics testers in many stores, and increased
merchandise presentation fixturing in order to create a sense of abundance. The
Company also eliminated a large number of stock items to improve inventory
turnover.
From fiscal 1991 to fiscal 1997, excluding the Color Studio stores, the
average size of the new stores opened in each fiscal year increased from 765 to
1,217 square feet to accommodate the Company's expanding product assortment and
merchandising displays. The 23 Color Studio stores opened in fiscal 1997
averaged 1,762 square feet per store.
MARKETING
The Company's marketing strategy is to create brand awareness through
high-value promotional offerings, positive experiences with the Company's
products, and exploiting alternate channels of distribution, such as a hotel
amenities program that can help build recognition of the "Garden Botanika" name.
Catalog operations have also been an important element of Garden Botanika's
efforts to create brand awareness and encourage store visits. The Company
typically uses its in-house mailing list of store customers to target catalogs,
direct-mail postcards and folios to support promotions and new product
introductions, which are reinforced with point-of-sale materials and bright
in-store displays. To an increasing extent, the Company has made use of, and
continues to explore, channels of distribution outside mall-based specialty
retail stores. Examples of such channels of distribution include commercial
sales to Costco Wholesale for resale through its membership warehouses and
appearances on Home Shopping Network.
Garden Botanika also operates a mail-order division for sales to customers
who are outside of areas served by its stores, or who simply prefer to purchase
by mail or telephone. In fiscal 1996, the Company committed significant
resources in mailings to new prospects to build a "house file" of mail-order
customers. In fiscal 1997, to reduce mailing and printing costs, the Company
significantly decreased prospect mailings and focused its efforts on the more
productive house file of established and active mail-order customers. As
expected, the strategy also resulted in significantly lower mail-order sales
from reduced circulation. The Company currently intends to limit future
prospecting mailings and will seek to maintain its list of mail-order customers
at its present size.
To a large extent, the Company relies on its store locations and signage,
its colorful visual presentations of products, and word-of-mouth advertising to
attract prospective customers into its stores. Garden Botanika offers
value-priced bundles of many of its most popular products on a regular basis to
promote trial use. In addition, the Company seeks to be viewed as a responsible
member of its community and has sponsored holiday donations to CARE, a worldwide
hunger relief effort.
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STORE LOCATIONS
In selecting store sites, the Company has generally sought high-traffic
locations within regional malls, generally ranging from 1,200 to 1,500 square
feet for its traditional stores and from 1,500 to 2,100 square feet for its
newer Color Studio format. The following map shows the number of stores in each
state as of April 27, 1998:
[LOGO]
STORE OPERATIONS
Management and Employees. The Company's stores are organized into two
geographic regions (East and West), each of which has a regional director who is
responsible for store operations within her region and who reports to the
Company's Vice President -- Stores. The Company's 27 district managers report to
the regional directors and frequently visit the cluster of approximately eight
to 15 stores within their respective geographic areas to monitor performance and
ensure adherence to the Company's operating standards. The typical staff of a
Garden Botanika store consists of one store manager, one assistant store manager
and five to seven additional hourly sales associates, most of whom work
part-time. The typical Color Studio store staff includes a second assistant
store manager and a total of seven to nine hourly sales associates. The Company
intends for store employees to focus substantially all of their efforts on
customer service. As a consequence, the Company has centralized as many
administrative functions as possible, including all buying, development of
in-store merchandising displays, inventory allocation, human resources and
accounting functions, at its Redmond, Washington corporate offices.
Training and Compensation. Approximately 20 hours of training per month are
allocated for each store to train employees, with an emphasis on product
knowledge, merchandising standards and operating guidelines, which include
customer service and sales techniques. Store managers are also required to
complete a training program of approximately three weeks' duration, during which
they are instructed in the technical aspects of personal care products,
communication skills and employee relations. New store and district
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managers are typically required to work alongside individuals in comparable
positions for two to three weeks before they are asked to perform their duties
without direct supervision. The Company has found that such hands-on training,
together with the use of detailed operating and training manuals, is a highly
effective way to introduce new managers to the Garden Botanika concept. Training
bulletins and a Company newsletter are distributed from the Company's
headquarters on a regular basis to educate store managers and sales associates
about new products as they are introduced.
District managers participate in an incentive plan that ties compensation
awards to the achievement of specified sales and other financial performance
criteria, and each store manager receives a commission based on a percentage of
store sales. The Company also seeks to instill enthusiasm and dedication in its
sales associates through targeted promotions, including prizes for successful
sales efforts, and regularly solicits employee suggestions regarding store
operations.
SUPPLIERS AND PURCHASING
The Company deals with its suppliers principally on an order-by-order basis
and, with the exception of certain packaging orders, has no long-term purchase
contracts or other contractual assurance of continued supply or pricing with its
suppliers. In fiscal 1997, the Company's largest supplier, Randall Products
International, accounted for approximately 12% of the Company's purchases, and
approximately 62% of the Company's purchases of raw materials, finished
products, packaging and other supplies were obtained from its 15 largest
suppliers. During that time, a significant portion of the Company's merchandise
purchases originated from independent foreign manufacturers, located primarily
in Canada, the Far East and Germany, with the majority of those purchases
consisting of finished accessories and packaging. Based on the current
capabilities of its manufacturing division and available equipment, the Company
contemplates manufacturing approximately 20% of its production requirements from
its own facilities. The Company has not experienced any significant difficulty
and, provided suppliers can be assured of payment, does not anticipate any
significant difficulty in obtaining satisfactory or adequate sources of supply.
The Company maintains its own central buying staff, which negotiates
payment terms and discounts and generally determines inventory allocation among
the stores. In many instances in which the Company does not manufacture products
itself, its ownership of substantially all of its formulas allows it to obtain
favorable pricing through competitive bidding. The Company's buyers consistently
utilize computerized management information systems to monitor the flow of
merchandise through its stores and seek to ensure that in-stock availability
will be maintained in accordance with customer demands and the specific
requirements of each store. However, because of the lead time required for
manufacturing and the unanticipated popularity of certain new product
introductions, the Company has occasionally experienced in-store shortages of
particular items.
STORE DISTRIBUTION
Management believes that the Company's retail store distribution system
allows it to support a wide selection of inventory in its stores while
minimizing inventory requirements and maintaining effective inventory control.
The Company leases distribution facilities, consisting of approximately 110,000
square feet, in Ontario, California. Merchandise is delivered by suppliers to
these facilities, where relevant information is entered into the Company's
computerized management information system. Merchandise is then allocated to
stores on the basis of sales trends, historical patterns and anticipated
responses to special promotions. Inventory is typically shipped to stores on a
weekly or bi-weekly basis using an independent delivery service, thereby
providing each store with a steady flow of merchandise. The Company strives to
keep substantially all of its in-store inventory on display and available for
sale. The Company's information and control systems have enabled management to
manage store inventories and ensure better in-stock availability by tracking
local preferences and historical merchandise sales of each store.
CATALOG OPERATIONS
The Company's catalogs are distributed to both store and mail-order
customers, using separate lists maintained by the Company. Each edition of the
catalog is used as an advertising piece to promote in-store
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visits, while also offering Garden Botanika's mail-order customers a
comprehensive assortment of products. The Company currently uses a combination
of in-house marketing support and an outside catalog design agency to monitor
the catalog production process and develop effective catalog presentations.
The Company's overall catalog strategy focused, first, on the acquisition
of names and improved segmentation of prospective and active customer files, so
that mailings can be directed most effectively. In fiscal 1997, as the second
part of a two-year strategy, the Company mailed only to the most productive
segments of its active store customer lists and significantly decreased prospect
mailings for mail-order sales, thus focusing its marketing efforts on the more
productive house file of active mail-order customers. While this resulted in
lower circulation and reduced mail-order sales, the strategy also significantly
reduced overall mailing and printing costs and was implemented to improve the
Company's goal of achieving profitability. In fiscal 1997, the Company prepared
and circulated 10 editions of its catalog, which averaged 26 pages, two shorter
folios and a postcard, with total mailings of approximately 16.8 million. While
this is roughly comparable to the total number of mailings in fiscal 1996, last
year's mailings were more heavily weighted to retail store customers with less
emphasis on mail-order sales. Despite this shift in emphasis, retail store
mailings on a per-store basis actually declined from fiscal 1996 to fiscal 1997,
on account of the 40% increase in store months of operations in 1997. It is
likely that the relative reduction in the number of catalogs mailed per store
contributed to the slower rate of growth in both total and comparable store
sales in 1997, but the Company believes the impact of reduced per-store mailings
on retail store sales cannot be determined with accuracy.
COMMERCIAL SALES
Garden Botanika recently organized a commercial sales division to actively
pursue opportunities in new channels of distribution, including sales through
selected retailers, television retailing, international licensing and the
expansion of its hotel amenities program. In December 1997, the Company
completed its first significant commercial sale, consisting of a bundled
selection of color cosmetics, for resale by Costco Wholesale through selected
membership warehouse stores. Because of the initial success of this program, the
Company intends to pursue sales to Costco Wholesale, including planned sales of
bundled Transparencies and Natural Color Cosmetics products in the spring of
1998. Home Shopping Network has also placed an experimental order for Garden
Botanika products that the Company understands will be marketed in three
one-half hour time periods later this spring. Finally, the Company recently
signed a licensing agreement with a new supplier in the hotel amenities
industry, which it believes will increase its opportunities in this area, and is
actively exploring international licensing opportunities. In addition to
providing additional sales overall, the Company believes that commercial sales
to third parties can help build Garden Botanika's brand recognition and improve
overall profitability.
The Company has no current intention to offer through commercial sales in
the United States the same full array of its products that is available in its
Company-owned stores or through its mail-order catalog. As a consequence, the
Company expects that customers introduced to Garden Botanika products through a
third party, and wishing to make additional purchases of greater variety, will
be directed to purchase particular products directly from the Company.
MANAGEMENT INFORMATION SYSTEMS
Garden Botanika's management information systems include integrated store,
distribution and financial systems. These systems utilize UNIX-based
minicomputers to run third-party software, and the Company currently relies on
two related outside vendors for both its software and the day-to-day support of
its systems. Sales information is updated daily in the sales audit and
merchandise reporting systems by polling transaction data from each store's
point-of-sale ("POS") terminals. The Company's POS system consists of registers
providing price look-up, scanning of bar-coded tickets and capture of credit
information and payroll hours. The POS system also tracks store-initiated
transfers, which are uploaded to the host system, and price changes, which are
downloaded into the POS devices. Nightly communication with the stores enables
the Company to receive store transfer and physical inventory details and updates
for the Company's in-house customer database. Information obtained from nightly
polling also results in automatic merchandise replenishment on a
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weekly or biweekly basis in response to the specific SKU requirements of each
store. The Company evaluates information obtained through such reporting to
implement decisions regarding merchandising assortment, allocation and
markdowns. In addition, this information allows the Company to forecast
purchasing requirements for its distribution center based on the combination of
recent sales trends and historical purchase patterns. The Company also has
installed (i) a computerized warehouse management system at its distribution
center, which tracks and directs, as needed, inventory, warehouse space and
labor resources; and (ii) an integrated manufacturing information system, which
is designed to interface with its basic retail information system. This latter
system monitors work-in-progress, projects inventory requirements from third-
party suppliers and better allows the Company to place raw material and
component purchase orders as required. The Company believes that its management
information systems are an important factor in allowing it to efficiently
support its size and maintain a competitive industry position.
The Company is addressing the need to ensure that its operations will not
be adversely impacted by software or other system failures related to the year
2000. The Company's outside vendors that supply its management information
systems have represented to the Company that they have made the necessary
modifications to their computer systems, applications and business processes,
which the Company has acquired, or will acquire, as it obtains updated versions
of its software packages. The costs associated with this effort are expected to
be incurred through 1999 and are not expected to have a material impact on the
Company's financial condition in any given year. However, no assurances can be
given that the Company will be able to completely identify or address all year
2000 compliance issues, or that third parties with whom the Company does
business will not experience system failures as a result of the year 2000 issue,
nor can the Company fully predict the consequences of noncompliance.
COMPETITION
The personal care, make-up and fragrance businesses are highly competitive.
The Company's products compete directly against personal care, make-up,
fragrance and other functionally similar products sold through a variety of
channels, including department stores, drugstores, mass merchandisers,
supermarkets, telemarketing programs, television "infomercials" and catalogs.
The Company competes against a number of companies, many of which have
substantially greater resources and better name recognition than the Company and
which sell their products through broader distribution channels. Some department
stores have introduced less expensive product lines that the Company believes
compete more directly with its products.
The Company also competes directly against mall-based specialty retailers
of personal care and other products, including national and international chains
such as Bath and Body Works, The Body Shop, Victoria's Secret and Crabtree &
Evelyn, as well as local and regional specialty retailers. The number of
specialty retail outlets selling personal care products has increased
significantly in recent years, and the lack of significant barriers to entry may
result in new competition, including possible imitators of the Company. In
addition to competing for customers, the Company also competes generally with
specialty retailers for store sites, and, should the Company again become active
in opening new stores, there can be no assurance that management will be able to
secure suitable sites on satisfactory terms.
Management believes that the primary elements of competition in its
business are quality, price, customer service, brand recognition and market
penetration. The Company also believes that successful competition in the
personal care industry depends on both the regular introduction of new and
appealing products and customer acceptance of its store environment.
EMPLOYEES
At April 27, 1998, the Company employed approximately 2,400 persons, of
whom approximately 2,200 were store employees. Of the latter, approximately 25%
were full-time employees and approximately 75% were part-time employees. The
number of part-time associates employed by the Company fluctuates depending on
seasonal needs and has reached as high as 3,400 during peak selling periods. At
April 27, 1998, the Company employed approximately 200 non-store employees in
its corporate headquarters, its distribution center, manufacturing division and
in different parts of the country as regional or district managers.
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None of the Company's employees are covered by collective bargaining
agreements, and management believes that its relations with its employees are
satisfactory.
TRADEMARKS
The name "Garden Botanika" is registered as a trademark with the United
States Patent and Trademark Office. Management believes that the "Garden
Botanika" name is an important element of the Company's marketing strategy.
Accordingly, the Company intends to maintain its mark and the related
registration. The Company also has a number of other registered trademarks,
including Transparencies, Garden Botanika Natural Color and the GB-and-design
stylized logo, as well as other pending applications for registration in the
United States, Canada and selected other foreign countries. The Company believes
that establishing and maintaining brand identities are important to the
Company's operations.
GOVERNMENTAL REGULATION
The Company and its products are subject to regulation by the Food and Drug
Administration ("FDA") and the Federal Trade Commission ("FTC") in the United
States, as well as various other federal, state and local regulatory
authorities. In the event of international sales, the Company may also be
subject to the regulatory authority of a foreign jurisdiction. Such regulations
relate principally to the ingredients, labeling, packaging and marketing of the
Company's products. The Company believes that it is in substantial compliance
with such regulations, as well as with applicable federal, state, local and
foreign rules and regulations governing the discharge of materials hazardous to
the environment. There are no significant capital expenditures for environmental
control matters either estimated in the current fiscal year or expected in the
near future.
ITEM 2. PROPERTIES
The Company currently leases all of its existing store locations and
expects that its policy of leasing, rather than owning, will continue. The
Company's store leases generally provide for initial lease terms of five to 12
years. Management believes that these terms, in contrast to longer lease terms,
allow the Company flexibility to pursue various expansion opportunities
resulting from changing market conditions. Rent is generally the greater of a
percentage, ranging from 5% to 8%, of the store's sales volume or a fixed
minimum base rent. Lease rental payments are also subject to annual increases
for taxes, common area maintenance and insurance. See Notes to Financial
Statements.
As most of the Company's stores were opened during the last three years,
most of the store leases have at least seven more years under their current
terms. In February 1998, the Company announced its intention to close
approximately 12 under-performing stores during fiscal 1998, and one such store
has already been closed. In addition to estimated asset write-offs of $1.89
million for anticipated store closings, the Company has reserved approximately
$1.31 million for closing expenses associated with extracting itself from lease
obligations. On a regular basis, the Company reviews the performance of each of
its stores and is currently seeking to restructure the rent or obtain other
relief, either long- or short-term, for some of its most unprofitable stores. As
current leases expire, assuming relationships with landlords remain good, the
Company believes that it will be able either to obtain lease renewals for
present store locations, if desired, or to obtain leases for equivalent or
better locations in the same general area. To date, the Company has not had any
experience renewing leases for existing locations.
In addition to its stores, the Company currently leases approximately
20,971 square feet of office space in two buildings in Redmond, Washington for
its corporate headquarters and catalog call and customer service center. The
Company also leases approximately 110,000 square feet in Ontario, California as
its principal distribution and basket fabrication facility. To support its
manufacturing capabilities, the Company entered a
9
<PAGE> 11
lease for an 8,700 square-foot building and storage facility in Oceanside,
California. The Company believes that its facilities are adequate for its
business as currently conducted.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various routine legal proceedings incident to
the ordinary course of its business. The Company believes that the outcome of
all pending legal proceedings, in the aggregate, will not have a material
adverse effect on its business, financial condition, liquidity or operating
results.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders during the quarter
ended January 31, 1998.
10
<PAGE> 12
PART II
ITEM 5. -- MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Since its initial public offering on May 22, 1996, the Company's Common
Stock has been traded on the Nasdaq National Market tier of the Nasdaq Stock
Market under the symbol "GBOT." The following table sets forth the high and low
closing sale prices of the Company's Common Stock for the fiscal quarters
indicated.
<TABLE>
<CAPTION>
HIGH LOW
------- -------
<S> <C> <C>
FISCAL 1996:
Second quarter (from May 22, 1996)........................ $35.000 $11.750
Third quarter............................................. $16.875 $ 7.875
Fourth quarter............................................ $12.000 $ 7.750
FISCAL 1997:
First quarter............................................. $10.875 $ 5.125
Second quarter............................................ $ 6.625 $ 4.325
Third quarter............................................. $ 6.875 $ 3.875
Fourth quarter............................................ $ 5.063 $ 1.938
FISCAL 1998:
First quarter (through April 27, 1998).................... $ 2.188 $ 1.375
</TABLE>
The last sale price of the Company's Common Stock on April 27, 1998, as
reported on the Nasdaq National Market, was $1.625 per share.
As of April 27, 1998, there were 216 holders of record of the Company's
Common Stock.
The Company has not paid cash dividends since its inception. The Company
currently intends to retain all earnings, if any, for use in the expansion of
its business and therefore does not anticipate paying any cash dividends in the
foreseeable future. Additionally, in the event the Company were to draw upon its
proposed line of credit, the terms of the Company's bank line of credit would
prohibit the payment of cash dividends to holders of Common Stock without the
lender's consent.
11
<PAGE> 13
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------------------------------------
JANUARY 29, JANUARY 28, FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1994 1995 1996(1) 1997 1998
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SQUARE FOOT AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
RESULTS OF OPERATIONS DATA:
Net sales........................ $12,569 $27,510 $55,339 $ 92,465 $114,591
Cost of sales (including buying
and occupancy costs).......... 7,794 15,521 31,448 52,551 73,846
------- ------- ------- -------- --------
Gross margin.................. 4,775 11,989 23,891 39,914 40,745
Operating expenses:
Stores and catalog(2)......... 4,093 8,956 18,746 35,544 39,524
General and administrative.... 2,759 3,917 6,041 8,871 10,919
Preopening and facility
relocation expenses........... 417 733 798 1,426 397
Provision for store closings..... -- -- -- -- 3,200
Impairment loss on long-lived
assets........................ -- -- -- -- 2,600
------- ------- ------- -------- --------
Operating loss................... (2,494) (1,617) (1,694) (5,927) (15,895)
Interest income, net............. 140 230 30 994 315
------- ------- ------- -------- --------
Net loss......................... $(2,354) $(1,387) $(1,664) $ (4,933) $(15,580)
======= ======= ======= ======== ========
Basic loss per share(3).......... $ (0.88) $ (0.43) $ (0.44) $ (0.80) $ (2.20)
Cash dividends declared per
common share.................. -- -- -- -- --
Weighted average common
shares(000's)(3).............. 2,676 3,209 3,756 6,146 7,069
Capital expenditures............. $ 3,865 $11,439 $16,800 $ 24,225 $ 14,161
SELECTED OPERATING DATA:
Stores open at period-end........ 41 86 152 253 280
Average square footage of stores
opened during period.......... 951 1,077 1,256 1,362 1,693
Sales per square foot(4)......... $ 484 $ 535 $ 458 $ 387 $ 324
Average store age (in months).... 16 16 18 20 30
Comparable store sales
increase(5)................... 18% 34% 16% 7% 1%
Number of catalogs
mailed(000's)(2).............. -- 2,311 5,021 15,933 16,753
BALANCE SHEET DATA (AT PERIOD-END):
Working capital.................. $12,522 $ 1,415 $ 2,662 $ 36,315 $ 19,690
Total assets..................... $21,910 $25,518 $47,137 $103,523 $ 87,837
Note payable to bank............. -- -- $ 2,540 -- --
Shareholders' equity............. $19,542 $18,183 $33,117 $ 84,456 $ 68,936
</TABLE>
- ---------------
(1) The fiscal year ended February 3, 1996 was a 53-week year.
(2) The Company commenced its catalog operations in the third quarter of fiscal
1994.
(3) Based on the number of common and preferred shares outstanding after giving
effect to the conversion of all Preferred Stock into Common Stock. See Notes
to Financial Statements.
(4) For stores open at beginning of period indicated.
(5) Stores enter the comparable store base upon completing one full fiscal year
of operation. The numbers of comparable stores used to compute such
percentages were 13, 23, 41, 86 and 253 in fiscal years 1993 through 1997,
respectively.
12
<PAGE> 14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The following discussion and analysis of Garden Botanika's results of
operations and financial condition should be read in conjunction with the
Financial Statements and Notes thereto included herein. The term "store months
of operations" refers to the aggregate number of full months during which stores
were open during a particular fiscal year and is used to compare the financial
results of various fiscal periods. The term "contribution margin" refers to
store level operating income, exclusive of buying costs.
GENERAL
Since opening its first store in August 1990, Garden Botanika has opened
281 stores across the country, closing one store in February 1998, and has
established itself as a market presence in core markets in the Pacific
Northwest, California and parts of the East Coast. From 1990 to the Company's
initial public offering in May 1996, the Company pursued an aggressive growth
strategy, which was fueled by double-digit comparable store sales increases of
18%, 34% and 16% for the fiscal years 1993 through 1995, respectively, as well
as private financings that raised a total of $42.24 million. The most rapid
period of expansion occurred in 1995 and 1996, when the Company opened 66 and
101 stores, respectively. The 167 stores opened in those years performed
significantly below historical experience and the Company's expectations, which
the Company believes was due, at least in part, to the fact that such stores
were geographically widely dispersed from other Garden Botanika stores and thus
did not have sufficient market penetration to effectively build and benefit from
the Garden Botanika brand. These new units, representing approximately 60% of
the Company's store base, adversely affected the performance of the Company as a
whole. Brand awareness and name recognition were slow to develop in many new
markets, a disproportionate number of which consisted of only one or two stores,
and competition from Bath and Body Works, the Body Shop, Victoria's Secret and
other specialty retailers and mass merchandisers increased substantially.
Comparable store sales increased only 7% in fiscal 1996.
In 1997, in an effort to boost sales, the Company undertook an extensive
remerchandising program with the goal of increasing store level productivity and
improving inventory turnover. As part of this program, the Company narrowed its
product assortment, eliminating approximately 275 core SKUs (or 30% of the
total) by eliminating certain product types and reducing the number of sizes in
which others were offered. In order to move discontinued inventory, the Company
held clearance sales, adversely impacting same store sales and gross margin. In
order to make the Garden Botanika shopping experience more customer-friendly,
the Company also invested approximately $2 million as part of a strategy to
soften and enhance the appearance of its stores. In addition, the Company
focused its catalog mailings on its most productive list of existing mail-order
customers, reducing the use of the catalog for customer prospecting in new
markets. By narrowing catalog distribution and condensing the catalog itself,
the Company significantly reduced catalog-related expenses as circulation and
pages mailed fell by 40% and 56%, respectively. As a result of the
remerchandising campaign and narrowed catalog operations, same store sales only
increased 1% in fiscal 1997, including a 4% decline in the fourth quarter, the
first quarterly same-store sales decline in the Company's history. In past
years, the productivity of each class of the Company's stores has generally
improved as they have matured, but recent declines have included the Company's
older classes of stores.
In order to reverse declining same store sales trends and attempt to
achieve profitability in 1998 and beyond, the Company intends to refocus its
efforts on building brand loyalty, brand image and brand awareness. The Company
has developed a three-pronged strategy designed to improve performance both at
the store and corporate levels. Garden Botanika intends (i) to drive same store
sales with, among other things, an emphasis on value pricing and gift
strategies, the leveraging of the success of the Color Studio concept for color
cosmetics and the increased use of its customer database to refocus store
advertising efforts; (ii) to further reduce operating expenses to improve
profitability; and (iii) to leverage the Garden Botanika brand by making use of
new channels of distribution. Because of the seasonality of its mall-based
business, the Company has historically experienced net losses in the first three
quarters of each fiscal year and expects that this pattern will continue in
fiscal 1998.
13
<PAGE> 15
RISK FACTORS AND FORWARD-LOOKING STATEMENTS
Garden Botanika does not provide forecasts of future financial performance.
Forward-looking statements in this Annual Report are made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995, and,
in connection therewith, the Company wishes to caution readers that the
following important factors, among others, in some cases have affected and in
the future could affect the Company's actual results and could cause such
results to differ materially from those expressed in forward-looking statements
made by or on behalf of the Company.
Historical Net Losses; Failure to Achieve Profitability. During fiscal
years 1995 through 1997, respectively, the Company incurred net losses of $1.66
million, $4.93 million and $15.58 million. As of the end of fiscal 1997, the
Company had an accumulated deficit of $29.64 million, and there can be no
assurance that the Company will generate profits in future periods. The
Company's future operating results will depend upon a number of factors,
particularly the performance of its stores, the level of competition, the
Company's ability to cost-effectively close or restructure the rent of some of
its most unprofitable stores and its success in identifying and responding to
emerging trends in the personal care products industry. The Company's
achievement of profitability, if any, will depend upon a number of additional
factors, including the Company's ability to (i) create brand awareness and
attract customers in stores and markets where it has not been profitable to
date; (ii) obtain targeted sales volumes through competitive pricing, while
maintaining acceptable gross margins; and (iii) succeed in entering new channels
of distribution. The Company's future operating results will also depend on many
other factors that are beyond the Company's control, including the level of mall
traffic and general economic conditions affecting consumer confidence and
spending. There can be no assurance that the Company will achieve targeted sales
and profitability levels in the future, or that the Company can achieve
profitability.
Dependence on Line of Credit; Limited Resources. Like many mall-based
specialty retailers, the Company experiences substantial seasonal fluctuations
in its sales and operating results, with its largest sales volumes in the months
of November and December. The Company currently expects to incur losses during
the first three quarters of 1998 and will need to borrow under a line of credit
to finance its inventory build-up and increasing operating costs prior to the
holiday season. On April 29, 1998, the Company received a new credit facility
from Foothill Capital Corporation under which Foothill has agreed to provide the
Company with a three-year $10.00 million revolving line of credit, subject to
certain operating covenants and financial conditions. There can be no assurance,
however, that this facility will provide the Company with adequate funding. The
most recent report of the Company's independent public accountants was qualified
with the assumption that the Company will continue as a going concern and noted
matters, primarily relating to the uncertainty of adequate funding, that may
raise substantial doubt as to the Company's ability to continue as a going
concern. Limitations on the Company's borrowing ability and access to funding
generally may also limit the Company's ability to pursue certain business
initiatives that it might otherwise undertake in an effort to increase sales.
The Company's limited resources, and increases in the amount or ages of accounts
payable, may also cause vendors to restrict its use of vendor credit terms,
generally 30 to 60 days, to finance merchandise inventory costs. The Company's
potential inability to avail itself of an adequate, meaningful line of credit
and/or use vendor credit terms could have a substantial adverse impact on the
Company's financial condition.
Declines in Comparable Store Sales. A variety of factors affect the
Company's comparable store sales, including, among others: the retail sales
environment and the level of competition; the Company's ability to execute its
business strategy efficiently; acceptance of new product introductions; the
timing of holidays, promotional events and the mailing of the Company's
catalogs; and general economic and competitive conditions. The Company recently
has experienced monthly comparable store sales declines and the first quarterly
decline in the Company's history in the fourth quarter of fiscal 1997. The
Company's comparable store sales decreased 9% in November 1997 and increased by
2% the following month, followed by a comparable store decrease of 19% in
January 1998, resulting in a 4% overall comparable store sales decline in the
fourth quarter of 1997 and a 1% increase for the fiscal year. This trend has
continued in February and March of 1998, as comparable store sales declined,
respectively, 14% and 13%. The Company does not expect
14
<PAGE> 16
comparable store sales to increase as in past years, and there can be no
assurance that comparable store sales for any particular period will not
decrease.
Competition. The personal care, makeup and fragrance businesses are highly
competitive. The Company's products compete directly against functionally
similar products sold through a variety of retail channels, including department
stores, mass merchants, drugstores, supermarkets, telemarketing programs,
television "infomercials", shopping channels and catalogs. The Company competes
against a number of companies that have substantially greater resources and
better name recognition than Garden Botanika and which sell their products
through broader distribution channels. Some department stores, which have
historically offered personal care products at higher price points than the
Company, have introduced less expensive product lines that compete more directly
with the Company's products. The Company also competes directly against mall-
based specialty retailers of personal care and other products, including
national and international chains that are larger and that have grown more
rapidly than the Company. In general, there are no provisions in the Company's
leases that limit or restrict competing businesses from operating in malls in
which the Company's stores are located. The number of specialty retail outlets
selling personal care products, either exclusively or as an extension of a
related brand (such as a clothing brand), has increased significantly in recent
years. This has led to an increasingly competitive marketplace that the Company
believes has had, and may continue to have, an adverse effect on the Company's
business, financial condition and operating results, as well as on those of
certain of its competitors. In addition, the lack of significant barriers to
entry may result in new competition, including possible imitators of the Garden
Botanika concept. Should any of the Company's competitors reduce prices, the
Company may be required to implement price reductions in order to remain
competitive, which could also have an adverse impact on its business, financial
condition and operating results. The Company believes that success in the
personal care industry depends, in part, on the regular introduction of new and
attractive products. In a competitive environment, there can be no assurance (i)
that the Company will continue to be able to develop original products or (ii)
that sales of new products will justify the costs associated with their
development and marketing and will not adversely affect sales of the Company's
preexisting products. The Company also competes generally for store sites, and,
in the event the Company seeks to open new stores, there can be no assurance
that it will be able to secure suitable sites on satisfactory terms.
Turnover and Dependence on Key Personnel. The Company has experienced
significant turnover among its corporate staff and senior management, including
the resignations in fiscal 1997 and 1998 of the Company's Senior Vice
President -- Operations, Chief Financial Officer and Vice President of Real
Estate. The Company has elected not to replace any of these individuals at the
present time, all of whose duties have been assumed by others. The Company
remains dependent upon the efforts of its key officers and employees, including
Michael W. Luce, President, Chief Executive Officer and a director; Arlee J.
Jensen, Senior Vice President -- Merchandising and Marketing; and John A.
Garruto, Vice President -- Research and Product Development. Although the
Company has employment agreements with certain key officers, the loss of any of
these individuals could adversely affect the Company's business, financial
condition and operating results. The Company has obtained insurance on the lives
of Mr. Luce and Ms. Jensen in the amounts of $1.50 million and $1.00 million,
respectively. There can be no assurance that the Company will be able to
motivate, attract and retain key employees and qualified personnel in the
future.
Commercial Sales Strategy. In fiscal 1998, the Company plans to focus
significant efforts on building its commercial sales division, which will be
responsible for overseeing and developing, among other things, the Company's
hotel amenities program, its sales to third-party retailers such as Costco
Wholesale, television shopping channel sales and international licensing
opportunities, if any. The Company has little historical experience with such
new channels of distribution and limited management and financial resources to
develop them. It is also anticipated that the financial return from certain
commercial sales opportunities, such as the expansion of Garden Botanika's
amenities program and the introduction of international sales, may take time to
develop. Sales in new channels of distribution will generally be made at
significantly lower margins than sales made through the Company's stores,
although the elimination of store-level costs significantly decreases the
expenses associated with such sales. The Company believes that the development
of new channels of distribution will build brand awareness and benefit retail
store sales. It is possible, however, that sales in new
15
<PAGE> 17
channels of distribution may compete indirectly with retail store sales with
higher margins. There can be no assurance that commercial sales in new channels
of distribution will justify the costs associated with their development and
marketing or that they will not adversely impact the Company's retail store
sales.
Remerchandising Strategy. In 1997, in an effort to boost sales, the Company
undertook an extensive remerchandising program with the goal of increasing store
level productivity and improving inventory turnover. As part of this program,
the Company undertook to soften and enhance the appearance of the Company's
stores and narrowed its product assortment, eliminating approximately 275 SKUs
(or 30% of the total) by eliminating certain product types and reducing the
number of sizes in which others were offered. In addition, the Company increased
the number of fixtures in its stores, which required additional inventory to
create the desired sense of abundance. This additional inventory must be carried
at additional cost to the Company. The Company intends to continue to experiment
with its stores' appearance and merchandising direction and to eliminate certain
of its less popular product lines with the goal of attracting a broader customer
base and increasing productivity overall. There can be no assurance, however,
that these efforts will be successful or that certain changes will not have an
adverse effect on sales in those markets in which the Company has established a
loyal customer base.
Ability to Manage Operations. In order for the Company to operate
successfully, management will be required to anticipate the changing demands of
the Company's operations and adapt systems and procedures accordingly. There can
be no assurance that the Company will anticipate all of the changing demands
that its expanding operations, including the anticipated growth of its
commercial sales division, will impose on such systems. The Company will also
need to continually evaluate the adequacy of its management information systems,
including its inventory control and distribution systems. Failure to upgrade its
information systems or unexpected difficulties encountered with these systems
could adversely affect the Company's business, financial condition and operating
results.
Reliance on Management Information Systems Vendors. The Company currently
relies on three outside vendors, two of which are related, for the software and
day-to-day support that form the basis of the Company's management information,
distribution and financial systems. While the Company believes that these
vendors have sufficient experience and commitment to their product lines to be
relied upon for continued support in developing, testing and implementing
systems and controls that are adequate to support the Company's current
operations and anticipated future growth, it may have little control, apart from
changing vendors, over the level of systems maintenance and support it receives.
In the event it were to change information systems vendors, the Company could
experience unforeseen delays or interruptions in its access to information. Such
problems, were they to occur, could adversely affect the Company's business,
financial condition and operating results.
Mail-Order Strategy. In the third quarter of fiscal 1994, the Company
introduced the Garden Botanika catalog. One purpose of the catalog was to enable
the Company to effect mail-order sales and expand brand recognition in areas
where it had not opened stores. To date, the additional costs associated with
the Company's mail-order business have exceeded sales directly attributable to
that business, and the Company expects this to continue in fiscal 1998. In
fiscal 1996, the Garden Botanika catalog was distributed widely to prospective
mail-order customers in an effort to build a "house file" of proven customers
from the respondents. This practice was greatly reduced in fiscal 1997, and, in
fiscal 1998, the Company intends to continue to focus on smaller mailings to its
house file of active mail-order customers. While this strategy is expected to
result in significant savings, there can be no assurance that it will lead to
mail-order profitability or that the planned reduction in mailings will not
result in an eventual decline in the size of the Company's active mail-order
house file.
Store Advertising Expenses. The Company's store advertising program is
built primarily around the Garden Botanika catalog, which, in addition to its
role in mail-order sales, is mailed to certain active customers of existing
stores. In fiscal 1998, the Company intends to continue reduced mailings of
catalogs per store by focusing on what it believes are or will be its most
productive store customers in order to justify the cost of the mailings. There
can be no assurance that the Company's more focused store advertising mailings
will generate sufficient sales to make store operations profitable. Apart from
its catalog and related mailings,
16
<PAGE> 18
the Company does not advertise in the print or broadcast media, as do many of
its competitors. Postal rates, delivery charges and paper and printing costs
directly affect the cost of the Company's store advertising program, as well as
its mail-order business, and a significant increase in any of these expenses
could adversely affect the Company's overall business, financial condition and
operating results.
Volatility of Stock Price. The market price of the Company's Common Stock
has been subject to significant downward fluctuations, primarily in response to
the Company's comparable store sales and overall operating results. In addition,
the stock market in recent years has experienced extreme price and volume
fluctuations that often have been unrelated or disproportionate to the operating
performance of companies. These fluctuations, as well as general economic and
market conditions, may adversely affect the market price of the Common Stock.
Concentration of Suppliers. In fiscal 1997, approximately 62% of the
Company's purchases of raw materials, finished product, packaging and other
supplies were obtained from the Company's 15 largest suppliers, with the
Company's largest supplier accounting for approximately 12% of such purchases.
With the exception of certain packaging orders, the Company has no long-term
contracts or other contractual assurance of continued supply, pricing or access
to new products. The inability, failure or unwillingness of one or more
principal vendors to continue to supply the Company or a material change in the
Company's purchase terms could have a material adverse effect on the Company's
business, financial condition and operating results. There can be no assurance
that the Company will be able to acquire desired materials in sufficient
quantities on acceptable terms in the future.
Regulation and Potential Claims. The Company's advertising and product
labeling practices are subject to regulation by the FTC, and its cosmetic
manufacturing practices are subject to regulation by the FDA, as well as various
other federal, state and local regulatory authorities. In addition, in the event
of international sales, the Company could become subject to the regulatory
requirements of a foreign jurisdiction, which may differ substantially from
those of the United States and whose impact on such sales are uncertain.
Compliance with international, federal, state and local laws and regulations,
including laws and regulations pertaining to the protection of the environment,
has not had, and is not anticipated to have, a material adverse effect on the
competitive position of the Company. Nonetheless, federal, state and local
regulations in the United States that are designed to protect consumers or the
environment have had, and can be expected to have, an increasing influence on
product claims, manufacturing, contents and packaging. In addition, if the
Company were to expand its manufacturing capabilities to include
over-the-counter drug ingredients, it would become subject to FDA registration
and a higher degree of inspection and greater burden of regulatory compliance
than at present. The nature and use of personal care products could give rise to
product liability claims if one or more of Garden Botanika's customers were to
suffer adverse reactions following use of its products. Such reactions could be
caused by various factors, many of which are beyond the Company's control,
including hypoallergenic sensitivity, the possibility of malicious tampering
with the Company's products and the unforeseen discovery of harmful effects in
one or more of the ingredients used in the Company's products. In the event of
such an occurrence, the Company could incur substantial litigation expense,
receive adverse publicity and suffer a loss of sales.
17
<PAGE> 19
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the Company's
results of operations expressed as percentages of net sales.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED(1)
----------------------------------
FEB. 3, FEB. 1, JAN. 31,
1996(2) 1997 1998
------- ------- --------
<S> <C> <C> <C>
Net sales (in thousands)................. $55,339 $92,465 $114,591
======= ======= ========
Net sales................................ 100.0% 100.0% 100.0%
Cost of sales (including buying and
occupancy costs)....................... 56.8 56.8 64.4
------- ------- --------
Gross margin............................. 43.2 43.2 35.6
Operating expenses:
Stores and catalog..................... 33.9 38.4 34.5
General and administrative............. 10.9 9.6 9.5
Preopening and facility relocation
expenses............................... 1.4 1.5 0.3
Provision for store closings............. -- -- 2.8
Impairment loss on long-lived assets..... -- -- 2.3
------- ------- --------
Operating loss........................... (3.1) (6.4) (13.9)
Interest income, net..................... 0.1 1.1 0.3
------- ------- --------
Net loss................................. (3.0)% (5.3)% (13.6)%
======= ======= ========
</TABLE>
- ---------------
(1) Percentage amounts may not total 100% due to rounding.
(2) The fiscal year ended February 3, 1996 was a 53-week year.
FISCAL 1997 VS FISCAL 1996
General. The Company operated 280 stores at the end of fiscal 1997,
compared to 253 stores at the end of fiscal 1996. There were 3,212 store months
of operations during fiscal 1997 versus 2,290 store months in the prior period,
an increase of 40%. The average age of the Company's stores increased from 20
months to 30 months.
Net Sales. Net sales for fiscal 1997 were $114.59 million, compared to net
sales of $92.47 million for fiscal 1996. The increase of $22.12 million, or 24%,
in net sales was due primarily to (i) the 40% increase in store months of
operations during the year and (ii) a 1% increase in comparable store sales over
the prior year. Positive factors were also partially offset by a 41% decline in
mail-order sales, resulting primarily from a planned reduction in catalog
circulation.
Annual sales per square foot in the 253 stores open at the beginning of
fiscal 1997 declined by 16%, to $324, during the period, due primarily to an 8%
increase in average square footage per store that was not accompanied by a
corresponding increase in sales and the effect of 167 newer stores, which
initially have lower than average sales, opened in geographically dispersed
markets during fiscal 1995 and 1996.
The Garden Botanika catalog is used as the Company's primary marketing
vehicle by both the store and mail-order divisions. In order to control its
advertising costs in fiscal 1997, the Company mailed a total of approximately
16.8 million catalogs, compared to approximately 15.9 million catalogs mailed in
fiscal 1996, an increase of only 6% compared to the 40% increase in store months
of operations. With the relative reduction in the number of catalogs mailed, the
Company's mail-order sales declined to 4% of total sales in fiscal 1997 from 8%
in the prior year. It is also likely that the relative reduction in the number
of catalogs mailed contributed to the slower rate of growth in both total and
comparable store sales.
Gross Margin. Gross margin declined as a percentage of net sales from 43.2%
in fiscal 1996 to 35.6% in fiscal 1997. This decline reflected primarily the
effects of: (i) relatively fixed store occupancy costs (especially in the
Company's newer classes of stores) in a period of declining comparable store
sales, (ii) the Company's 1997 change in toiletries pricing, (iii) its program
to clear discontinued items from stock in connection with its
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<PAGE> 20
1997 remerchandising program and (iv) markdowns to stimulate sales and reduce
inventory levels during the fourth quarter. The dollar amount of gross margin
increased by $831,000, or 2%, primarily as a result of the 24% increase in
sales.
Operating Expenses
Stores and Catalog. Store and catalog expenses, including distribution,
declined as a percentage of net sales from 38.4% in fiscal 1996 to 34.5% in
fiscal 1997. This decline was primarily attributable to the reduction in catalog
circulation discussed above (see Net Sales). The dollar amount of store and
catalog expenses increased by $3.98 million, or 11%, over the prior year,
primarily as a result of the 40% increase in store months of operations.
General and Administrative. General and administrative expenses, at 9.5% of
net sales, were basically unchanged from the fiscal 1996 level of 9.6%. The
dollar amount of general and administrative expenses increased by $2.05 million,
or 23%, from the prior year to support the 40% increase in store months of
operations and the 24% increase in net sales.
Preopening and Facility Relocation Expenses. Preopening and facility
relocation expenses ("Preopening Expenses") vary with the number of new stores
opened and the number of existing stores relocated during a particular period.
In addition, the one-time startup costs of new facilities and operations are
included in Preopening Expenses. Preopening Expenses were $397,000, or 0.3% of
net sales, in fiscal 1997, when the Company opened 27 new stores, relocated
three existing stores and finalized Preopening Expenses associated with stores
opened in the fourth quarter of fiscal 1996. The Company incurred Preopening
Expenses of $1.43 million, or 1.5% of net sales, during the prior year, when it
opened 101 new stores, relocated or committed to the relocation of five existing
stores and relocated certain of its warehouse, distribution and mail-order
fulfillment operations.
Provision for Store Closings. In early February 1998, the Company announced
its intention to close approximately 12 under-performing stores during fiscal
1998. A charge of $3.20 million was recorded to cover estimated asset writeoffs
and closure expenses. Of this amount, $1.89 million reduced property and
equipment, while the remaining $1.31 million is shown as a reserve for store
closing expenses to be incurred in future months. The first of the 12 stores was
closed during February.
Impairment Loss on Long-Lived Assets. At the conclusion of the 1997 holiday
season, the Company reviewed the asset values of individual stores in accordance
with Statement of Financial Accounting Standards No. 121. As a result of that
review, a charge of $2.60 million was recorded at the end of the fourth quarter
to recognize potential impairment of long-lived assets. This amount reduced
property and equipment.
All stores opened prior to fiscal 1997 were included in the impairment
review, which then concentrated on the approximately 100 stores, opened
primarily during fiscal 1996, with negative fiscal 1997 store level contribution
margin. The initial evaluation identified 26 stores, exclusive of the 12
previously identified for closure, whose net book value at January 31, 1998
exceeded the undiscounted cash flow expected to be produced over their remaining
lease terms. An impairment charge was recorded for each of these 26 stores equal
to the difference between its current net book value and the estimated fair
value of those assets as measured by the discounted cash flow expected to be
produced over the remaining lease term.
The determination of impairment for any given store is highly sensitive to
assumptions regarding future performance. Therefore, there can be no assurance
that a future deterioration in performance will not require an additional
impairment charge for one or more of these 26 stores, or that a future charge
may not be necessary for other stores. Due to the heavy concentration of sales
in the fourth quarter of each fiscal year, the Company does not believe it is
meaningful to make impairment determinations on an interim basis during the
fiscal year.
Operating Loss. For the reasons explained above, the fiscal 1997 loss from
operations increased 168%, to $15.90 million, from $5.93 million in the prior
year. Expressed as a percentage of net sales, the Company's loss from operations
increased from 6.4% to 13.9%, reflecting primarily (i) the effects of slower
growth in comparable store sales, (ii) the cost, both in terms of gross margin
and operating expenses, of remerchandising
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<PAGE> 21
programs designed to improve the Company's competitive position and bring its
inventory levels into line with fourth quarter and anticipated future sales and
(iii) charges to provide for the costs of anticipated store closings and
potential impairment of historical property and equipment values.
Interest Income, Net. Net interest income during fiscal 1997 was $315,000,
or 0.3% of net sales, compared to $994,000, or 1.1% of net sales, during the
prior year. This change reflected the effect of the Company's net use of cash in
its 1997 expansion and remerchandising programs, as well in its routine
operations during the first nine months of the year. Interest expense was
$92,000 in fiscal 1997 and $321,000 in fiscal 1996.
Income Taxes. The Company did not record an income tax benefit for either
fiscal 1997 or fiscal 1996. Net operating loss carryforwards of $8.18 million at
January 31, 1998 begin to expire in 2005, and the amount of such carryforwards
that can be used in any one year is subject to limitation based on the nature of
past ownership changes. See Notes to Financial Statements.
Net Loss. For the reasons explained above, during fiscal 1997, the
Company's net loss increased 216%, to $15.58 million, or $2.20 per weighted
average common share, from $4.93 million, or $0.80 per share, in fiscal 1996.
The net loss also increased as a percentage of net sales, from 5.3% in fiscal
1996 to 13.6% in the current year, with the negative effects of slower growth in
comparable store sales, the cost of programs designed to improve the Company's
competitive position and bring its inventory levels into line and significant
charges for store closings and asset impairment being further magnified by the
significant reduction in interest income.
FISCAL 1996 VS FISCAL 1995
General. The Company operated 253 stores at the end of fiscal 1996,
compared to 152 stores at the end of fiscal 1995. There were 2,290 store months
of operations during fiscal 1996 versus 1,375 store months in the prior period,
an increase of 67%. The average age of the Company's stores increased from 18
months to 20 months.
Net Sales. Net sales for fiscal 1996 were $92.47 million, compared to net
sales of $55.34 million for fiscal 1995. The increase of $37.13 million, or 67%,
in net sales was due primarily to the following factors: (i) the 67% increase in
store months of operations during the year; (ii) an increase of 7% in comparable
store sales over the prior year, resulting primarily from an increase in the
number of customer transactions; and (iii) a 100% increase in mail-order sales,
resulting primarily from an increase in circulation.
Annual sales per square foot for the 152 stores open at the beginning of
fiscal 1996 declined by 16%, to $387, during the period, due primarily to an 8%
increase in average square footage per store and the effect of the 111 newer
stores, which initially have lower than average sales, opened during fiscal 1994
and 1995.
In fiscal 1995 and 1996, the sales directly attributable to the Company's
mail-order operation accounted for 7% and 8%, respectively, of the Company's
total net sales. In fiscal 1995 and 1996, the Company mailed approximately 5.0
million and 15.9 million catalogs, respectively, to store and mail-order
customers.
Gross Margin. Gross margin as a percentage of net sales was unchanged from
fiscal 1995 at 43.2%. Merchandise margin improvement of approximately 200 basis
points was offset by an increase in store occupancy costs related primarily to
the 167 newest stores. The dollar amount of gross margin increased by $16.02
million, or 67%, as a result of the 67% increase in sales.
Operating Expenses
Stores and Catalog. Store and catalog expenses, including distribution,
increased as a percentage of net sales from 33.9% in fiscal 1995 to 38.4% in
fiscal 1996. Improved leverage on mail-order operating expenses and distribution
were more than offset by increases in advertising and other store operating
costs as the Company sought to increase sales in its newer stores in less
developed markets and felt the impact of generally slower sales growth in those
stores. The dollar amount of store and catalog expenses increased by $16.80
million, or 90%, over the prior year, primarily as a result of the 67% increase
in store months of operations and the increase in store advertising.
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<PAGE> 22
General and Administrative. General and administrative expenses declined as
a percentage of net sales from 10.9% in fiscal 1995 to 9.6% in fiscal 1996. This
decline reflected improved leverage associated with increases in total and
comparable stores sales. The dollar amount of general and administrative
expenses increased by $2.83 million, or 47%, from the prior year to support the
67% increases in store months of operations and net sales.
Preopening and Facility Relocation Expenses. Preopening Expenses were $1.43
million, or 1.5% of net sales, in fiscal 1996, when the Company opened 101 new
stores, relocated or committed to the relocation of five existing stores and
relocated its warehouse, distribution and mail-order fulfillment operations. The
Company incurred Preopening Expenses of $798,000, or 1.4% of net sales, during
the prior year, when it opened 66 new stores, relocated two existing stores and
brought its mail-order customer service and fulfillment operations in house.
Operating Loss. For the reasons explained above, the fiscal 1996 loss from
operations increased 250%, to $5.93 million, from $1.69 million in the prior
year. Expressed as a percentage of net sales, the Company's loss from operations
increased from 3.1% to 6.4%, reflecting both the effects of slower growth in
comparable store sales and the costs of programs designed to improve sales in
newer stores located primarily in less developed markets.
Interest Income, Net. Net interest income during fiscal 1996 was $994,000,
or 1.1% of net sales, compared to $30,000, or 0.1% of net sales, during the
prior year. This change was due primarily to temporary investment of funds
provided by the Company's May 1996 initial public offering. Interest expense was
$321,000 in fiscal 1996 and $105,000 in fiscal 1995.
Income Taxes. The Company did not record an income tax benefit for either
fiscal 1996 or fiscal 1995 due to its pre-tax losses.
Net Loss. For the reasons explained above, during fiscal 1996, the
Company's net loss increased 196%, to $4.93 million, or $0.80 per weighted
average common share, from $1.66 million, or $0.44 per share, in fiscal 1995.
The net loss also increased as a percentage of net sales, from 3.0% in fiscal
1995 to 5.3% in fiscal 1996, with the negative effects of slower growth in
comparable store sales and the costs of programs designed to improve sales being
partially offset by increased interest income.
SEASONALITY AND QUARTERLY FLUCTUATIONS
The Company has experienced, and expects to continue to experience,
substantial seasonal fluctuations in its sales and operating results, which is
typical of many mall-based specialty retailers. As illustrated in the following
table, a disproportionate amount (ranging from 39% to 45% during the past three
fiscal years) of the Company's annual net sales, and all of its profits, if any,
have been realized during its fourth fiscal quarter. The Company expects this
pattern to continue during the current fiscal year and anticipates that in
subsequent years the fourth quarter will continue to contribute
disproportionately to its operating results, particularly during November and
December. In anticipation of increased sales activity during the fourth quarter,
the Company incurs significant additional expenses, including the hiring of a
substantial number of temporary employees to supplement its permanent store
staff. If, for any reason, the Company's sales fall below its expectations
during November and December, the Company's business, financial condition and
annual operating results are adversely affected. The Company's quarterly results
of operations may also fluctuate significantly as a result of a variety of other
factors, including the timing of new store openings, net sales contributed by
new stores, increases or decreases in comparable store sales, adverse weather
conditions, shifts
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in the timing of holidays, shifts in the timing of promotions and catalog
mailings and changes in the Company's product mix.
<TABLE>
<CAPTION>
FISCAL QUARTER(1)
----------------------------------------
FIRST SECOND THIRD FOURTH
------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
FISCAL 1995:(2)
Net sales................................. $ 9,532 $10,138 $10,671 $24,998
% of full year......................... 17.2% 18.3% 19.3% 45.2%
Gross margin.............................. $ 4,084 $ 4,212 $ 4,170 $11,425
% of full year......................... 17.1% 17.6% 17.5% 47.8%
Net (loss) income......................... $ (827) $ (836) $(1,986) $ 1,985
FISCAL 1996:
Net sales................................. $16,647 $16,916 $17,681 $41,221
% of full year......................... 18.0% 18.3% 19.1% 44.6%
Gross margin.............................. $ 7,046 $ 6,793 $ 6,633 $19,442
% of full year......................... 17.7% 17.0% 16.6% 48.7%
Net (loss) income......................... $(2,685) $(1,987) $(3,780) $ 3,519
FISCAL 1997:
Net sales................................. $23,918 $24,873 $21,284 $44,516
% of full year......................... 20.9% 21.7% 18.6% 38.8%
Gross margin.............................. $ 8,736 $ 8,075 $ 5,695 $18,239
% of full year......................... 21.4% 19.8% 14.0% 44.8%
Net loss.................................. $(3,225) $(4,162) $(5,918) $(2,275)
</TABLE>
- ---------------
(1) Percentage amounts may not total 100% due to rounding.
(2) Fiscal 1995 was a 53-week year. The 53rd week is included in fourth quarter
results.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow for Fiscal 1997
The Company began fiscal 1997 with cash and cash equivalents totaling $7.21
million and short-term investments of $20.43 million. During the first three
quarters of the year, all short-term investments were liquidated to fund (a) the
Company's net loss, (b) fixed asset additions related primarily to store
openings and the 1997 remerchandising program and (c) an increase in inventory
to support a commitment to higher in-stock and customer service levels. In the
fourth quarter, the Company borrowed against its U.S. Bank credit line of credit
to complete its 1997 store expansion program and build up inventory levels for
the holiday season. The maximum amount borrowed during this time was $7.82
million; the interest rate on all borrowings was 9.0%. All borrowings were
repaid during December, and the Company ended fiscal 1997 with cash and cash
equivalents totaling $8.59 million and no short-term investments or bank
borrowings. Due to its fourth quarter loss, the Company was in violation of the
tangible net worth covenant of its credit line at January 31, 1998. U.S. Bank
has indicated its willingness to provide the Company with a forbearance letter
stating that it will not take any action with respect to the Company's
violation. However, U.S. Bank will not permit further borrowings under the
Company's existing $5.00 million credit line until the violation is cured, and
there is no present likelihood that this will occur or that borrowing will be
necessary prior to expiration of the line on May 31, 1998.
On April 29, 1998, the Company received a new credit facility from Foothill
Capital Corporation ("Foothill"), under which Foothill has agreed, subject to
certain financial conditions, to provide the Company with a three-year, $10.00
million revolving line of credit for general corporate purposes. Credit
available under the Foothill line at any time during this period is generally a
variable percentage (ranging from 55% to 65%) of eligible finished goods
inventory. This line, which is secured by the assets of the Company, bears
interest at prime plus 0.5%, with a LIBOR rate available on certain borrowings,
at the Company's option. The minimum interest rate on any borrowings under the
line is 7.00%. In order to access the Foothill credit line, the Company is
required to maintain certain financial covenants, including covenants relating
to earnings and
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limitations on losses that vary from quarter to quarter. Future capital
expenditures, including those for store expansion, are limited in accordance
with a business plan to be approved by Foothill.
Future Cash Flow Plans and Expectations
The Company's future plans call for the opening of one new store in fiscal
1998, which has already occurred, and anticipates total capital expenditures of
approximately $2.60 million, based on the one planned store opening, certain
store remodels and updates to existing stores, and improvements to existing
distribution, manufacturing and central office facilities that support
operations. They Company's average net capital expenditure for the 27 new stores
opened in fiscal 1997 was approximately $305,000 per store, after deducting the
construction allowances paid by lessors. The average Preopening Expense for each
of these stores was approximately $10,000. In addition, other working capital
requirements, consisting primarily of the purchase of inventory, averaged
approximately $41,500 per store. On an ongoing basis, the Company expects to
continue to be able to finance a portion of its merchandise inventory costs by
using vendor credit terms, generally ranging from 30 to 60 days. In addition to
such vendor financing, subject to its meeting certain financial conditions, the
Company may finance 55% to 65% of its inventory under the terms its credit line
with Foothill.
The Company believes that its cash balance at the end of fiscal 1997,
combined with its cash flow from operations and borrowings under its new credit
facility, will be sufficient to satisfy its currently anticipated working
capital and capital expenditure requirements through fiscal 1998. The Company's
capital requirements, and its ability to obtain financing, may vary
significantly from those anticipated, however, depending particularly on
operating results and other factors. The Company may be required to seek
additional sources of funds to support its ongoing operations in fiscal 1998,
and there can be no assurance that such funds, if required, will be available on
satisfactory terms. Failure to obtain such financing could impair its future
business, financial condition and operating results.
IMPACT OF INFLATION AND CHANGING PRICES
Although the Company cannot accurately predict the effect of inflation on
its future operations, it does not believe inflation has had a material effect
on net sales or results of operations. As its operations have expanded to the
present levels, the Company has been able to access larger vendors and to
realize certain economies of scale in its purchasing and distribution, thus
largely offsetting any raw material price increases.
ADOPTION OF ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." This
pronouncement established new standards for computing and presenting earnings
per share for entities with publicly held common stock. The Company adopted SFAS
No. 128 in the fourth quarter of fiscal 1997. The adoption did not have a
significant effect on the Company's earnings per share.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCUSSION ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information called for by this Item is included in "Item
14 -- Exhibits, Financial Statement Schedules and Reports on Form 8-K," pages
(F-1) through (F-14).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON AUDITING AND FINANCIAL
DISCLOSURE
There were no changes in or disagreements with accountants on auditing and
financial disclosure during the fiscal year ended January 31, 1998.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company's directors and executive officers are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Jeffrey H. Brotman 55 Chairman of the Board and Secretary
Michael W. Luce 47 Director, President and Chief Executive Officer
Arlee J. Jensen 49 Senior Vice President - Merchandising and
Marketing
Susan M. Detmer 43 Vice President - Brand Development
John A. Garruto 45 Vice President - Research and Product Development
Jeffrey M. Hare 33 Vice President - Distribution Services
George W. Newman 49 Vice President - Controller
Susan M. Walker 38 Vice President - Stores
Gerald R. Gallagher 57 Director
William B. Randall 77 Director
Dale J. Vogel 53 Director
</TABLE>
Jeffrey H. Brotman is a co-founder of the Company and has served as
Chairman of the Board and Secretary since 1990. Mr. Brotman is also a founder
and currently Chairman of the Board of Costco Wholesale, a warehouse-format
discount retailer ("Costco"). In addition, Mr. Brotman is a director of
Starbucks Corporation and The Sweet Factory. Mr. Brotman also serves as a
Trustee of the University of Washington Medical Center, the Seattle Foundation
and The Seattle Art Museum. Mr. Brotman also serves on the Advisory Board of
Seafirst Bank.
Michael W. Luce is a co-founder of the Company and has served as a director
and its President and Chief Executive Officer since its formation in 1989. Prior
to founding Garden Botanika, Mr. Luce was President and Chief Operating Office
of Eddie Bauer Company ("Eddie Bauer"), an outdoor clothing retailer, until it
was acquired by Spiegel, Inc. in 1988. From 1984 to 1988, before becoming its
President, Mr. Luce held various positions in the store and mail-order divisions
of Eddie Bauer, including General Merchandise Manager and Vice President of
Marketing. Prior to joining Eddie Bauer, Mr. Luce was employed for nine years at
the Meier and Frank Company, a Portland, Oregon-based department store chain and
a division of May Company, where, among other positions, he served as a
Divisional Vice President. Mr. Luce graduated from Harvard University and
obtained a Masters of Business Administration degree from the Amos Tuck School
of Dartmouth College.
Arlee J. Jensen has been the Company's Senior Vice
President - Merchandising and Marketing since June 1995 and was its Vice
President - Merchandising since the Company began operations in 1990. Prior to
joining Garden Botanika, Ms. Jensen was employed at Eddie Bauer from 1983 to
1989, where, from 1986 to 1989, she was Divisional Vice President - Womenswear,
responsible for the women's segment of both the catalog and retail outlet
operations. Prior to 1983, Ms. Jensen was employed at Frederick & Nelson, a
Seattle-based department store chain, where she was Divisional Merchandise
Manager - Women's Apparel, and at Meier and Frank, where she was Creative
Merchandising Director.
Susan M. Detmer has been the Company's Vice President - Brand Development
since October 1996. Prior to joining Garden Botanika, Ms. Detmer served as a
consultant to The Paul Allen Group and, from September 1994 to October 1995, was
the General Merchandise Manager for Egghead Computer, a national retailer. Prior
to that, from May 1993 to June 1994, Ms. Detmer was Executive Vice President of
Jay Jacobs, a national clothing retailer, where she was responsible for
merchandising and allocations. From February 1991 to May 1993, Ms. Detmer was
associated with American Retail Group ("ARG"), a U.S. division of an
international retailer, where in January 1993, she became a Vice President
responsible for the private-branded products for ARG's department store group.
Jay Jacobs commenced reorganization proceedings under Chapter 11 of the Federal
Bankruptcy Code in May 1994.
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<PAGE> 26
John A. Garruto has been the Company's Vice President - Research and
Product Development since October 1995. From February 1991 to October 1995, Mr.
Garruto was Vice President - Research and Development for Innovative Biosciences
Corporation, a manufacturer of personal care products sold to, among others,
Garden Botanika. Mr. Garruto held the same position with Randall Products
International, which was founded by a Director of the Company, from 1989 to
1991.
Jeffrey M. Hare has been the Company's Vice President - Distribution
Services since April 1997. In previous positions with the Company, Mr. Hare has
been continuously responsible for the Company's warehouse, outbound freight and
gift assembly functions since October 1991. In addition, Mr. Hare assumed
responsibility for the Company's catalog fulfillment operations when the Company
introduced its mail-order catalog in 1994. Prior to joining Garden Botanika,
from 1983 to 1991, Mr. Hare held various positions with Precor USA, an exercise
equipment manufacturer, including the position of Production Manager.
George W. Newman has been the Company's Vice President - Controller since
January 1998 and was its Controller since joining the Company in February 1996.
Mr. Newman is currently acting in the capacity of the Company's Chief Financial
Officer. Prior to joining the Company, Mr. Newman was employed as Controller at
Pacific Linen, Inc., a regional soft lines retailer, from January 1995 to
February 1996. From 1979 to 1994, Mr. Newman was employed at The Kobacker
Company, a national footwear retailer where, among other positions, he served as
Controller.
Susan M. Walker has been the Company's Vice President - Stores since March
1996. Prior to joining the Company, Ms. Walker was employed by Zales Jewelers, a
national jewelry retailer, from 1980 to 1996, where, from 1993 to 1996, she was
a Director - Stores, responsible for supervising 13 regional managers and 127
stores, as well as for recruiting, hiring and training all levels of store
personnel.
Gerald R. Gallagher has been a director of the Company since 1991. Since
April 1987, Mr. Gallagher has been a general partner of Oak Investment Partners,
a venture capital partnership. For more than 25 years, he has been involved with
the retail industry, holding positions as a research analyst, manager and
venture capitalist. Before joining Oak Investment Partners, Mr. Gallagher was
Vice Chairman of Dayton Hudson Corporation where, for ten years, he served in
both operating and staff positions. From 1969 to 1977, Mr. Gallagher was the
retail company research analyst at Donaldson, Lufkin & Jenrette Securities
Corporation. Mr. Gallagher is also a director of ten private retail and
restaurant companies.
William B. Randall has been a director of the Company since 1990. Mr.
Randall founded Randall International in 1989 and has been its President and
Chief Executive Officer since its inception. Randall International is engaged in
manufacturing and packaging personal care products for private spas, resorts and
hotels, and manufactures certain products for Garden Botanika in accordance with
the Company's specifications. From 1974 to 1986, Mr. Randall was President of La
Costa Products International, which created and manufactured numerous body care
products under the "La Costa Spa" brand. Prior to that, Mr. Randall was
President and the founder of Renauld Incorporated, a maker of fashion
sunglasses, and Sea and Ski Company, a marketer of sun protection products.
Dale J. Vogel has been a director of the Company since 1991. Mr. Vogel has
been a general partner with U.S. Venture Partners since 1990. From 1984 to 1990,
Mr. Vogel was a general partner of Norwest Venture Capital and, from 1980 to
1984, President of K2 Corporation, a privately held ski company. Mr. Vogel was
President of JanSport, a sporting goods apparel manufacturer, from 1979 to 1980.
Mr. Vogel is also a director of Leeann Chinn, Inc. and Cucina, Cucina, Inc.,
both of which are restaurant companies, as well as Chronology Corporation, a
company providing software for electronic design automation, and Portable
Software, Inc., an expense-tracking software company.
THE BOARD OF DIRECTORS
The Board of Directors consists of three classes, each with either one or
two members. At the 1997 Annual Meeting of Shareholders, the directors in Class
1 were elected for a one-year term, the directors in Class 2 were elected for a
two-year term, and the directors in Class 3 were elected for a three-year term.
At each subsequent annual meeting of shareholders, directors elected to succeed
those directors whose terms
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<PAGE> 27
expire will each be elected for a three-year term of office, so that directors
will hold office for staggered terms of three years and until their successors
are elected and qualified.
The Company's Board of Directors is authorized to set the number of
directors, so long as the number is not less than three nor more than nine, and
so long as any reduction in the number of members does not have the effect of
shortening the term of an incumbent director. After the resignation of one of
the directors in Class 1, the number of members on the Board of Directors is
currently set at five.
Further Information Concerning the Board Of Directors
The Board of Directors held eight meetings during fiscal year 1997. The
Company has established two standing committees of the Board of Directors, an
Audit Committee and a Compensation Committee, and does not have a standing
Nominating Committee.
The purpose of the Audit Committee is to review the functions of the
Company's management and independent auditors pertaining to the Company's
financial statements and perform such other related duties and functions as are
deemed appropriate by the Audit Committee and the Board of Directors. The Audit
Committee held three meetings during fiscal year 1997. Messrs. Brotman and Vogel
are the members of the Audit Committee.
The purpose of the Compensation Committee is to determine officer and
director compensation and administer the Company's 1992 Combined Incentive and
Nonqualified Stock Option Plan (the "Employee Plan"). The Compensation Committee
held two meetings during fiscal year 1997. Messrs. Brotman, Gallagher and Vogel
are the members of the Compensation Committee.
All directors attended 75% or more of the aggregate number of Board
meetings and committee meetings on which they served.
Directors' Compensation and Benefits
Nonemployee directors of the Company are reimbursed for reasonable
out-of-pocket expenses in connection with their travel to and attendance at
Board of Directors meetings. Under the terms of the 1996 Directors' Nonqualified
Stock Option Plan (the "Directors Plan"), each nonemployee director will receive
an automatic grant of an option to purchase 1,271 shares of Common Stock upon
his or her election or appointment to the Board of Directors and thereafter at
each Annual Meeting of the Board of Directors for as long as the individual
continues to serve as a director of the Company. The exercise price of options
granted under the Directors' Plan must equal the fair market value of the Common
Stock on the date of grant. Options will vest at the rate of one-twelfth per
month so that each year's options are fully vested at the end of one year.
The Annual Meeting of the Board of Directors for fiscal 1998 is scheduled
to be held following the Annual Meeting of Shareholders, at which time the
Company expects options to purchase an aggregate of 6,355 shares will be granted
to current directors. To date, 7,626 options have been granted under the
Directors' Plan.
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<PAGE> 28
ITEM 11. EXECUTIVE COMPENSATION
The following Summary Compensation Table shows compensation information for
the Company's Chief Executive Officer and the four most highly paid executive
officers of the Company other than the Chief Executive Officer who were serving
as executive officers at the end of the year ending January 31, 1998
(collectively referred to as "the Named Officers") for the indicated calendar
years.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION AWARDS
ANNUAL COMPENSATION SECURITIES
------------------------------- UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) OPTIONS(#) COMPENSATION
--------------------------- ---- ---------- --------- ------------------- ------------
<S> <C> <C> <C> <C> <C>
Michael W. Luce.................... 1997 $260,729 -- 57,778 $9,578(1)
President and Chief Executive 1996 $253,076 -- 120,580 $4,125(1)
Officer 1995 $216,923 $30,000 31,780 $2,032(1)
C. Michael Fisher (2).............. 1997 $188,323 -- 21,600 --
Senior Vice President -- 1996 $180,750 $17,079 40,700 --
Operations 1995 $174,423 $40,820 19,067 $ 240(1)
Arlee J. Jensen.................... 1997 $184,005 -- 20,800 $6,142(1)
Senior Vice President -- 1996 $178,272 $15,132 40,000 $2,527(1)
Merchandising and Marketing 1995 $170,192 $36,094 19,067 $1,286(1)
Susan M. Detmer.................... 1997 $157,041 -- 17,200 --
Vice President -- Brand 1996 $ 23,067(3) -- 25,000 --
Development 1995 -- -- -- --
John A. Garruto.................... 1997 $132,675 -- 10,300 --
Vice President -- Research and 1996 $130,201 $ 7,448 29,300 --
Development 1995 $ 16,902(4) -- 25,424 --
</TABLE>
- ---------------
(1) Represents term life insurance and medical insurance premiums.
(2) Mr. Fisher resigned his position with the Company effective March 1998.
(3) Ms. Detmer joined the Company during calendar year 1996. If Ms. Deter had
been employed for the entire year at the same annual base salary rate, her
annual salary would have been $150,000.
(4) Mr. Garruto joined the Company during calendar year 1995. If Mr. Garruto had
been employed for the entire year at the same annual base salary rate, his
annual salary would have been $130,000.
STOCK OPTIONS
Option Grants in Fiscal Year 1997
The following table provides information on option grants to the Named
Officers in fiscal 1997. Individual grants are listed separately for each Named
Officer. In addition, this table shows the potential gain that could be realized
if the fair market value of the Company's Common Stock were to appreciate at
either a 5% or 10% annual rate for the period of the option term.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS (1) POTENTIAL REALIZABLE VALUE AT
---------------------------------------------------- ASSUMED ANNUAL RATES OF
% OF TOTAL STOCK PRICE APPRECIATION FOR
SECURITIES GRANTED TO OPTION TERM (3)
UNDERLYING EMPLOYEES EXERCISE EXPIRA- ------------------------------
NAME OPTIONS (#) IN 1997 (2) PRICE TION DATE 5% 10%
---- ----------- ------------ -------- --------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Michael W. Luce 57,778 20.9% $6.125 7/04/07 $228,967 $604,091
C. Michael Fisher (4) 21,600 7.8% $6.125 7/04/07 $ 85,598 $225,836
Arlee J. Jensen 20,800 7.5% $6.125 7/04/07 $ 82,428 $217,472
Susan M. Detmer 17,200 6.2% $6.125 7/04/07 $ 68,161 $179,832
John A. Garruto 10,300 3.7% $6.125 7/04/07 $ 40,818 $107,690
</TABLE>
27
<PAGE> 29
- ---------------
(1) All options were granted at fair market value at the date of grant. All
options vest annually over a four-year period and expire after ten years and
two days. See also "Employment Agreements and Change in Control
Arrangements."
(2) Based on an aggregate of 276,868 shares subject to options granted to
employees in the fiscal year ended January 31, 1998.
(3) The assumed rates of growth are prescribed by the Securities and Exchange
Commission for illustrative purposes only and are not intended to predict or
forecast future stock prices, nor do they reflect the Company's estimate of
future stock price growth.
(4) Mr. Fisher resigned his position with the Company effective March 1998.
1997 Fiscal Year-end Option Values
The following table shows options the value of grants outstanding as of
January 31, 1998 for each Named Officer. None of the Named Officers exercised
options in 1997.
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED, IN-THE-
MONEY OPTIONS (1)
NUMBER OF SECURITIES UNDERLYING OPTIONS -----------------------------
--------------------------------------- EXERCISABLE UNEXERCISABLE
NAME EXERCISABLE (#) UNEXERCISABLE (#) ($ VALUE) ($ VALUE)
---- ----------------- ------------------- ------------ --------------
<S> <C> <C> <C> <C>
Michael W. Luce 42,856 167,282 -- --
C. Michael Fisher 48,624 70,878 -- --
Arlee J. Jensen 35,738 64,784 -- --
Susan M. Detmer 5,000 37,200 -- --
John A. Garruto 18,764 46,260 -- --
</TABLE>
- ---------------
(1) Calculation based on the spread between the closing sale price of $1.9375
per share of Common Stock on the last trading day before January 31, 1998
and the exercise price of the grants.
EMPLOYMENT AGREEMENTS AND CHANGE IN CONTROL ARRANGEMENTS
The Company is a party to an employment agreement with Mr. Luce which
provides for an annual base salary of $150,000 and pursuant to which the Company
agreed, among other things, to review the level of Mr. Luce's compensation every
six months and, with the proceeds of insurance (if any) on the life of Mr. Luce
obtained by the Company, to repurchase Company stock owned by his estate in the
event of his death at the "fair market value" of such stock, as determined by an
appraisal. In addition, Mr. Luce agreed not to participate, while an employee of
the Company and for a period of two years thereafter, in a business or
enterprise that competes with the Company.
In the event that Mr. Luce is terminated for any reason other than for
cause, including termination in connection with a change of control of the
Company, he is entitled to one year's salary, any benefits that would have
accrued during such one-year period and any reimbursable out-of-pocket expenses
incurred prior to termination. Mr. Luce forfeits such termination benefits in
the event he breaches either the noncompete or confidentiality provisions of his
employment agreement.
The Company is a party to an Option and Severance Agreement with Mr. John
A. Garruto, the Company's Vice President of Research and Product Development,
which provides for an annual base salary of $130,000. In addition, Mr. Garruto
received stock options to purchase 25,424 shares of Common Stock at $1.97 per
share, which options vest monthly over a five-year period for as long as Mr.
Garruto is employed by the Company. These options were not granted under the
Employee Plan. In the event Mr. Garruto is terminated without cause (as
determined by the Company's Board of Directors), he will be entitled to
severance payments equal to his then-current salary for nine months following
the effective date of termination.
In February 1998, the Board of Directors authorized a Retention Plan and
granted certain key employees the right to earn two annual cash bonuses if they
stay continuously employed by the Company for one and two
28
<PAGE> 30
years, respectively, following the date of the grant. On the first anniversary
of the date of the grant, these employees would be given one-third of the total
amount which they would be able to earn, and the remaining two-thirds would be
given to these employees on the second anniversary, provided they remained
continuously employed. In addition, the key employees would be entitled to
receive the entire cash bonus in the event of a merger or sale of the Company's
assets, if the successor company does not continue to offer the Retention Plan
to these employees. Of the Named Officers, Ms. Jensen, Ms. Detmer and Mr.
Garruto would each be able to earn, over two years, an amount equal to his or
her full 1997 base salary. Neither Mr. Luce nor Mr. Fisher are participants in
the Retention Plan.
Under the Employee Plan, outstanding options vest, at the discretion of the
Compensation Committee, upon the occurrence of certain transactions, including
certain mergers and other business combinations involving the Company.
REPORT OF THE COMPENSATION COMMITTEE
The Compensation Committee of the Board of Directors of the Company
determined and administered the compensation of the Company's executive officers
during fiscal 1997.
Compensation Principles
The Compensation Committee believes that a significant portion of executive
compensation should be at risk, that performance should be rewarded, that the
financial interests of executive officers should be aligned with shareholders
through stock ownership, and that compensation should be competitive with others
in the personal care products industry. We have structured compensation at
Garden Botanika to meet these criteria.
The Company's executive compensation program consists of three components:
(i) base salaries, (ii) short-term incentives in the form of annual cash
bonuses, and (iii) long-term incentives in the form of stock options. At higher
management levels, the mixture of components is weighted more heavily toward
variable performance-based incentives. In developing its compensation program
and setting compensation levels, the Company has consulted with compensation
experts and reviewed prior years' compensation levels among comparable
executives.
Base salary levels are vital to the Company's ability to attract and retain
qualified key officers. Increases in salary, if appropriate, are made on the
basis of an annual performance rating of the individual. In formulating a
performance rating, the Compensation Committee considers an individual's
contribution to sales increases, operating efficiency, expense control, earnings
and expansion. Qualitative factors, such as leadership ability, are also
recognized.
The purpose of annual cash bonus awards, which are paid after the fiscal
year-end, is to provide a direct linkage between executive compensation and the
Company's overall annual performance. At the beginning of each fiscal year, the
Compensation Committee and the Board of Directors establish target annual
financial performance levels for the Company. At the end of each fiscal year,
the Compensation Committee and the Board of Directors rate the Company's prior
year's performance based, in part, on its financial achievements (in relation to
the target performance levels for that year) and, in part, on a variety of
qualitative assessments. Based on the disappointing results produced by the
Company in 1997, no executive cash bonuses were paid for that year.
Stock option grants to executives constitute the long-term equity incentive
component of the Company's compensation program, the purpose of which is to
strengthen the link between the executive's compensation and the Company's
long-term stock performance. Stock options are granted at the fair market value
of the Company's Common Stock on the date of grant and expire after ten years
and two days. The Compensation Committee determines the vesting schedule, which
is generally in equal increments annually over the course of four or five years.
In determining stock option awards, the Compensation Committee considers the
executive's expected contributions toward meeting the Company's long-term
strategic goals and grants of options in prior years.
29
<PAGE> 31
Chief Executive Officer Compensation
During fiscal 1997, Garden Botanika's most highly compensated officer was
Michael W. Luce, President and Chief Executive Officer of the Company since its
inception in 1989. Mr. Luce's 1996 performance, which was the basis for setting
the level of his compensation for fiscal 1997, was reviewed by the Compensation
Committee and discussed with the Board of Directors and Mr. Luce. The Committee
noted that, during fiscal 1996, the Company had increased its sales volume by
approximately 67.1% and opened 101 stores, increasing its store base by
approximately 66.4%. The Compensation Committee also noted, however, that the
Company's comparable store sales increased only 7%, well below historical
levels, and the Company needed to improve its performance in meeting certain
financial targets, such as overall sales and store contribution margins. Against
this background, Mr. Luce's annual salary for fiscal 1997 was not increased from
the prior year, and no annual cash bonus for the year was awarded.
The Compensation Committee also determined that equity-based incentive
compensation should continue as a significant portion of Mr. Luce's total
compensation so that the value ultimately realized by Mr. Luce would depend
directly on the long-term performance of the Company and would be commensurate
with the value realized by shareholders. In fiscal 1997, the Committee granted
Mr. Luce a nonqualified stock option to purchase 57,778 shares of Common Stock.
Internal Revenue Code Section 162
Under Section 162 of the Internal Revenue Code of 1986, as amended (the
"Code"), the federal income tax deduction for compensation paid to the Chief
Executive Officer and the four most highly compensated other executive officers
of publicly held corporations is limited to $1 million per officer per fiscal
year, unless the compensation qualifies as "performance-based compensation"
under Section 162(m) of the Code. The Compensation Committee is aware of this
limitation and believes that no compensation paid by the Company during 1997
will exceed the $1 million limitation.
Compensation Committee
Jeffrey H. Brotman
Gerald R. Gallagher
Dale J. Vogel
30
<PAGE> 32
STOCK PERFORMANCE GRAPH
The following graph compares cumulative total shareholder return on the
Common Stock since May 22, 1996, the date the Company's shares began trading on
the Nasdaq National Market, with the cumulative total return on the Nasdaq Stock
Market (U.S.) Index and the Nasdaq Retail Trade Stocks Index over the same
period. The comparison assumes $100 was invested on May 22, 1996 in the Common
Stock and in each of the indices and assumes reinvestment of dividends, if any,
since that date. The Company has not paid cash dividends on the Common Stock.
Historic stock price is not indicative of future stock performance.
<TABLE>
<CAPTION>
Nasdaq Stock
Measurement Period 'Garden Botanika, Market (U.S.) Nasdaq Retail
(Fiscal Year Covered) Inc.' Index Trade Stocks Index
<S> <C> <C> <C>
5/22/96 100 100 100
1/31/97 48 111 96
1/31/98 10 131 112
</TABLE>
- ---------------
(1) Assumes $100 investment of May 22, 1996.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During fiscal 1997, the following individuals (none of whom was or had been
an employee of the Company) served on the Company's Compensation Committee:
Jeffrey H. Brotman, Gerald R. Gallagher and Dale J. Vogel. There were no
interlocks with other companies within the meaning of the Commission's proxy
rules during fiscal 1997.
31
<PAGE> 33
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information regarding the beneficial
ownership of the Company's Common Stock as of May 4, 1998 by (i) each director;
(ii) the Named Officers; and (iii) all directors and executive officers of the
Company as a group.
<TABLE>
<CAPTION>
AMOUNT OF
NAME BENEFICIAL OWNERSHIP PERCENTAGE
---- -------------------- ----------
<S> <C> <C>
Jeffrey H. Brotman (1).............................. 174,429 2.41%
Gerald R. Gallagher (2)............................. 294,797 4.00%
Michael W. Luce (3)................................. 196,498 2.70%
William B. Randall (4).............................. 15,286 *
Dale J. Vogel (5)................................... 9,018 *
C. Michael Fisher (6)............................... 75,217 1.05%
Arlee J. Jensen (7)................................. 74,142 1.04%
Susan M. Detmer (8)................................. 9,300 *
John A. Garruto (9)................................. 28,039 *
All directors and executive officers as a group (12
persons).......................................... 632,762 8.95%
</TABLE>
- ---------------
* Less than one percent.
(1) Includes 22,336 shares of Common Stock held by Mr. Brotman's spouse; 28,564
shares held by the 1991 Brotman's Children's Trust, John Meisenbach TTE as
to which Mr. Brotman disclaims beneficial ownership; and 10 shares held by
Mr. Brotman's minor son as to which Mr. Brotman also disclaims beneficial
ownership. Also includes 8,046 shares of Common Stock that are issuable upon
the exercise of currently exercisable options and 212 shares of Common Stock
that are issuable upon the exercise of options exercisable within 60 days.
(2) Represents 272,638 shares of Common Stock held by Oak Investment Partners
IV, Limited Partnership and 15,808 shares of Common Stock held by Oak IV
Affiliates Fund, Limited Partnership. Mr. Gallagher is a managing member of
Oak Associates IV, L. L.C., which is the general partner of Oak Investment
Partners IV, Limited Partnership. Mr. Gallagher has shared voting and
investment power with respect to such shares but disclaims beneficial
ownership. Also includes 6,139 shares of Common Stock that are issuable upon
the exercise of currently exercisable options and 212 shares of Common Stock
that are issuable upon the exercise of options exercisable within 60 days.
(3) Includes 5,084 shares of Common Stock held by certain family members of Mr.
Luce for which Mr. Luce may be deemed a beneficial owner. Also includes
49,212 shares of Common Stock that are issuable upon the exercise of
currently exercisable options and 14,445 shares of Common Stock that are
issuable upon the exercise of options exercisable within 60 days.
(4) Includes 1,063 shares of Common Stock held by Southwest Securities, Inc. FBO
William Randall IRA and 500 shares of Common Stock held by Mr. Randall's
spouse. Also includes 8,046 shares of Common Stock that are issuable upon
the exercise of currently exercisable options and 212 shares of Common Stock
that are issuable upon the exercise of options exercisable within 60 days.
(5) Includes 667 shares of Common Stock held by Mr. Vogel's spouse and 6,139
shares of Common Stock that are issuable upon the exercise of currently
exercisable options and 212 shares of Common Stock that are issuable upon
the exercise of options exercisable within 60 days.
(6) Includes 67,420 shares of Common Stock that are issuable upon the exercise
of currently exercisable options and 7,464 shares of Common Stock that are
issuable upon the exercise of options exercisable within 60 days. Mr. Fisher
has resigned and is no longer employed by the Company.
(7) Includes 200 shares of Common Stock held by Ms. Jensen's spouse for the
benefit of a minor child and 39,551 shares of Common Stock that are issuable
upon the exercise of currently exercisable options and 6,471 shares of
Common Stock that are issuable upon the exercise of options exercisable
within 60 days.
32
<PAGE> 34
(8) Consists of 5,000 shares of Common Stock that are issuable upon the exercise
of currently exercisable options and 4,300 shares of Common Stock that are
issuable upon the exercise of options exercisable within 60 days.
(9) Includes 20,460 shares of Common Stock that are issuable upon the exercise
of currently exercisable options and 3,423 shares of Common Stock that are
issuable upon the exercise of options exercisable within 60 days.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table sets forth information regarding the beneficial
ownership of the Company's Common Stock as of May 5, 1998 by each person known
by the Company to be the beneficial owner of more than five percent of the
Company's Common Stock.
<TABLE>
<CAPTION>
COMMON STOCK/AMOUNT
NATURE OF PERCENT OF
NAME AND ADDRESS(1) BENEFICIAL OWNERSHIP CLASS
------------------- --------------------- ----------
<S> <C> <C>
BankAmerica Ventures(2)........................ 699,908 9.9%
950 Tower Lane, Suite 700
Foster City, CA 94104
Dimensional Fund Advisors Inc.(3).............. 509,400 7.1%
1299 Ocean Avenue, 11th Floor
Santa Monica, CA 90401
Olympus Private Placement Fund, L.P.(4)........ 378,577 5.4%
One Station Place
Stanford, CT 06902
</TABLE>
- ---------------
(1) This table is based upon information supplied by officers, directors,
principal shareholders and Schedules 13G filed with the Securities and
Exchange Commission (the "Commission"). The Schedules 13G received by the
Company were dated as early as February 6, 1998 and as late as February 9,
1998.
(2) Does not include 300 shares over which BankAmerica Corporation ("BAC"), the
ultimate parent corporation of BankAmerica Ventures, has shared voting power
due to the corporate relationships of lower-tier BAC subsidiaries.
(3) Includes 174,600 shares of Common Stock held by two open-end management
investment companies, whose officers are also officers of Dimensional Fund
Advisors Inc. All shares are owned by advisory clients of Dimensional Fund
Advisors Inc., which disclaims beneficial ownership of such shares.
(4) Includes 22,000 shares of Common Stock held by Olympus Executive Fund, L.P.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act ("Section 16(a)") requires the Company's
directors and certain of its officers, and persons who own more than 10% of a
registered class of the Company's equity securities (collectively, "Insiders"),
to file reports of ownership and changes in ownership with the Commission.
Insiders are required by Commission regulations to furnish the Company with
copies of all Section 16(a) forms they file.
Based solely on its review of the copies of such forms received by it, or
written representation from certain reporting persons that no Form 5 was
required for those persons, the Company believes that its Insiders complied with
all applicable Section 16(a) filing requirements for fiscal 1997, with the
exception of Mr. Brotman, who filed a late Form 4 reporting a single
transaction, and Mr. Hare, who filed a late Form 3 to report his becoming an
executive officer of the Company. Apart from options granted under the Company's
Employee Plan, Mr. Hare owned no securities of the Company and had no other
transactions to report.
33
<PAGE> 35
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Since its inception, the Company has acquired through arm's length
transactions a significant portion of its finished personal care products,
particularly in its Aromatics line, from Randall International, the President
and majority shareholder of which, William B. Randall, is a member of the
Company's Board of Directors. The cost of products purchased from Randall
International by the Company in fiscal 1997 was approximately $5.3 million.
These purchases represented approximately 12% of the Company's total purchases
for such year.
In the fourth quarter of fiscal 1997, the Company began to supply, on an
experimental basis through arm's length transactions, selected specially priced
Garden Botanika products for resale by Costco in certain of its membership
warehouse stores. Jeffrey H. Brotman, a founder of Costco and currently its
Chairman of the Board, is also a co-founder of the Company and has served as its
Chairman of the Board and Secretary since 1990. Total sales by the Company to
Costco in fiscal 1997 were not material. However, sales have continued in the
first quarter of fiscal 1998 in the amount of approximately $556,000, and
further sales to Costco may continue throughout fiscal 1998.
34
<PAGE> 36
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. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Arthur Andersen LLP, Independent Public
Accountants............................................... F-2
Balance Sheets -- January 31, 1998 and February 1, 1997..... F-3
Statements of Operations -- For the fiscal years ended
January 31, 1998, February 1, 1997 and February 3, 1996... F-4
Statements of Shareholders' Equity -- For the fiscal years
ended January 31, 1998, February 1, 1997 and February 3,
1996...................................................... F-5
Statements of Cash Flows -- For the fiscal years ended
January 31, 1998, February 1, 1997 and February 3, 1996... F-6
Notes to Financial Statements............................... F-7
Selected Quarterly Financial Data (Unaudited) -- For the
fiscal years ended January 31, 1998, February 1, 1997 and
February 3, 1996 -- See Note (9) of Notes to Financial
Statements................................................ F-14
</TABLE>
2. FINANCIAL STATEMENT SCHEDULES
All schedules are omitted because they are not applicable or because the
information is presented in the financial statements or notes thereto.
3. EXHIBITS
The required exhibits are included at the end of the Form 10-K Annual
Report and are described in the Exhibit Index immediately preceding the first
exhibit.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the quarter ended January 31,
1998.
35
<PAGE> 37
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on May 26, 1998.
GARDEN BOTANIKA, INC.
By: /s/ MICHAEL W. LUCE
------------------------------------
Michael W. Luce
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 May 26, 1998, on behalf
of the Registrant and in the capacities indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
/s/ JEFFREY H. BROTMAN Chairman, Secretary and Director
- --------------------------------------------------------
Jeffrey H. Brotman
/s/ MICHAEL W. LUCE President, Chief Executive Officer and
- -------------------------------------------------------- Director (Principal Executive Officer)
Michael W. Luce
/s/ GEORGE W. NEWMAN Vice President -- Controller
- -------------------------------------------------------- (Principal Accounting Officer)
George W. Newman
/s/ GERALD R. GALLAGHER Director
- --------------------------------------------------------
Gerald R. Gallagher
/s/ WILLIAM B. RANDALL Director
- --------------------------------------------------------
William B. Randall
/s/ DALE J. VOGEL Director
- --------------------------------------------------------
Dale J. Vogel
</TABLE>
36
<PAGE> 38
GARDEN BOTANIKA, INC.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FINANCIAL STATEMENTS:
Report of Arthur Andersen, Independent Auditors............. F-2
Balance Sheets -- January 31, 1998 and February 1, 1997..... F-3
Statements of Operations -- For the fiscal years ended
January 31, 1998, February 1, 1997 and February 3, 1996... F-4
Statements of Shareholders' Equity -- For the fiscal years
ended January 31, 1998, February 1, 1997 and February 3,
1996...................................................... F-5
Statements of Cash Flows -- For the fiscal years ended
January 31, 1998, February 1, 1997 and February 3, 1996... F-6
Notes to Financial Statements -- For the fiscal years ended
January 31, 1998, February 1, 1997 and February 3, 1996... F-7
Selected Quarterly Financial Data (Unaudited) -- For the
fiscal years ended January 31, 1998, February 1, 1997 and
February 3, 1996 -- See Note (9) of Notes to Financial
Statements................................................ F-14
</TABLE>
FINANCIAL STATEMENT SCHEDULES
All schedules are omitted because they are not applicable or because
the information is presented in the financial statements or notes thereto.
F-1
<PAGE> 39
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Garden Botanika, Inc.:
We have audited the accompanying balance sheets of Garden Botanika, Inc. (a
Washington corporation) as of January 31, 1998 and February 1, 1997, and the
related statements of operations, shareholders' equity and cash flows for the
fiscal years ended January 31, 1998, February 1, 1997 and February 3, 1996.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Garden Botanika, Inc. as of
January 31, 1998 and February 1, 1997, and the results of its operations and its
cash flows for the fiscal years ended January 31, 1998, February 1, 1997 and
February 3, 1996, in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1, the Company
has incurred significant net losses since its inception. The Company is in the
process of completing an agreement for a new line of credit to finance its
operations during fiscal 1998. There can be no assurance that the agreement will
be completed or that it will provide the Company with adequate funding for the
next fiscal year. These matters raise substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
ARTHUR ANDERSEN LLP
Seattle, Washington
April 24, 1998
F-2
<PAGE> 40
GARDEN BOTANIKA, INC.
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
JANUARY 31, FEBRUARY 1,
1998 1997
----------- -----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 8,594 $ 7,205
Short-term investments.................................... -- 20,426
Inventories............................................... 23,747 18,940
Prepaid expenses:
Rent................................................... 1,640 1,238
Other.................................................. 1,033 1,793
Receivable from lessors................................... 550 2,633
Other..................................................... -- 727
-------- --------
Total current assets.............................. 35,564 52,962
Property and equipment:
Leasehold improvements.................................... 53,030 51,431
Furniture and equipment................................... 16,420 9,016
Equipment under capital lease............................. 261 261
-------- --------
69,711 60,708
Less accumulated depreciation and amortization............ (17,456) (10,168)
-------- --------
Net property and equipment............................. 52,255 50,540
Other assets................................................ 18 21
-------- --------
Total assets...................................... $ 87,837 $103,523
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Checks drawn in excess of bank balances................... $ 6,055 $ 6,600
Accounts payable.......................................... 5,818 7,438
Accrued salaries, wages and benefits...................... 1,536 1,366
Reserve for store closing expenses........................ 1,311 --
Accrued sales tax......................................... 398 442
Other..................................................... 756 801
-------- --------
Total current liabilities......................... 15,874 16,647
Deferred rent and other..................................... 3,027 2,420
-------- --------
Total liabilities................................. 18,901 19,067
Commitments
Shareholders' equity:
Preferred Stock, $.01 par value; 10,000,000 shares
authorized; none issued and outstanding................ -- --
Common Stock, $.01 par value; 36,092,374 shares
authorized; 7,069,098 issued and outstanding........... 98,573 98,513
Accumulated deficit....................................... (29,637) (14,057)
-------- --------
Total shareholders' equity........................ 68,936 84,456
-------- --------
Total liabilities & shareholders' equity.......... $ 87,837 $103,523
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 41
GARDEN BOTANIKA, INC.
STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
----------------------------------------------
JANUARY 31, FEBRUARY 1, FEBRUARY 3,
1998 1997 1996
------------ ------------ ------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Net sales............................................... $114,591 $92,465 $55,339
Cost of sales (including buying and occupancy costs).... 73,846 52,551 31,448
-------- ------- -------
Gross margin....................................... 40,745 39,914 23,891
Operating expenses:
Stores and catalog.................................... 39,524 35,544 18,746
General and administrative............................ 10,919 8,871 6,041
Preopening and facility relocation expenses............. 397 1,426 798
Provision for store closings............................ 3,200 -- --
Impairment loss on long-lived assets.................... 2,600 -- --
-------- ------- -------
Operating loss..................................... (15,895) (5,927) (1,694)
Interest income, net.................................... 315 994 30
-------- ------- -------
Net loss........................................... $(15,580) $(4,933) $(1,664)
======== ======= =======
Basic loss per share, giving effect to the conversion of
all preferred shares to common........................ $ (2.20) $ (0.80) $ (0.44)
Weighted average common shares, giving effect to the
conversion of all preferred shares to common.......... 7,069 6,146 3,756
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 42
GARDEN BOTANIKA, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
------------------ ----------------- ACCUMULATED
SHARES AMOUNT SHARES AMOUNT DEFICIT TOTAL
------ -------- ------ ------- ----------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance, January 28, 1995.... 2,910 $ 25,595 262 $ 49 $ (7,460) $ 18,184
Sale of Series C preferred
stock................... 509 9,960 -- -- -- 9,960
Sale of Series D preferred
stock................... 275 6,472 -- -- -- 6,472
Exercise of stock
options................. -- -- 3 19 -- 19
Issuance of common stock in
connection with
acquisition............. -- -- 4 131 -- 131
Deferred compensation...... -- -- -- 15 -- 15
Net loss................... -- -- -- -- (1,664) (1,664)
------ -------- ----- ------- -------- --------
Balance, February 3, 1996.... 3,694 42,027 269 214 (9,124) 33,117
Sale of common stock....... -- -- 3,104 56,191 -- 56,191
Conversion of preferred
stock to common......... (3,694) (42,027) 3,694 42,027 -- --
Exercise of stock
options................. -- -- 2 24 -- 24
Deferred compensation...... -- -- -- 57 -- 57
Net loss................... -- -- -- -- (4,933) (4,933)
------ -------- ----- ------- -------- --------
Balance, February 1, 1997.... -- -- 7,069 98,513 (14,057) 84,456
Deferred compensation...... -- -- -- 60 -- 60
Net loss................... -- -- -- -- (15,580) (15,580)
------ -------- ----- ------- -------- --------
Balance, January 31, 1998.... -- $ -- 7,069 $98,573 $(29,637) $ 68,936
====== ======== ===== ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 43
GARDEN BOTANIKA, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 31, FEBRUARY 1, FEBRUARY 3,
1998 1997 1996
----------- ----------- -----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss................................................ $(15,580) $ (4,933) $ (1,664)
-------- -------- --------
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization........................ 7,869 5,153 2,908
Reserves for store closings and asset impairment..... 4,489 -- --
Loss on retirement of property and equipment......... 88 422 --
Changes in assets and liabilities:
Inventories........................................ (4,807) (8,764) (4,543)
Prepaid rent....................................... (402) (443) (416)
Other assets....................................... 1,490 (499) (1,117)
Accounts payable and checks drawn in excess of bank
balances........................................ (2,165) 5,284 3,674
Accrued expenses................................... 81 987 (38)
Reserve for store closing expenses................. 1,311 -- --
Deferred rent and other............................ 607 1,353 484
-------- -------- --------
Total adjustments............................... 8,561 3,493 952
-------- -------- --------
Net cash used by operating activities........... (7,019) (1,440) (712)
-------- -------- --------
Cash flows from investing activities:
Additions to property and equipment..................... (14,161) (24,225) (16,800)
Redemption (purchase) of short-term investments......... 20,426 (20,426) --
Decrease (increase) in receivable from lessors.......... 2,083 (1,708) (1,230)
Other................................................... -- -- (25)
-------- -------- --------
Net cash provided (used by) investing
activities.................................... 8,348 (46,359) (18,055)
-------- -------- --------
Cash flows from financing activities:
Sale of stock........................................... -- 56,191 16,432
Advances on note payable to bank........................ 16,325 11,958 13,856
Payments on note payable to bank........................ (16,325) (14,498) (11,316)
Other................................................... 60 45 65
-------- -------- --------
Net cash provided by financing activities....... 60 53,696 19,037
-------- -------- --------
Increase in cash and cash equivalents, net................ 1,389 5,897 270
Cash and cash equivalents, beginning of period............ 7,205 1,308 1,038
-------- -------- --------
Cash and cash equivalents, end of period.................. $ 8,594 $ 7,205 $ 1,308
======== ======== ========
Supplemental disclosures:
Cash paid for interest.................................. $ 92 $ 302 $ 82
Cash paid for income taxes.............................. $ -- $ -- $ --
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 44
GARDEN BOTANIKA, INC.
NOTES TO FINANCIAL STATEMENTS
JANUARY 31, 1998
1. ORGANIZATION
Garden Botanika, Inc. (the "Company") was incorporated in the State of
Washington in October 1989. The Company produces and markets proprietary,
botanically based personal care products. These products are sold at retail in a
chain of Company-owned and -operated specialty retail stores. As of January 31,
1998, Garden Botanika operated 280 retail locations in 41 states.
On October 30, 1995, in order to establish its initial in-house research
and development, quality control and manufacturing capabilities, the Company
purchased the principal assets of Innovative Biosciences Corporation of
Oceanside, California ("IBC"). IBC was in the business of formulating,
manufacturing and selling personal care products, including a number of such
products formulated and manufactured for the Company. The purchase price paid
for IBC's principal assets was approximately $156,000, which was paid in cash
and shares of the Company's Common Stock. The acquisition was accounted for as a
purchase and the operations of IBC have been included in the results of
operations beginning October 31, 1995.
The Company has only a limited operating history, and over 45% of its 280
stores had been open for less than 24 months at January 31, 1998. In addition,
the Company has announced plans to close approximately 12 stores during 1998.
The Company's future operations are subject to risks inherent in an emerging
business. The principal risk factors relate to the ability of the Company to
increase comparable store sales and achieve profitability in its highly
competitive environment, develop alternate channels of distribution, increase
brand awareness and maintain sufficient capital to fund operations and introduce
new products.
The Company has incurred net losses of $1.66 million, $4.93 million and
$15.58 million in fiscal 1995, 1996 and 1997, and has accumulated a deficit of
$29.64 million since inception. There can be no assurance that the Company will
generate profits in future periods. The Company's future operating results will
depend upon a number of factors, particularly the performance of its stores, the
level of competition, and the Company's ability to cost-effectively close or
restructure the rent of some of its most unprofitable stores and its success in
identifying and responding to emerging trends in the personal care products
industry.
The Company expects to incur losses during the first three quarters of
fiscal 1998 and will need to borrow under a line of credit to finance its
inventory build-up and increased operating costs prior to the holiday season. As
discussed in Note 5, the Company received a commitment letter from a lender for
a line of credit up to $10.00 million. The Company and the lender are in the
process of completing a formal agreement. There can be no assurance that the
agreement will be completed or that it will provide the Company with adequate
funding for the next fiscal year. These factors, when considered in the
aggregate, raise substantial doubt about the Company's ability to continue as a
going concern. The financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fiscal Year
The Company's 52/53-week fiscal year ends on the Saturday nearest the end
of January. Fiscal 1995 (ended February 3, 1996) was a 53-week year.
Estimates and Assumptions
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 the
disclosure of contingent assets and liabilities at the date of the financial
statements, as well
F-7
<PAGE> 45
GARDEN BOTANIKA, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
as the amounts of revenues and expenses reported during the period. Actual
results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all short-term investments with maturities of 90 days
or less at the date of purchase to be cash equivalents. Cash includes all
depository accounts maintained at financial institutions, including amounts
invested in money-market mutual funds. The Company estimates that the fair value
of its financial instruments approximate their carrying value, and therefore no
separate disclosure of fair value is made.
The Company's cash management system provides for the reimbursement of all
major bank disbursement accounts on a daily basis. Checks issued but not yet
presented for payment to the bank are reflected as checks drawn in excess of
bank balances on the balance sheet.
Short-Term Investments
Short-term investments include highly liquid investments in United States
government obligations and other investment vehicles which have maturities of
more than 90 days at the date of purchase. The Company's policy is to classify
these items as short-term investments rather than cash equivalents if they are
to be held to maturity or are restricted by agreement.
Inventory
Inventory is recorded at the lower of weighted average cost or net
realizable value.
Advertising
The Company expenses the production cost of advertising the first time the
advertising takes place, except for the costs of direct response advertising,
which are capitalized and amortized over the expected period of future benefit.
Direct response advertising consists primarily of catalog advertising expenses.
The capitalized costs of such advertising are amortized over a maximum of 13
weeks following initial distribution of mail-order catalogs, based on historical
direct response revenue flows. Under this policy, as of January 31, 1998 and
February 1, 1997, respectively, $200,000 and $1.27 million of advertising was
reported as assets. Advertising expense was $7.93 million, $9.57 million and
$3.34 million in fiscal years 1997, 1996 and 1995, respectively.
Property and Equipment
Property and equipment are stated at cost and include the costs of
acquiring new store leases and leasehold improvements. Depreciation of equipment
under capital leases, furniture and fixtures is provided using the straight-line
method over estimated useful lives ranging from five to seven years. The costs
of acquiring new store leases and the costs of leasehold improvements are
capitalized and amortized over the shorter of the life of the lease or the
useful lives of the assets. Leasehold acquisition costs capitalized in fiscal
years 1997, 1996 and 1995 were $219,000, $1.13 million and $754,000,
respectively. Depreciation and amortization expense was $7.87 million, $5.15
million and $2.91 million, for fiscal years 1997, 1996 and 1995, respectively.
In February 1998, the Company announced its intention to close
approximately 12 under-performing stores during the coming year. A charge of
$3.20 million was recorded as of January 31, 1998 to cover estimated asset
writeoffs and closure expenses. Of this amount, $1.89 million reduced property
and equipment, while the remaining $1.31 million is shown as a reserve for store
closing expenses to be incurred in future months.
F-8
<PAGE> 46
GARDEN BOTANIKA, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
At the conclusion of the 1997 holiday season, the Company reviewed the
asset values of individual stores in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 121. As a result of that review, a charge of
$2.60 million was recorded at the end of the fourth quarter to recognize
potential impairment of long-lived assets at 26 stores not previously identified
for closure. This amount reduced property and equipment. All stores opened prior
to fiscal 1997 were included in the impairment review, which then concentrated
on the approximately 100 stores, opened primarily during fiscal 1996, with
negative fiscal 1997 store level contribution margin. The initial evaluation
identified 26 stores, exclusive of the 12 previously identified for closure,
whose net book value at January 31, 1998 exceeded the undiscounted cash flow
expected to be produced over their remaining lease terms. An impairment charge
was recorded for each of these 26 stores equal to the difference between its
current net book value and the estimated fair value of those assets as measured
by the discounted cash flow expected to be produced over the remaining lease
term.
Preopening and Facility Relocation Costs
Store preopening costs are expensed as incurred. The unamortized cost of
leasehold improvements related to facilities to be remodeled and/or relocated
are written off in the period in which the new lease is signed.
Deferred Rent
The Company expenses rent on a straight-line basis over the life of the
lease. During the initial years of a store lease, cash payments are typically
less than the straight-line rent expense. The differential is recorded as
deferred rent on the balance sheet.
Income Taxes
The Company accounts for income taxes under Statement of Financial
Accounting Standards ("SFAS") No. 109. Accordingly, deferred taxes are provided
to reflect temporary differences between financial and tax reporting. Deferred
tax assets and liabilities are measured based on enacted tax laws and rates. Due
to its net operating losses, the Company has not paid federal income taxes since
its inception.
Earnings per Common and Common Share Equivalent; Adoption of Financial
Accounting Standards Board Statement No. 128
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, "Earnings Per Share." This pronouncement established new standards for
computing and presenting earnings per share for entities with publicly held
common stock. The Company adopted SFAS No. 128 in the fourth quarter of fiscal
1997. The adoption did not have a significant effect on the Company's earnings
per share.
For each of fiscal years 1997, 1996 and 1995, outstanding stock options and
warrants to purchase common stock were excluded from the annual earnings per
share calculation because their effect would have been anti-dilutive. The number
of "in the money" options and warrants thus excluded from the earnings per share
calculation was 25,424 in 1997, 440,953 on a full-year equivalent basis in 1996
and 267,994 on a full-year equivalent basis in 1995.
Reclassifications
Certain reclassifications have been reflected in the financial statements
in order to conform prior years to the current year presentation.
F-9
<PAGE> 47
GARDEN BOTANIKA, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. INVENTORIES
Inventories at fiscal year-end were composed of the following (in
thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Finished products held for sale.......................... $16,498 $12,814
Raw materials and components............................. 7,249 6,126
------- -------
Total inventories...................................... $23,747 $18,940
======= =======
</TABLE>
4. LEASES
The Company is obligated under non-cancelable operating leases for its
retail store outlets. Lease terms range from five to 12 years with options to
renew at varying terms. The leases generally provide for contingent payments
based upon a percentage of sales. Contingent payments were $184,000, $218,000
and $184,000, and rent expense was $14.99 million, $10.46 million and $5.68
million for fiscal years 1997, 1996 and 1995, respectively.
Future minimum rental payments under operating leases are (in thousands):
<TABLE>
<CAPTION>
FISCAL YEAR AMOUNT
- ----------- --------
<S> <C>
1998........................................................ $ 14,470
1999........................................................ 14,706
2000........................................................ 14,989
2001........................................................ 15,167
2002........................................................ 15,138
Thereafter.................................................. 48,072
--------
Total future minimum rental payments.............. $122,542
========
</TABLE>
The Company has announced its intention to close approximately 12 stores
during fiscal 1998, and closed the first of these stores in February. The store
closure process, which will involve negotiation with landlords regarding
individual properties, may result in changes to the future minimum rental
commitments shown above.
5. LINE OF CREDIT
The Company's existing $5.00 million credit line with U.S. Bank expires on
May 31, 1998. There were no borrowings under this line at January 31, 1998, nor
have there been any subsequent borrowings as of April 27, 1998. The Company was
in violation of the $75.00 million tangible net worth covenant of the credit
agreement at January 31, 1998. U.S. Bank has indicated its willingness to
provide the Company with a forbearance letter stating that it will not take any
action with respect to the Company's violation. However, U.S. Bank will not
permit further borrowings until that violation is cured, and there is no present
likelihood that this will occur or that borrowing will be necessary prior to
expiration of the line.
On April 2, 1998, the Company received a commitment letter from Foothill
Capital Corporation, under which Foothill agrees, subject to certain financial
conditions and the satisfactory completion of loan documentation, to provide the
Company with a three-year, $10.00 million revolving line of credit for general
corporate purposes. Credit available under the Foothill line at any time during
this period would generally be a variable percentage (ranging from 55% to 65%)
of eligible finished goods inventory. This line, which would be secured by the
assets of the Company, would bear interest at prime plus 0.5%, with a LIBOR rate
available on certain borrowings at the Company's option. The minimum interest
rate on any borrowings under the line would be 7.00%. As a result of
negotiations since April 2, 1998, in order to access the Foothill credit line,
the
F-10
<PAGE> 48
GARDEN BOTANIKA, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Company would be required to maintain certain financial covenants, including
covenants relating to earnings and limitations on losses that would vary from
quarter to quarter. Future capital expenditures, including those for store
expansion, would be limited in accordance with the Company's business plan. The
Company's Board of Directors has authorized management to proceed with
negotiations for the Foothill credit line on the terms proposed.
During fiscal years 1997, 1996 and 1995, the Company incurred interest
expense of $92,000, $321,000 and $105,000, respectively.
6. INCOME TAXES
The components of the Company's deferred tax accounts at fiscal year-end,
assuming a 35% statutory tax rate, were as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
Net operating loss carryforward......................... $ 8,180 $ 3,632
Depreciation............................................ (1,456) (620)
Inventory............................................... 870 813
Deferred rent........................................... 1,020 691
Reserves not currently deductible....................... 2,503 473
Other................................................... 226 87
Valuation allowance..................................... (11,343) (5,076)
-------- -------
Net deferred taxes............................ $ -- $ --
======== =======
</TABLE>
The Company has established a valuation allowance because the net deferred
tax asset does not meet the recognition criteria established by SFAS No. 109.
Deferred state taxes have not been disclosed, as amounts are not material.
The Company's net operating loss carryforward begins to expire in 2005. Of
the $8.18 million carryforward benefit at January 31, 1998, $6.31 million is
subject to a usage limitation of $425,000 per year.
7. SHAREHOLDERS' EQUITY
Common and Preferred Stock
On March 29, 1996, the Company's board of directors approved an approximate
1-to-7.87 reverse stock split. The accompanying financial statements have been
adjusted to reflect this action.
On May 22, 1996, the Company, in its initial public offering, issued
3,104,365 shares of Common Stock at $20.00 per share. Concurrent with the
initial public offering, all outstanding shares of Preferred Stock were
automatically converted to Common Stock.
Stock Compensation Plans
At January 31, 1998, the Company had two stock-based compensation plans
(the 1992 Plan and the 1996 Plan, each as described below). The Company had also
made an option grant outside these plans (the "IBC Options" as described below).
The Company applies Accounting Principles Board Opinion No. 25 in accounting for
these fixed stock option plans and the non-plan grant. Accordingly, with the
exception of the IBC Options (which were granted at an exercise price below the
current market value, thereby requiring recognition of compensation expense as
described below), no related compensation cost has been recognized. Had
compensation cost been determined based on the fair value at the grant dates for
options awarded under the 1992 Plan, the 1996 Plan and the IBC Options,
consistent with the method of SFAS No. 123, the
F-11
<PAGE> 49
GARDEN BOTANIKA, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Company's fiscal 1997 and 1996 reported net losses and basic losses per share
would have been increased to the amounts indicated below:
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C> <C>
Net loss (in thousands)........ As reported.................... $(15,580) $(4,933)
Pro forma SFAS No. 123......... $(17,427) $(5,751)
Basic loss per share........... As reported.................... $ (2.20) $ (0.80)
Pro forma SFAS No. 123......... $ (2.47) $ (0.94)
</TABLE>
As specified by SFAS No. 123, the fair value of each fiscal 1995 and
subsequent option grant was estimated, by optionee group, as of the date of
grant using the Black-Scholes option pricing model and the following weighted
average assumptions:
<TABLE>
<CAPTION>
1997 1996
------------------ ------------------
<S> <C> <C>
Risk-free interest rate......................... 6.35% to 6.44% 5.88% to 6.41%
Expected life................................... 6 years to 8 years 6 years to 8 years
Dividend rate................................... 0% 0%
Expected volatility............................. 90% 80%
</TABLE>
The Company's two fixed stock option plans are: (i) the 1992 Combined
Incentive and Non-Qualified Stock Option Plan (the "1992 Plan") and (ii) the
1996 Directors' Non-Qualified Stock Option Plan (the "1996 Plan"). Under the
terms of the 1992 Plan, as amended at the 1997 Annual Meeting of Shareholders,
incentive or non-qualified stock options to purchase 1,089,038 shares of the
Company's Common Stock may be granted to employees, directors, consultants and
independent contractors of the Company. The exercise price of incentive stock
options may not be less than 100% of fair market value at the date of grant,
while the exercise price of non-qualified stock options may be greater than or
less than fair market value. All options outstanding at January 31, 1998 vest on
schedules of four to five years and terminate after 10 years and two days. At
that date, 247,279 shares were available for future grant under the amended 1992
Plan.
Under the terms of the 1996 Plan, non-qualified stock options to purchase
63,561 shares of the Company's Common Stock may be granted to members of the
Company's board of directors. The 1996 Plan provides that each non-employee
director of the Company will automatically be granted an option to purchase
1,271 shares of Common Stock upon election or appointment to the board of
directors and thereafter at each annual meeting of the board of directors for so
long as the individual continues to serve as a director of the Company. The
exercise price of these options must equal the fair market value of the
Company's Common Stock at the date of grant. Options granted under the 1996 Plan
vest monthly over a one-year period and terminate after 10 years and two days.
At January 31, 1998, 58,054 shares were available for future grant under the
1996 Plan.
As part of the agreement for the 1995 purchase of IBC, an owner of IBC
became Vice President - Research and Product Development of the Company. In
connection with his employment, this individual was granted options to purchase
25,424 shares of the Company's Common Stock at an exercise price of $1.97 per
share (the "IBC Options"). In connection with the issuance of these options, the
Company recorded $300,000 of deferred compensation expense, which is being
amortized over the five-year option vesting period. The IBC Options terminate
after 10 years and two days. At January 31, 1998, 11,439 of these options were
exercisable.
F-12
<PAGE> 50
GARDEN BOTANIKA, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
A summary of the transactions and balances relating to the Company's two
fixed stock option plans (the 1992 Plan and the 1996 Plan) during fiscal years
1997, 1996 and 1995 is presented below:
<TABLE>
<CAPTION>
1997 1996 1995
-------------------- ------------------- -------------------
EXERCISE EXERCISE EXERCISE
SHARES PRICE(1) SHARES PRICE(1) SHARES PRICE(1)
--------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year.... 273,333 $11.16 268,581 $11.52 131,950 $ 9.28
Previously granted options brought
under 1992 Plan by shareholder
approval........................ 447,735 $ 8.63
Granted........................... 283,223 $ 6.13 25,000 $ 7.88 145,210 $13.51
Exercised......................... (2,156) $11.45 (2,342) $ 8.43
Canceled.......................... (164,573) $ 8.61 (18,092) $11.84 (6,237) $11.73
--------- -------- --------
Outstanding, end of year.......... 839,718 $ 8.61 273,333 $11.16 268,581 $11.52
========= ======== ========
Exercisable, end of year.......... 225,503 104,105 55,386
Weighted average fair value of
options granted during year..... $ 5.03 $ 6.33 $ 11.06
</TABLE>
- ---------------
(1) Weighted average
The following table summarizes information regarding all fixed stock
options outstanding at January 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------------------- OPTIONS EXERCISABLE
RANGE OF REMAINING -------------------
EXERCISE CONTRACTUAL EXERCISE EXERCISE
PRICES NUMBER LIFE(1) PRICE(1) NUMBER PRICE(1)
-------- ------- ----------- -------- ------- --------
<S> <C> <C> <C> <C> <C>
$1.97 25,424 7.7 years $ 1.97 11,439 $ 1.97
$6.13 to $9.83 729,795 8.4 years $ 7.84 181,092 $ 8.78
$13.77 109,923 7.1 years $13.77 44,411 $13.77
------- -------
$1.97 to $13.77 865,142 8.2 years $ 8.42 236,942 $ 9.38
======= =======
</TABLE>
- ---------------
(1) Weighted average
Warrants
In connection with the issuance of certain shares of Convertible Preferred
Stock, the Company's investment advisor received warrants to purchase 23,724
shares of Common Stock at $9.83 per share. These warrants expire in 1998.
8. RELATED PARTY TRANSACTIONS
Approximately 12%, 11% and 12% of merchandise purchases during fiscal years
1997, 1996 and 1995, respectively, were from a supplier whose president is a
director of the Company. As of January 31, 1998 and February 1, 1997,
respectively, $656,000 and $698,000 payable to this supplier was included in
accounts payable on the balance sheet.
F-13
<PAGE> 51
GARDEN BOTANIKA, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
WEIGHTED BASIC
NET AVERAGE EARNINGS
NET GROSS INCOME COMMON (LOSS) PER
SALES(1) MARGIN(1) (LOSS)(1) SHARES(1) Share(2)
-------- --------- --------- --------- ----------
<S> <C> <C> <C> <C> <C>
FISCAL 1997
First quarter................. $23,918 $ 8,736 $(3,225) 7,069 $(0.46)
Second quarter................ $24,873 $ 8,075 $(4,162) 7,069 $(0.59)
Third quarter................. $21,284 $ 5,695 $(5,918) 7,069 $(0.84)
Fourth quarter................ $44,516 $18,239 $(2,275) 7,069 $(0.32)
FISCAL 1996
First quarter................. $16,647 $ 7,046 $(2,685) 3,963 $(0.68)
Second quarter................ $16,916 $ 6,793 $(1,987) 6,487 $(0.31)
Third quarter................. $17,681 $ 6,633 $(3,780) 7,067 $(0.53)
Fourth quarter................ $41,221 $19,442 $ 3,519 7,067 $ 0.50
FISCAL 1995
First quarter................. $ 9,532 $ 4,084 $ (827) 3,682 $(0.22)
Second quarter................ $10,138 $ 4,212 $ (836) 3,683 $(0.23)
Third quarter................. $10,671 $ 4,170 $(1,986) 3,683 $(0.54)
Fourth quarter................ $24,998 $11,425 $ 1,985 3,963 $ 0.50
</TABLE>
- ---------------
(1) In thousands.
(2) Interim per share amounts may not accumulate to annual amounts.
During the past three fiscal years, the Company has only been profitable in
two fiscal quarters. In the fourth quarter of fiscal 1996, diluted weighted
average common shares and earnings per weighted average common share were 7.14
million and $0.49, respectively. In the fourth quarter of fiscal 1995, the
comparable amounts were 4.05 million weighted average common shares and $0.49
per share, respectively.
F-14
<PAGE> 52
EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
3.3* Eighth Restated Articles of Incorporation.
3.4* Amended and Restated Bylaws.
4.1* Specimen Common Stock Certificate.
4.2 See Articles 4.2, 5 and 6 of Exhibit 3.1 and Articles 3 and
7 of Exhibit 3.4 which confirm certain rights of holders of
Common Stock.
10.1* Employment Agreement by and between Garden Botanika, Inc.
(formerly known as American Body Care, Inc.) and Michael
Luce, dated January 1, 1990.
10.2* Employment Agreement by and between Garden Botanika, Inc.
and Jeffrey Mason, dated November 18, 1994.
10.3* Hardware Purchase and Software License Agreement by and
between Garden Botanika, Inc. (formerly known as American
Body Care, Inc.) and STS Systems, Ltd., dated June 22, 1990.
10.3A* Addendum 65 to Hardware Purchase and Software License
Agreement by and between Garden Botanika, Inc. and STS
Systems, Ltd., dated June 22, 1990.
10.4* Equipment Maintenance Agreement by and between Garden
Botanika, Inc. (formerly known as American Body Care, Inc.)
and STS Systems, Ltd. dated June 22, 1990.
10.5* Software Maintenance Agreement by and between Garden
Botanika, Inc. (formerly known as American Body Care, Inc.)
and STS Systems, Ltd., dated June 22, 1990.
10.6* Credit Agreement by and among U.S. Bank of Washington,
National Association and Garden Botanika, Inc. and Garden
Botanika Direct, Inc., dated November 30, 1995.
10.7* Revolving Note in the amount of $5,000,000 dated November
30, 1995 in favor of U.S. Bank of Washington, National
Association.
10.8* Bridge Note in the amount of $4,000,000 dated November 30,
1995 in favor of U.S. Bank of Washington, National
Association.
10.9* Security Agreement dated November 30, 1995 by and between
Garden Botanika, Inc. and U.S. Bank of Washington, National
Association.
10.10* Distribution Agreement by and between Garden Botanika, Inc.
and Essential Amenities, Inc., dated November 2, 1995.
10.11* Corporate Headquarters lease agreement by and between
Westpark "P" Limited Partnership and Garden Botanika, Inc.,
dated October 8, 1992, as amended.
10.12* Corporate Headquarters expansion lease agreement by and
between Teachers Insurance & Annuity Association and Garden
Botanika, Inc., dated September 27, 1995.
10.13* Ontario Distribution Facility lease agreement by and between
Grumet-Goodrich Corporation and Garden Botanika, Inc., dated
December 16, 1992.
10.14* Fontana Distribution Facility lease agreement by and between
the Tuffli Company and Garden Botanika, Inc., dated June 29,
1995.
10.15* Garden Botanika, Inc. 1992 Combined Incentive and
Nonqualified Stock Option Plan (as amended through October
30, 1995).
10.16* 1996 Directors' Nonqualified Stock Option Plan.
10.17* Stock Option Agreement and Payment Obligation by and between
Garden Botanika, Inc. and Jeffrey Mason, dated January 4,
1995.
10.18* Option and Severance Agreement by and between Garden
Botanika, Inc. and John Garruto, dated October 30, 1995.
</TABLE>
<PAGE> 53
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
10.19* Warrant to Purchase 1,740 Shares of Common Stock, dated
September 20, 1993, held by DLJ First ESC L.L.C.
10.20* Warrant to Purchase 166 Shares of Common Stock, dated
September 20, 1993, held by DLJ Capital Corporation.
10.21* Warrant to Purchase 21,817 Shares of Common Stock, dated
September 20, 1993, held by DLJ Capital Corporation.
10.22* Asset Purchase and Sale Agreement by and among Garden
Botanika, Inc., Innovative Biosciences Corporation and its
Shareholders, dated September 19, 1995, as amended by
Amendment Number 1 to Asset Purchase and Sale Agreement
dated October 30, 1995.
10.23* Amended and Restated Investors Rights Agreement, by and
among certain Investors and Garden Botanika, Inc., dated
November 1, 1995, as amended.
10.24* Standard Industrial Lease, between William D. Vogel and
Garden Botanika, Inc., dated February 21, 1996.
10.24A** Form of Standard Industrial Lease, between William D. Vogel
and Garden Botanika, Inc., dated April 14, 1997.
10.25* Corporate Headquarters Expansion Lease Agreement by and
between Persis Corporation and Garden Botanika, Inc., dated
March 29, 1996.
10.26* U.S. Bank waiver letter, dated March 27, 1996.
10.27* U.S. Bank borrowing base amendment letter, dated April 11,
1996.
10.28* Letter of Understanding to Purchase by Garden Botanika from
Momentis of System Development and Maintenance Services
dated March 28, 1996.
10.29+ Distribution Agreement with Hunter Packaging Ltd. dated
October 20, 1997
10.30+ License and Distribution Agreement with Hunter Packaging
Ltd. dated March 19, 1998
10.31+ Commitment Letter with Foothill Capital Corporation dated
April 2, 1998, as amended
10.32 Loan and Security Agreement with Foothill Capital
Corporation dated as of April 29, 1998
11+ Calculation of Earnings Per Common and Common Equivalent
Share
23.1 Consent of Independent Auditor.
27.1+ Financial Data Schedule
99.1* Donaldson, Lufkin & Jenrette Securities Corporation question
and answer materials and related documents.
</TABLE>
- ---------------
* Incorporated by reference to exhibits filed with Registrant's Registration
Statement on Form S-1 (Reg. No. 333-1744) as declared effective May 22, 1996.
** Incorporated by reference to exhibits filed with Registrant's Report on Form
10-K for fiscal 1996, as filed April 18, 1997.
+ Previously filed with Registrant's Report on Form 10-K for fiscal 1997, as
filed May 1, 1998.
<PAGE> 1
================================================================================
LOAN AND SECURITY AGREEMENT
by and between
GARDEN BOTANIKA, INC.
and
FOOTHILL CAPITAL CORPORATION
Dated as of April 29, 1998
================================================================================
<PAGE> 2
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
Page(s)
-------
<S> <C>
1. DEFINITIONS AND CONSTRUCTION................................................... 1
1.1 Definitions............................................................. 1
1.2 Accounting Terms........................................................ 16
1.3 Code.................................................................... 16
1.4 Construction............................................................ 16
1.5 Schedules and Exhibits.................................................. 17
2. LOAN AND TERMS OF PAYMENT...................................................... 17
2.1 Revolving Advances...................................................... 17
2.2 [Intentionally omitted]................................................. 18
2.3 [Intentionally omitted]................................................. 18
2.4 [Intentionally omitted]................................................. 18
2.5 Overadvances............................................................ 18
2.6 Interest: Rates, Payments, and Calculations............................ 18
2.7 Collection of Accounts.................................................. 20
2.8 Crediting Payments; Application of Collections.......................... 20
2.9 Designated Account...................................................... 21
2.10 Maintenance of Loan Account; Statements of Obligations.................. 21
2.11 Fees.................................................................... 21
2.12 Eurodollar Rate Loans................................................... 22
2.13 Illegality.............................................................. 24
2.14 Requirements of Law..................................................... 25
2.15 Taxes................................................................... 26
2.16 Indemnity............................................................... 29
3. CONDITIONS; TERM OF AGREEMENT.................................................. 29
3.1 Conditions Precedent to Effectiveness of the Agreement.................. 29
3.2 Conditions Precedent to Initial Advances................................ 31
3.3 Condition Subsequent.................................................... 31
3.4 Conditions Precedent to All Advances.................................... 32
3.5 Term; Automatic Renewal................................................. 32
3.6 Effect of Termination................................................... 32
3.7 Early Termination by Borrower........................................... 33
3.8 Termination Upon Event of Default....................................... 33
4. CREATION OF SECURITY INTEREST.................................................. 33
4.1 Grant of Security Interest.............................................. 33
4.2 Negotiable Collateral................................................... 33
4.3 Collection of Accounts, General Intangibles, and Negotiable
Collateral.............................................................. 33
</TABLE>
i
<PAGE> 3
<TABLE>
<S> <C>
4.4 Delivery of Additional Documentation Required........................... 34
4.5 Power of Attorney....................................................... 34
4.6 Right to Inspect........................................................ 35
4.7 Control Agreements...................................................... 35
5. REPRESENTATIONS AND WARRANTIES................................................. 35
5.1 No Encumbrances......................................................... 35
5.2 [Intentionally Omitted]................................................. 35
5.3 Eligible Inventory...................................................... 35
5.4 Equipment............................................................... 35
5.5 Location of Inventory and Equipment..................................... 36
5.6 Inventory Records....................................................... 36
5.7 Location of Chief Executive Office; FEIN................................ 36
5.8 Due Organization and Qualification; Subsidiaries........................ 36
5.9 Due Authorization; No Conflict.......................................... 36
5.10 Litigation.............................................................. 37
5.11 No Material Adverse Change. ............................................ 37
5.12 Solvency................................................................ 38
5.13 Employee Benefits....................................................... 38
5.14 Environmental Condition................................................. 38
5.15 Brokerage Fees.......................................................... 38
5.16 Year 2000 Compliance.................................................... 39
6. AFFIRMATIVE COVENANTS.......................................................... 39
6.1 Accounting System....................................................... 39
6.2 Collateral Reporting.................................................... 39
6.3 Financial Statements, Reports, Certificates............................. 40
6.4 Tax Returns............................................................. 41
6.5 [Intentionally Omitted]................................................. 41
6.6 Returns................................................................. 41
6.7 Title to Equipment...................................................... 41
6.8 Maintenance of Equipment................................................ 42
6.9 Taxes................................................................... 42
6.10 Insurance............................................................... 42
6.11 No Setoffs or Counterclaims............................................. 43
6.12 Location of Inventory and Equipment..................................... 44
6.13 Compliance with Laws.................................................... 44
6.14 Employee Benefits....................................................... 44
6.15 Leases.................................................................. 45
6.16 Brokerage Commissions. ................................................. 45
6.17 Store Closings and Store Openings. ..................................... 45
7. NEGATIVE COVENANTS............................................................. 45
7.1 Indebtedness............................................................ 45
</TABLE>
ii
<PAGE> 4
<TABLE>
<S> <C>
7.2 Liens................................................................... 46
7.3 Restrictions on Fundamental Changes..................................... 46
7.4 Disposal of Assets...................................................... 46
7.5 Change Name............................................................. 46
7.6 Guarantee............................................................... 46
7.7 Nature of Business...................................................... 46
7.8 Prepayments and Amendments.............................................. 47
7.9 Change of Control....................................................... 47
7.10 Consignments............................................................ 47
7.11 Distributions........................................................... 47
7.12 Accounting Methods...................................................... 47
7.13 Investments............................................................. 47
7.14 Transactions with Affiliates............................................ 48
7.15 Suspension.............................................................. 48
7.16 [Intentionally Omitted]................................................. 48
7.17 Use of Proceeds......................................................... 48
7.18 Change in Location of Chief Executive Office; Inventory and
Equipment with Bailees.................................................. 48
7.19 No Prohibited Transactions Under ERISA.................................. 48
7.20 Financial Covenants..................................................... 49
7.21 Capital Expenditures.................................................... 50
7.22 Securities Accounts..................................................... 50
7.23 Store Openings. ........................................................ 50
8. EVENTS OF DEFAULT.............................................................. 50
9. FOOTHILL'S RIGHTS AND REMEDIES................................................. 52
9.1 Rights and Remedies..................................................... 52
9.2 Remedies Cumulative..................................................... 54
10. TAXES AND EXPENSES............................................................. 54
11. WAIVERS; INDEMNIFICATION....................................................... 55
11.1 Demand; Protest; etc.................................................... 55
11.2 Foothill's Liability for Collateral..................................... 55
11.3 Indemnification......................................................... 55
12. NOTICES........................................................................ 56
13. CHOICE OF LAW AND VENUE; JURY TRIAL WAIVER..................................... 57
14. DESTRUCTION OF BORROWER'S DOCUMENTS............................................ 58
15. GENERAL PROVISIONS............................................................. 58
15.1 Effectiveness........................................................... 58
15.2 Successors and Assigns.................................................. 58
</TABLE>
iii
<PAGE> 5
<TABLE>
<S> <C>
15.3 Section Headings........................................................ 58
15.4 Interpretation.......................................................... 58
15.5 Severability of Provisions.............................................. 58
15.6 Amendments in Writing................................................... 59
15.7 Counterparts; Telefacsimile Execution................................... 59
15.8 Revival and Reinstatement of Obligations................................ 59
15.9 Integration............................................................. 59
</TABLE>
SCHEDULES AND EXHIBITS
----------------------
Schedule E-1 Eligible Inventory Locations
Schedule P-1 Permitted Liens
Schedule 5.8 Subsidiaries, Capitalization
Schedule 5.10 Litigation
Schedule 5.13 ERISA Benefit Plans
Schedule 6.12 Location of Inventory and Equipment
Schedule 7.1 Permitted Indebtedness
Schedule 7.14 Transactions with Affiliates
Exhibit C-1 Form of Compliance Certificate
iv
<PAGE> 6
LOAN AND SECURITY AGREEMENT
THIS LOAN AND SECURITY AGREEMENT (THIS "AGREEMENT"), is entered into as
of April 29, 1998, between FOOTHILL CAPITAL CORPORATION, a California
corporation ("Foothill"), with a place of business located at 11111 Santa Monica
Boulevard, Suite 1500, Los Angeles, California 90025-3333 and GARDEN BOTANIKA,
INC., a Washington corporation ("Borrower"), with its chief executive office
located at 8624 154th Avenue NE, Redmond, Washington 98052.
The parties agree as follows:
1. DEFINITIONS AND CONSTRUCTION.
1.1 DEFINITIONS. As used in this Agreement, the following terms
shall have the following definitions:
"Account Debtor" means any Person who is or who may become
obligated under, with respect to, or on account of, an Account.
"Accounts" means all currently existing and hereafter
arising accounts, contract rights, and all other forms of obligations owing to
Borrower arising out of the sale or lease of goods or the rendition of services
by Borrower, irrespective of whether earned by performance, and any and all
credit insurance, guaranties, or security therefor.
"Adjusted Eurodollar Rate" means, with respect to each
Interest Period for any Eurodollar Rate Loan, the rate per annum (rounded
upwards, if necessary, to the next 1/16%) determined by dividing (a) the
Eurodollar Rate for such Interest Period by (b) a percentage equal to (i) 100%
minus (ii) the Reserve Percentage. The Adjusted Eurodollar Rate shall be
adjusted on and as of the effective day of any change in the Reserve Percentage.
"Advances" has the meaning set forth in Section 2.1(a).
"Affiliate" means, as applied to any Person, any other
Person who, directly or indirectly, controls, is controlled by, is under common
control with, or is a director or officer of such Person. For purposes of this
definition, "control" means the possession, directly or indirectly, of the power
to vote 10% or more of the Stock having ordinary voting power for the election
of directors (or comparable managers) or the direct or indirect power to direct
the management and policies of a Person.
"Agreement" has the meaning set forth in the preamble
hereto.
1
<PAGE> 7
"Applicable Advance Rate" means (a) 55% for any date of
determination from and after January 1 of any year through September 30 of such
year, (b) 65% for any date of determination from and after October 1 of any year
through the Sunday immediately preceding the first Monday in December of such
year; (c) 62.5% for any date of determination from and after the first Monday in
December of any year through the immediately following Sunday; (d) 60% for any
date of determination from and after the second Monday in December of any year
through the immediately following Sunday; (e) 57.5% for any date of
determination from and after the third Monday in December of any year through
the immediately following Sunday; (f) 55% for any date of determination from and
after the fourth Monday in December of any year through December 31.
"Applicable Termination Rate" means (a) 3.0% from and
after the Effective Date through May 6, 1999, (b) 2.0% from and after May 6,
1999 through May 6, 2000, and (c) 1.0% thereafter; provided, however, that if
this Agreement is terminated in conjunction with the consummation of (i) a sale
of all or substantially all of the assets of Borrower, or (ii) a sale of all of
the equity interests in Borrower, the foregoing percentage amounts shall be (1)
1.5% from and after the Effective Date through May 6, 1999, (2) 1.0% from and
after May 6, 1999 through May 6, 2000, and (3) 0.5% thereafter.
"Authorized Person" means any officer or other employee of
Borrower.
"Bankruptcy Code" means the United States Bankruptcy Code
(11 U.S.C. Section 101 et seq.), as amended, and any successor statute.
"Benefit Plan" means a "defined benefit plan" (as defined
in Section 3(35) of ERISA) for which Borrower, any Subsidiary of Borrower, or
any ERISA Affiliate has been an "employer" (as defined in Section 3(5) of ERISA)
within the past six years.
"Borrower" has the meaning set forth in the preamble to
this Agreement.
"Borrower's Books" means all of Borrower's books and
records including: ledgers; records indicating, summarizing, or evidencing
Borrower's properties or assets (including the Collateral) or liabilities; all
information relating to Borrower's business operations or financial condition;
and all computer programs, disk or tape files, printouts, runs, or other
computer prepared information.
"Borrower's Intellectual Property" means the General
Intangibles of Borrower consisting of: (a) all trademarks, service marks, trade
names, trade styles, trade
2
<PAGE> 8
dress, logos, other source or business identifiers, designs and general
intangibles of like nature; and (b) all the goodwill of Borrower's business
symbolized by the foregoing or associated therewith.
"Borrowing Base" has the meaning set forth in Section
2.1(a).
"Business Day" means any day that is not a Saturday,
Sunday, or other day on which national banks are authorized or required to
close.
"Change of Control" shall be deemed to have occurred at
such time as a "person" or "group" (within the meaning of Sections 13(d) and
14(d)(2) of the Securities Exchange Act of 1934) becomes the "beneficial owner"
(as defined in Rule 13d-3 under the Securities Exchange Act of 1934), directly
or indirectly, of more than 25% of the total voting power of all classes of
Stock then outstanding of Borrower entitled to vote in the election of
directors.
"Closing Date" means the earlier to occur of (a) the date
of the making of the initial Advance, or (b) the date on which each of the
conditions set forth in Section 3.2 shall have been fulfilled (or else shall
have been waived in writing by Foothill).
"Code" means the California Uniform Commercial Code.
"Collateral" means each of the following:
(a) the Accounts,
(b) Borrower's Books,
(c) the Equipment,
(d) the General Intangibles,
(e) the Inventory,
(f) the Negotiable Collateral,
(g) any money, or other assets of Borrower that now or
hereafter come into the possession, custody, or control of Foothill, and
(h) the proceeds and products, whether tangible or
intangible, of any of the foregoing, including proceeds of insurance covering
any or all of the Collateral, and any and all Accounts, Borrower's Books,
Equipment, General Intangibles,
3
<PAGE> 9
Inventory, Negotiable Collateral, Real Property, money, deposit accounts, or
other tangible or intangible property resulting from the sale, exchange,
collection, or other disposition of any of the foregoing, or any portion thereof
or interest therein, and the proceeds thereof.
"Collateral Access Agreement" means a landlord waiver,
mortgagee waiver, bailee letter, or acknowledgement agreement of any
warehouseman, processor, lessor, consignee, or other Person in possession of,
having a Lien upon, or having rights or interests in the Equipment or Inventory,
in each case, in form and substance satisfactory to Foothill.
"Collections" means all cash, checks, notes, instruments,
and other items of payment (including, insurance proceeds, proceeds of cash
sales, rental proceeds, and tax refunds).
"Compliance Certificate" means a certificate substantially
in the form of Exhibit C-1 and delivered by the chief accounting officer of
Borrower to Foothill.
"Concentration Account" shall mean a depositary account
established pursuant to one of the Concentration Account Agreements.
"Concentration Account Agreements" means those certain
Concentration Account Operating Procedural Agreements and those certain
Depository Account Agreements, in form and substance satisfactory to Foothill,
each of which is among Borrower, Foothill, and one of the Concentration Account
Banks.
"Concentration Account Banks" means U.S. Bank of
Washington, N.A.
"Concentration Accounts" has the meaning set forth in
Section 2.7.
"Consolidated EBITDA" means, for any applicable period,
the aggregate amount of net income (or net loss) of Borrower and its
Subsidiaries, minus the amount of any extraordinary gains for such period, plus
the amount of any non-cash expenses associated with the write-down or write-off
of any assets of Borrower during such period, plus the sum of (a) interest
expense, (b) income tax expense (or credit), (c) depreciation expense, and (e)
amortization expense, in each case as determined in accordance with GAAP for
such period.
"Control Agreement" means a control agreement, in form and
substance satisfactory to Foothill, between Borrower, Foothill, and the
applicable securities intermediary, that provides (among other things) that,
from and after the giving of notice by Foothill to such securities intermediary
(a "Notice of Exclusive Control"),
4
<PAGE> 10
such securities intermediary shall take instructions solely from Foothill with
respect to the applicable Securities Account and related Investment Property.
"Daily Balance" means the amount of an Obligation owed at
the end of a given day.
"deems itself insecure" means that the Person deems itself
insecure in accordance with the provisions of Section 1208 of the Code.
"Default" means an event, condition, or default that, with
the giving of notice, the passage of time, or both, would be an Event of
Default.
"Designated Account" means account number ________________
of Borrower maintained with Borrower's Designated Account Bank, or such other
deposit account of Borrower (located within the United States) that has been
designated, in writing and from time to time, by Borrower to Foothill.
"Designated Account Bank" means U.S. Bank of Washington,
N.A., whose office is located at 1420 Fifth Avenue, Seattle, Washington 98101,
and whose ABA number is 125-000-105.
"Dollars or $" means United States dollars.
"Early Termination Premium" has the meaning set forth in
Section 3.7.
"Effective Date" means the first date on which each of the
conditions set forth in Section 3.1 shall have been fulfilled or waived in
writing by Foothill.
"Eligible Consignee" shall mean The Home Shopping Network
and its affiliates, and such other Persons as are consented to by Foothill in
writing from time to time after the Effective Date.
"Eligible Inventory" means Inventory consisting of first
quality finished goods held for sale in the ordinary course of Borrower's
business, that are located at or in-transit between Borrower's premises
identified on Schedule E-1, that strictly comply with each and all of the
representations and warranties respecting Inventory made by Borrower to Foothill
in the Loan Documents, and that are and at all times continue to be acceptable
to Foothill in all respects; provided, however, that standards of eligibility
may be fixed and revised from time to time by Foothill in Foothill's reasonable
credit judgment. In determining the amount to be so included, Inventory shall be
valued at the lower of cost or market on a basis consistent with Borrower's
current and historical accounting practices. An item of Inventory shall not be
included in Eligible Inventory if:
5
<PAGE> 11
(a) it is not owned solely by Borrower or Borrower does
not have good, valid, and marketable title thereto;
(b) it is not located at one of the locations set forth on
Schedule E-1;
(c) it is not located on property owned or leased by
Borrower or in a contract warehouse, in each case, subject to a Collateral
Access Agreement executed by the mortgagee, lessor, the warehouseman, or other
third party, as the case may be, and segregated or otherwise separately
identifiable from goods of others, if any, stored on the premises;
(d) it is not subject to a valid and perfected first
priority security interest in favor of Foothill;
(e) it consists of goods returned or rejected by
Borrower's customers or goods in transit; and
(f) it is discontinued, including Inventory located at any
clearance store, obsolete or slow moving, a restrictive or custom item,
work-in-process, a component that is not part of finished goods, or constitutes
spare parts, packaging and shipping materials, supplies used or consumed in
Borrower's business, Inventory subject to a Lien in favor of any third Person,
bill and hold goods, defective goods, "seconds," Inventory acquired on
consignment, a training kit, a sample, or a display item.
"Equipment" means all of Borrower's present and hereafter
acquired machinery, machine tools, motors, equipment, furniture, furnishings,
fixtures, vehicles (including motor vehicles and trailers), tools, parts, goods
(other than consumer goods, farm products, or Inventory), wherever located,
including, (a) any interest of Borrower in any of the foregoing, and (b) all
attachments, accessories, accessions, replacements, substitutions, additions,
and improvements to any of the foregoing.
"ERISA" means the Employee Retirement Income Security Act
of 1974, 29 U.S.C. Sections 1000 et seq., amendments thereto, successor
statutes, and regulations or guidance promulgated thereunder.
"ERISA Affiliate" means (a) any corporation subject to
ERISA whose employees are treated as employed by the same employer as the
employees of Borrower under IRC Section 414(b), (b) any trade or business
subject to ERISA whose employees are treated as employed by the same employer as
the employees of Borrower under IRC Section 414(c), (c) solely for purposes of
Section 302 of ERISA and Section 412 of the IRC, any organization subject to
ERISA that is a member of an affiliated service group of which Borrower is a
member under IRC Section 414(m), or (d) solely
6
<PAGE> 12
for purposes of Section 302 of ERISA and Section 412 of the IRC, any party
subject to ERISA that is a party to an arrangement with Borrower and whose
employees are aggregated with the employees of Borrower under IRC Section
414(o).
"ERISA Event" means (a) a Reportable Event with respect to
any Benefit Plan or Multiemployer Plan, (b) the withdrawal of Borrower, any of
its Subsidiaries or ERISA Affiliates from a Benefit Plan during a plan year in
which it was a "substantial employer" (as defined in Section 4001(a)(2) of
ERISA), (c) the providing of notice of intent to terminate a Benefit Plan in a
distress termination (as described in Section 4041(c) of ERISA), (d) the
institution by the PBGC of proceedings to terminate a Benefit Plan or
Multiemployer Plan, (e) any event or condition (i) that provides a basis under
Section 4042(a)(1), (2), or (3) of ERISA for the termination of, or the
appointment of a trustee to administer, any Benefit Plan or Multiemployer Plan,
or (ii) that may result in termination of a Multiemployer Plan pursuant to
Section 4041A of ERISA, (f) the partial or complete withdrawal within the
meaning of Sections 4203 and 4205 of ERISA, of Borrower, any of its Subsidiaries
or ERISA Affiliates from a Multiemployer Plan, or (g) providing any security to
any Plan under Section 401(a)(29) of the IRC by Borrower or its Subsidiaries or
any of their ERISA Affiliates.
"Eurodollar Rate" means, with respect to the Interest
Period for a Eurodollar Rate Loan, the interest rate per annum (rounded upwards,
if necessary, to the next 1/16%) at which United States dollar deposits are
offered to Foothill (or its Affiliates) by major banks in the London interbank
market (or other Eurodollar Rate market selected by Foothill) on or about 11:00
a.m. (California time) 2 Business Days prior to the commencement of such
Interest Period in amounts comparable to the amount of the Eurodollar Rate Loans
requested by and available to Borrower in accordance with this Agreement and for
a period of 3 months from the date of such offer.
"Eurodollar Rate Loans" means any Advance (or any portion
thereof) made or outstanding hereunder during any period when interest on such
Advance (or portion thereof) is payable based on the Adjusted Eurodollar Rate.
"Event of Default" has the meaning set forth in Section 8.
"Excess Availability" means the Dollar amount of (a) the
Borrowing Base, as of any date of determination, minus (b) the aggregate
principal amount of Obligations outstanding in respect of Advances.
"Existing Lender" means U.S. Bank of Washington, N.A.
"FEIN" means Federal Employer Identification Number.
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<PAGE> 13
"Foothill" has the meaning set forth in the preamble to
this Agreement.
"Foothill Account" has the meaning set forth in Section
2.7.
"Foothill Expenses" means all: costs or expenses
(including taxes, and insurance premiums) required to be paid by Borrower under
any of the Loan Documents that are paid or incurred by Foothill; fees or charges
paid or incurred by Foothill in connection with Foothill's transactions with
Borrower, including, fees or charges for photocopying, notarization, couriers
and messengers, telecommunication, public record searches (including tax lien,
litigation, and UCC searches and including searches with the patent and
trademark office, the copyright office, or the department of motor vehicles),
filing, recording, publication, appraisal (including periodic Collateral
appraisals), real estate surveys, real estate title policies and endorsements,
and environmental audits; costs and expenses incurred by Foothill in the
disbursement of funds to Borrower (by wire transfer or otherwise); charges paid
or incurred by Foothill resulting from the dishonor of checks; costs and
expenses paid or incurred by Foothill to correct any default or enforce any
provision of the Loan Documents, or in gaining possession of, maintaining,
handling, preserving, storing, shipping, selling, preparing for sale, or
advertising to sell the Collateral, or any portion thereof, irrespective of
whether a sale is consummated; costs and expenses paid or incurred by Foothill
in examining Borrower's Books; costs and expenses of third party claims or any
other suit paid or incurred by Foothill in enforcing or defending the Loan
Documents or in connection with the transactions contemplated by the Loan
Documents or Foothill's relationship with Borrower or any guarantor; and
Foothill's reasonable attorneys fees and expenses incurred in advising,
structuring, drafting, reviewing, administering, amending, terminating,
enforcing (including attorneys fees and expenses incurred in connection with a
"workout," a "restructuring," or an Insolvency Proceeding concerning Borrower or
any guarantor of the Obligations), defending, or concerning the Loan Documents,
irrespective of whether suit is brought.
"GAAP" means generally accepted accounting principles as
in effect from time to time in the United States, consistently applied.
"General Intangibles" means all of Borrower's present and
future general intangibles and other personal property (including contract
rights, rights arising under common law, statutes, or regulations, choses or
things in action, goodwill, patents, trade names, trademarks, servicemarks,
copyrights, blueprints, drawings, purchase orders, customer lists, monies due or
recoverable from pension funds, route lists, rights to payment and other rights
under any royalty or licensing agreements, infringement claims, computer
programs, information contained on computer disks or tapes, literature, reports,
catalogs, deposit accounts, insurance premium rebates, tax refunds, and tax
refund claims), other than goods, Accounts, and Negotiable Collateral.
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<PAGE> 14
"Governing Documents" means the certificate or articles of
incorporation, by-laws, or other organizational or governing documents of any
Person.
"Governmental Authority" shall mean any federal, state,
local, or other governmental or administrative body, instrumentality,
department, or agency or any court, tribunal, administrative hearing body,
arbitration panel, commission, or other similar dispute-resolving panel or body.
"Hazardous Materials" means (a) substances that are
defined or listed in, or otherwise classified pursuant to, any applicable laws
or regulations as "hazardous substances," "hazardous materials," "hazardous
wastes," "toxic substances," or any other formulation intended to define, list,
or classify substances by reason of deleterious properties such as ignitability,
corrosivity, reactivity, carcinogenicity, reproductive toxicity, or "EP
toxicity", (b) oil, petroleum, or petroleum derived substances, natural gas,
natural gas liquids, synthetic gas, drilling fluids, produced waters, and other
wastes associated with the exploration, development, or production of crude oil,
natural gas, or geothermal resources, (c) any flammable substances or explosives
or any radioactive materials, and (d) asbestos in any form or electrical
equipment that contains any oil or dielectric fluid containing levels of
polychlorinated biphenyls in excess of 50 parts per million; provided, however,
that anything contained in the foregoing to the contrary notwithstanding, the
foregoing shall not include any substances incorporated into the customary
formulations of Borrower's personal care products Inventory.
"Indebtedness" means: (a) all obligations of Borrower for
borrowed money, (b) all obligations of Borrower evidenced by bonds, debentures,
notes, or other similar instruments and all reimbursement or other obligations
of Borrower in respect of letters of credit, bankers acceptances, interest rate
swaps, or other financial products, (c) all obligations of Borrower under
capital leases, (d) all obligations or liabilities of others secured by a Lien
on any property or asset of Borrower, irrespective of whether such obligation or
liability is assumed, and (e) any obligation of Borrower guaranteeing or
intended to guarantee (whether guaranteed, endorsed, co-made, discounted, or
sold with recourse to Borrower) any indebtedness, lease, dividend, letter of
credit, or other obligation of any other Person.
"Insolvency Proceeding" means any proceeding commenced by
or against any Person under any provision of the Bankruptcy Code or under any
other bankruptcy or insolvency law, assignments for the benefit of creditors,
formal or informal moratoria, compositions, extensions generally with creditors,
or proceedings seeking reorganization, arrangement, or other similar relief.
"Intangible Assets" means, with respect to any Person,
that portion of the book value of all of such Person's assets that would be
treated as intangibles under GAAP.
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<PAGE> 15
"Interest Period" means, for any Eurodollar Rate Loan, the
period commencing on the Business Day such Eurodollar Rate Loan is disbursed or
continued, or on the Business Day on which a Reference Rate Loan is converted to
such Eurodollar Rate Loan, and ending on the date that is 30, 60, or 90 days
thereafter, as selected by Borrower and notified to Foothill pursuant to Section
2.1(c), and as further provided in Section 2.12(a) and (b).
"Inventory" means all present and future inventory in
which Borrower has any interest, including goods held for sale or lease or to be
furnished under a contract of service and all of Borrower's present and future
raw materials, work in process, finished goods, and packing and shipping
materials, wherever located.
"Inventory Liquidation Value" means the liquidation value
of Borrower's Inventory, net of estimated liquidation expenses, as determined by
Great American/Hilco Appraisal & Valuation Services, or such other independent
appraisal firm as shall be selected by Foothill from time to time in its sole
discretion.
"Investment Property" means "investment property" as that
term is defined in Section 9115 of the Code.
"Inventory Security Agreement" means an Inventory Security
Agreement between Borrower and Foothill, in form and substance satisfactory to
Foothill.
"IRC" means the Internal Revenue Code of 1986, as amended,
and the regulations thereunder.
"License Agreement" means a license agreement between
Borrower and Foothill, in form and substance satisfactory to Foothill.
"Lien" means any interest in property securing an
obligation owed to, or a claim by, any Person other than the owner of the
property, whether such interest shall be based on the common law, statute, or
contract, whether such interest shall be recorded or perfected, and whether such
interest shall be contingent upon the occurrence of some future event or events
or the existence of some future circumstance or circumstances, including the
lien or security interest arising from a mortgage, deed of trust, encumbrance,
pledge, hypothecation, assignment, deposit arrangement, security agreement,
adverse claim or charge, conditional sale or trust receipt, or from a lease,
consignment, or bailment for security purposes and also including reservations,
exceptions, encroachments, easements, rights-of-way, covenants, conditions,
restrictions, leases, and other title exceptions and encumbrances affecting Real
Property.
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<PAGE> 16
"Loan Account" has the meaning set forth in Section 2.10.
"Loan Documents" means this Agreement, the Concentration
Account Agreements, the Trademark Security Agreement, the Inventory Security
Agreement, the License Agreement, any Control Agreement (from and after the date
such document is executed and delivered), any note or notes executed by Borrower
and payable to Foothill, and any other agreement entered into, now or in the
future, in connection with this Agreement.
"Material Adverse Change" means, from and after the
Effective Date, as measured against Borrower's unaudited, company prepared
financial statements for Borrower's fiscal year ended January 31, 1998, and
against Borrower's projected monthly balance sheet, income statement, and
statement of cash flows for each month from February 28, 1998 through January
31, 1999, delivered to Foothill in connection with Foothill's conduct of its due
diligence in entering into this Agreement, (a) a material adverse change in the
business, prospects, operations, results of operations, assets, liabilities or
condition (financial or otherwise) of Borrower, (b) the material impairment of
Borrower's ability to perform its obligations under the Loan Documents to which
it is a party or of Foothill to enforce the Obligations or realize upon the
Collateral, (c) a material adverse effect on the value of the Collateral or the
amount that Foothill would be likely to receive (after giving consideration to
delays in payment and costs of enforcement) in the liquidation of such
Collateral, or (d) a material impairment of the priority of Foothill's Liens
with respect to the Collateral. In the foregoing respect, a material adverse
change means a change that is both material and adverse, as objectively (and not
subjectively) determined, and an objective determination is a determination that
would be made by an intelligent, reasonable, and neutral third party apprised of
all of the relevant facts and circumstances.
"Maximum Revolving Amount" means $10,000,000.
"Multiemployer Plan" means a "multiemployer plan" (as
defined in Section 4001(a)(3) of ERISA) to which Borrower, any of its
Subsidiaries, or any ERISA Affiliate has contributed, or was obligated to
contribute, within the past six years.
"Negotiable Collateral" means all of a Person's present
and future letters of credit, notes, drafts, instruments, Investment Property,
documents, personal property leases (wherein such Person is the lessor), chattel
paper, and Books relating to any of the foregoing.
"Notice of Exclusive Control" has the meaning set forth in
the definition of "Control Agreement."
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<PAGE> 17
"Obligations" means all loans, Advances, debts, principal,
interest (including any interest that, but for the provisions of the Bankruptcy
Code, would have accrued), premiums (including Early Termination Premiums),
liabilities (including all amounts charged to Borrower's Loan Account pursuant
hereto), obligations, fees, charges, costs, or Foothill Expenses (including any
fees or expenses that, but for the provisions of the Bankruptcy Code, would have
accrued), lease payments, guaranties, covenants, and duties owing by Borrower to
Foothill of any kind and description (whether pursuant to or evidenced by the
Loan Documents or pursuant to any other agreement between Foothill and Borrower,
and irrespective of whether for the payment of money), whether direct or
indirect, absolute or contingent, due or to become due, now existing or
hereafter arising, and including any debt, liability, or obligation owing from
Borrower to others that Foothill may have obtained by assignment or otherwise,
and further including all interest not paid when due and all Foothill Expenses
that Borrower is required to pay or reimburse by the Loan Documents, by law, or
otherwise.
"Ordinary Course Dispositions" means dispositions
consisting of (a) sales or other dispositions of Inventory in the ordinary
course of Borrower's business as currently conducted, (b) dispositions of cash
and cash equivalents consistent with the provisions hereof, and (c) granting of
license rights with respect to Borrower's Intellectual Property in connection
with licenses or franchises entered into by Borrower in the ordinary course of
business.
"Overadvance" has the meaning set forth in Section 2.5.
"Participant" means any Person to which Foothill has sold
a participation interest in its rights under the Loan Documents.
"Pay-Off Letter" means a letter, in form and substance
reasonably satisfactory to Foothill, from Existing Lender respecting the amount
necessary to repay in full all of the obligations of Borrower owing to Existing
Lender and obtain a termination or release of all of the Liens existing in favor
of Existing Lender in and to the properties or assets of Borrower.
"PBGC" means the Pension Benefit Guaranty Corporation as
defined in Title IV of ERISA, or any successor thereto.
"Permitted Disposition" means (a) Ordinary Course
Dispositions, (b) sales of Equipment conducted in connection with any Permitted
Store Closing, and (d) sales or transfers of any Real Property sold or
transferred in connection with any Permitted Store Closing.
"Permitted Liens" means (a) Liens held by Foothill, (b)
Liens for unpaid taxes that either (i) are not yet due and payable or (ii) are
the subject of Permitted
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<PAGE> 18
Protests, (c) Liens set forth on Schedule P-1, (d) (i) the interests of lessors
under operating leases, and (ii) purchase money Liens and the interests of
lessors under capital leases to the extent that the acquisition or lease of the
underlying asset is permitted under Section 7.21 and so long as the Lien only
attaches to the asset purchased or acquired and only secures the purchase price
of the asset, (e) Liens arising by operation of law in favor of warehousemen,
landlords, carriers, mechanics, materialmen, laborers, or suppliers, incurred in
the ordinary course of business of Borrower and not in connection with the
borrowing of money, and which Liens either (i) are for sums not yet due and
payable, or (ii) are the subject of Permitted Protests, (f) Liens arising from
deposits made in connection with obtaining worker's compensation or other
unemployment insurance, (g) Liens or deposits to secure performance of bids,
tenders, or leases (to the extent permitted under this Agreement), incurred in
the ordinary course of business of Borrower and not in connection with the
borrowing of money, (h) Liens arising by reason of security for surety or appeal
bonds in the ordinary course of business of Borrower, (i) Liens of or resulting
from any judgment or award that reasonably could not be expected to result in a
Material Adverse Change and as to which the time for the appeal or petition for
rehearing of which has not yet expired, or in respect of which Borrower is in
good faith prosecuting an appeal or proceeding for a review and in respect of
which a stay of execution pending such appeal or proceeding for review has been
secured, (j) with respect to any Real Property, easements, rights of way, zoning
and similar covenants and restrictions, and similar encumbrances that
customarily exist on properties of Persons engaged in similar activities and
similarly situated and that in any event do not materially interfere with or
impair the use or operation of the Collateral by Borrower or the value of
Foothill's Lien thereon or therein, or materially interfere with the ordinary
conduct of the business of Borrower.
"Permitted Protest" means the right of Borrower to protest
any Lien other than any such Lien that secures the Obligations, tax (other than
payroll taxes or taxes that are the subject of a United States federal tax
lien), or rental payment, provided that (a) a reserve with respect to such
obligation is established on the books of Borrower in an amount that is
reasonably satisfactory to Foothill, (b) any such protest is instituted and
diligently prosecuted by Borrower in good faith, and (c) Foothill is satisfied
that, while any such protest is pending, there will be no impairment of the
enforceability, validity, or priority of any of the Liens of Foothill in and to
the Collateral.
"Permitted Store Closing" means the closing of one or more
of the store locations of Borrower that are (a) undertaken in ordinary course of
Borrower's business as currently conducted, and (b) that have been duly approved
by Borrower's Board of Directors on the basis of its determination that each
such store closing is in the best interest of Borrower.
"Person" means and includes natural persons, corporations,
limited liability companies, limited partnerships, general partnerships, limited
liability
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partnerships, joint ventures, trusts, land trusts, business trusts, or other
organizations, irrespective of whether they are legal entities, and governments
and agencies and political subdivisions thereof.
"Plan" means any employee benefit plan, program, or
arrangement maintained or contributed to by Borrower or with respect to which it
may incur liability.
"Real Property" means any estates or interests in real
property now owned or hereafter acquired by Borrower.
"Reference Rate" means the variable rate of interest, per
annum, most recently announced by Norwest Bank Minnesota, National Association,
or any successor thereto, as its "base rate," irrespective of whether such
announced rate is the best rate available from such financial institution.
"Reference Rate Loan" means any Advance (or portion
thereof) made or outstanding hereunder during any period when interest on such
Advance (or portion thereof) is payable based on the Reference Rate.
"Renewal Date" has the meaning set forth in Section 3.5.
"Reportable Event" means any of the events described in
Section 4043(c) of ERISA or the regulations thereunder other than a Reportable
Event as to which the provision of 30 days notice to the PBGC is waived under
applicable regulations.
"Requirement of Law" means, as to any Person: all (a) (i)
statutes and regulations and (ii) court orders and injunctions, arbitrators'
decisions, and/or similar rulings, in each instance by any Governmental
Authority, or other body which has jurisdiction over such Person, or any
property of such Person, or of any other Person whose conduct such Person would
be responsible; and (b) that Person's organizational documents, by-laws and/or
other instruments which deal with corporate or similar governance, as
applicable.
"Reserve Percentage" means and refers to, as of the date
of determination thereof, the maximum percentage (rounded upward, if necessary
to the nearest 1/100th of 1%), as determined by Foothill (or its Affiliates) in
accordance with its (or their) usual procedures (which determination shall be
conclusive in the absence of manifest error), that is in effect on such date as
prescribed by the Federal Reserve Board for determining the reserve requirements
(including supplemental, marginal, and emergency reserve requirements) with
respect to eurocurrency funding (currently referred to as "eurocurrency
liabilities") by Foothill or its Affiliates.
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<PAGE> 20
"Retiree Health Plan" means an "employee welfare benefit
plan" within the meaning of Section 3(1) of ERISA that provides benefits to
individuals after termination of their employment, other than as required by
Section 601 of ERISA.
"SEC" means the Securities and Exchange Commission.
"Securities Account" means a "securities account" as that
term is defined in Section 8501 of the Code.
"Shrinkage Reserve" means an amount equal to the sum of
all reserves maintained on Borrower's Books in accordance with Borrower's
historical practices in connection with Borrower's recognition in its financial
statements of ongoing shrinkage in Borrower's Inventory.
"Solvent" means, with respect to any Person on a
particular date, that on such date (a) at fair valuations, all of the properties
and assets of such Person are greater than the sum of the debts, including
contingent liabilities, of such Person, (b) the present fair salable value of
the properties and assets of such Person is not less than the amount that will
be required to pay the probable liability of such Person on its debts as they
become absolute and matured, (c) such Person is able to realize upon its
properties and assets and pay its debts and other liabilities, contingent
obligations and other commitments as they mature in the normal course of
business, (d) such Person does not intend to, and does not believe that it will,
incur debts beyond such Person's ability to pay as such debts mature, and (e)
such Person is not engaged in business or a transaction, and is not about to
engage in business or a transaction, for which such Person's properties and
assets would constitute unreasonably small capital after giving due
consideration to the prevailing practices in the industry in which such Person
is engaged. In computing the amount of contingent liabilities at any time, it is
intended that such liabilities will be computed at the amount that, in light of
all the facts and circumstances existing at such time, represents the amount
that reasonably can be expected to become an actual or matured liability.
"Stock" means all shares, options, warrants, interests,
participations, or other equivalents (regardless of how designated) of or in a
corporation or equivalent entity, whether voting or nonvoting, including common
stock, preferred stock, or any other "equity security" (as such term is defined
in Rule 3a11-1 of the General Rules and Regulations promulgated by the SEC under
the Exchange Act).
"Subsidiary" of a Person means a corporation, partnership,
limited liability company, or other entity in which that Person directly or
indirectly owns or controls the shares of Stock having ordinary voting power to
elect a majority of the board of directors (or appoint other comparable
managers) of such corporation, partnership, limited liability company, or other
entity.
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<PAGE> 21
"Trademark Security Agreement" means a Trademark Security
Agreement between Borrower and Foothill, the form and substance of which is
reasonably satisfactory to Foothill.
"Triggering Event" means (a) the date on which an Event of
Default occurs, (b) the first date on which the aggregate principal amount of
Obligations outstanding in respect of Advances are equal to or greater than
$5,000,000, or (c) the first date on which Excess Availability is less than
$2,500,000.
"Voidable Transfer" has the meaning set forth in Section
15.8.
"Year 2000 Compliant" means, with regard to any Person,
that all software in goods produced or sold by, or utilized by and material to
the business operations or financial condition of, such entity are able to
interpret and manipulate data on and involving all calendar dates correctly and
without causing any abnormal ending scenario, including in relation to dates in
and after the Year 2000.
1.2 ACCOUNTING TERMS. All accounting terms not specifically
defined herein shall be construed in accordance with GAAP. When used herein, the
term "financial statements" shall include the notes and schedules thereto.
Whenever the term "Borrower" is used in respect of a financial covenant or a
related definition, it shall be understood to mean Borrower on a consolidated
basis unless the context clearly requires otherwise.
1.3 CODE. Any terms used in this Agreement that are defined in
the Code shall be construed and defined as set forth in the Code unless
otherwise defined herein.
1.4 CONSTRUCTION. Unless the context of this Agreement clearly
requires otherwise, references to the plural include the singular, references to
the singular include the plural, the term "including" is not limiting, and the
term "or" has, except where otherwise indicated, the inclusive meaning
represented by the phrase "and/or." The words "hereof," "herein," "hereby,"
"hereunder," and similar terms in this Agreement refer to this Agreement as a
whole and not to any particular provision of this Agreement. Section,
subsection, clause, schedule, and exhibit references are to this Agreement
unless otherwise specified. Any reference in this Agreement or in the Loan
Documents to this Agreement or any of the Loan Documents shall include all
alterations, amendments, changes, extensions, modifications, renewals,
replacements, substitutions, and supplements, thereto and thereof, as
applicable.
1.5 SCHEDULES AND EXHIBITS. All of the schedules and exhibits
attached to this Agreement shall be deemed incorporated herein by reference.
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2. LOAN AND TERMS OF PAYMENT.
2.1 REVOLVING ADVANCES.
(a) Subject to the terms and conditions of this Agreement,
Foothill agrees to make advances ("Advances") to Borrower in an amount
outstanding not to exceed at any one time the lesser of (i) the Maximum
Revolving Amount or (ii) the Borrowing Base. For purposes of this Agreement,
"Borrowing Base", as of any date of determination, shall mean the result of:
(x) the lesser of (i) the Applicable Advance rate
times the value of the Eligible Inventory, or (ii) 85% of the
Inventory Liquidation Value, minus
(y) the Shrinkage Reserve, minus
(z) the aggregate amount of reserves, if any,
established by Foothill under Section 2.1(b).
(b) Anything to the contrary in Section 2.1(a) above
notwithstanding:
(i) Foothill may create reserves against or reduce
its advance rates based upon Eligible Inventory if an Event of
Default has occurred;
(ii) if no Event of Default has occurred and is
continuing, but if Foothill has determined that Borrower is not
current in the payment of its obligations to one or more of its
real property lessors and if the claims of the affected real
property lessors would, as a function of applicable state law,
have a lien on the Inventory for unpaid rentals or other charges
that would be prior to Foothill's security interest in the
Inventory, then Foothill may create a reserve against the
Borrowing Base in an amount up to the maximum amount of the
claims of such lessors that would, as a function of applicable
state law, have priority over Foothill's security interest in the
affected Inventory;
(iii) if no Event of Default has occurred and is
continuing, but if Foothill has determined that Borrower is not
current in the payment of its obligations (including in respect
of ad valorem or sales taxes) to federal, state, or local taxing
authorities and if the claims of the affected taxing authorities
would, as a function of applicable federal or state law, have a
lien on the Inventory for unpaid taxes or other charges or
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<PAGE> 23
assessments that would be prior to Foothill's security interest
in the Inventory, then Foothill may create a reserve against the
Borrowing Base in an amount up to the maximum amount of the
claims of such taxing authorities that would, as a function of
applicable federal or state law, have priority over Foothill's
security interest in the affected Inventory; and
(iv) if no Event of Default has occurred and is
continuing, but if Borrower's Excess Availability is $3,000,000,
or less, then Foothill may create a reserve against the Borrowing
Base in an amount up to the maximum amount of $1,000,000.
(c) Foothill shall have no obligation to make Advances
hereunder to the extent they would cause the outstanding Obligations to exceed
the Maximum Revolving Amount.
(d) Amounts borrowed pursuant to this Section 2.1 may be
repaid and, subject to the terms and conditions of this Agreement, reborrowed at
any time during the term of this Agreement.
2.2 [INTENTIONALLY OMITTED].
2.3 [INTENTIONALLY OMITTED].
2.4 [INTENTIONALLY OMITTED].
2.5 OVERADVANCES. If, at any time or for any reason, the amount
of Obligations owed by Borrower to Foothill pursuant to Sections 2.1 is greater
than either the Dollar or percentage limitations set forth in Sections 2.1 (an
"Overadvance"), Borrower immediately shall pay to Foothill, in cash, the amount
of such excess to be used by Foothill to repay Advances outstanding under
Section 2.1.
2.6 INTEREST: RATES, PAYMENTS, AND CALCULATIONS.
(a) Interest Rate. Except as provided in clause (c) below,
all Obligations shall bear interest as follows:
(i) each Eurodollar Rate Loan shall bear interest at
a per annum rate of 3.00 percentage points above the Adjusted Eurodollar Rate;
and
(ii) all other Obligations shall bear interest at a
per annum rate of 0.50 percentage points above the Reference Rate.
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(b) [Intentionally Omitted].
(c) Default Rate. Upon the occurrence and during the
continuation of an Event of Default, all Obligations shall bear interest as
follows:
(i) subject to the optional conversion provisions of
Section 2.12(c), each Eurodollar Rate Loan shall bear interest at a per annum
rate of 7.00 percentage points above the Adjusted Eurodollar Rate; and
(ii) all other Obligations shall bear interest at a
per annum rate equal to 4.50 percentage points above the Reference Rate.
(d) Minimum Interest. In no event shall the rate of
interest chargeable hereunder for any day be less than 7.00% per annum. To the
extent that interest accrued hereunder at the rate set forth herein would be
less than the foregoing minimum daily rate, the interest rate chargeable
hereunder for such day automatically shall be deemed increased to the minimum
rate. To the extent that interest accrued hereunder at the rate set forth herein
(including the minimum interest rate) would yield less than the foregoing
minimum amount, the interest rate chargeable hereunder for the period in
question automatically shall be deemed increased to that rate that would result
in the minimum amount of interest being accrued and payable hereunder.
(e) Payments. Interest in respect of Reference Rate Loans
payable hereunder shall be due and payable, in arrears, on the first day of each
month during the term hereof. Interest in respect of each Eurodollar Rate Loan
shall be due and payable, in arrears, on the earlier of (i) last day of the
applicable Interest Period, and (ii) the first day of each month occurring
during the term thereof. Borrower hereby authorizes Foothill, at its option,
without prior notice to Borrower, to charge such interest, all Foothill Expenses
(as and when incurred), the fees and charges provided for in Section 2.11 (as
and when accrued or incurred), and all installments or other payments due under
any Loan Document to Borrower's Loan Account, which amounts thereafter shall
accrue interest at the rate then applicable to Advances hereunder. Any interest
not paid when due shall be compounded and shall thereafter accrue interest at
the rate then applicable to Advances hereunder.
(f) Computation. The Reference Rate as of the date of this
Agreement is 8.50% per annum. In the event the Reference Rate is changed from
time to time hereafter, the applicable rate of interest hereunder automatically
and immediately shall be increased or decreased by an amount equal to such
change in the Reference Rate. All interest and fees chargeable under the Loan
Documents shall be computed on the basis of a 360 day year for the actual number
of days elapsed.
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(g) Intent to Limit Charges to Maximum Lawful Rate. In no
event shall the interest rate or rates payable under this Agreement, plus any
other amounts paid in connection herewith, exceed the highest rate permissible
under any law that a court of competent jurisdiction shall, in a final
determination, deem applicable. Borrower and Foothill, in executing and
delivering this Agreement, intend legally to agree upon the rate or rates of
interest and manner of payment stated within it; provided, however, that,
anything contained herein to the contrary notwithstanding, if said rate or rates
of interest or manner of payment exceeds the maximum allowable under applicable
law, then, ipso facto as of the date of this Agreement, Borrower is and shall be
liable only for the payment of such maximum as allowed by law, and payment
received from Borrower in excess of such legal maximum, whenever received, shall
be applied to reduce the principal balance of the Obligations to the extent of
such excess.
2.7 COLLECTION OF ACCOUNTS. Borrower either (a) shall remit, on a
daily basis, all of its Collections to the Concentration Account, or (b) shall
deposit, on a daily basis, all of its Collections to a deposit account of
Borrower all of the proceeds of which are remitted, on a daily basis, to the
Concentration Account. From and after the Closing Date until the date, if ever,
that a Triggering Event occurs, Foothill shall permit Borrower to access the
collected funds in the Concentration Account and to transfer the collected funds
to the Designated Account and, thereafter, Borrower shall have the unrestricted
use of such funds subject to the terms and conditions of this Agreement. From
and after the date, if ever, that a Triggering Event occurs, at Foothill's
instruction to the Concentration Account Bank, all amounts received in such
Concentration Account automatically shall be wire transferred each Business Day
into an account (the "Foothill Account") maintained by Foothill at a depositary
selected by Foothill. In addition, Borrower agrees to provide reports to
Foothill on a weekly basis, in form and substance satisfactory to Foothill, of
the amount of Collections for purposes of calculating the clearance or float
charge provided for in Section 2.8.
2.8 CREDITING PAYMENTS; APPLICATION OF COLLECTIONS. The receipt
of any Collections by Foothill (whether from transfers to Foothill by the
Concentration Account Banks pursuant to the Concentration Account Agreements or
otherwise) immediately shall be applied provisionally to reduce the Obligations
outstanding under Section 2.1, but shall not be considered a payment on account
unless such Collection item is a wire transfer of immediately available federal
funds and is made to the Foothill Account or unless and until such Collection
item is honored when presented for payment. From and after the Effective Date,
Foothill shall be entitled to charge Borrower for 1 Business Day of `clearance'
or `float' at the rate set forth in Section 2.6(a)(ii) or Section 2.6(c)(i), as
applicable, on all Collections that are received by Borrower or Foothill
(regardless of whether forwarded by the Collection Account Banks to Foothill,
whether provisionally applied to reduce the Obligations under Section 2.1, or
otherwise); provided, however, prior to the occurrence and continuation of an
Event of Default, the aggregate amount payable to Foothill in connection with
the foregoing float charge shall
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be limited to $40,000 in each calendar year during the effectiveness of this
Agreement. This across-the-board 1 Business Day clearance or float charge on all
Collections is acknowledged by the parties to constitute an integral aspect of
the pricing of Foothill's financing of Borrower, and shall apply irrespective of
the characterization of whether receipts are owned by Borrower or Foothill, and
whether or not there are any outstanding Advances, the effect of such clearance
or float charge being the equivalent of charging 1 Business Day of interest on
such Collections. Should any Collection item not be honored when presented for
payment, then Borrower shall be deemed not to have made such payment, and
interest shall be recalculated accordingly. Anything to the contrary contained
herein notwithstanding, any Collection item shall be deemed received by Foothill
only if it is received into the Foothill Account on a Business Day on or before
11:00 a.m. California time. If any Collection item is received into the Foothill
Account on a non-Business Day or after 11:00 a.m. California time on a Business
Day, it shall be deemed to have been received by Foothill as of the opening of
business on the immediately following Business Day.
2.9 DESIGNATED ACCOUNT. Foothill is authorized to make the
Advances under this Agreement based upon telephonic or other instructions
received from anyone purporting to be an Authorized Person, or without
instructions if pursuant to Section 2.6(e). Borrower agrees to establish and
maintain the Designated Account with the Designated Account Bank for the purpose
of receiving the proceeds of the Advances requested by Borrower and made by
Foothill hereunder. Unless otherwise agreed by Foothill and Borrower, any
Advance requested by Borrower and made by Foothill hereunder shall be made to
the Designated Account.
2.10 MAINTENANCE OF LOAN ACCOUNT; STATEMENTS OF OBLIGATIONS.
Foothill shall maintain an account on its books in the name of Borrower (the
"Loan Account") on which Borrower will be charged with all Advances made by
Foothill to Borrower or for Borrower's account, including, accrued interest,
Foothill Expenses, and any other payment Obligations of Borrower. In accordance
with Section 2.8, the Loan Account will be credited with all payments received
by Foothill from Borrower or for Borrower's account, including all amounts
received in the Foothill Account from any Concentration Account Bank. Foothill
shall render statements regarding the Loan Account to Borrower, including
principal, interest, fees, and including an itemization of all charges and
expenses constituting Foothill Expenses owing, and such statements shall be
conclusively presumed to be correct and accurate and constitute an account
stated between Borrower and Foothill unless, within 30 days after receipt
thereof by Borrower, Borrower shall deliver to Foothill written objection
thereto describing the error or errors contained in any such statements.
2.11 FEES. Borrower shall pay to Foothill the following fees:
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(a) Commitment Fee. A commitment fee of $75,000, which
shall be fully earned and non-refundable on the Effective Date, and of which
$25,000 shall be due and payable on the Effective Date, $25,000 shall be due and
payable on the first anniversary of the Effective Date, and $25,000 shall be due
and payable on the second anniversary of the Effective Date; provided, however,
that any amounts paid by Borrower to Foothill with respect to the commitment fee
prior to the Effective Date shall be credited toward the payment of the amounts
due on the Effective Date;
(b) [intentionally omitted].
(c) [intentionally omitted].
(d) Financial Examination, Documentation, and Appraisal
Fees. (i) Foothill's customary fee of $650 per day per examiner, plus
out-of-pocket expenses for each financial analysis and examination (i.e.,
audits) of Borrower performed by personnel employed by Foothill; provided, that
the aggregate amount of all fees for personnel employed by Foothill with respect
to such financial analysis and examinations charged to Borrower hereunder shall
not exceed $48,000 in each year, plus any related out-of-pocket expenses with
respect thereto; plus (ii) Foothill's out-of-pocket expenses for each
semi-annual appraisal of the Collateral performed by personnel employed by
Foothill, provided, that the aggregate amount of all fees for personnel employed
by Foothill with respect to such semi-annual Collateral appraisals shall not
exceed $24,000 in each year, plus any related out-of-pocket expenses with
respect thereto, and provided, further, that upon the occurrence and during the
continuation of an Event of Default, Foothill may conduct appraisals of the
Collateral more frequently); plus, (iii) the actual charges paid or incurred by
Foothill if it elects to employ the services of one or more third Persons to
perform such financial analyses and examinations (i.e., audits) of Borrower or
to appraise the Collateral; and
(e) Collateral Management Fee. On the first day of each
month during the term of this Agreement, and thereafter so long as any
Obligations are outstanding, a collateral servicing fee in an amount equal to
$2,500.
2.12 EURODOLLAR RATE LOANS. Any other provisions herein to the
contrary notwithstanding, the following provisions shall govern with respect to
Eurodollar Rate Loans as to the matters covered:
(a) Borrowing; Conversion; Continuation. Borrower may from
time to time, on or after the Effective Date (and subject to the satisfaction of
the requirements of Sections (3.2) and (3.4), request in a written or telephonic
communication with Foothill: (i) Advances to constitute Eurodollar Rate Loans
(pursuant to Section 2.1(c)); (ii) that Reference Rate Loans be converted into
Eurodollar Rate Loans; or (iii) that existing Eurodollar Rate Loans continue for
an additional Interest Period. Any such
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request shall specify the aggregate amount of the requested Eurodollar Rate
Loans, the proposed funding date therefor (which shall be a Business Day, and
with respect to continued Eurodollar Rate Loans shall be the last day of the
Interest Period of the existing Eurodollar Rate Loans being continued), and the
proposed Interest Period, in each case subject to the limitations set forth
below). Eurodollar Rate Loans may only be made, continued, or extended if, as of
the proposed funding date therefor each of the following conditions is
satisfied:
(v) no Event of Default exists;
(w) no more than five Interest Periods may be in
effect at any one time;
(x) the amount of each Eurodollar Rate Loan
borrowed, converted, or continued must be in an amount not less
than $1,000,000 and integral multiples of $500,000 in excess
thereof;
(y) Foothill shall have determined that the
Interest Period or Adjusted Eurodollar Rate is available to
Foothill and can be readily determined as of the date of the
request for such Eurodollar Rate Loan by Borrower; and
(z) Foothill shall have received such request at
least two Business Days prior to the proposed funding date
therefor.
Any request by Borrower to borrow Eurodollar Rate Loans, to
convert Reference Rate Loans to Eurodollar Rate Loans, or to continue any
existing Eurodollar Rate Loans shall be irrevocable, except to the extent that
Foothill shall determine under Sections 2.12(a), 2.13 or 2.14 that such
Eurodollar Rate Loans cannot be made or continued.
(b) Determination of Interest Period. By giving notice as
set forth in Section 2.12(a), Borrower shall select an Interest Period for such
Eurodollar Rate Loan. The determination of the Interest Period shall be subject
to the following provisions:
(i) in the case of immediately successive Interest
Periods, each successive Interest Period shall commence on the
day on which the next preceding Interest Period expires;
(ii) if any Interest Period would otherwise expire
on a day which is not a Business Day, the Interest Period shall
be extended to expire
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on the next succeeding Business Day; provided, however, that if
the next succeeding Business Day occurs in the following
calendar month, then such Interest Period shall expire on the
immediately preceding Business Day;
(iii) if any Interest Period begins on the last
Business Day of a month, or on a day for which there is no
numerically corresponding day in the calendar month at the end of
such Interest Period, then the Interest Period shall end on the
last Business Day of the calendar month at the end of such
Interest Period; and
(iv) Borrower may not select an Interest Period
which expires later than the Maturity Date.
(c) Automatic Conversion: Optional Conversion by Foothill.
Any Eurodollar Rate Loan shall automatically convert to a Reference Rate Loan
upon the last day of the applicable Interest Period, unless Foothill has
received a request to continue such Eurodollar Rate Loan at least two Business
Days prior to the end of such Interest Period in accordance with the terms of
Section 2.12(a). Any Eurodollar Rate Loan shall, at Foothill's option, upon
notice to Borrower, convert to a Reference Rate Loan in the event that (i) an
Event of Default shall have occurred and be continuing as of the last day of the
Interest Period for such Eurodollar Rate Loan, or (ii) this Agreement shall
terminate, and Borrower shall pay to Foothill any amounts required by Section
2.16 as a result thereof.
2.13 ILLEGALITY. Any other provision herein to the contrary
notwithstanding, if the adoption of or any change in any Requirement of Law or
in the interpretation or application thereof shall make it unlawful for Foothill
to make or maintain Eurodollar Rate Loans as contemplated by this Agreement, (a)
the obligation of Foothill hereunder to make Eurodollar Rate Loans, continue
Eurodollar Rate Loans as such, and convert Reference Rate Loans to Eurodollar
Rate Loans shall forthwith be cancelled and (b) Foothill's then outstanding
Eurodollar Rate Loans, if any, shall be converted automatically to Reference
Rate Loans on the respective last days of the then current Interest Periods with
respect thereto or within such earlier period as required by law; provided,
however, that before making any such demand, Foothill agrees to use reasonable
efforts (consistent with its internal policy and legal and regulatory
restrictions and so long as such efforts would not be disadvantageous to it, in
its reasonable discretion, in any legal, economic, or regulatory manner) to
designate a different lending office if the making of such a designation would
allow Foothill or its lending office to continue to perform its obligations to
make Eurodollar Rate Loans. If any such conversion of a Eurodollar Rate Loan
occurs on a day which is not the last day of the then current Interest Period
with respect thereto, Borrower shall pay to such Lender such amounts, if any, as
may be required pursuant to Section 2.16. If circumstances subsequently change
so that Foothill shall determine that it is no longer so affected,
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Foothill will promptly notify Borrower, and upon receipt of such notice, the
obligations of Foothill to make or continue Eurodollar Rate Loans or to convert
Reference Rate Loans into Eurodollar Rate Loans shall be reinstated.
2.14 REQUIREMENTS OF LAW. (a) If the adoption of or any change in
any Requirement of Law or in the interpretation or application thereof or
compliance by Foothill with any request or directive (whether or not having the
force of law) from any central bank or other Governmental Authority made
subsequent to the date hereof
(i) shall subject Foothill to any tax, levy,
charge, fee, reduction, or withholding of any kind whatsoever
with respect to this Agreement or any Advance, or change the
basis of taxation of payments to Foothill in respect thereof
(except for taxes covered by Section 2.15 and the establishment
of a tax based on the net income of Foothill or changes in the
rate of tax on the net income of Foothill);
(ii) shall 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 other extensions of credit by, or any
other acquisition of funds by, any office of Foothill; or
(iii) shall impose on Foothill any other condition
with respect to this Agreement or any Advance;
and the result of any of the foregoing is to increase the cost to Foothill, by
an amount which Foothill deems to be material, of making, converting into,
continuing, or maintaining Advances or to increase the cost to Foothill, by an
amount which Foothill deems to be material, or to reduce any amount receivable
hereunder in respect of Advances, or to forego any other sum payable thereunder
or make any payment on account thereof, then, in any such case, Borrower shall
promptly pay Foothill, upon its demand, any additional amounts necessary to
compensate Foothill for such increased cost or reduced amount receivable;
provided, however, that before making any such demand, Foothill agrees to use
reasonable efforts (consistent with its internal policy and legal and regulatory
restrictions and so long as such efforts would not be disadvantageous to it, in
its reasonable discretion, in any legal, economic, or regulatory manner) to
designate a different Eurodollar lending office if the making of such
designation would allow Foothill or its Eurodollar lending office to continue to
perform its obligations to make Eurodollar Rate Loans or to continue to fund or
maintain Eurodollar Rate Loans and avoid the need for, or materially reduce the
amount of, such increased cost. If Foothill becomes entitled to claim any
additional amounts pursuant to this Section 2.14, Foothill shall promptly notify
Borrower of the event by reason of which it has become so entitled. A
certificate
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as to any additional amounts payable pursuant to this Section 2.14 submitted by
Foothill to Borrower shall be conclusive in the absence of manifest error. If
Borrower so notifies Foothill within 5 Business Days after Foothill notifies
Borrower of any increased cost pursuant to the foregoing provisions of this
Section 2.14, Borrower may convert all Eurodollar Rate Loans then outstanding
into Reference Rate Loans in accordance with Section 2.12 and, additionally,
reimburse Foothill for any cost in accordance with Section 2.16. This covenant
shall survive the termination of this Agreement and the payment of the Advances
and all other amounts payable hereunder for nine months following such
termination and repayment.
(b) If Foothill shall have determined that the adoption of
or any change in any Requirement of Law regarding capital adequacy or in the
interpretation or application thereof or compliance by Foothill or any Person
controlling Foothill with any request or directive regarding capital adequacy
(whether or not having the force of law) from any Governmental Authority made
subsequent to the date hereof does or shall have the effect of increasing the
amount of capital required to be maintained or reducing the rate of return on
Foothill's or such Person's capital as a consequence of its obligations
hereunder to a level below that which such Foothill or such Person could have
achieved but for such change or compliance (taking into consideration Foothill's
or such Person's policies with respect to capital adequacy) by an amount deemed
by Foothill to be material, then from time to time, after submission by Foothill
to Borrower of a prompt written request therefor, Borrower shall pay to Foothill
such additional amount or amounts as will compensate Foothill or such Person for
such reduction. This covenant shall survive the termination of this Agreement
and the payment of the Advances and all other amount payable hereunder for nine
months following such termination and repayment.
2.15 TAXES. (a) Except as provided below in this Section 2.15,
all payments made by Borrower under this Agreement and any other Loan Documents
shall be made free and clear of, and without deduction or withholding for or on
account of, any present or future income, stamp or other taxes, levies, imposts,
duties, charges, fees, deductions, or withholdings, now or hereafter imposed,
levied, collected, withheld, or assessed by any Governmental Authority,
excluding net income taxes and franchise taxes imposed in lieu of net income
taxes. If any such non-excluded taxes, levies, imposts, duties, charges, fees,
deductions or withholdings ("Non-Excluded Taxes") are required to be withheld
from any amounts payable to Foothill hereunder or under any other Loan
Documents, the amounts so payable to Foothill shall be increased to the extent
necessary to yield to Foothill (after payment of all Non-Excluded Taxes)
interest or any such other amounts payable hereunder at the rates or in the
amounts specified in this Agreement and any other Loan Documents, provided,
however, that Borrower shall be entitled to deduct and withhold any Non-Excluded
Taxes and shall not be required to increase any such amounts payable to Foothill
if Foothill fails or is unable to comply with the requirements of paragraph (b)
of this Section 2.15. Whenever any Non-Excluded Taxes are payable by Borrower,
as promptly as possible thereafter Borrower shall send to Foothill a certified
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copy of an original official receipt received by Borrower showing payment
thereof. If Borrower fails to pay any Non-Excluded Taxes when due to the
appropriate taxing authority or fails to remit to Foothill the required receipts
or other required documentary evidence, Borrower shall indemnify Foothill for
any incremental taxes, interest or penalties that may become payable by Foothill
as a result of any such failure. The agreements in this Section 2.15 shall
survive the termination of this Agreement and the payment of the Advances and
all other amounts payable hereunder.
(b) Any Participant or assignee of Foothill that is not
incorporated under the laws of the United States of America or a state thereof
(any such Person, a "Foreign Lender") shall:
(i) (x) on or before the date of any payment by
Borrower under this Agreement to such Foreign Lender, deliver to
Borrower and Foothill (A) two duly completed copies of United
States Internal Revenue Service Form 1001 or 4224, or successor
applicable form, as the case may be, certifying that it is
entitled to receive payments under this Agreement without any
deduction or withholding of any United States federal income
taxes and (B) a duly completed Internal Revenue Service Form W-8
or W-9, or successor applicable form, as the case may be,
certifying that it is entitled to an exemption from United States
backup withholding tax;
(y) deliver to Borrower and Foothill two
further copies of any such form or certification on or before the
date that any such form or certification expires or becomes
obsolete and after the occurrence of any event requiring a change
in the most recent form previously delivered by it to Borrower,
and
(z) obtain such extensions of time for filing
and complete such forms or certifications as may reasonably be
requested by Borrower or Foothill;
or
(ii) in the case of any such Foreign Lender that is
not a "bank" within the meaning of Section 881(c)(3)(A) of the
IRC and that does not comply with subparagraph (i) of this
paragraph (b),
(x) represent to Borrower (for the benefit of
Borrower and Foothill) that it is not a bank within the meaning
of Section 881(c)(3)(A) of the IRC,
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(y) deliver to Borrower on or before the date
of any payment by Borrower, with a copy to Foothill: (1) a
certificate stating that such Foreign Lender (A) is not a "bank"
under Section 881(c)(3)(A) of the IRC, is not subject to
regulatory or other legal requirements as a bank in any
jurisdiction, and has not been treated as a bank for purposes of
any tax, securities law, or other filing or submission made to
any Governmental Authority, any application made to a rating
agency or qualification for any exemption from tax, securities
law or other legal requirements, (B) is not a 10-percent
shareholder within the meaning of Section 881(c)(3)(B) of the
IRC, and (C) is not a controlled foreign corporation receiving
interest from a related person within the meaning of Section
881(c)(3)(C) of the IRC (any such certificate a "U.S. Tax
Compliance Certificate"); and (2) two duly completed copies of
Internal Revenue Service Form W-8, or successor applicable form,
certifying to such Foreign Lender's legal entitlement at the date
of such certificate to an exemption from U.S. withholding tax
under the provisions of Section 881(c) of the IRC with respect to
payments to be made under this Agreement (and to deliver to
Borrower and Foothill two further copies of Form W-8 on or before
the date it expires or becomes obsolete and after the occurrence
of any event requiring a change in the most recently provided
form and, if necessary, obtain any extensions of time reasonably
requested by Borrower or Foothill for filing and completing such
forms), and
(z) agree, to the extent legally entitled to do
so, upon reasonable request by Borrower, to provide to Borrower
(for the benefit of Borrower and Foothill) such other forms as
may be reasonably required in order to establish the legal
entitlement of such Foreign Lender to an exemption from
withholding with respect to payments under this Agreement;
(c) Foothill and each Foreign Lender shall, upon the
reasonable request by Borrower, deliver to Borrower or the applicable
Governmental Authority, as the case may be, any form or certificate required in
order that any payment by Borrower under this Agreement may be made free and
clear of, and without deduction or withholding for or on Non-Excluded Taxes (or
to allow any such deduction or withholding to be at a reduced rate) imposed on
such payment under the laws of any jurisdiction, provided that Foothill or such
Foreign Lender, as the case may be, is legally entitled to complete, execute and
deliver such form or certificate and such completion, execution or submission
would not materially prejudice the legal position of Foothill or such Foreign
Lender, as the case may be,
unless in any such case any change in treaty, law, or regulation has occurred
after the date such Person becomes a Foreign Lender hereunder which renders all
such forms and
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certificates inapplicable or which would prevent such Foreign Lender from duly
completing and delivering any such form or certificate with respect to it and
such Foreign Lender so advises Borrower and Foothill. Each Person that shall
become an assignee or a Participant shall, upon the effectiveness of the related
transfer, be required to provide all of the forms, certifications, and
statements required pursuant to this Section 2.15; provided, however, that in
the case of a Participant the obligations of such Participant pursuant to this
paragraph (b) shall be determined as if such Participant were an assignee except
that such Participant shall furnish all such required forms, certifications, and
statements to Foothill.
2.16 INDEMNITY. Borrower agrees to indemnify Foothill and to hold
Foothill harmless from any loss or expense which Foothill may sustain or incur
as a consequence of (a) default by Borrower in payment when due of the principal
amount of or interest on any Eurodollar Rate Loan, (b) default by Borrower in
making a borrowing of, conversion into, or continuation of Eurodollar Rate Loans
after Borrower has given a notice requesting the same in accordance with the
provisions of this Agreement, (c) default by Borrower in making any prepayment
after Borrower has given a notice thereof in accordance with the provisions of
this Agreement, or (d) the making of a prepayment of Eurodollar Rate Loans on a
day which is not the last day of an Interest Period with respect thereto
(whether due to the termination of this Agreement upon an Event of Default or
otherwise), including, in each case, any such loss or expense (but excluding
loss of margin) arising from the reemployment of funds obtained by it or from
fees payable to terminate the deposits from which such funds were obtained.
Calculation of all amounts payable to Foothill under this Section 2.16 shall be
made as though Foothill had actually funded the relevant Eurodollar Rate Loan
through the purchase of a deposit bearing interest at the Eurodollar Rate in an
amount equal to the amount of such Eurodollar Rate Loan and having a maturity
comparable to the relevant Interest Period; provided, however, that Foothill may
fund each of the Eurodollar Rate Loans in any manner it sees fit, and the
foregoing assumption shall be utilized only for the calculation of amounts
payable under this Section 2.16. This covenant shall survive the termination of
this Agreement and the payment of the Loans and all other amounts payable
hereunder for a period of nine months thereafter.
3. CONDITIONS; TERM OF AGREEMENT.
3.1 CONDITIONS PRECEDENT TO EFFECTIVENESS OF THE AGREEMENT. The
effectiveness of this Agreement is subject to the fulfillment, to the
satisfaction of Foothill and its counsel, of each of the following conditions:
(a) the Effective Date shall occur on or before May 6,
1998;
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(b) Foothill shall have received searches reflecting the
filing of its financing statements and fixture filings;
(c) Foothill shall have received each of the following
documents, duly executed, and each such document shall be in full force and
effect:
i. the Pay-Off Letter, together with UCC
termination statements and other documentation
evidencing the termination by Existing Lender of
its Liens in and to the properties and assets of
Borrower;
ii. the Trademark Security Agreement;
iii. the Inventory Security Agreement; and
iv. the License Agreement;
(d) Foothill shall have received a certificate from the
President of Borrower attesting to the resolutions of Borrower's Board of
Directors authorizing its execution, delivery, and performance of this Agreement
and the other Loan Documents to which Borrower is a party and authorizing
specific officers of Borrower to execute the same;
(e) Foothill shall have received copies of Borrower's
Governing Documents, as amended, modified, or supplemented to the Effective
Date, certified by the President of Borrower;
(f) Foothill shall have received a certificate of status
with respect to Borrower, dated within 10 days of the Effective Date, such
certificate to be issued by the appropriate officer of the jurisdiction of
organization of Borrower, which certificate shall indicate that Borrower is in
good standing in such jurisdiction;
(g) Foothill shall have received certificates of status
with respect to Borrower, each dated within 15 days of the Effective Date, such
certificates to be issued by the appropriate officer of the jurisdictions in
which its failure to be duly qualified or licensed would constitute a Material
Adverse Change, which certificates shall indicate that Borrower is in good
standing in such jurisdictions;
(h) Foothill shall have received a certificate of the
President of Borrower certifying that Borrower does not own any items of
Collateral that are subject to certificates of title;
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(i) Foothill shall have received an opinion of Borrower's
counsel in form and substance satisfactory to Foothill in its sole discretion;
(j) Foothill shall have received satisfactory evidence
that all tax returns required to be filed by Borrower have been timely filed and
all taxes upon Borrower or its properties, assets, income, and franchises
(including real property taxes and payroll taxes) have been paid prior to
delinquency, except such taxes that are the subject of a Permitted Protest;
(k) Foothill shall have completed a "field survey" and
appraisal of the Collateral, the results of which shall be satisfactory to
Foothill; and
(l) Foothill shall have completed reference checks with
respect to key management personnel, the results of which shall be satisfactory
to Foothill.
3.2 CONDITIONS PRECEDENT TO INITIAL ADVANCES. The obligation of
Foothill to make the initial Advance is subject to the fulfillment, to the
satisfaction of Foothill and its counsel, of each of the following conditions on
or before the Closing Date:
(a) Each of the conditions set forth in Section 3.1 shall
have been fulfilled, or else shall have been waived by Foothill;
(b) Foothill shall have received a certificate of
insurance, together with the endorsements thereto, as are required by Section
6.10, the form and substance of which shall be satisfactory to Foothill and its
counsel;
(c) Foothill shall have received Collateral Access
Agreements with respect to Borrower's distribution center in Ontario,
California, and from such other lessors, warehousemen, bailees, and other third
persons as Foothill may require;
(d) Foothill shall have received each Collateral Access
Agreement that Borrower has been able to obtain on a good-faith, best efforts
basis from Borrower's landlords with respect to each of Borrower's retail store
locations, or Foothill shall have received satisfactory evidence of Borrower's
good-faith, best-efforts to obtain each such Collateral Access Agreement;
(e) within 15 days of the Effective Date, Foothill shall
have received the Concentration Account Agreements, duly executed, and in full
force and effect;
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(f) within 15 days of the Effective Date, Borrower,
Foothill, and the applicable financial intermediary shall enter into a Control
Agreement in respect of each Securities Account in existence as of the Effective
Date; and
(g) all other documents and legal matters in connection
with the transactions contemplated by this Agreement shall have been delivered,
executed, or recorded and shall be in form and substance satisfactory to
Foothill and its counsel.
3.3 CONDITION SUBSEQUENT. As a condition subsequent to initial
closing hereunder, Borrower shall perform or cause to be performed the following
(the failure by Borrower to so perform or cause to be performed constituting an
Event of Default):
(a) within 30 days of the Effective Date, deliver to
Foothill, in form and substance satisfactory to Foothill and its counsel,
certified copies of the policies of insurance, together with the endorsements
thereto as are required by Section 6.10, with respect to (i) all insurance
policies entered into by Borrower in connection with Borrower's distribution
center in Ontario, California, and (ii) all umbrella liability insurance
policies entered into by Borrower.
3.4 CONDITIONS PRECEDENT TO ALL ADVANCES. The following shall be
conditions precedent to all Advances hereunder:
(a) the representations and warranties contained in this
Agreement and the other Loan Documents shall be true and correct in all respects
on and as of the date of such Advance, as though made on and as of such date
(except to the extent that such representations and warranties relate solely to
an earlier date);
(b) no Event of Default or event which with the giving of
notice or passage of time would constitute an Event of Default shall have
occurred and be continuing on the date of such Advance, nor shall either result
from the making thereof; and
(c) no injunction, writ, restraining order, or other order
of any nature prohibiting, directly or indirectly, the making of such Advance
shall have been issued and remain in force by any governmental authority against
Borrower, Foothill, or any of their Affiliates.
3.5 TERM; AUTOMATIC RENEWAL. This Agreement shall become
effective upon the execution and delivery hereof by Borrower and Foothill and
shall continue in full force and effect for a term ending on the date (the
"Renewal Date") that is 3 years from the Effective Date and automatically shall
be renewed for successive 1 year periods thereafter, unless sooner terminated
pursuant to the terms hereof. Either party may terminate this Agreement
effective on the Renewal Date or on any 1 year anniversary of
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the Renewal Date by giving the other party at least 90 days prior written
notice. The foregoing notwithstanding, Foothill shall have the right to
terminate its obligations under this Agreement immediately and without notice
upon the occurrence and during the continuation of an Event of Default.
3.6 EFFECT OF TERMINATION. On the date of termination of this
Agreement, all Obligations immediately shall become due and payable without
notice or demand. No termination of this Agreement, however, shall relieve or
discharge Borrower of Borrower's duties, Obligations, or covenants hereunder,
and Foothill's continuing security interests in the Collateral shall remain in
effect until all Obligations have been fully and finally discharged and
Foothill's obligation to provide additional credit hereunder is terminated. If
Borrower has sent a notice of termination pursuant to the provisions of Section
3.5, but fails to pay the Obligations in full on the date set forth in said
notice, then Foothill may, but shall not be required to, renew this Agreement
for an additional term of 1 year.
3.7 EARLY TERMINATION BY BORROWER. The provisions of Section 3.5
that allow termination of this Agreement by Borrower only on the Renewal Date
and certain anniversaries thereof notwithstanding, Borrower has the option, at
any time upon 90 days prior written notice to Foothill, to terminate this
Agreement by paying to Foothill, in cash, the Obligations, in full, together
with a premium (the "Early Termination Premium") equal to the Applicable
Termination Rate times the Maximum Revolving Amount.
3.8 TERMINATION UPON EVENT OF DEFAULT. If Foothill terminates
this Agreement upon the occurrence of an Event of Default, in view of the
impracticability and extreme difficulty of ascertaining actual damages and by
mutual agreement of the parties as to a reasonable calculation of Foothill's
lost profits as a result thereof, Borrower shall pay to Foothill upon the
effective date of such termination, a premium in an amount equal to the Early
Termination Premium. The Early Termination Premium shall be presumed to be the
amount of damages sustained by Foothill as the result of the early termination
and Borrower agrees that it is reasonable under the circumstances currently
existing. The Early Termination Premium provided for in this Section 3.8 shall
be deemed included in the Obligations.
4. CREATION OF SECURITY INTEREST.
4.1 GRANT OF SECURITY INTEREST. Borrower hereby grants to
Foothill a continuing security interest in all currently existing and hereafter
acquired or arising Collateral in order to secure prompt repayment of any and
all Obligations and in order to secure prompt performance by Borrower of each of
its covenants and duties under the Loan Documents. Foothill's security interests
in the Collateral shall attach to all Collateral without further act on the part
of Foothill or Borrower. Anything contained in
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this Agreement or any other Loan Document to the contrary notwithstanding,
except for Permitted Dispositions, Borrower has no authority, express or
implied, to dispose of any item or portion of the Collateral.
4.2 NEGOTIABLE COLLATERAL. In the event that any Collateral,
including proceeds, is evidenced by or consists of Negotiable Collateral,
Borrower, immediately upon the request of Foothill, shall endorse and deliver
physical possession of such Negotiable Collateral to Foothill.
4.3 COLLECTION OF ACCOUNTS, GENERAL INTANGIBLES, AND NEGOTIABLE
COLLATERAL. At any time, Foothill or Foothill's designee may (a) notify
customers or Account Debtors of Borrower that the Accounts, General Intangibles,
or Negotiable Collateral have been assigned to Foothill or that Foothill has a
security interest therein, and (b) collect the Accounts, General Intangibles,
and Negotiable Collateral directly and charge the collection costs and expenses
to the Loan Account. Borrower agrees that it will hold in trust for Foothill, as
Foothill's trustee, any Collections that it receives and immediately will
deliver said Collections to Foothill in their original form as received by
Borrower.
4.4 DELIVERY OF ADDITIONAL DOCUMENTATION REQUIRED. At any time
upon the request of Foothill, Borrower shall execute and deliver to Foothill all
financing statements, continuation financing statements, fixture filings,
security agreements, pledges, assignments, endorsements of certificates of
title, applications for title, affidavits, reports, notices, schedules of
accounts, letters of authority, and all other documents that Foothill reasonably
may request, in form satisfactory to Foothill, to perfect and continue perfected
Foothill's security interests in the Collateral, and in order to fully
consummate all of the transactions contemplated hereby and under the other the
Loan Documents. Without limiting the foregoing, Borrower agrees to execute and
deliver any Control Agreements, security agreements, financing statements, or
other documents reasonably required by Foothill to create, perfect, or maintain
the perfection or priority of, its Liens on Borrower's Securities Accounts and
related Investment Property.
4.5 POWER OF ATTORNEY. Borrower hereby irrevocably makes,
constitutes, and appoints Foothill (and any of Foothill's officers, employees,
or agents designated by Foothill) as Borrower's true and lawful attorney, with
power to (a) if Borrower refuses to, or fails timely to execute and deliver any
of the documents described in Section 4.4, sign the name of Borrower on any of
the documents described in Section 4.4, (b) at any time that an Event of Default
has occurred and is continuing or Foothill deems itself insecure, sign
Borrower's name on any invoice or bill of lading relating to any Account, drafts
against Account Debtors, schedules and assignments of Accounts, verifications of
Accounts, and notices to Account Debtors, (c) send requests for verification of
Accounts, (d) endorse Borrower's name on any Collection item that may come into
Foothill's possession, (e) at any time that an Event of Default has occurred and
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is continuing or Foothill deems itself insecure, notify the post office
authorities to change the address for delivery of Borrower's mail to an address
designated by Foothill, to receive and open all mail addressed to Borrower, and
to retain all mail relating to the Collateral and forward all other mail to
Borrower, (f) at any time that an Event of Default has occurred and is
continuing or Foothill deems itself insecure, make, settle, and adjust all
claims under Borrower's policies of insurance and make all determinations and
decisions with respect to such policies of insurance, and (g) at any time that
an Event of Default has occurred and is continuing or Foothill deems itself
insecure, settle and adjust disputes and claims respecting the Accounts directly
with Account Debtors, for amounts and upon terms that Foothill determines to be
reasonable, and Foothill may cause to be executed and delivered any documents
and releases that Foothill determines to be necessary. The appointment of
Foothill as Borrower's attorney, and each and every one of Foothill's rights and
powers, being coupled with an interest, is irrevocable until all of the
Obligations have been fully and finally repaid and performed and Foothill's
obligation to extend credit hereunder is terminated.
4.6 RIGHT TO INSPECT. Foothill (through any of its officers,
employees, or agents) shall have the right, from time to time hereafter to
inspect Borrower's Books and to check, test, and appraise the Collateral in
order to verify Borrower's financial condition or the amount, quality, value,
condition of, or any other matter relating to, the Collateral.
4.7 CONTROL AGREEMENTS. Foothill agrees that it will not give any
Notice of Exclusive Control unless an Event of Default has occurred and is
continuing. Borrower agrees that it will not transfer assets out of any
Securities Accounts other than as permitted under Section 7.22 and, if to
another securities intermediary, unless each of Borrower, Foothill, and the
substitute securities intermediary have entered into a Control Agreement. No
arrangement contemplated hereby or by any Control Agreement in respect of any
Securities Accounts or other investment property shall be modified by Borrower
without the prior written consent of Foothill. Upon the occurrence and during
the continuance of an Event of Default or if Foothill deems itself insecure,
Foothill may notify any securities intermediary to liquidate or transfer the
applicable Securities Account or any related investment property maintained or
held thereby and remit the proceeds thereof to the Foothill Account.
5. REPRESENTATIONS AND WARRANTIES.
In order to induce Foothill to enter into this Agreement,
Borrower makes the following representations and warranties which shall be true,
correct, and complete in all respects as of the date hereof, and shall be true,
correct, and complete in all respects as of the Effective Date, and at and as of
the date of the making of each Advance made thereafter, as though made on and as
of the date of such Advance (except to the extent that
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such representations and warranties relate solely to an earlier date) and such
representations and warranties shall survive the execution and delivery of this
Agreement:
5.1 NO ENCUMBRANCES. Borrower has good and indefeasible title to
the Collateral, free and clear of Liens except for Permitted Liens.
5.2 [INTENTIONALLY OMITTED].
5.3 ELIGIBLE INVENTORY. All Eligible Inventory is of good and
merchantable quality, free from defects.
5.4 EQUIPMENT. All of the Equipment is used or held for use in
Borrower's business and is fit for such purposes.
5.5 LOCATION OF INVENTORY AND EQUIPMENT. The Inventory and
Equipment are not stored with a bailee, warehouseman, or similar party (without
Foothill's prior written consent) and are located only at the locations
identified on Schedule 6.12 or otherwise permitted by Section 6.12.
5.6 INVENTORY RECORDS. Borrower keeps correct and accurate
records itemizing and describing the kind, type, quality, and quantity of the
Inventory, and Borrower's cost therefor.
5.7 LOCATION OF CHIEF EXECUTIVE OFFICE; FEIN. The chief executive
office of Borrower is located at the address indicated in the preamble to this
Agreement and Borrower's FEIN is 95-1464962.
5.8 DUE ORGANIZATION AND QUALIFICATION; SUBSIDIARIES.
(a) Borrower is duly organized and existing and in good
standing under the laws of the jurisdiction of its incorporation and qualified
and licensed to do business in, and in good standing in, any state where the
failure to be so licensed or qualified reasonably could be expected to have a
Material Adverse Change.
(b) Set forth on Schedule 5.8, is a complete and accurate
list of Borrower's direct and indirect Subsidiaries, showing: (i) the
jurisdiction of their incorporation; (ii) the number of shares of each class of
common and preferred Stock authorized for each of such Subsidiaries; and (iii)
the number and the percentage of the outstanding shares of each such class owned
directly or indirectly by Borrower. All of the outstanding Stock of each such
Subsidiary has been validly issued and is fully paid and non-assessable.
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(c) Except as set forth on Schedule 5.8, no Stock (or any
securities, instruments, warrants, options, purchase rights, conversion or
exchange rights, calls, commitments or claims of any character convertible into
or exercisable for Stock) of any direct or indirect Subsidiary of Borrower is
subject to the issuance of any security, instrument, warrant, option, purchase
right, conversion or exchange right, call, commitment or claim of any right,
title, or interest therein or thereto.
5.9 DUE AUTHORIZATION; NO CONFLICT.
(a) The execution, delivery, and performance by Borrower
of this Agreement and the Loan Documents to which it is a party have been duly
authorized by all necessary corporate action.
(b) The execution, delivery, and performance by Borrower
of this Agreement and the Loan Documents to which it is a party do not and will
not (i) violate any provision of federal, state, or local law or regulation
(including Regulations G, T, U, and X of the Federal Reserve Board) applicable
to Borrower, the Governing Documents of Borrower, or any order, judgment, or
decree of any court or other Governmental Authority binding on Borrower, (ii)
conflict with, result in a breach of, or constitute (with due notice or lapse of
time or both) a default under any material contractual obligation or material
lease of Borrower, (iii) result in or require the creation or imposition of any
Lien of any nature whatsoever upon any properties or assets of Borrower, other
than Permitted Liens, or (iv) require any approval of stockholders or any
approval or consent of any Person under any material contractual obligation of
Borrower.
(c) Other than the filing of any required reports with the
SEC, and the filing of appropriate financing statements, fixture filings, and
mortgages, the execution, delivery, and performance by Borrower of this
Agreement and the Loan Documents to which Borrower is a party do not and will
not require any registration with, consent, or approval of, or notice to, or
other action with or by, any federal, state, foreign, or other Governmental
Authority or other Person.
(d) This Agreement and the Loan Documents to which
Borrower is a party, and all other documents contemplated hereby and thereby,
when executed and delivered by Borrower will be the legally valid and binding
obligations of Borrower, enforceable against Borrower in accordance with their
respective terms, except as enforcement may be limited by equitable principles
or by bankruptcy, insolvency, reorganization, moratorium, or similar laws
relating to or limiting creditors' rights generally.
(e) The Liens granted by Borrower to Foothill in and to
its properties and assets pursuant to this Agreement and the other Loan
Documents are validly created, perfected, and first priority Liens, subject only
to Permitted Liens.
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5.10 LITIGATION. There are no actions or proceedings pending by
or against Borrower before any court or administrative agency and Borrower does
not have knowledge or belief of any pending, threatened, or imminent litigation,
governmental investigations, or claims, complaints, actions, or prosecutions
involving Borrower, except for: (a) ongoing collection matters in which Borrower
is the plaintiff; (b) matters disclosed on Schedule 5.10; and (c) matters that,
if decided adversely to Borrower, reasonably could not be expected to result in
a Material Adverse Change.
5.11 NO MATERIAL ADVERSE CHANGE. All financial statements
relating to Borrower or any guarantor of the Obligations that have been
delivered by Borrower to Foothill have been prepared in accordance with GAAP
(except, in the case of unaudited financial statements, for the lack of
footnotes and being subject to year-end audit adjustments) and fairly present
Borrower's (or such guarantor's, as applicable) financial condition as of the
date thereof and Borrower's results of operations for the period then ended.
There has not been a Material Adverse Change with respect to Borrower (or such
guarantor, as applicable) since the date of the latest financial statements
submitted to Foothill on or before the Effective Date.
5.12 SOLVENCY. Borrower is Solvent. No transfer of property is
being made by Borrower and no obligation is being incurred by Borrower in
connection with the transactions contemplated by this Agreement or the other
Loan Documents with the intent to hinder, delay, or defraud either present or
future creditors of Borrower.
5.13 EMPLOYEE BENEFITS. None of Borrower, any of its
Subsidiaries, or any of their ERISA Affiliates maintains or contributes to any
Benefit Plan, other than those listed on Schedule 5.13. Borrower, each of its
Subsidiaries and each ERISA Affiliate have satisfied the minimum funding
standards of ERISA and the IRC with respect to each Benefit Plan to which it is
obligated to contribute. No ERISA Event has occurred nor has any other event
occurred that may result in an ERISA Event that reasonably could be expected to
result in a Material Adverse Change. None of Borrower or its Subsidiaries, any
ERISA Affiliate, or any fiduciary of any Plan is subject to any direct or
indirect liability with respect to any Plan under any applicable law, treaty,
rule, regulation, or agreement. None of Borrower or its Subsidiaries or any
ERISA Affiliate is required to provide security to any Plan under Section
401(a)(29) of the IRC.
5.14 ENVIRONMENTAL CONDITION. None of Borrower's properties or
assets has ever been used by Borrower or, to the best of Borrower's knowledge,
by previous owners or operators in the disposal of, or to produce, store,
handle, treat, release, or transport, any Hazardous Materials. None of
Borrower's properties or assets has ever been designated or identified in any
manner pursuant to any environmental protection statute as a Hazardous Materials
disposal site, or a candidate for closure pursuant to any environmental
protection statute. No Lien arising under any environmental protection statute
has attached to any revenues or to any real or personal property owned or
operated
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by Borrower. Borrower has not received a summons, citation, notice, or directive
from the Environmental Protection Agency or any other federal or state
governmental agency concerning any action or omission by Borrower resulting in
the releasing or disposing of Hazardous Materials into the environment.
5.15 BROKERAGE FEES. No brokerage commission or finders fees has
or shall be incurred or payable in connection with or as a result of Borrower's
obtaining financing from Foothill under this Agreement, and Borrower has not
utilized the services of any broker or finder in connection with Borrower's
obtaining financing from Foothill under this Agreement.
5.16 YEAR 2000 COMPLIANCE.
(a) On the basis of a comprehensive inventory, review and
assessment currently being undertaken by Borrower, or that Borrower shall have
caused each of its applicable computer application or software vendors to
undertake, of Borrower's computer applications utilized by Borrower or contained
in products produced or sold by Borrower, and upon inquiry made of Borrower's
principal suppliers and vendors, Borrower's management is of the considered view
that Borrower, its products, and all such suppliers and vendors will be Year
2000 Compliant before October 1, 1999.
(b) Borrower (i) has undertaken, or shall have caused each
of Borrower's applicable computer application or software vendors to undertake,
a detailed inventory, review and assessment of all areas within its business and
operations that could be adversely affected by the failure of Borrower or its
products to be Year 2000 Compliant on a timely basis, (ii) is developing a
detail plan and timeline for becoming Year 2000 Compliant on a timely basis, and
(iii) to date, is implementing that plan in accordance with that timetable in
all material respects. Borrower reasonably anticipates that it will be Year 2000
Compliant on a timely basis.
6. AFFIRMATIVE COVENANTS.
Borrower covenants and agrees that, so long as any credit
hereunder shall be available and until full and final payment of the
Obligations, and unless Foothill shall otherwise consent in writing, Borrower
shall do all of the following:
6.1 ACCOUNTING SYSTEM. Maintain a standard and modern system of
accounting that enables Borrower to produce financial statements in accordance
with GAAP, and maintain records pertaining to the Collateral that contain
information as from time to time may be requested by Foothill. Borrower also
shall keep a modern inventory reporting system that shows all additions, sales,
claims, returns, and allowances with respect to the Inventory, including the
completion of one complete physical inventory or
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one complete inventory cycle count with respect to each of Borrower's store and
warehouse locations during each fiscal year of Borrower.
6.2 COLLATERAL REPORTING. Provide Foothill with the following
documents at the following times in form satisfactory to Foothill: (a) on a
weekly basis, (i) Inventory reports specifying Borrower's cost and the market
value of its Inventory, and (ii) a detailed calculation of the Borrowing Base;
(b) on a monthly basis and, in any event, by no later than the 15th day of each
month during the term of this Agreement, (i) a summary aging, by vendor, of
Borrower's accounts payable, (ii) Inventory reports specifying Borrower's cost
and the market value of its Inventory by category and by store location; (iii)
Borrower's rent rolls for the preceding month, reflecting the payment of the
applicable monthly lease or rental expense for the preceding month with respect
to each of Borrower's locations; and (iv) a summary of the results of Borrower's
inventory cycle count and physical inventory counts, as applicable, conducted
during the preceding month with respect to each of Borrower's locations for
which such inventory testing was conducted during that period; (c) on a monthly
basis and, in any event, by no later than the 30th day of each month during the
term of this Agreement; (i) a summary of any book overdraft with respect to
Borrower's accounts payable; and (ii) a report detailing all sales, franchise,
income, and other taxes paid and payable by Borrower to the states of Michigan,
Pennsylvania, and Texas for the preceding month, and for any other state with
respect to which any state tax liens on Borrower's properties or assets would
have priority over the security interest in the Collateral granted to Foothill
hereunder; (d) as requested by Foothill from time to time, access to Borrower's
electronic data; and (e) such other reports as to the Collateral or the
financial condition of Borrower as Foothill may request from time to time.
6.3 FINANCIAL STATEMENTS, REPORTS, CERTIFICATES. Deliver to
Foothill: (a) as soon as available, but in any event within 30 days after the
end of each month during each of Borrower's fiscal years, a company prepared
balance sheet, income statement, and statement of cash flow covering Borrower's
operations during such period; and (b) as soon as available, but in any event
within 90 days after the end of each of Borrower's fiscal years, financial
statements of Borrower for each such fiscal year, audited by independent
certified public accountants reasonably acceptable to Foothill and certified,
without any qualifications (except for a "going concern" qualification that is
the proximate result of Borrower's financial condition as of the Effective Date
or as of the end of any subsequent fiscal year end of Borrower thereafter
occurring during the term of this Agreement), by such accountants to have been
prepared in accordance with GAAP, together with a certificate of such
accountants addressed to Foothill stating that such accountants do not have
knowledge of the existence of any Default or Event of Default. Such audited
financial statements shall include a balance sheet, profit and loss statement,
and statement of cash flow and, if prepared, such accountants' letter to
management. If Borrower is a parent company of one or more Subsidiaries, or
Affiliates, or is a Subsidiary or Affiliate of another company, then, in
addition to the financial statements
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referred to above, Borrower agrees to deliver financial statements prepared on
a consolidating basis so as to present Borrower and each such related entity
separately, and on a consolidated basis.
Together with the above, Borrower also shall deliver to
Foothill Borrower's Form 10-Q Quarterly Reports, Form 10-K Annual Reports, and
Form 8-K Current Reports, and any other filings made by Borrower with the SEC,
if any, as soon as the same are filed, or any other information that is provided
by Borrower to its shareholders, and any other report reasonably requested by
Foothill relating to the financial condition of Borrower.
Each month, together with the financial statements
provided pursuant to Section 6.3(a), Borrower shall deliver to Foothill a
certificate signed by its chief financial officer to the effect that: (i) all
financial statements delivered or caused to be delivered to Foothill hereunder
have been prepared in accordance with GAAP (except, in the case of unaudited
financial statements, for the lack of footnotes and being subject to year-end
audit adjustments) and fairly present the financial condition of Borrower, (ii)
the representations and warranties of Borrower contained in this Agreement and
the other Loan Documents are true and correct in all material respects on and as
of the date of such certificate, as though made on and as of such date (except
to the extent that such representations and warranties relate solely to an
earlier date), (iii) for each month that also is the date on which a financial
covenant in Section 7.20 is to be tested, a Compliance Certificate demonstrating
in reasonable detail compliance at the end of such period with the applicable
financial covenants contained in Section 7.20, and (iv) on the date of delivery
of such certificate to Foothill there does not exist any condition or event that
constitutes a Default or Event of Default (or, in the case of clauses (i), (ii),
or (iii), to the extent of any non-compliance, describing such non-compliance as
to which he or she may have knowledge and what action Borrower has taken, is
taking, or proposes to take with respect thereto).
Borrower shall have issued written instructions to its
independent certified public accountants authorizing them to communicate with
Foothill and to release to Foothill whatever financial information concerning
Borrower that Foothill may request. Borrower hereby irrevocably authorizes and
directs all auditors, accountants, or other third parties to deliver to
Foothill, at Borrower's expense, copies of Borrower's financial statements,
papers related thereto, and other accounting records of any nature in their
possession, and to disclose to Foothill any information they may have regarding
Borrower's business affairs and financial conditions.
6.4 TAX RETURNS. Deliver to Foothill copies of each of Borrower's
future federal income tax returns, and any amendments thereto, within 30 days of
the filing thereof with the Internal Revenue Service.
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6.5 [INTENTIONALLY OMITTED].
6.6 RETURNS. Cause returns and allowances, if any, as between
Borrower and its Account Debtors to be on the same basis and in accordance with
the usual customary practices of Borrower, as they exist at the time of the
execution and delivery of this Agreement.
6.7 TITLE TO EQUIPMENT. Upon Foothill's request, Borrower
immediately shall deliver to Foothill, properly endorsed, any and all evidences
of ownership of, certificates of title, or applications for title to any items
of Equipment.
6.8 MAINTENANCE OF EQUIPMENT. Maintain the Equipment in good
operating condition and repair (ordinary wear and tear excepted), and make all
necessary replacements thereto so that the value and operating efficiency
thereof shall at all times be maintained and preserved. Other than those items
of Equipment that constitute fixtures on the Effective Date, Borrower shall not
permit any item of Equipment to become a fixture to real estate or an accession
to other property, and such Equipment shall at all times remain personal
property.
6.9 TAXES. Cause all assessments and taxes, whether real,
personal, or otherwise, due or payable by, or imposed, levied, or assessed
against Borrower or any of its property to be paid in full, before delinquency
or before the expiration of any extension period, except to the extent that the
validity of such assessment or tax shall be the subject of a Permitted Protest.
Borrower shall make due and timely payment or deposit of all such federal,
state, and local taxes, assessments, or contributions required of it by law
before delinquency or before the expiration of any extension period, except to
the extent that the validity of such assessment or tax shall be the subject of a
Permitted Protest, and will execute and deliver to Foothill, on demand,
appropriate certificates attesting to the payment thereof or deposit with
respect thereto. Borrower will make timely payment or deposit of all tax
payments and withholding taxes required of it by applicable laws, including
those laws concerning F.I.C.A., F.U.T.A., state disability, and local, state,
and federal income taxes, and will, upon request, furnish Foothill with proof
satisfactory to Foothill indicating that Borrower has made such payments or
deposits.
6.10 INSURANCE.
(a) At its expense, keep the Collateral insured against
loss or damage by fire, theft, explosion, sprinklers, and all other hazards and
risks, and in such amounts, as are ordinarily insured against by other owners in
similar businesses. Borrower also shall maintain business interruption, public
liability, product liability, and property damage insurance relating to
Borrower's ownership and use of the Collateral, as well as insurance against
larceny, embezzlement, and criminal misappropriation; provided, however, that
Borrower shall have 45 days from the Effective Date to obtain
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<PAGE> 48
insurance against larceny, embezzlement, and criminal misappropriation, in form
and amount satisfactory to Foothill.
(b) All such policies of insurance shall be in such form,
with such companies, and in such amounts as may be reasonably satisfactory to
Foothill. All insurance required herein shall be written by companies which are
authorized to do insurance business in the State of California. All hazard
insurance and such other insurance as Foothill shall specify, shall contain a
California Form 438BFU (NS) mortgagee endorsement, or an equivalent endorsement
satisfactory to Foothill, showing Foothill as sole loss payee thereof, and shall
contain a waiver of warranties. Every policy of insurance referred to in this
Section 6.10 shall contain an agreement by the insurer that it will not cancel
such policy except after 30 days prior written notice to Foothill and that any
loss payable thereunder shall be payable notwithstanding any act or negligence
of Borrower or Foothill which might, absent such agreement, result in a
forfeiture of all or a part of such insurance payment and notwithstanding (i)
occupancy or use of the Real Property for purposes more hazardous than permitted
by the terms of such policy, or (ii) any change in title or ownership of the
Real Property. Borrower shall deliver to Foothill certified copies of such
policies of insurance and evidence of the payment of all premiums therefor.
(c) Original policies or certificates thereof satisfactory
to Foothill evidencing such insurance shall be delivered to Foothill at least 30
days prior to the expiration of the existing or preceding policies. Borrower
shall give Foothill prompt notice of any loss covered by such insurance
(exclusive of any casualty loss in an amount equal to or less than $50,000 per
occurrence), and Foothill shall have the right to adjust any loss. Foothill
shall have the exclusive right to adjust all losses payable under any such
insurance policies without any liability to Borrower whatsoever in respect of
such adjustments. Any monies received as payment for any loss under any
insurance policy including the insurance policies mentioned above (exclusive of
any casualty loss wherein the insurance proceeds with respect thereto are less
than $50,000 per occurrence), shall be paid over to Foothill to be applied at
the option of Foothill either to the prepayment of the Obligations without
premium, in such order or manner as Foothill may elect, or shall be disbursed to
Borrower under stage payment terms satisfactory to Foothill for application to
the cost of repairs, replacements, or restorations. All repairs, replacements,
or restorations shall be effected with reasonable promptness and shall be of a
value at least equal to the value of the items or property destroyed prior to
such damage or destruction. Upon the occurrence of an Event of Default, Foothill
shall have the right to apply all prepaid premiums to the payment of the
Obligations in such order or form as Foothill shall determine.
(d) Borrower shall not take out separate insurance
concurrent in form or contributing in the event of loss with that required to be
maintained under this Section 6.10, unless Foothill is included thereon as named
insured with the loss payable
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to Foothill under a standard California 438BFU (NS) Mortgagee endorsement, or
its local equivalent. Borrower immediately shall notify Foothill whenever such
separate insurance is taken out, specifying the insurer thereunder and full
particulars as to the policies evidencing the same, and originals of such
policies immediately shall be provided to Foothill.
6.11 NO SETOFFS OR COUNTERCLAIMS. Make payments hereunder and
under the other Loan Documents by or on behalf of Borrower without setoff or
counterclaim and free and clear of, and without deduction or withholding for or
on account of, any federal, state, or local taxes.
6.12 LOCATION OF INVENTORY AND EQUIPMENT. Keep the Inventory and
Equipment only at the locations identified on Schedule 6.12; provided, however,
that Borrower may amend Schedule 6.12 so long as such amendment occurs by
written notice to Foothill not less than 30 days prior to the date on which the
Inventory or Equipment is moved to such new location, so long as such new
location is within the continental United States, and so long as, at the time of
such written notification, Borrower provides any financing statements or fixture
filings necessary to perfect and continue perfected Foothill's security
interests in such assets and also provides to Foothill a Collateral Access
Agreement.
6.13 COMPLIANCE WITH LAWS. Comply with the requirements of all
applicable laws, rules, regulations, and orders of any governmental authority,
including the Fair Labor Standards Act and the Americans With Disabilities Act,
other than laws, rules, regulations, and orders the non-compliance with which,
individually or in the aggregate, would not result in and reasonably could not
be expected to result in a Material Adverse Change.
6.14 EMPLOYEE BENEFITS.
(a) Cause to be delivered to Foothill, each of the
following: (i) promptly, and in any event within 10 Business Days after Borrower
or any of its Subsidiaries knows or has reason to know that an ERISA Event has
occurred that reasonably could be expected to result in a Material Adverse
Change, a written statement of the chief financial officer of Borrower
describing such ERISA Event and any action that is being taking with respect
thereto by Borrower, any such Subsidiary or ERISA Affiliate, and any action
taken or threatened by the IRS, Department of Labor, or PBGC. Borrower or such
Subsidiary, as applicable, shall be deemed to know all facts known by the
administrator of any Benefit Plan of which it is the plan sponsor, (ii)
promptly, and in any event within 3 Business Days after the filing thereof with
the IRS, a copy of each funding waiver request filed with respect to any Benefit
Plan and all communications received by Borrower, any of its Subsidiaries or, to
the knowledge of Borrower, any ERISA Affiliate with respect to such request, and
(iii) promptly, and in any event within
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3 Business Days after receipt by Borrower, any of its Subsidiaries or, to the
knowledge of Borrower, any ERISA Affiliate, of the PBGC's intention to terminate
a Benefit Plan or to have a trustee appointed to administer a Benefit Plan,
copies of each such notice.
(b) Cause to be delivered to Foothill, upon Foothill's
request, each of the following: (i) a copy of each Plan (or, where any such plan
is not in writing, complete description thereof) (and if applicable, related
trust agreements or other funding instruments) and all amendments thereto, all
written interpretations thereof and written descriptions thereof that have been
distributed to employees or former employees of Borrower or its Subsidiaries;
(ii) the most recent determination letter issued by the IRS with respect to each
Benefit Plan; (iii) for the three most recent plan years, annual reports on Form
5500 Series required to be filed with any governmental agency for each Benefit
Plan; (iv) all actuarial reports prepared for the last three plan years for each
Benefit Plan; (v) a listing of all Multiemployer Plans, with the aggregate
amount of the most recent annual contributions required to be made by Borrower
or any ERISA Affiliate to each such plan and copies of the collective bargaining
agreements requiring such contributions; (vi) any information that has been
provided to Borrower or any ERISA Affiliate regarding withdrawal liability under
any Multiemployer Plan; and (vii) the aggregate amount of the most recent annual
payments made to former employees of Borrower or its Subsidiaries under any
Retiree Health Plan.
6.15 LEASES. Pay when due all rents and other amounts payable
under any leases to which Borrower is a party or by which Borrower's properties
and assets are bound, unless such payments are the subject of a Permitted
Protest. To the extent that Borrower fails timely to make payment of such rents
and other amounts payable when due under its leases, Foothill shall be entitled,
in its discretion, to reserve an amount equal to such unpaid amounts against the
Borrowing Base.
6.16 BROKERAGE COMMISSIONS. Pay any and all brokerage commission
or finders fees incurred by in connection with or as a result of Borrower's
obtaining financing from Foothill under this Agreement.
6.17 STORE CLOSINGS AND STORE OPENINGS. Provide written notice to
Foothill of each store closing and any new store opening by Borrower or any
Subsidiary of Borrower that shall occur during the effectiveness of this
Agreement within 10 days of the date of such store closing or such new store
opening, as applicable.
7. NEGATIVE COVENANTS.
Borrower covenants and agrees that, so long as any credit
hereunder shall be available and until full and final payment of the
Obligations, Borrower will not do any of the following without Foothill's prior
written consent:
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7.1 INDEBTEDNESS. Create, incur, assume, permit, guarantee, or
otherwise become or remain, directly or indirectly, liable with respect to any
Indebtedness, except:
(a) Indebtedness evidenced by this Agreement;
(b) Indebtedness set forth in Schedule 7.1;
(c) Indebtedness secured by Permitted Liens; and
(d) refinancings, renewals, or extensions of Indebtedness
permitted under clauses (b) and (c) of this Section 7.1 (and continuance or
renewal of any Permitted Liens associated therewith) so long as: (i) the terms
and conditions of such refinancings, renewals, or extensions do not materially
impair the prospects of repayment of the Obligations by Borrower, (ii) the net
cash proceeds of such refinancings, renewals, or extensions do not result in an
increase in the aggregate principal amount of the Indebtedness so refinanced,
renewed, or extended, (iii) such refinancings, renewals, refundings, or
extensions do not result in a shortening of the average weighted maturity of the
Indebtedness so refinanced, renewed, or extended, and (iv) to the extent that
Indebtedness that is refinanced was subordinated in right of payment to the
Obligations, then the subordination terms and conditions of the refinancing
Indebtedness must be at least as favorable to Foothill as those applicable to
the refinanced Indebtedness.
7.2 LIENS. Create, incur, assume, or permit to exist, directly or
indirectly, any Lien on or with respect to any of its property or assets, of any
kind, whether now owned or hereafter acquired, or any income or profits
therefrom, except for Permitted Liens (including Liens that are replacements of
Permitted Liens to the extent that the original Indebtedness is refinanced under
Section 7.1(d) and so long as the replacement Liens only encumber those assets
or property that secured the original Indebtedness).
7.3 RESTRICTIONS ON FUNDAMENTAL CHANGES. Enter into any merger,
consolidation, reorganization, or recapitalization, or reclassify its Stock, or
liquidate, wind up, or dissolve itself (or suffer any liquidation or
dissolution), or convey, sell, assign, lease, transfer, or otherwise dispose of,
in one transaction or a series of transactions, all or any substantial part of
its property or assets.
7.4 DISPOSAL OF ASSETS. Except for Permitted Dispositions, sell,
lease, assign, transfer, or otherwise dispose of any of Borrower's properties or
assets.
7.5 CHANGE NAME. Change Borrower's name, FEIN, corporate
structure (within the meaning of Section 9402(7) of the Code), or identity, or
add any new fictitious name.
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7.6 GUARANTEE. Guarantee or otherwise become in any way liable
with respect to the obligations of any third Person except by endorsement of
instruments or items of payment for deposit to the account of Borrower or which
are transmitted or turned over to Foothill.
7.7 NATURE OF BUSINESS. Make any change in the principal nature
of Borrower's business.
7.8 PREPAYMENTS AND AMENDMENTS.
(a) Except in connection with a refinancing permitted by
Section 7.1(d), prepay, redeem, retire, defease, purchase, or otherwise acquire
any Indebtedness owing to any third Person, other than the Obligations in
accordance with this Agreement, and
(b) Directly or indirectly, amend, modify, alter,
increase, or change any of the terms or conditions of any agreement, instrument,
document, indenture, or other writing evidencing or concerning Indebtedness
permitted under Sections 7.1(b), (c), or (d).
7.9 CHANGE OF CONTROL. Cause, permit, or suffer, directly or
indirectly, any Change of Control.
7.10 CONSIGNMENTS. Consign any Inventory or sell any Inventory on
bill and hold, sale or return, sale on approval, or other conditional terms of
sale; provided, however, that Borrower may make consignments of Inventory to an
Eligible Consignee in an amount not to exceed $75,000 in the aggregate at any
one time, or in such increased amount to which as Foothill may consent in
writing from time to time after the Effective Date.
7.11 DISTRIBUTIONS. Make any distribution or declare or pay any
dividends (in cash or other property, other than Stock) on, or purchase,
acquire, redeem, or retire any of Borrower's Stock, of any class, whether now or
hereafter outstanding.
7.12 ACCOUNTING METHODS. Modify or change its method of
accounting or enter into, modify, or terminate any agreement currently existing,
or at any time hereafter entered into with any third party accounting firm or
service bureau for the preparation or storage of Borrower's accounting records
without said accounting firm or service bureau agreeing to provide Foothill
information regarding the Collateral or Borrower's financial condition. Borrower
waives the right to assert a confidential relationship, if any, it may have with
any accounting firm or service bureau in connection with any information
requested by Foothill pursuant to or in accordance with this
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Agreement, and agrees that Foothill may contact directly any such accounting
firm or service bureau in order to obtain such information.
7.13 INVESTMENTS. Directly or indirectly make, acquire, or incur
any liabilities (including contingent obligations) for or in connection with (a)
the acquisition of the securities (whether debt or equity) of, or other
interests in, a Person, (b) loans, advances, capital contributions, or transfers
of property to a Person, or (c) the acquisition of all or substantially all of
the properties or assets of a Person.
7.14 TRANSACTIONS WITH AFFILIATES. Directly or indirectly enter
into or permit to exist any material transaction with any Affiliate of Borrower
except for transactions that are in the ordinary course of Borrower's business,
upon fair and reasonable terms, that are fully disclosed to Foothill, including
all those transactions with Affiliates disclosed on Schedule 7.14, and that are
no less favorable to Borrower than would be obtained in an arm's length
transaction with a non-Affiliate.
7.15 SUSPENSION. Suspend or go out of a substantial portion of
its business.
7.16 [INTENTIONALLY OMITTED].
7.17 USE OF PROCEEDS. Use the proceeds of the Advances made
hereunder for any purpose other than (i) on the Closing Date, (y) to repay in
full the outstanding principal, accrued interest, and accrued fees and expenses
owing to Existing Lender, and (z) to pay transactional costs and expenses
incurred in connection with this Agreement, and (ii) thereafter, consistent with
the terms and conditions hereof, for its lawful and permitted corporate
purposes.
7.18 CHANGE IN LOCATION OF CHIEF EXECUTIVE OFFICE; INVENTORY AND
EQUIPMENT WITH BAILEES. Relocate its chief executive office to a new location
without providing 30 days prior written notification thereof to Foothill and so
long as, at the time of such written notification, Borrower provides any
financing statements or fixture filings necessary to perfect and continue
perfected Foothill's security interests and also provides to Foothill a
Collateral Access Agreement with respect to such new location. The Inventory and
Equipment shall not at any time now or hereafter be stored with a bailee,
warehouseman, or similar party without Foothill's prior written consent.
7.19 NO PROHIBITED TRANSACTIONS UNDER ERISA. Directly or
indirectly:
(a) engage, or permit any Subsidiary of Borrower to
engage, in any prohibited transaction which is reasonably likely to result in a
civil penalty or excise tax described in Sections 406 of ERISA or 4975 of the
IRC for which a statutory or class
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exemption is not available or a private exemption has not been previously
obtained from the Department of Labor;
(b) permit to exist with respect to any Benefit Plan any
accumulated funding deficiency (as defined in Sections 302 of ERISA and 412 of
the IRC), whether or not waived;
(c) fail, or permit any Subsidiary of Borrower to fail, to
pay timely required contributions or annual installments due with respect to any
waived funding deficiency to any Benefit Plan;
(d) terminate, or permit any Subsidiary of Borrower to
terminate, any Benefit Plan where such event would result in any liability of
Borrower, any of its Subsidiaries or any ERISA Affiliate under Title IV of
ERISA;
(e) fail, or permit any Subsidiary of Borrower to fail, to
make any required contribution or payment to any Multiemployer Plan;
(f) fail, or permit any Subsidiary of Borrower to fail, to
pay any required installment or any other payment required under Section 412 of
the IRC on or before the due date for such installment or other payment;
(g) amend, or permit any Subsidiary of Borrower to amend,
a Plan resulting in an increase in current liability for the plan year such that
either of Borrower, any Subsidiary of Borrower or any ERISA Affiliate is
required to provide security to such Plan under Section 401(a)(29) of the IRC;
or
(h) withdraw, or permit any Subsidiary of Borrower to
withdraw, from any Multiemployer Plan where such withdrawal is reasonably likely
to result in any liability of any such entity under Title IV of ERISA;
which, individually or in the aggregate, results in or reasonably would be
expected to result in a claim against or liability of Borrower, any of its
Subsidiaries or any ERISA Affiliate in excess of $50,000.
7.20 FINANCIAL COVENANTS. Fail to maintain:
(a) Minimum Consolidated EBITDA. Consolidated EBITDA of
not less than the amount shown below with respect to each of the corresponding
periods set forth in the table below:
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<TABLE>
<CAPTION>
- -------------------------------------------------------------------------
Applicable Period Consolidated
EBITDA
=========================================================================
<S> <C>
For the six months ended July 31, 1998 ($4,500,000)
- -------------------------------------------------------------------------
For the nine months ended October 30, 1998 ($7,000,000)
- -------------------------------------------------------------------------
For the twelve months ended January 30, 1999 $2,000,000
- -------------------------------------------------------------------------
</TABLE>
With respect to subsequent periods, on or before January
30, 1998, Borrower shall deliver financial projections to Foothill, in form and
substance satisfactory to Foothill, for Borrower's fiscal year beginning
February 1, 1999 and ending January 31, 2000. On the basis of such Borrower
projections, on or before February 28, 1999, Foothill shall establish required
levels of minimum Consolidated EBITDA for each of Borrower's fiscal quarters
occurring during Borrower's fiscal year ending January 31, 2000.
7.21 CAPITAL EXPENDITURES. Make capital expenditures in
Borrower's fiscal year ending January 31, 1998 in excess of $2,600,000, and in
any subsequent fiscal year of Borrower in excess of $1,500,000.
7.22 SECURITIES ACCOUNTS. Borrower shall not establish or
maintain any Securities Account unless Foothill shall have received a Control
Agreement, duly executed and in full force and effect, in respect of such
Securities Account. Borrower agrees that it will not transfer assets out of any
Securities Accounts; provided, however, that, so long as no Event of Default has
occurred and is continuing or would result therefrom, Borrower may use such
assets to the extent permitted by this Agreement.
7.23 STORE OPENINGS. Borrower shall not open, and shall cause
each of its Subsidiaries not to open, any new store location during the period
commencing with the effectiveness of this Agreement and ending on January 31,
1999.
8. EVENTS OF DEFAULT.
Any one or more of the following events shall constitute an event
of default (each, an "Event of Default") under this Agreement:
8.1 If Borrower fails to pay when due and payable or when
declared due and payable, any portion of the Obligations (whether of principal,
interest (including any interest which, but for the provisions of the Bankruptcy
Code, would have accrued on such amounts), fees and charges due Foothill,
reimbursement of Foothill Expenses, or other amounts constituting Obligations);
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8.2 (a) If Borrower fails or neglects to perform, keep, or
observe any term, provision, condition, covenant, or agreement applicable to
such Borrower contained in Sections 6.2 (Collateral Reporting), 6.3 (Financial
Statements, Reports, Certificates), 6.4 (Tax Returns), 6.7 (Title to Equipment),
6.12 (Location of Equipment), 6.13 (Compliance with Laws), 6.14 (Employee
Benefits), or 6.15 (Leases) of this Agreement and such failure continues for a
period of 5 Business Days; (b) If Borrower fails or neglects to perform, keep,
or observe any term, provision, condition, covenant, or agreement contained in
Sections 6.1 (Accounting System) or 6.8 (Maintenance of Equipment) of this
Agreement and such failure continues for a period of 15 Business Days; or (c) If
Borrower fails or neglects to perform, keep, or observe any other term,
provision, condition, covenant, or agreement applicable to such Borrower
contained in this Agreement, or in any of the other Loan Documents (giving
effect to any grace periods, cure periods, or required notices, if any,
expressly provided for in such Loan Documents); in each case, other than any
such term, provision, condition, covenant, or agreement that is the subject of
another provision of this Section 8, in which event such other provision of this
Section 8 shall govern; provided that, during any period of time that any such
failure or neglect of Borrower referred to in this paragraph exists, even if
such failure or neglect is not yet an Event of Default by virtue of the
existence of a grace or cure period or the pre-condition of the giving of a
notice, Foothill shall be relieved of its obligation to extend credit hereunder;
8.3 If there is a Material Adverse Change;
8.4 If any material portion of Borrower's properties or assets is
attached, seized, subjected to a writ or distress warrant, or is levied upon, or
comes into the possession of any third Person;
8.5 If an Insolvency Proceeding is commenced by Borrower;
8.6 If an Insolvency Proceeding is commenced against Borrower and
any of the following events occur: (a) Borrower consents to the institution of
the Insolvency Proceeding against it; (b) the petition commencing the Insolvency
Proceeding is not timely controverted; (c) the petition commencing the
Insolvency Proceeding is not dismissed within 45 calendar days of the date of
the filing thereof; provided, however, that, during the pendency of such period,
Foothill shall be relieved of its obligation to extend credit hereunder; (d) an
interim trustee is appointed to take possession of all or a substantial portion
of the properties or assets of, or to operate all or any substantial portion of
the business of, Borrower; or (e) an order for relief shall have been issued or
entered therein;
8.7 If Borrower is enjoined, restrained, or in any way prevented
by court order from continuing to conduct all or any material part of its
business affairs;
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8.8 If a notice of Lien, levy, or assessment is filed of record
with respect to any of Borrower's properties or assets by the United States
Government, or any department, agency, or instrumentality thereof, or by any
state, county, municipal, or governmental agency, or if any taxes or debts owing
at any time hereafter to any one or more of such entities becomes a Lien,
whether choate or otherwise, upon any of Borrower's properties or assets and the
same is not paid on the payment date thereof;
8.9 If a judgment or other claim becomes a Lien or encumbrance
upon any material portion of Borrower's properties or assets;
8.10 If there is a default in any material agreement to which
Borrower is a party with one or more third Persons and such default (a) occurs
at the maturity of the payment obligations thereunder, or (b) results in a right
by such third Person(s), irrespective of whether exercised, to accelerate the
maturity of Borrower's obligations thereunder, or (c) results in a right by such
third Person(s) irrespective of whether exercised, to cancel its obligations
thereunder;
8.11 If Borrower makes any payment on account of Indebtedness
that has been contractually subordinated in right of payment to the payment of
the Obligations, except to the extent such payment is permitted by the terms of
the subordination provisions applicable to such Indebtedness;
8.12 If any material misstatement or misrepresentation exists now
or hereafter in any warranty, representation, statement, or report made to
Foothill by Borrower or any officer, employee, agent, or director of Borrower,
or if any such warranty or representation is withdrawn; or
8.13 If the obligation of any guarantor under its guaranty or
other third Person under any Loan Document is limited or terminated by operation
of law or by the guarantor or other third Person thereunder, or any such
guarantor or other third Person becomes the subject of an Insolvency Proceeding.
9. FOOTHILL'S RIGHTS AND REMEDIES.
9.1 RIGHTS AND REMEDIES. Upon the occurrence, and during the
continuation, of an Event of Default Foothill may, at its election, without
notice of its election and without demand, do any one or more of the following,
all of which are authorized by Borrower:
(a) Declare all Obligations, whether evidenced by this
Agreement, by any of the other Loan Documents, or otherwise, immediately due and
payable;
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(b) Cease advancing money or extending credit to or for
the benefit of Borrower under this Agreement, under any of the Loan Documents,
or under any other agreement between Borrower and Foothill;
(c) Terminate this Agreement and any of the other Loan
Documents as to any future liability or obligation of Foothill, but without
affecting Foothill's rights and security interests in the Collateral and without
affecting the Obligations;
(d) Settle or adjust disputes and claims directly with
Account Debtors for amounts and upon terms which Foothill considers advisable,
and in such cases, Foothill will credit Borrower's Loan Account with only the
net amounts received by Foothill in payment of such disputed Accounts after
deducting all Foothill Expenses incurred or expended in connection therewith;
(e) Cause Borrower to hold all returned Inventory in trust
for Foothill, segregate all returned Inventory from all other property of
Borrower or in Borrower's possession and conspicuously label said returned
Inventory as the property of Foothill;
(f) Without notice to or demand upon Borrower or any
guarantor, make such payments and do such acts as Foothill considers necessary
or reasonable to protect its security interests in the Collateral. Borrower
agrees to assemble the Collateral if Foothill so requires, and to make the
Collateral available to Foothill as Foothill may designate. Borrower authorizes
Foothill to enter the premises where the Collateral is located, to take and
maintain possession of the Collateral, or any part of it, and to pay, purchase,
contest, or compromise any encumbrance, charge, or Lien that in Foothill's
determination appears to conflict with its security interests and to pay all
expenses incurred in connection therewith. With respect to any of Borrower's
owned or leased premises, Borrower hereby grants Foothill a license, to the
maximum extent permissable, to enter into possession of such premises and to
occupy the same, without charge, for up to 120 days in order to exercise any of
Foothill's rights or remedies provided herein, at law, in equity, or otherwise;
(g) Without notice to Borrower (such notice being
expressly waived), and without constituting a retention of any collateral in
satisfaction of an obligation (within the meaning of Section 9505 of the Code),
set off and apply to the Obligations any and all (i) balances and deposits of
Borrower held by Foothill (including any amounts received in the Concentration
Accounts), or (ii) indebtedness at any time owing to or for the credit or the
account of Borrower held by Foothill;
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<PAGE> 59
(h) Hold, as cash collateral, any and all balances and
deposits of Borrower held by Foothill, and any amounts received in the
Concentration Accounts, to secure the full and final repayment of all of the
Obligations;
(i) Ship, reclaim, recover, store, finish, maintain,
repair, prepare for sale, advertise for sale, and sell (in the manner provided
for herein) the Collateral. Foothill is hereby granted a license or other right
to use, without charge, Borrower's labels, patents, copyrights, rights of use of
any name, trade secrets, trade names, trademarks, service marks, and advertising
matter, or any property of a similar nature, as it pertains to the Collateral,
in completing production of, advertising for sale, and selling any Collateral
and Borrower's rights under all licenses and all franchise agreements shall
inure to Foothill's benefit;
(j) Sell the Collateral at either a public or private
sale, or both, by way of one or more contracts or transactions, for cash or on
terms, in such manner and at such places (including Borrower's premises) as
Foothill determines is commercially reasonable. It is not necessary that the
Collateral be present at any such sale;
(k) Foothill shall give notice of the disposition of the
Collateral as follows:
(1) Foothill shall give Borrower and each holder of a
security interest in the Collateral who has filed with Foothill a written
request for notice, a notice in writing of the time and place of public sale,
or, if the sale is a private sale or some other disposition other than a public
sale is to be made of the Collateral, then the time on or after which the
private sale or other disposition is to be made;
(2) The notice shall be personally delivered or
mailed, postage prepaid, to Borrower as provided in Section 12, at least 5 days
before the date fixed for the sale, or at least 5 days before the date on or
after which the private sale or other disposition is to be made; no notice needs
to be given prior to the disposition of any portion of the Collateral that is
perishable or threatens to decline speedily in value or that is of a type
customarily sold on a recognized market. Notice to Persons other than Borrower
claiming an interest in the Collateral shall be sent to such addresses as they
have furnished to Foothill;
(3) If the sale is to be a public sale, Foothill also
shall give notice of the time and place by publishing a notice one time at least
5 days before the date of the sale in a newspaper of general circulation in the
county in which the sale is to be held;
(l) Foothill may credit bid and purchase at any public
sale; and
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(m) Any deficiency that exists after disposition of the
Collateral as provided above will be paid immediately by Borrower. Any excess
will be returned, without interest and subject to the rights of third Persons,
by Foothill to Borrower.
9.2 REMEDIES CUMULATIVE. Foothill's rights and remedies under
this Agreement, the Loan Documents, and all other agreements shall be
cumulative. Foothill shall have all other rights and remedies not inconsistent
herewith as provided under the Code, by law, or in equity. No exercise by
Foothill of one right or remedy shall be deemed an election, and no waiver by
Foothill of any Event of Default shall be deemed a continuing waiver. No delay
by Foothill shall constitute a waiver, election, or acquiescence by it.
10. TAXES AND EXPENSES.
If Borrower fails to pay any monies (whether taxes, assessments,
insurance premiums, or, in the case of leased properties or assets, rents or
other amounts payable under such leases) due to third Persons, or fails to make
any deposits or furnish any required proof of payment or deposit, all as
required under the terms of this Agreement, then, to the extent that Foothill
determines that such failure by Borrower could result in a Material Adverse
Change, in its discretion and without prior notice to Borrower, Foothill may do
any or all of the following: (a) make payment of the same or any part thereof;
(b) set up such reserves in Borrower's Loan Account as Foothill deems necessary
to protect Foothill from the exposure created by such failure; or (c) obtain and
maintain insurance policies of the type described in Section 6.10, and take any
action with respect to such policies as Foothill deems prudent. Any such amounts
paid by Foothill shall constitute Foothill Expenses. Any such payments made by
Foothill shall not constitute an agreement by Foothill to make similar payments
in the future or a waiver by Foothill of any Event of Default under this
Agreement. Foothill need not inquire as to, or contest the validity of, any such
expense, tax, or Lien and the receipt of the usual official notice for the
payment thereof shall be conclusive evidence that the same was validly due and
owing.
11. WAIVERS; INDEMNIFICATION.
11.1 DEMAND; PROTEST; ETC. Borrower waives demand, protest,
notice of protest, notice of default or dishonor, notice of payment and
nonpayment, nonpayment at maturity, release, compromise, settlement, extension,
or renewal of accounts, documents, instruments, chattel paper, and guarantees at
any time held by Foothill on which Borrower may in any way be liable.
11.2 FOOTHILL'S LIABILITY FOR COLLATERAL. So long as Foothill
complies with its obligations, if any, under Section 9207 of the Code, Foothill
shall not in any way or manner be liable or responsible for: (a) the safekeeping
of the Collateral; (b) any loss
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or damage thereto occurring or arising in any manner or fashion from any cause;
(c) any diminution in the value thereof; or (d) any act or default of any
carrier, warehouseman, bailee, forwarding agency, or other Person. All risk of
loss, damage, or destruction of the Collateral shall be borne by Borrower.
11.3 INDEMNIFICATION. Borrower shall pay, indemnify, defend, and
hold Foothill, each Participant, and each of their respective officers,
directors, employees, counsel, agents, and attorneys-in-fact (each, an
"Indemnified Person") harmless (to the fullest extent permitted by law) from and
against any and all claims, demands, suits, actions, investigations,
proceedings, and damages, and all reasonable attorneys fees and disbursements
and other costs and expenses actually incurred in connection therewith (as and
when they are incurred and irrespective of whether suit is brought), at any time
asserted against, imposed upon, or incurred by any of them in connection with or
as a result of or related to the execution, delivery, enforcement, performance,
and administration of this Agreement and any other Loan Documents or the
transactions contemplated herein, and with respect to any investigation,
litigation, or proceeding related to this Agreement, any other Loan Document, or
the use of the proceeds of the credit provided hereunder (irrespective of
whether any Indemnified Person is a party thereto), or any act, omission, event
or circumstance in any manner related thereto (all the foregoing, collectively,
the "Indemnified Liabilities"). Borrower shall have no obligation to any
Indemnified Person under this Section 11.3 with respect to any Indemnified
Liability that a court of competent jurisdiction finally determines to have
resulted from the gross negligence or willful misconduct of such Indemnified
Person. This provision shall survive the termination of this Agreement and the
repayment of the Obligations.
12. NOTICES.
Unless otherwise provided in this Agreement, all notices or
demands by any party relating to this Agreement or any other Loan Document shall
be in writing and (except for financial statements and other informational
documents which may be sent by first-class mail, postage prepaid) shall be
personally delivered or sent by registered or certified mail (postage prepaid,
return receipt requested), overnight courier, or telefacsimile to Borrower or to
Foothill, as the case may be, at its address set forth below:
IF TO BORROWER: GARDEN BOTANIKA, INC.
8624 154th Avenue NE
Redmond, Washington 98052
Attn: Mr. George Newman
Vice President/Controller
Fax No. 425.883.1803
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WITH COPIES TO: SUMMIT LAW GROUP
1505 Westlake Avenue North
Suite 300
Seattle, WA 98109
Attn: Michael J. Erickson, Esq.
Fax No. 206.281.9882
IF TO FOOTHILL: FOOTHILL CAPITAL CORPORATION
11111 Santa Monica Boulevard
Suite 1500
Los Angeles, California 90025-3333
Attn: Business Finance Division Manager
Fax No. 310.478.9788
WITH COPIES TO: BROBECK, PHLEGER & HARRISON LLP
550 South Hope Street
Los Angeles, California 90071
Attn: John Francis Hilson, Esq.
Fax No. 213.745.3345
The parties hereto may change the address at which they are to
receive notices hereunder, by notice in writing in the foregoing manner given to
the other. All notices or demands sent in accordance with this Section 12, other
than notices by Foothill in connection with Sections 9504 or 9505 of the Code,
shall be deemed received on the earlier of the date of actual receipt or 3 days
after the deposit thereof in the mail. Borrower acknowledges and agrees that
notices sent by Foothill in connection with Sections 9504 or 9505 of the Code
shall be deemed sent when deposited in the mail or personally delivered, or,
where permitted by law, transmitted telefacsimile or other similar method set
forth above.
13. CHOICE OF LAW AND VENUE; JURY TRIAL WAIVER.
THE VALIDITY OF THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS
(UNLESS EXPRESSLY PROVIDED TO THE CONTRARY IN AN ANOTHER LOAN DOCUMENT), THE
CONSTRUCTION, INTERPRETATION, AND ENFORCEMENT HEREOF AND THEREOF, AND THE RIGHTS
OF THE PARTIES HERETO AND THERETO WITH RESPECT TO ALL MATTERS ARISING HEREUNDER
OR THEREUNDER OR RELATED HERETO OR THERETO SHALL BE DETERMINED UNDER, GOVERNED
BY, AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF
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CALIFORNIA. THE PARTIES AGREE THAT ALL ACTIONS OR PROCEEDINGS ARISING IN
CONNECTION WITH THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS SHALL BE TRIED AND
LITIGATED ONLY IN THE STATE AND FEDERAL COURTS LOCATED IN THE COUNTY OF LOS
ANGELES, STATE OF CALIFORNIA OR, AT THE SOLE OPTION OF FOOTHILL, IN ANY OTHER
COURT IN WHICH FOOTHILL SHALL INITIATE LEGAL OR EQUITABLE PROCEEDINGS AND WHICH
HAS SUBJECT MATTER JURISDICTION OVER THE MATTER IN CONTROVERSY. EACH OF BORROWER
AND FOOTHILL WAIVES, TO THE EXTENT PERMITTED UNDER APPLICABLE LAW, ANY RIGHT
EACH MAY HAVE TO ASSERT THE DOCTRINE OF FORUM NON CONVENIENS OR TO OBJECT TO
VENUE TO THE EXTENT ANY PROCEEDING IS BROUGHT IN ACCORDANCE WITH THIS SECTION
13. BORROWER AND FOOTHILL HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO A JURY TRIAL
OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF ANY OF THE LOAN
DOCUMENTS OR ANY OF THE TRANSACTIONS CONTEMPLATED THEREIN, INCLUDING CONTRACT
CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW OR
STATUTORY CLAIMS. EACH OF BORROWER AND FOOTHILL REPRESENTS THAT IT HAS REVIEWED
THIS WAIVER AND EACH KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS
FOLLOWING CONSULTATION WITH LEGAL COUNSEL. IN THE EVENT OF LITIGATION, A COPY OF
THIS AGREEMENT MAY BE FILED AS A WRITTEN CONSENT TO A TRIAL BY THE COURT.
14. DESTRUCTION OF BORROWER'S DOCUMENTS.
All documents, schedules, invoices, agings, or other papers
delivered to Foothill may be destroyed or otherwise disposed of by Foothill 4
months after they are delivered to or received by Foothill, unless Borrower
requests, in writing, the return of said documents, schedules, or other papers
and makes arrangements, at Borrower's expense, for their return.
15. GENERAL PROVISIONS.
15.1 EFFECTIVENESS. This Agreement shall be binding and deemed
effective when executed by Borrower and Foothill.
15.2 SUCCESSORS AND ASSIGNS. This Agreement shall bind and inure
to the benefit of the respective successors and assigns of each of the parties;
provided, however, that Borrower may not assign this Agreement or any rights or
duties hereunder without Foothill's prior written consent and any prohibited
assignment shall be absolutely void. No consent to an assignment by Foothill
shall release Borrower from its
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Obligations. Foothill may assign this Agreement and its rights and duties
hereunder and no consent or approval by Borrower is required in connection with
any such assignment. Foothill reserves the right to sell, assign, transfer,
negotiate, or grant participations in all or any part of, or any interest in
Foothill's rights and benefits hereunder. In connection with any such assignment
or participation, Foothill may disclose all documents and information which
Foothill now or hereafter may have relating to Borrower or Borrower's business.
To the extent that Foothill assigns its rights and obligations hereunder to a
third Person, Foothill thereafter shall be released from such assigned
obligations to Borrower and such assignment shall effect a novation between
Borrower and such third Person.
15.3 SECTION HEADINGS. Headings and numbers have been set forth
herein for convenience only. Unless the contrary is compelled by the context,
everything contained in each section applies equally to this entire Agreement.
15.4 INTERPRETATION. Neither this Agreement nor any uncertainty
or ambiguity herein shall be construed or resolved against Foothill or Borrower,
whether under any rule of construction or otherwise. On the contrary, this
Agreement has been reviewed by all parties and shall be construed and
interpreted according to the ordinary meaning of the words used so as to fairly
accomplish the purposes and intentions of all parties hereto.
15.5 SEVERABILITY OF PROVISIONS. Each provision of this Agreement
shall be severable from every other provision of this Agreement for the purpose
of determining the legal enforceability of any specific provision.
15.6 AMENDMENTS IN WRITING. This Agreement can only be amended by
a writing signed by both Foothill and Borrower.
15.7 COUNTERPARTS; TELEFACSIMILE EXECUTION. This Agreement may be
executed in any number of counterparts and by different parties on separate
counterparts, each of which, when executed and delivered, shall be deemed to be
an original, and all of which, when taken together, shall constitute but one and
the same Agreement. Delivery of an executed counterpart of this Agreement by
telefacsimile shall be equally as effective as delivery of an original executed
counterpart of this Agreement. Any party delivering an executed counterpart of
this Agreement by telefacsimile also shall deliver an original executed
counterpart of this Agreement but the failure to deliver an original executed
counterpart shall not affect the validity, enforceability, and binding effect of
this Agreement.
15.8 REVIVAL AND REINSTATEMENT OF OBLIGATIONS. If the incurrence
or payment of the Obligations by Borrower or any guarantor of the Obligations or
the transfer by either or both of such parties to Foothill of any property of
either or both of such parties should for any reason subsequently be declared to
be void or voidable under
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any state or federal law relating to creditors' rights, including provisions of
the Bankruptcy Code relating to fraudulent conveyances, preferences, and other
voidable or recoverable payments of money or transfers of property
(collectively, a "Voidable Transfer"), and if Foothill is required to repay or
restore, in whole or in part, any such Voidable Transfer, or elects to do so
upon the reasonable advice of its counsel, then, as to any such Voidable
Transfer, or the amount thereof that Foothill is required or elects to repay or
restore, and as to all reasonable costs, expenses, and attorneys fees of
Foothill related thereto, the liability of Borrower or such guarantor
automatically shall be revived, reinstated, and restored and shall exist as
though such Voidable Transfer had never been made.
15.9 INTEGRATION. This Agreement, together with the other Loan
Documents, reflects the entire understanding of the parties with respect to the
transactions contemplated hereby and shall not be contradicted or qualified by
any other agreement, oral or written, before the date hereof.
[Remainder of page intentionally left blank.]
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IN WITNESS WHEREOF, the parties hereto have caused this Agreement
to be executed in Los Angeles, California.
GARDEN BOTANIKA, INC.,
a Washington corporation
By
-----------------------------------------
Title:
--------------------------------------
FOOTHILL CAPITAL CORPORATION,
a California corporation
By
-----------------------------------------
Title:
--------------------------------------
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EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
As independent public accountants, we hereby consent to the incorporation of our
reports included in this form 10-K/A, with the Company's previously filed
Registration Statement File No. 333-08717.
/s/ ARTHUR ANDERSEN LLP
Seattle, Washington
May 28, 1998
